UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(Mark One)

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-3473

PET DRX CORPORATION

(Exact name of registrant as specified in its charter)

Delaware		56-2517815
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
215 Centerview Drive, Suite 360
Brentwood, Tennessee		37027
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code:
(615) 369-1914

Securities registered pursuant to Section 12(b) of the Act:

Title of each class		Name of each exchange on which registered
Common Stock, par value $.0001 per share		Nasdaq Capital Market

Securities registered pursuant to Section 12(g) of the Act:

     Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes o       No þ

     Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o       No þ

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ       No o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer o		Smaller reporting company þ
				(Do not check if a smaller reporting company)

     Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act). Yes o      No þ

     At June 30 2009, the aggregate market value of the voting common stock held by non-affiliates of the Registrant (without admitting that any person whose shares are not included in such calculation is an affiliate) was approximately $6,400,000. At March 23, 2010, there were 23,714,460 shares of the Registrant’s common stock outstanding.

     Portions of the registrant’s Proxy Statement to be filed within 120 days of the close of the registrant’s fiscal year in connection with the registrant’s 2010 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.

 

 

INDEX

TO FORM 10-K

				Page
PART I
Item 1.		Business			1
Item 1A.		Risk Factors			7
Item 1B.		Unresolved Staff Comments			17
Item 2.		Properties			17
Item 3.		Legal Proceedings			17
Item 4.		Submission of Matters to a Vote of Security Holders			17
PART II
Item 5.		Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			17
Item 6.		Selected Financial Data			19
Item 7.		Management's Discussion and Analysis of Financial Condition and Results of Operations			19
Item 7A.		Quantitative and Qualitative Disclosures About Market Risk			35
Item 8.		Financial Statements and Supplementary Data			35
Item 9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			69
Item 9A.		Controls and Procedures			69
Item 9B.		Other Information			70
PART III
Item 10.		Directors, Executive Officers, and Corporate Governance			70
Item 11.		Executive Compensation			70
Item 12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			70
Item 13.		Certain Relationships and Related Transactions, and Director Independence			70
Item 14.		Principal Accountant Fees and Services			70
PART IV
Item 15.		Exhibits, Financial Statement Schedules			70
EX-21.1
EX-23.1
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I

Item 1. BUSINESS

Company Overview

Pet DRx Corporation is a provider of primary and specialty veterinary care services to companion animals through a network of veterinary hospitals. As of December 31, 2009, we owned and operated twenty-three veterinary hospitals located in northern and southern California.

Our hospitals offer a full range of general medical treatment for companion animals, including (i) preventative care, such as vaccinations, examinations, spaying/neutering, and dental care, and (ii) a broad range of specialized diagnostic and medical services, such as x-ray, ultra-sound, internal medicine, surgery, cardiology, ophthalmology, dermatology, oncology, neurology and other services. Our hospitals also sell pharmaceutical products, pet food and pet supplies.

We intend to grow and enhance our profitability by expanding same-store revenue and capitalizing on economies of scale and cost reduction efficiencies and by acquiring established veterinary practices in select regions throughout the United States.

Our principal executive offices are located at 215 Centerview Drive, Suite 360, Brentwood, Tennessee 37027. We can be contacted at (615) 369-1914.

For convenience, the terms “Pet DRx,” “Company,” “our,” and “we” are used to refer collectively to Pet DRx Corporation and its subsidiaries, unless otherwise required by the context.

Operating Segment

As of December 31, 2009, we had a single operating and reporting segment, animal hospitals. Our objective is to become a preferred provider of high quality pet care by offering a broad array of pet care services under one brand.

Company History

We were incorporated in Delaware on June 10, 2005 as Echo Healthcare Acquisition Corp. (“Echo”), a blank check company formed for the purpose of acquiring, through a merger, capital stock exchange, asset acquisition or other similar business combination, one or more domestic or international operating businesses in the healthcare industry. A registration statement for our initial public offering was declared effective on March 17, 2006. On March 22, 2006, we consummated our initial public offering of 6,250,000 units. On March 27, 2006, we consummated the closing of an additional 937,500 units that were subject to the underwriters’ over-allotment option. Each unit consisted of one share of common stock, par value $0.0001 per share, and one warrant. Each warrant entitles the holder to purchase from us one share of our common stock at an exercise price of $6.00 per share. Our common stock and warrants began trading separately on June 6, 2006.

Concurrently with the closing of our initial public offering, certain of our initial stockholders and directors purchased an aggregate of 458,333 warrants (“Founding Director Warrants”) in a private placement transaction (the “Private Placement”) at an offering price of $1.20 per Founding Director Warrant, generating gross proceeds to us of $550,000, which was deposited in our trust account along with net proceeds from the Offering. The Founding Director Warrants entitle the holders to purchase, when exercised, one share of our common stock, at $6.00 per share. The Founding Director Warrants were sold to accredited investors in a private placement transaction under exemptions provided by Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 promulgated thereunder.

Our gross proceeds from the sale of our units, together with the proceeds of our Private Placement, were approximately $58,050,000. Of this amount, $54,947,000 was deposited in trust. Approximately $233,000 of the remaining proceeds were available to be used by us to provide for business, legal and accounting due diligence on prospective acquisitions and continuing general and administrative expenses.

On September 11, 2006, we entered into a merger agreement with Pet DRx Veterinary Group, Inc. (“PVGI”) (f/k/a XLNT Veterinary Care, Inc.) which merger agreement was subsequently amended and restated on February 16, 2007 and on October 23, 2007 (as so amended and restated, the “Merger Agreement”). On January 4, 2008, we closed the merger transaction pursuant to the Merger Agreement, pursuant to which a wholly-owned subsidiary of ours merged with and into PVGI (the “Merger”). In connection with the Merger, we changed our name from Echo to Pet DRx Corporation.

Upon the closing of the Merger on January 4, 2008, we issued 16,214,267 shares of common stock (of which 1,589,872 shares were placed in escrow (the “Escrow Shares”) to satisfy any indemnification claims that may be asserted by us under the Merger Agreement) for the benefit of the former holders of capital stock of PVGI, based on an exchange ratio, calculated pursuant to the Merger Agreement, of 0.7710 of a share of our common stock for each share of PVGI common stock issued and outstanding immediately prior to the effective time of the Merger (the “Effective Time”). All of the Escrow Shares were subsequently released to the former holders of capital stock of PVGI in accordance with terms of the Merger Agreement.

Immediately after giving effect to the Merger, the former holders of PVGI common stock prior to the Merger held approximately 72% of our issued and outstanding shares of common stock on a fully diluted basis (including escrowed shares).

Holders of 1,361,573 shares of common stock elected to convert their common stock at the Effective Time into their pro rata portion of the trust account established at the time of our initial public offering, at a conversion price of $8.10 per share of common stock. Cash in the amount of approximately $11 million was paid to converting stockholders.

On March 17, 2010, the Founding Director Warrants and the publicly-traded warrants expired by their terms.

Business Strategy

Our objective is to deliver a broad scope of high-quality services to our customers through a “hub and spoke” network of veterinary hospitals within select local markets. Specifically, we offer, through specialty and emergency hospitals (“hubs”), a wide range of medical, diagnostic and specialty-medical services and use the traditional smaller general practices as “spokes” to feed to the “hub” units patients requiring more specialized services than a general practice is equipped to provide. We pursue the following strategies to achieve our objectives:

		o		recruit and retain top veterinary professionals;
		o		provide high quality veterinary care to our customers;
		o		pursue acquisitions of additional veterinary hospitals, with a focus on continuing to develop “hub and spoke” networks that will improve customer service;
		o		increase veterinary hospital visits through advertising, market positioning, consumer education, wellness programs and branding;
		o		increase veterinary hospital margins through same-store revenue growth and cost savings realized through consolidated purchasing arrangements for high volume items such as food and medical supplies and generally lower costs through economies of scale;
		o		increase veterinary hospital productivity through professional development and training, integration of performance data collection systems, application of productivity standards to previously under-managed operations and removal of administrative burdens from veterinary professionals; and
		o		capture valuation arbitrage differentials between individual practice value and larger consolidated enterprise value.

Our Veterinary Hospitals

As of December 31, 2009, we owned and operated twenty-three veterinary hospitals located throughout the state of California.

Medical Advisory Board

We have established a medical advisory board to support our management team, our veterinarians and our operations. Under the direction of our Chief Medical Officer, our medical advisory board recommends standards of excellence in the provision of veterinary care services across all of our veterinary hospitals. Our medical advisory board is comprised of both general practitioners and specialists recognized for their outstanding knowledge and reputations in the veterinary field.

Customers

Our customers consist almost entirely of individual pet owners. For the years ended December 31, 2009, 2008 and 2007, no customer accounted for more than 5% of the Company’s net revenue.

Industry and Competition

The Industry

The U.S. veterinary market is a large and growing industry sector. Pet ownership, share of household income spent on pets and general awareness of the value of effective veterinary care due to advances in science, medicine and technology are all on the rise. There are over 60,000 veterinarians in the U.S. and 22,000 veterinary hospitals who are members of the American Veterinary Medical Association, or AVMA as of December 31, 2009. The American Pet Products Manufacturers Association, Inc., or APPMA, estimates that spending on pets in the U.S. reached $45.5 billion in 2009. Veterinary medical services accounted for $12.0 billion, medications and over the counter supplies represented $10.4 billion, pet food represented $17.6 billion, and ancillary services such as grooming and boarding reached $3.5 billion in 2009. The APPMA estimates that $47.7 billion will be spent on pets in the U.S. in 2010.

Within the Company’s initial target market of California, the State of California Veterinary Medical Board lists 12,577 licensed veterinarians (State of California Department of Consumer Affairs, 2005).

According to the APPMA, the ownership of pets is widespread and growing, with over 71 million U.S. households, representing approximately 63% of U.S. households, owning at least one pet, including companion and other animals, including about 77.5 million dogs and 93.6 million cats. Specifically, 45 million households owned at least one dog and 38 million households owned at least one cat.

The growth of the veterinary care industry is primarily being driven by:

		o		an increased emphasis on pet health and wellness;
		o		continued technological and medical developments which are migrating from human healthcare to veterinary medicine, driving new and previously unconsidered diagnostic tests, procedures and treatments; and
		o		favorable demographic trends supporting a growing pet population.

While it is growing, the U.S. veterinary services market remains highly fragmented and comprised principally of smaller independent practices. We estimate that the three largest companies in the industry, Banfield, the Pet Hospital^®, VCA Antech, Inc. and National Veterinary Associates (“NVA”) represent approximately 5% of companion animal veterinary hospitals in the U.S. According to the AVMA, there are approximately 22,000 veterinary hospitals/clinics in the U.S. and these three companies combined currently own or operate about 1,300 hospitals.

Most Doctors of Veterinary Medicine (DVMs or veterinarians) are highly educated, and we believe are attracted to the industry because they care for the welfare of animals. As a result, often they spend their careers developing individual or small practices that have few liquidity options. The small economic scale of these practices often makes it difficult to afford and adopt state-of-the-art technologies, and medical and diagnostic equipment. We believe veterinarians are gravitating toward larger, multi-doctor animal hospitals that provide state-of-the-art facilities, treatments, methods and pharmaceuticals to enhance the services they can provide their clients. In addition, we believe the fragmented animal hospital industry is consolidating due to:

		o		the purchasing, marketing and administrative cost advantages that can be realized by large, multiple location, multi-doctor veterinary providers;
		o		the cost of financing equipment purchases and upgrading technology necessary for a successful practice and the associated ability of a large provider to obtain the necessary financing on more competitive terms;
		o		the desire of veterinarians to minimize the percentage of their time spent dealing with administrative functions and to focus instead on practicing veterinary medicine;
		o		the desire of some owners of animal hospitals to obtain liquidity by selling all or a portion of their investment in the animal hospital (which we believe will increase as more owners of animal hospitals approach retirement); and
		o		the appeal to many veterinarians of the benefits and flexible work schedule that is not typically available to a sole practitioner or single-site provider.

The veterinary care industry also has other notable characteristics, including:

		o		Extensive veterinarian training requirements represent significant competitive barriers to entry. Although the number of pets and pet services is growing rapidly, the number of veterinarians and available hospitals is limited, with the potential for increasing the number of veterinarians constrained by the extensive training requirements for veterinarians.
		o		Highly fragmented industry service sector. Although the pet care market is large and growing, no single entity accounts for more than 5% of the hospital industry. The market consists mainly of independent private practices consisting of sole practitioners or small groups of veterinarians. Most practices do not offer a broad range of products and services. Many veterinarians spend a significant portion of their time handling the administrative burden of running a small business, versus seeing customers. The Company believes that these small animal hospitals tend to be profitable in spite of the inefficiencies associated with a small operating scale and limited marketing clout and that these factors make veterinary hospitals an attractive consolidation opportunity.
		o		Attractive industry payor and pricing characteristics. The animal health care services industry does not experience the problems of extended payment collection cycles or pricing pressures from third-party payors faced by human health care providers. Fees for animal hospital services are due, and typically paid for, at the time of the service via cash or credit card. Pet care services are predominantly provided on a cash-pay basis. Thus, (unlike human healthcare) there are (i) few accounts receivable to finance, (ii) no government payors, and (iii) no managed care contracting. Also, because of expanding options for care services coupled with the growing awareness of pet health and wellness and pet owner sentiments to their pets, veterinarians typically enjoy the ability to pass through pricing increases to their customers.
		o		Opportunity to increase hospital productivity through an integrated management information system. By deploying integrated management information systems that monitor each veterinarian and hospital on products and services delivered, productivity and prices, veterinary hospitals are able to identify opportunities and areas for growth and to monitor veterinarians and target individuals who may benefit

				from additional training in specific treatment disciplines.
		o		Limited medical malpractice liabilities. Unlike human healthcare, veterinarians have limited corresponding medical malpractice liabilities.
		o		Veterinary care’s recession resistant revenue characteristics. Although the practice of veterinary medicine is subject to seasonal fluctuations based on weather and holiday seasons, the Company believes that veterinary care revenues have historically been recession resistant and veterinary hospitals have one of the lowest failure rates of any business. However, the industry was affected by the recent recession that started in 2008.

Competition

The market for veterinary care services to companion animals is highly competitive, particularly in urban environments, and evolving in the manner in which services are delivered and providers are selected. The Company believes that the primary factors influencing a customer’s selection of an animal hospital are convenient location and hours, quality of care and reasonableness of fees. The Company’s primary competitors are individual practitioners or small, regional multi-clinic practices. In addition, the Company experiences competition from some national and large regional companies in the pet care industry, such as our three largest competitors mentioned above, as well as operators of pet super-stores that are developing networks of animal hospitals in markets that include our animal hospitals.

Companion Animals

As the U.S. population has gravitated from rural to urban environments, and the extended family with all its opportunities for close relationships has been replaced by the nuclear family, the single family, or no family at all, we believe the pet has assumed a more important role in maintaining good mental health and well being in society. According to the American Animal Hospital Association’s (“AAHA”) 2004 Pet Owner Survey, 94% of pet owners surveyed said they take their pets for regular veterinary checkups to ensure their pets’ quality of life.

Favorable demographic trends should continue to fuel the growth in demand for pet care services in the foreseeable future. The leading edge of the “baby boom” generation has already entered middle age and their ranks will swell by 46% in this decade. This middle-aged demographic, age 45 to 69, own more pets, have more income and account for nearly two-thirds of all pet care expenditures.

Acquisition Program

We target veterinary hospitals for acquisitions that are profitable or which we believe will be profitable when integrated into our operations. We work to build incremental value through programs designed to drive incremental new revenues and benefit from economies of scale, proactive marketing, centralized management, management information systems, “brand name” identification, and by broadening the scope of services and products offered at our hospitals. The consideration paid in our acquisitions may consist of cash, promissory notes, common stock, warrants and/or debentures, including convertible debentures.

Government Regulation

California imposes various registration requirements upon our veterinary hospitals. Accordingly, we have registered each of our facilities with appropriate governmental agencies and, where required, have appointed a licensed veterinarian to act on behalf of each facility. All veterinarians practicing in our hospitals are required to maintain valid state licenses to practice.

Employees

As of December 31, 2009, we employed approximately 600 full-time employees. We have not entered into any collective bargaining agreements with our employees and we believe that relations with our employees are good. We

believe that our future success will depend in part upon the continued service of our key employees and on our continued ability to hire and retain qualified personnel.

Seasonality

The practice of veterinary medicine is subject to seasonal fluctuation. In particular, demand for veterinary services is slightly higher during the warmer months because pets spend a greater amount of time outdoors where they are more likely to be injured and are more susceptible to disease and parasites. In addition, use of veterinary services may be affected by levels of flea infestation, heartworm and ticks, and the number of daylight hours. The seasonality we experience at our clinics varies throughout the year depending on the geographic region of those locations. Our clinics in the desert region of California experience their highest sales volume in the winter months. However, revenue may be impacted significantly from quarter to quarter by natural disasters, such as earthquakes, landslides and fires, and other factors unrelated to such adverse events, such as changing economic conditions.

Executive Officers of Pet DRx

We provide below information regarding each of our executive officers.

Name		Age				Position
Gene E. Burleson			69			Chairman of the Board and Chief Executive Officer
Harry L. Zimmerman			54			Executive Vice President and Chief Financial Officer
George A. Villasana			42			Executive Vice President, General Counsel and Secretary

GENE E. BURLESON, our Chairman of the Board, has served as a director of the Company since the Merger in January 2008. Mr. Burleson has served as Chief Executive Officer of the Company since November 18, 2008 and served as interim Chief Executive Officer of the Company from September 25, 2008 until November 17, 2008. Mr. Burleson also served as the Chief Executive Officer of the Company from its formation in June 2005 until it merged with PVGI. Mr. Burleson served as Chairman of the board of directors of Mariner Post-Acute Network, Inc., an operator of long-term care facilities, from January 2000 to June 2002. Mr. Burleson also served as Chairman of the board of directors of Alterra Healthcare Corporation, a developer and operator of assisted living facilities, during 2003 and as a member of the board of directors from 1995 to 2003. Mr. Burleson also served on the board of directors of Deckers Outdoor Corporation (Nasdaq:DECK), an outdoor shoe company, where he served from 1993 until 2008; and Prospect Medical Holdings, Inc. (AMEX:PZZ), a provider of management services to affiliated independent physician associations from 2004 to 2008. Mr. Burleson currently serves on the board of directors of SunLink Health Systems, Inc. (AMEX:SSY), an owner and operator of acute care hospitals. In addition, Mr. Burleson is involved with several private companies, including Med Images, Inc., a provider of integrated documentation services to surgeons and hospitals through multimedia technology and Marina Medical, Inc., a provider of medical billing and accounts receivable management services to hospital based physicians. Mr. Burleson served as Chairman of the board of directors of GranCare (formerly an NYSE listed company) from 1989 to 1997. Additionally, Mr. Burleson served as President and Chief Executive Officer of GranCare from 1990 to 1997. Upon completion of the merger of GranCare’s pharmacy operations with Vitalink Pharmacy Services, Inc. in 1997, he became Chief Executive Officer and a Director of Vitalink Pharmacy Services Inc. (formerly an NYSE listed company). Mr. Burleson resigned as Chief Executive Officer and Director of Vitalink Pharmacy Services, Inc. in 1997. From 1986 to 1989, Mr. Burleson served as President, Chief Operating Officer and a Director of American Medical International (AMI), one of the largest owners and operators of acute care hospitals in the nation. Based in London from 1981 to 1986, Mr. Burleson served as Managing Director of AMI’s international operations. Mr. Burleson graduated from East Tennessee State University with a Bachelor of Science in accounting and earned an M.B.A. in 1972.

HARRY L. ZIMMERMAN has served as our Chief Financial Officer since October 13, 2008 and was appointed as Executive Vice President on March 18, 2009. Prior thereto, Mr. Zimmerman served as our Chief of Business Development since September 1, 2008. Prior to joining the Company, Mr. Zimmerman served as Executive Vice

President and General Counsel of Encore Medical Corporation (formerly a Nasdaq listed company), an orthopedics medical device company, from early 1994 until the end of 2007. Prior to joining Encore, Mr. Zimmerman was a senior corporate associate with the law firm of Winstead, Sechrest & Minick, P.C. Mr. Zimmerman has a Bachelor of Science in Economics (cum laude) from the Wharton School at the University of Pennsylvania and a Juris Doctor (with honors) from the University of Texas School of Law. He is licensed as a Certified Public Accountant and an attorney in the State of Texas.

GEORGE A. VILLASANA has served as our General Counsel and Secretary since the Merger and was also appointed as Executive Vice President on March 6, 2008. Mr. Villasana served as the General Counsel and Secretary of PVGI from June 2007 until the Merger. Prior thereto, he served as Senior Corporate Counsel of AutoNation, Inc., the largest automotive retailer in the U.S. (NYSE: AN), from August 2000 until June 2007. Prior thereto, Mr. Villasana was a corporate attorney with Holland & Knight, LLP from 1999 to 2000 and with Shutts & Bowen, LLP from 1997 to 1999. From 1995 to 1997, he served as a staff attorney with the U.S. Securities & Exchange Commission in Washington, D.C. He received a Master of Laws from Georgetown University Law Center, a Juris Doctor from American University, Washington College of Law, a Master of Accounting from Florida International University and a Bachelor of Science in Accounting from The Pennsylvania State University.

Availability of Our Reports Filed with the Securities and Exchange Commission

Our web site is located at www.petdrx.com. The information on or accessible through our web site is not incorporated by reference in the Annual Report on Form 10-K. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities and Exchange Act of 1934, as amended, are available free of charge, on our web site as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (“SEC”).

The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. Copies of our reports filed electronically with the SEC may be accessed on the SEC’s website www.sec.gov. The public also may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street N.E., Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at (800) SEC-0330.

Item 1A. RISK FACTORS

Risks Related to Our Business

We have a history of losses and may incur losses in the foreseeable future.

We do not have a significant operating history upon which potential investors may assess future performance. PVGI acquired its first two veterinary hospitals in September 2004 and acquired additional veterinary hospitals throughout 2005, 2006 and 2007. We also acquired a veterinary hospital in 2008. We have only incurred losses to date. We are continuing to develop our operational infrastructure and face additional risks similar to those of other businesses with limited operating history. Our prospects must be considered in light of the risks, expenses, delays, problems and difficulties frequently encountered in the establishment of a new business. Operating results may also vary depending on a number of factors, many of which are outside our control, including:

	•		changes in pricing policies or those of our competitors;
	•		the hiring and retention of key personnel;
	•		fluctuation in costs related to acquisitions of businesses;
	•		wage and cost pressures;
	•		availability of facilities that are suitable for acquisition;
	•		viability of the hub and spoke model;
	•		hiring and retention of veterinarians;
	•		increased competition and pricing pressure;

	•		seasonal and general economic factors, including a recession or economic slowdown; and
	•		level of personal discretionary spending.

We have substantial indebtedness which requires a significant amount of cash to service. We may not be able to generate or raise sufficient cash to meet our debt service obligations, and these obligations will reduce the amount of cash available to operate and expand our business.

We have, and will continue to have, a substantial amount of debt, including debt incurred as a result of financing acquisitions and the Senior Notes described below (See “Risk Factors — We may not be able to pay our obligations with respect to our Senior Notes upon maturity, prepayment or redemption”). Our substantial amount of debt requires us to dedicate a significant portion of our cash flow from operations to pay down our indebtedness and related interest, thereby reducing the funds available to use for working capital, capital expenditures, acquisitions and general corporate purposes. Because interest on the Senior Notes is payable by increasing the principal amount of the Senior Notes, our interest payments on the Senior Notes will not affect cash flow. However, interest on the Senior Notes will increase our interest expense and thereby impact net earnings (loss).

Our ability to make payments on our debt, pay our expenses and fund acquisitions will depend upon our ability to generate cash in the future. Insufficient cash flow could place us at risk of default under our debt agreements which could result in the acceleration of the maturity of our debt obligations and could prevent us from paying fixed costs or expanding our business as planned. Our ability to generate cash is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Our business may not generate sufficient cash flow from operations, our strategy to increase operating efficiencies may not be realized and future borrowings may not be available in an amount sufficient to enable us to service our debt or to fund our other liquidity needs. Our debt comes due in various amounts between 2010 and 2014. In order to meet our debt obligations, we may need to refinance all or a portion of our debt. We may not be able to refinance any of our debt on commercially reasonable terms or at all.

We may not be able to pay our obligations with respect to our Senior Notes upon maturity, prepayment or redemption.

In the first quarter of 2009, we issued an aggregate original principal amount of $6.5 million of our 12% senior secured convertible notes (the “Senior Notes”). The terms of the Senior Notes require us to pay a premium of 184% of the original principal amount of the Senior Notes (in addition to the repayment of the then-outstanding principal amount and accrued but unpaid interest) (i) upon any repayment of the Senior Notes at maturity, (ii) if accelerated upon the occurrence of an “event of default” (as defined in the Senior Notes), or (iii) upon any redemption or prepayment of the Senior Notes prior to maturity. Accordingly, the amount due upon maturity, prepayment or redemption of the $6.5 million principal amount of Senior Notes outstanding as of the date of this report will be approximately $18.5 million after giving effect to such premium, but before giving effect to future increases in the principal amount outstanding as payment-in-kind of the interest on the outstanding Senior Notes. After giving effect to payment-in-kind of interest on the Senior Notes by increasing the outstanding principal through maturity, the amount due on maturity of the Senior Notes at January 21, 2013 would be approximately $22.4 million. We do not currently have the resources to pay the full redemption price in cash, and anticipate that we would need to refinance such debt prior to its maturity or redemption. We have not established a sinking fund for payment of our obligations under the Senior Notes, nor do we anticipate doing so.

Our debt instruments may adversely affect our ability to run our business.

Our substantial amount of debt, as well as the guarantees of our subsidiaries and the security interests in our assets and those of our subsidiaries, could impair our ability to operate our business effectively and may limit our ability to take advantage of business opportunities. For example, our debt instruments contain certain restrictions that:

	•		limit our ability to borrow additional funds or to obtain other financing in the future for working capital, capital expenditures, acquisitions, investments or general corporate purposes;
	•		limit our ability to dispose of our assets, create liens on our assets or to extend credit; and
	•		make us more vulnerable to economic downturns and reduce our flexibility in responding to changing business and economic conditions;

If compliance with our debt obligations materially hinders our ability to operate our business and adapt to changing industry conditions, we may lose market share, our revenue may decline and our operating results may suffer.

The issuance of the Senior Notes and related financing warrants will impact net earnings (loss) going forward.

We recorded $3.6 million as a debt discount to the Senior Notes. Additionally, we also recorded approximately $930,000 of fees and expenses related to the sale of the Senior Notes, as a debt discount as well. We are amortizing these amounts over the life of the Senior Notes. Additionally, we are accounting for the 184% debt discount as a loan accretion, by which we are charging the accretion to interest expense, which amounts to approximately $12.0 million, over the life of the loan. Interest on the Senior Notes is paid by increasing the principal amount of the Senior Notes, which will increase our interest expense going forward. Furthermore, a number of the holders of outstanding “seller notes” agreed to a “standstill” provision contemplated by the loan documentation in exchange for warrants and/or a higher interest rate on their notes, which will also increase our interest expense going forward.

Galen and Camden, investors in the Senior Notes, may have the ability to significantly influence our business and affairs.

A representative of Camden Partners Strategic Fund III, L.P. and Camden Partners Strategic Fund III-A, L.P. (collectively, “Camden”) and a representative of Galen Partners IV, L.P., Galen Partners International IV, L.P. and Galen Employee Fund IV, L.P. (collectively, “Galen,” and together with Camden, collectively, the “lead investors”) serve on our board of directors. In addition, the lead investors currently hold a significant principal amount of the issued and outstanding Senior Notes, and accordingly, control our ability to obtain consents, waivers and amendments with respect to the loan documentation and covenants contained therein. In addition, the lead investors are each substantial shareholders in our company.

We may be unable to effectively execute our growth strategy which could cause our margins and profitability to decline. Even if we are able to effectively execute our growth strategy, the growth of the business may put a strain on the business, and we may not achieve desired economies of scale.

Our success depends in part on our ability to build on our position as a leading animal healthcare services company through selective acquisitions of established animal hospitals and internal growth initiatives. If we cannot implement or effectively execute this strategy, our results of operations may be adversely affected. We intend, as part of our growth strategies, to acquire additional veterinary hospitals. We may not be able to attract or compete successfully for prospective acquisition candidates or achieve sufficient “cluster” hospitals in any market we may target in order to achieve targeted efficiencies. In addition, acquisitions may take longer than anticipated or may not be cost effective.

Results of operations may be materially adversely affected if we are unable to manage our growth effectively, which may increase costs of operations and hinder our ability to execute our business strategy. Our internal revenue growth from new services and pet pharmaceuticals as well as our expected cost savings may not develop as anticipated, and reduction in our expected rate of internal growth may cause our revenue and margins to decrease from management’s expectations. Expected growth may place a significant strain on management and operational systems and resources. If our business grows, we will need to improve and enhance our overall financial and managerial controls, reporting systems and procedures, and expand, train and manage our workforce. We will also need to increase the capacity of current systems to meet additional demands.

Even if we effectively implement our growth strategy, we may not achieve the presently targeted internal growth and the growth may be below historical rates. Any reductions in the rate of internal growth may cause revenues and margins to decrease. Investors should not assume that the historical growth rates and margins are reliable indicators of results in future periods.

Failure to satisfy covenants in our debt instruments will cause a default under those instruments.

In addition to imposing restrictions on our business and operations, some of our debt instruments include a number of covenants imposing restrictions on our business and operations, and we may borrow money on terms requiring us

to meet financial ratios and other tests. Our ability to comply with these covenants may be affected by events beyond our control, including prevailing economic, financial and industry conditions. The breach of any of these covenants would result in a default under these instruments. An event of default would permit our lenders and other debtholders to declare all amounts borrowed from them to be due and payable, together with accrued and unpaid interest. If we are unable the repay debt to our senior lenders, these lenders and debtholders could proceed against our assets.

Incurring substantial amounts of debt could adversely affect our financial condition.

Leverage. We have and may continue to utilize a leveraged capital structure to, among other things, fund our operations. We have issued promissory notes and other forms of debt in connection with past acquisitions and may likely do so in the future. As a result, we are, and in the future may be, subject to the risks normally associated with debt financing, including, (i) the risk that cash flow from operations will be insufficient to meet required payments of principal and interest, (ii) the risk that existing debt (which will not have been fully amortized at maturity) will not be able to be refinanced or that the terms of such refinancings will not be as favorable to us, and (iii) the risk that necessary capital expenditures will not be able to be financed on favorable terms or at all.

Risk of Rising Interest Rates. While currently all of our debt bears interest at a fixed rate, we may incur indebtedness in the future that also bears interest at a variable rate or may be required to refinance our debt at higher rates. By its very nature, a variable interest rate will move up or down based on changes in the economy and other factors, all of which are beyond our control. Accordingly, there can be no assurance that such rates will not rise significantly and, consequently, that we would be required to pay more interest than is anticipated. A significant increase in market interest rates could jeopardize our ability to pay required debt service on loans and could possibly result in a default under the loan and/or foreclosure.

Limitations on Debt. Our second amended and restated certificate of incorporation does not contain any limitation on the amount of indebtedness we may incur. Accordingly, we could become more leveraged, resulting in an increase in debt service that could increase the risk of default on our indebtedness.

Our business strategy includes growth through acquisitions, which involve special risks that could increase expenses, and divert the time and attention of management. Difficulties integrating new acquisitions may impose substantial costs and disrupt our business, which could adversely affect our financial condition, results of operations, cash flows and prospects.

As part of our business strategy, we have in the past acquired veterinary hospitals. We expect to continue to acquire animal hospitals. Acquisitions involve a number of special risks and challenges, including:

•		diversion of management’s attention from our existing business;
•		integration of acquired veterinary hospitals and employees into our existing business, including coordination of geographically dispersed operations, which can take longer and be more complex than initially expected;
•		dependence on retention, hiring and training of key personnel, including specialists;
•		loss or termination of employees, including costs associated with the termination of those employees;
•		dilution of then-current stockholders’ percentage ownership;
•		dilution of earnings if synergies with the acquired veterinary hospitals are not achieved;
•		inability to generate sufficient revenue and profitability to offset acquisition or investment costs;
•		assumption of liabilities of the acquired businesses, including costly litigation related to alleged liabilities of the acquired businesses; and
•		risk of impairment charges related to potential write-down of acquired assets in future acquisitions.

Acquisitions of veterinary hospitals are inherently risky and create many challenges. Future acquisitions may not achieve the desired objectives. If we fail to properly evaluate and execute acquisitions or investments, our financial condition, results of operations, cash flows and prospects may be seriously harmed.

We may be unsuccessful in the integration of the acquired businesses that are new to our operations. The process of integration may require a disproportionate amount of the time and attention of management, which may distract

management’s attention from its day-to-day duties. During these periods, there may be less attention directed to marketing efforts or staffing issues, which could affect our revenue and expenses. In addition, any interruption or deterioration in service resulting from an acquisition may result in a customer’s decision to stop doing business with us. Any difficulties in the integration process could result in increased expense, loss of customers and a decline in profitability or an increase in exiting losses. We have experienced delays and increased costs in integrating acquired businesses. We also could experience delays in converting the systems of acquired businesses into our systems, which could result in increased staff and payroll expense as well as delays in reporting our results, both for a particular region and on a consolidated basis. Further, the legal and business environment prevalent in new territories and with respect to new businesses may pose risks that we do not anticipate and could adversely impact our ability to integrate newly acquired operations. For all of these reasons, our historical record in integrating acquired businesses is not a reliable indicator of our ability to do so in the future. If we are not successful in timely and cost-effectively integrating future acquisitions, it could adversely affect our financial condition, results of operations, cash flows and prospects.

The termination or failure to renew a lease or sublease for a veterinary hospital facility would require us to relocate such hospital to a different facility and make substantial capital expenditures, which could disrupt our business and adversely impact our results of operations, cash flows and financial condition.

The majority of our veterinary hospital facilities are leased or subleased. Certain of these leases or subleases are on a month-to-month basis or do not include a renewal option. We may be unable to renew these leases or subleases upon termination or expiration on terms acceptable to us or at all. Higher lease costs could adversely impact our results of operations, cash flows and financial condition. Failure by a lessor or sublessor to renew an existing lease or sublease could require us to relocate to a different facility which could disrupt our business and require us to make significant capital expenditures for leasehold improvements which could adversely impact our results of operations, cash flows and financial condition.

Loss of key personnel could adversely affect our business.

Our results of operations will depend, in part, on our ability to attract and retain highly qualified directors, executive officers, veterinarians and other employees. We may not be able to continue to attract and retain highly qualified persons for such positions, which could have a material adverse effect on us.

Due to the fixed cost nature of our business, fluctuations in our revenue could adversely affect its operating income.

A substantial portion of our expenses, particularly rent and personnel costs, are relatively fixed costs and are based in part on expectations of revenue. We may be unable to reduce spending in a timely manner to compensate for any significant fluctuations in our revenue. Accordingly, shortfalls in revenue may adversely affect our operating income.

Demand for certain products and services, including animal vaccinations, may decline, which could have a material adverse effect on our financial condition, results of operations, cash flows and prospects.

Demand for vaccinations will be impacted in the future as protocols for vaccinations change. Some professionals in the industry have recommended that vaccinations be given less frequently. In the summer of 2003, the Centers for Disease Control and Prevention updated a publication on animal vaccinations, which called for less frequent canine revaccinations. The study concluded that some vaccinations remain effective for periods of three to five years, suggesting that veterinarians should decrease the frequency of vaccinations. Our veterinarians establish their own vaccine protocols. Some of our veterinarians have changed their protocols and others may change their protocols in light of such recent and/or future literature. A decrease in the frequency of revaccinations and the related revenue could adversely affect our results of operations.

The frequency of customer visits to our animal hospitals may also decline. We believe that the frequency of visits is impacted by several trends in the industry. Pet-related products, including medication prescriptions, traditionally sold at animal hospitals, have become more widely available in retail stores and other channels of distribution, including the internet. Client visits may also be negatively impacted as a result of preventative care and better pet

nutrition. If demand for retail products, vaccinations or for our services generally decline, the frequency of visits may decline which may result in a reduction in revenue, which could have a material adverse effect on our financial condition, results of operations, cash flows and prospects.

Further economic downturn could materially adversely affect our business and recessionary economic conditions may reduce demand for our services.

Our business may be materially adversely affected by negative trends in the general economy that reduce consumer spending. Our business depends on the ability and willingness of animal owners to pay for its services. This dependence could make us more vulnerable to any reduction in consumer confidence or disposable income as compared to companies in other industries that are less reliant on consumer spending, such as the human health care industry, in which a large portion of payments are made by insurance programs. The current financial crises and related economic uncertainty have had a significant impact on our revenue and profitability. Other veterinary care providers similar to us have recently reported a decline in demand for their veterinary services due, in part, to present economic conditions. If demand for our veterinary services similarly declines, our operating results will be negatively impacted. In addition, declines in our profitability could result in a charge to earnings for the impairment of goodwill, which would not affect our cash flow but could decrease our earnings, and our stock price could be adversely affected. Additionally, many of the effects and consequences of the global financial crisis currently are unknown, and may have a material adverse effect on our liquidity and capital resources, including our ability to refinance our existing long-term debt, raise additional capital if needed, and may negatively impact our business and financial results.

Goodwill and other intangible assets comprise a significant portion of our total assets. We must test our intangible assets for impairment at least annually, which may result in a material, non-cash write down of goodwill and could have a material adverse impact on our results of operations and stockholders’ equity.

Goodwill and indefinite-lived intangibles are subject to impairment assessments at least annually (or more frequently when events or circumstances indicate that an impairment may have occurred) by applying a fair-value based test. These impairment assessments may result in a material, non-cash write-down of goodwill. An impairment could have a material adverse impact on our results of operations and stockholders’ equity.

During the fourth quarter of 2009, in conjunction with our annual impairment test of goodwill, we recorded a goodwill impairment charge of $22.5 million. The factors that caused us to record the impairment were primarily the decreased revenues sustained in 2009 from the decline in the U.S. economy coupled with the increased amount of debt incurred by the Company. The fair market valuation of the reporting units was based on an income and market approach.

Shortages of skilled veterinarians may cause us to experience hiring difficulties which could result in a disruption of our business.

As the pet population continues to grow, the need for skilled veterinarians continues to increase. If we are unable to retain an adequate number of skilled veterinarians, we may lose customers, our revenue may decline and we may need to sell or close animal hospitals. As of December 2009, there were 28 veterinary schools in the country accredited by the American Veterinary Medical Association. These schools graduate approximately 2,500 veterinarians per year. There is a shortage of skilled veterinarians in some regional markets in which we operate animal hospitals. During shortages in these regions, we may be unable to hire enough qualified veterinarians to adequately staff our animal hospitals, in which event we may lose market share and our revenues and profitability may decline.

Currently existing or newly enacted laws and regulations could restrict our business or result in significant costs and expenses. Any failure to comply with these laws and regulations could have a material adverse effect on our financial condition, results of operations, cash flows and prospects.

We may expand our operations into states which have laws and regulations that prohibit business corporations from providing, or holding themselves out as providers of, veterinary-medical care. In those states, we will be unable to provide veterinary services or own veterinary practices. However, if we choose to enter such states, we would seek

alternative structures for operating in those states, including providing management and other administrative services to veterinary practices located in these states. Although we will seek to structure our operations to comply with the veterinary medicine laws of each state in which we operate, given the varying and uncertain interpretations of these laws, we may not be in compliance with restrictions on the corporate practice of veterinary medicine in all states. A determination that we are in violation of applicable restrictions on the practice of veterinary medicine in any state in which we operate could have a material adverse effect on our operations, particularly if we are unable to restructure our operations to comply with the requirements of that state.

In addition, most states impose various registration requirements on veterinarians and veterinary hospitals. To fulfill these requirements, we are required to register each of our facilities with appropriate governmental agencies and, where required, appoint a licensed veterinarian to act on behalf of each facility. All veterinarians practicing in our clinics are required to maintain valid state licenses to practice. Any failure to comply with these laws and regulations could have a material adverse effect on our operations.

The possible widespread implementation of pet insurance could adversely affect our business, operating results and prospects.

The possible widespread implementation of pet insurance and our operation under such insurance could impose additional fees and costs upon us and reduce the revenue from services and related items. If we do not accept such insurance or choose not to participate in pet insurance programs, it could place us at a competitive disadvantage. Acceptance of pet insurance could result in a reduction in fees or the possible imposition of caps for services. The involvement of insurance companies could also increase various administrative requirements related to the submission and processing of claims resulting in a delay in payments or disputes regarding the terms and amounts of available coverage.

We face increasing competition, including from better-established companies that have significantly greater resources, which places pressure on our pricing and which could prevent us from increasing revenue or maintaining profitability.

The market for our products and services is intensely competitive and is likely to become even more so in the future. Many of our potential competitors have substantial competitive advantages, such as:

	•		greater name recognition and larger marketing budgets and resources;
	•		established marketing relationships and access to larger customer bases; and
	•		substantially greater financial, technical and other resources.

As a result, they may be able to respond more quickly and effectively than we can to new or changing opportunities or customer requirements. For all of the foregoing reasons, we may not be able to compete successfully against our current and future competitors, and our results of operations could be adversely affected.

The costs of defending litigation and potential claims could be significant and adversely affect our results and financial condition.

From time to time we may be involved in various claims and legal actions arising in the ordinary course of business. We do not believe that the ultimate resolution of these matters will have a material adverse effect on our business, results of operations, financial condition, or cash flows. However, the results of these matters cannot be predicted with certainty, and an unfavorable resolution or the costs of defending of one or more of these matters could have a material adverse effect on our business, results of operations, financial condition, cash flows and prospects.

We are subject to local market risks as a result of the geographic concentration of our operations.

Our operations currently are concentrated in the California market. This concentration makes our business subject to the health of California’s economy, as well as actual or threatened natural disasters (such as earthquakes and fires) which may disrupt the operations of our veterinarian hospitals, all of which may adversely impact our financial condition, results of operations, cash flows and prospects.

Risks Related to our Common Stock

We may not be able to maintain compliance with NASDAQ’s continued listing requirements.

Our common stock is presently quoted on the Nasdaq Capital Market (“NASDAQ”). To maintain our listing on NASDAQ, we must satisfy certain minimum financial and other continued listing standards, including, among other requirements, (i) a $1.00 minimum bid price requirement, (ii) a requirement to maintain either (a) $2.5 million minimum stockholders’ equity, (b) $500,000 minimum annual net income or (c) $35 million minimum market value of listed securities, and (ii) a majority of independent directors. Our common stock price has been below the $1.00 minimum bid requirement since November 19, 2008. NASDAQ temporarily suspended the $1.00 minimum bid requirement through July 31, 2009 and reinstated it effective as of August 3, 2009.

On September 15, 2009, we received notification from the NASDAQ Listings Qualifications Department indicating that for the last 30 consecutive business days, the bid price of our common stock had closed below the minimum $1.00 per share required for continued inclusion on NASDAQ as set forth in NASDAQ Marketplace Rule 5550(a)(2). In accordance with NASDAQ Marketplace Rule 5810(c) (3) (A), we had 180 calendar days, or until March 15, 2010, to regain compliance. We would achieve compliance with this requirement if at any time before March 15, 2010, the bid price of our common stock closes at $1.00 per share or more for a minimum of ten consecutive business days. The Company was unable to regain compliance prior to March 15, 2010.

On March 16, 2010, we received a notice from The NASDAQ Stock Market indicating that we are not in compliance with the minimum bid price requirement for continued listing, and as a result our common stock is subject to suspension from trading and delisting from The NASDAQ Capital Market at the opening of business on March 25, 2010, unless we request a hearing by March 23, 2010 in accordance with the NASDAQ Marketplace Rules. We requested an appeal hearing on March 23, 2010 with the NASDAQ Listing Qualifications Panel (the “Panel”) to review the delisting determination. The hearing was scheduled by NASDAQ to occur on May 5, 2010. NASDAQ will ‘stay’ the delisting of our common stock pending the Panel’s decision. We are required to present a plan for regaining compliance with the bid price rule which will likely include our potential plan to consummate a reverse stock split which was approved by the stockholders at an annual meeting held on July 28, 2009 subject to approval by our board of directors of the Company, in order to exceed the minimum bid price requirement. The NASDAQ letter stated that historically, “Panels have generally viewed a reverse stock split in 30 — 60 days as the only definitive plan acceptable to resolve a bid price deficiency.” Nevertheless, there can be no assurance that NASDAQ will grant our request for the continued listing of our common stock on the NASDAQ Capital Market.

Effective as of July 28, 2009, Mr. Gary Brukardt retired from our board of directors. Mr. Brukardt also served on our audit committee and, accordingly, Mr. Brukardt’s retirement caused our audit committee to have only two members. As a result, we are currently noncompliant with NASDAQ Marketplace Rule 5605(c)(2)(A), which requires listed companies to have at least three audit committee members. The NASDAQ staff has informed us that we have until the earlier of the date of our next annual shareholders meeting or July 28, 2010 to comply with this requirement. Our board expects to appoint a new independent director to become a member of the audit committee prior to the expiration of the cure period at which time we expect to be in full compliance with NASDAQ Marketplace Rule 5605(c)(2)(A). In addition, if we must record significant impairment or other charges, the Company may have difficulty maintaining its NASDAQ Capital Market listing due to the stockholders’ equity requirement.

If the Company is unsuccessful in maintaining its NASDAQ listing, then trading in its common stock after a delisting would likely be conducted in the over-the-counter markets in the so-called “pink sheets” or the Over-The-Counter Bulletin Board and could also be subject to additional restrictions. There can be no assurance that the Company will meet the continued listing requirements for the NASDAQ Capital Market, or that it will not be delisted from the NASDAQ Capital Market in the future. The delisting of the Company’s common stock could have a material adverse effect on the trading price, liquidity, value and marketability of its common stock. In addition, certain of the Company’s outstanding convertible notes provide that the holder may demand payment in full upon the delisting of its common stock from NASDAQ.

If our securities are delisted from NASDAQ, trading of our securities may be restricted by the SEC’s penny stock regulations and FINRA’s sales practice requirements, which may limit a holder’s ability to buy and sell our securities.

If our securities are delisted from NASDAQ, trading of our securities may be subject to the penny stock rules. The Securities and Exchange Commission has adopted Rule 3a51-1 which generally defines “penny stock” to be any equity security that has a market price (as defined) less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. The penny stock rules impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and “accredited investors.” The term “accredited investor” refers generally to institutions with assets in excess of $5,000,000 or individuals with a net worth in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 jointly with their spouse. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form prepared by the SEC which provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny stock held in the customer’s account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer’s confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for the stock that is subject to these penny stock rules. Consequently, these penny stock rules may affect the ability of broker-dealers to trade our securities if they are delisted from NASDAQ.

In addition to the “penny stock” rules promulgated by the Securities and Exchange Commission, the Financial Industry Regulatory Authority (“FINRA”) has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives and other information. Under interpretations of these rules, FINRA believes that there is a high probability that speculative low-priced securities will not be suitable for at least some customers. The FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our equity securities, which may limit your ability to buy and sell our equity securities.

The market prices of our securities are likely to be highly volatile and subject to wide fluctuations.

The market price of our common stock, units and warrants could be highly volatile and could be subject to wide fluctuations in response to a number of factors that are beyond our control, including changes in government regulations and changes in general economic conditions.

In addition, the market prices of our securities could be subject to wide fluctuations in response to a number of additional factors, including:

	•		announcements of new products or services by our competitors;
	•		demand for our services;
	•		changes in the pricing policies of our competitors; and
	•		changes in government regulations.

The amount of stock held by executive officers, directors and other affiliates may limit your ability to influence the outcome of director elections and other matters requiring stockholder approval.

Our executive officers, directors and affiliates beneficially own a majority of our voting stock. In addition, certain of these stockholders are parties to a board voting agreement pursuant to which they have each agreed for three years following the consummation of the Merger to vote shares beneficially owned by them for the election to our board

of directors of (a) Robert Wallace, for so long as Mr. Wallace owns two percent or more of its fully diluted shares, (b) five designees named by the stockholders’ representatives of PVGI pursuant to the Merger Agreement, one of whom shall be the designee of Galen who shall serve as non-executive vice chairman of our board of directors, and (c) four designees named by Echo’s initial stockholders, one of whom shall include Gene Burleson.

These stockholders can have a substantial influence on all matters requiring approval by stockholders, including the election of directors and the approval of mergers or other business combination transactions. This concentration of ownership could have the effect of delaying or preventing a change in control or discouraging a potential acquirer from attempting to obtain control of our company, which in turn could have a material adverse effect on the market price of the common stock or prevent stockholders from realizing a premium over the market price for their shares of common stock.

If our existing stockholders exercise their registration rights, it may have an adverse effect on the market price of our common stock.

Certain stockholders are parties to registration rights agreements which entitle them to require us to register the resale of their shares of common stock under certain circumstances. The lead investors and certain of our directors and executive officers are among the parties to registration rights agreements with us. If these stockholders exercise their registration rights with respect to all of their shares of common stock, then there will be significantly more shares of common stock eligible for trading in the public market. The presence of this additional number of shares of common stock eligible for trading in the public market may have an adverse effect on the market price of our common stock.

The exercise of our outstanding warrants and/or conversion of our outstanding convertible securities will result in a dilution of our current stockholders’ voting power and an increase in the number of shares eligible for future resale in the public market which may negatively impact the market price of our stock.

The conversion or exercise of some or all our convertible debt obligations and warrants could significantly dilute the ownership interests of our existing stockholders.

We had outstanding warrants to purchase an aggregate of 23,870,685 shares of common stock as of December 31, 2009, including without limitation (i) the public warrants to purchase 7,187,500 shares of common stock which are offered hereby, (ii) the founding director warrants to purchase 458,333 shares of common stock subject to transfer restrictions but otherwise generally on the same terms as the public warrants, (iii) warrants to purchase 15,070,986 shares of common stock at an exercise price of $0.10 per share, which warrants were issued in connection with the private placement of the Senior Notes, (iv) warrants to purchase 250,000 shares of common stock at an exercise price of $0.10 per share issued to a lender, and (v) warrants to purchase up to 1,349,294 shares of common stock upon exercise of outstanding warrants originally issued by PVGI. On March 17, 2010, the public warrants and the founding director warrants referenced above expired by their terms and are no longer deemed outstanding.

The currently outstanding Senior Notes, together with accrued interest and the premium, are convertible into 1,918,178 shares of common stock. Additionally, the issuance of up to 714,295 shares issuable upon conversion of convertible debentures originally issued by PVGI, as well as stock options and other awards pursuant to our incentive plans, will further dilute our existing stockholders’ voting interest.

To the extent warrants are exercised or convertible securities converted, additional shares of common stock will be issued, which will dilute existing stockholders and increase the number of shares eligible for resale in the public market. In addition to the dilutive effects described above, the conversion or exercise of those securities would lead to a potential increase in the number of shares eligible for resale in the public market. Sales of substantial numbers of such shares in the public market could adversely affect the market price of our shares.

Future financings may dilute your ownership and investment or result in the issuance of additional debt.

We may seek additional equity or debt financings to allow us to meet our future growth, operating and/or capital requirements or to refinance our Senior Notes or other debt. Any equity financing may be dilutive to our stockholders, and debt financing, if available, may involve restrictive covenants or other adverse terms with respect

to raising future capital and other financial and operational matters. We may not be able to obtain additional financing in sufficient amounts or on acceptable terms when needed, which could adversely affect our financial condition, results of operations, cash flows and prospects. If we fail to arrange for sufficient capital in the future, we may be required to limit or reduce the scope of our business activities until we can obtain adequate financing.

Item 1B. Unresolved Staff Comments

Not applicable to smaller reporting companies.

Item 2. Properties.

We lease our corporate headquarters facility in Brentwood, Tennessee, pursuant to a lease expiring in 2012. As of March 2010, we also own one facility and lease numerous facilities relating to our operations in California. These facilities consist primarily of veterinary hospitals. We believe that our facilities are sufficient for our current needs and are in good condition in all material respects.

Item 3. Legal Proceedings.

We are involved in various claims and legal actions arising in the ordinary course of business. We do not believe that the ultimate resolution of these matters will have a material adverse effect on our business, results of operations, financial condition, or cash flows. However, the results of these matters cannot be predicted with certainty, and an unfavorable resolution of one or more of these matters could have a material adverse effect on our business, results of operations, financial condition, cash flows and prospects.

Item 4. Submission of Matters to a Vote of Security Holders.

None.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

On May 29, 2008, our common stock, warrants and units commenced trading on the NASDAQ Capital Market under the symbols “VETS,” “VETSW” and “VETSU,” respectively. Until May 29, 2008, our units, common stock and warrants traded on the OTC Bulletin Board under the symbols “PDXC.OB,” “PDXCW.OB” and “PDXCU.OB,” respectively.

The following tables set forth, for the calendar quarter indicated, the quarterly high and low sales prices of our common stock, warrants and units as reported on the OTC Bulletin Board and on the NASDAQ Capital Market for the respective periods presented.

		Common Stock								Warrants								Units
2009		High				Low				High				Low				High				Low
Fourth Quarter		$	0.64			$	0.19			$	0.02			$	0.01			$	0.75			$	0.25
Third Quarter		$	0.70			$	0.49			$	0.04			$	0.00			$	0.66			$	0.24
Second Quarter		$	1.10			$	0.17			$	0.02			$	0.00			$	0.96			$	0.01
First Quarter		$	0.53			$	0.10			$	0.08			$	0.00			$	0.80			$	0.11

		Common Stock								Warrants								Units
2008		High				Low				High				Low				High				Low
Fourth Quarter		$	3.01			$	0.08			$	0.25			$	0.01			$	4.00			$	0.16
Third Quarter		$	4.23			$	1.00			$	0.54			$	0.16			$	4.40			$	2.00
Second Quarter		$	4.78			$	3.30			$	0.65			$	0.36			$	4.85			$	4.30
First Quarter		$	7.85			$	3.74			$	1.12			$	0.40			$	8.20			$	4.05

On March 23, 2010, the last reported sales price on the NASDAQ Capital Market for our common stock was $.35 per share. On March 17, 2010, our publicly-traded warrants expired by their terms and ceased to trade on the Nasdaq Capital Market.

Stockholders

As of March 23, 2010, there were approximately 67 holders of record of our common stock.

Dividends

We have not paid cash dividends on our common stock and we do not anticipate paying cash dividends in the foreseeable future. Any future determination as to the payment of dividends will depend on our results of operations, financial condition, capital requirements and other factors deemed relevant by our board of directors.

EQUITY COMPENSATION PLANS

The following table provides information as of December 31, 2009 regarding equity compensation plans approved and not approved by stockholders.

(C)

Number of Securities

Remaining Available for

(A)

(B)

Future Issuance Under

Number of Securities

Weighted-Average

Equity

to be Issued Upon

Exercise Price of

Compensation Plans

Exercise of

Outstanding

(Excluding Securities

Outstanding Options,

Options, Warrants

Reflected

Warrants and Rights

and Rights

in Column A)

Plan Category

Equity Compensation Plans Approved by Security Holders

2,580,377

$

1.53

2,619,623

Equity Compensation Plans Not Approved by Security Holders

624,866

$

4.20

—

Total

3,205,243

$

2.06

2,619,623

Equity Compensation Plan not approved by Security Holders. The Company maintains the XLNT Veterinary Care, Inc. 2004 Stock Option Plan, as amended (the “2004 Plan”) as part of its compensation program. The Company adopted and assumed the 2004 Plan in connection with the Company’s merger involving XLNT Veterinary Care, Inc. (the “Merger”), including with respect to (i) the future issuance of awards and shares thereunder, (ii) the

reservation for future issuance under the 2004 Plan of shares of common stock of the Company, representing the remaining number of shares of XLNT Veterinary Care, Inc. common stock reserved under the 2004 Plan immediately prior to January 4, 2008, the date the Merger was consummated, multiplied by the Exchange Ratio (as defined in the Merger Agreement), less any shares of common stock of the Company actually issued under the 2004 Plan, and (iii) the issuance of common stock in accordance with the terms of awards granted under the 2004 Plan, which upon such issuance shall be validly issued, fully paid and non-assessable. The 2004 Plan has not been approved by the stockholders of the Company. On July 28, 2009, the 2004 Plan was terminated such that no additional awards may be made under the 2004 Plan; however, the validity of options issued and outstanding as of the termination date are not affected.

Item 6. Selected Financial Data.

Not applicable to smaller reporting companies.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following should be read in conjunction with our consolidated financial statements and the related notes.

Overview

General

The Company is a provider of primary and specialty veterinary care services to companion animals through a network of veterinary hospitals. As of December 31, 2009, we owned and operated twenty-three veterinary hospitals located in northern and southern California. Our hospital operations are conducted by our subsidiaries.

Our hospitals offer a full range of general medical treatment for companion animals, including (i) preventative care, such as vaccinations, examinations, spaying/neutering, and dental care, and (ii) a broad range of specialized diagnostic and medical services, such as x-ray, ultra-sound, internal medicine, surgery, cardiology, ophthalmology, dermatology, oncology, neurology and other services. Our hospitals also sell pharmaceutical products, pet food and pet supplies.

We intend to grow and enhance our profitability by expanding same-store revenue and capitalizing on economies of scale and cost reduction efficiencies and by acquiring established veterinary practices in select regions throughout the United States.

Business Strategy

Our objective is to deliver a broad scope of high-quality services to our customers through a “hub and spoke” network of veterinary hospitals within select local markets. Specifically, we offer, through specialty and emergency hospitals (“hubs”), a wide range of medical, diagnostic and specialty-medical services and use the traditional smaller general practices as “spokes” to feed to the “hub” units patients requiring more specialized services than a general practice is equipped to provide. We pursue the following strategies to achieve our objectives:

		o		recruit and retain top veterinary professionals;
		o		provide high quality veterinary care to our customers;
		o		pursue acquisitions of additional veterinary hospitals, with a focus on continuing to develop “hub and spoke” networks that will improve customer service;
		o		increase veterinary hospital visits through advertising, market positioning, consumer education, wellness programs and branding;

		o		increase veterinary hospital margins through same-store revenue growth and cost savings realized through consolidated purchasing arrangements for high volume items such as food and medical supplies and generally lower costs through economies of scale;
		o		increase veterinary hospital productivity through professional development and training, integration of performance data collection systems, application of productivity standards to previously under-managed operations and removal of administrative burdens from veterinary professionals; and
		o		capture valuation arbitrage differentials between individual practice value and larger consolidated enterprise value.

Seasonality

The practice of veterinary medicine is subject to seasonal fluctuation. In particular, demand for veterinary services is slightly higher during the warmer months because pets spend a greater amount of time outdoors where they are more likely to be injured and are more susceptible to disease and parasites. In addition, use of veterinary services may be affected by levels of flea infestation, heartworm and ticks, and the number of daylight hours. The seasonality we experience at our clinics varies throughout the year depending on the geographic region of those locations. Our clinics in the desert region of California experience their highest sales volume in the winter months. However, revenue may be impacted significantly from quarter to quarter by natural disasters, such as earthquakes, landslides and fires, and other factors unrelated to such adverse events, such as changing economic conditions.

Overview of Our Financial Results

(Results discussed relate to continuing operations unless stated otherwise)

The year of 2009 was a challenging year for the Company due to the economic environment of the U.S. and more specifically, the state of California. Revenues were down due to decreased sales volume; however, the Company made many great improvements in the area of cost of goods sold as well as veterinary and staff payroll. For the full year of 2009, 22 of our 23 hospitals achieved positive Hospital EBITDA (see Other Metrics below for definition of Hospital EBITDA).

Net revenue and net loss from continuing operations are key measurements of our financial results. For the year 2009, net revenue was $63.9 million, a decrease of 6.4% from net revenues in 2008. The net loss from continuing operations for 2009 of $30.3 million was an increase of $10.9 million, or 56.0%, over 2008 net loss of $19.4 million. Basic and diluted net loss from continuing operations per share was $(1.28) for the year ended December 31, 2009 versus $(0.83) at December 31, 2008.

The revenue decrease in 2009 from 2008 was primarily a result of the decreased volumes in our animal hospitals as a result of the economic environment of the U.S. and especially California, where all of our hospitals are located. Partially offsetting these decreases were acquisition revenues of Valley Animal Medical Center which was not acquired until the beginning of the third quarter of 2008. The increase in net loss from continuing operations and loss per share was primarily a result of the $22.5 million impairment charge to goodwill, offset by decreased veterinary and staff payroll at our animal hospitals and the lack of certain duplicative occupancy and staff costs at our corporate office, which were incurred in 2008 when the Company relocated its headquarters from San Jose, California to Brentwood, Tennessee.

The revenue increase in 2008 from 2007 was primarily due to the acquisition of five veterinary hospitals during the first quarter of 2007 and one acquisition in the third quarter of 2008. The increase in net loss from continuing operations and loss per share was primarily a result of expenses associated with relocating the Company’s

headquarters from California to Tennessee, developing a new executive and corporate staff in Brentwood, and recognizing the loss related to the impairment of goodwill and intangible assets. Additionally, the Company incurred increased interest expense as a result of one-time charges taken in conjunction with pre-paying the Fifth Street loans.

Cash used in operations for 2009 was $2.2 million compared to cash used in 2008 of $11.7 million. The use of cash in 2009 was primarily due to net loss incurred during the year of $30.3 million offset by certain non-cash expenses included in the net loss, including the goodwill impairment charge. Cash provided by investing activities during 2009 was from the sale of one of its buildings during the year, partially offset by purchases of property and equipment for our various animal hospitals. Cash provided from financing activities was principally from the $6.5 million of net proceeds received from the issuance of the Senior Notes in the first quarter of 2009.

Cash used in operations for 2008 was $11.7 million compared to cash used in 2007 of $2.6 million. The use of cash in 2008 was primarily due to the pay down of approximately $10.0 million of working capital deficit of PVGI on the date of the Merger. Cash used in investing activities during 2008 was principally for the acquisition of Valley Animal Medical Center on July 1, 2008 and for purchases of property and equipment for our various animal hospitals. Cash provided from financing activities was principally from the $36.4 million of net proceeds from the IPO that were received as a result of the merger with PVGI, which was partially offset by the $16.2 million payoff of the Fifth Street loans.

We had a working capital deficit of $4.4 million at December 31, 2009 as compared to working capital deficit of $7.2 million at December 31, 2008. The December 31, 2009 working capital deficit was favorably impacted by the $6.5 million of net proceeds received from the issuance of the Senior Notes.

Results of Our Operations

Fiscal year 2009 compared to fiscal year 2008

(in millions, except percentages)

Revenue

		For The Years Ended
		December 31,
		2009				2008				%Change
Revenue		$	63.9			$	68.3				(6.4	%)

Revenues decreased $4.3 million, or 6.4%, in 2009 as compared to 2008 primarily resulting from decreased volumes as a result of the economic environment of the U.S. and especially California, where all of our hospitals are located, partially offset by the acquisition revenues of Valley Animal Medical Center, which was not acquired until the beginning of the third quarter of 2008.

Direct Costs

Continuing Operations:

		For The Years Ended
		December 31,
		2009				2008				%Change
Total direct costs		$	58.1			$	64.5				(9.9	%)
Gross Margin as a percentage of total net revenue from continuing operations			9.1	%			5.5	%

Direct costs decreased $6.4 million, or 9.9%, in 2009 as compared to 2008. The decrease in direct costs was partially due to a $1.3 million reduction in cost of goods sold for the twelve months ended December 31, 2009 compared to the same time period one year ago due to lower revenue volumes and the continued improvement with centralization of purchasing of inventory items. Further decreasing direct costs was a $3.6 million decrease in veterinary and staff payroll in 2009 versus 2008 due to lower compensation paid to veterinarians as a result of lower revenues, improvements in adjusting staff levels to be in line with lower revenues, and the elimination of certain cost redundancies from three hospital consolidations that took place during 2008.

Selling, General and Administrative (“SG&A”)

		For The Years Ended
		December 31,
		2009				2008				%Change
Selling, general and administrative		$	31.1			$	19.0				63.4	%
As a percentage of total net revenue from continuing operations			48.6	%			27.9	%

The increase in SG&A of $12.1 million, or 63.4%, in 2009 as compared to 2008 was a result of the $22.5 million impairment charge to goodwill recorded in the fourth quarter of 2009, offset by several factors. First, the impairment charge taken in 2008 related to goodwill and intangible assets at two of its hospital locations totaled $4.6 million. Additionally, in 2008, the Company recorded approximately $0.3 million more of an impairment charge on its Assets Held for Sale than in 2009 when it recorded a smaller impairment amount at the time of sale of the building.

Additionally, in 2008, the Company was relocating its headquarters from California to Tennessee, which required the hiring of a new corporate team in Tennessee. For a period of time in 2008, the Company incurred certain duplicative staff and occupancy costs and experienced higher than normal travel, relocation, and recruiting expenditures. Additionally, in 2008, the Company executed certain corporate staff reductions and paid severance costs, which were also not incurred in 2009. Since these 2008 transition and staff reduction costs were not incurred in 2009, there was a direct reduction in payroll, travel, relocation/recruiting, and occupancy related costs for the twelve months ended December 31, 2009 of $2.0 million, $0.5 million, $0.4 million, and $0.2 million, respectively.

Further offsetting the increase in SG&A in 2009 as compared to 2008 were reductions in stock compensation expense and professional fees. Stock compensation expense was down $1.1 million in 2009 primarily from the majority of the option grants granted to certain executives and Board of Directors members in the first quarter of 2008 having completed their vesting in that year. The number of stock option granted in 2009 was significantly lower than grants in 2008 when the Company first became publicly traded. Professional fees, decreased $0.9 million from 2008 due to the decreased utilization of third party costs to assist with SEC filings and Sarbanes-Oxley requirements, as well as discontinuing the use of contract labor at its former headquarters location after the relocation to Tennessee.

Interest income

		For The Years Ended
		December 31,
		2009				2008				%Change
Interest income		$	0.0			$	0.3				(96.5	%)
As a percentage of total net revenues from continuing operations			0.0	%			0.5	%

The decrease in interest income for the twelve months ended December 31, 2009 as compared to the same time periods in the prior year was a result of having more cash on deposit at a banking institution for the majority of the prior year time period primarily due to the $36.4 million in net proceeds received from the merger with PVGI on January 4, 2008.

Interest Expense

		For The Years Ended
		December 31,
		2009				2008				%Change
Interest expense		$	5.8			$	4.6				27.1	%
As a percentage of total net revenues from continuing operations			9.0	%			6.7	%

Interest expense increased by $1.2 million, or 27.1%, in 2009 compared to 2008; however, the majority of interest expense incurred in the two comparative periods was unrelated to one another. In 2008, the Company had recorded certain one-time charges to interest expense related to the payoff of its Fifth Street loans in June 2008, including a $1.4 million charge to eliminate the debt discounts associated with those loans, a $0.2 million charge related to the write-off of the debt amendment costs incurred in February 2008, and a $0.2 million prepayment penalty that had been incurred. Additionally, interest expense incurred on the principal of the Fifth Street loans in the twelve months ended December 31, 2008 was approximately $1.2 million. In 2009, interest expense was incurred primarily from the issuance of the Senior Notes in the first quarter of 2009. Interest expense incurred on the principal of the notes, interest expense from the loan value accretion, and interest expense from the amortization of certain debt discounts associated with the notes was $0.7 million, $2.7 million, and $1.0 million, respectively, for the twelve months ended December 31, 2009. Additionally, for the twelve months ended December 31, 2009, the Company recorded a one-time charge to interest expense of $0.3 million related to the amendment of the Huntington Promissory Note.

Fiscal year 2008 compared to fiscal year 2007

(in millions, except percentages)

Revenue

Continuing Operations:

		For The Years Ended
		December 31,
		2008				2007				%Change
Revenue		$	68.3			$	60.3				13.3	%

Revenues increased $8.0 million, or 13.3%, during 2008 as compared to 2007. The revenue increase was due to having twelve months of revenue in 2008 from the five veterinary hospitals acquired in the first quarter of 2007 as well as six months of results from Valley Animal Medical Center, which was acquired in July 2008, as summarized below:

		Comparative Analysis
		2008				2007				%Change
Same-store revenue (1)		$	37.5			$	37.5				(0.2)	%
Net acquired revenue (2)			30.8				22.8				35.5	%
Total		$	68.3			$	60.3				13.3	%

Same-store revenues remained fairly consistent year over year, with a slight decrease in overall foot traffic to our clinics; however, revenue per invoice slightly increased, which partially offset the decrease in foot traffic.

Discontinued Operations:

		For The Years Ended
		December 31,
		2008				2007				%Change
Revenue		$	1.3			$	2.2				(42.0	)%

Revenues decreased $0.9 million, or 42.0%, during 2008 as compared to 2007. The revenue decrease was primarily due to a loss of key veterinarians coupled with increased competition in the area of South Bay. Management made the decision to close South Bay in the fourth quarter of 2008. See Note 16 in the notes to the consolidated financial statements for further discussion on South Bay.

Direct Costs

Continuing Operations:

		For The Years Ended
		December 31,
		2008				2007				%Change
Total direct costs		$	64.5			$	56.5				14.3	%
Gross Margin as a percentage of total net revenue from continuing operations			5.5	%			6.4	%

Direct costs increased $8.1 million, or 14.3%, in 2008 as compared to 2007 primarily due to the Company having a full twelve months of direct costs incurred in 2008 related to the 5 acquisitions that were made in the first quarter of 2007 and to the acquisition of Valley Animal Medical Center, which was purchased in July 2008.

Same store direct costs decreased $0.8 million year over year partially as a result of the Company centralizing its purchasing of medical and pet supplies during 2008, which allowed the Company to begin realizing advantageous pricing from economies of scale. Further decreasing same-store direct costs was a decrease in hospital staff costs as the Company merged six of its existing animal hospitals into three locations, which allowed the Company to avoid certain duplicative costs within hospitals in similar geographic regions.

Discontinued Operations:

		For The Years Ended
		December 31,
		2008				2007				%Change
Total direct costs		$	1.9			$	2.6				(29.2)	%
Gross Margin as a percentage of net revenue from discontinued operations			(43.4	)%			(17.7)	%

Direct costs from discontinued operations decreased $0.8 million, or 29.2%, in 2008 as compared to 2007. The decrease in direct costs year over year was primarily due to the timing of the closure of the facility, which occurred in early November 2008. Further reducing direct costs were lower payroll costs after the loss of key veterinarians in 2007, lower cost of goods sold due to the centralization of purchasing in 2008, and no amortization expense from intangible assets being incurred in 2008 since the Company recorded a one-time impairment charge in 2007 to write-off the full value of the intangible assets.

Selling, General and Administrative

		For The Years Ended
		December 31,
		2008				2007				%Change
Selling, general and administrative		$	19.0			$	12.7				50.1	%
As a percentage of total net revenue from continuing operations			27.9	%			21.0	%

The increase in selling, general and administrative of $6.4 million or 50.1% for 2008 over 2007, was largely due to the $4.6 million one-time impairment charge recorded for goodwill and intangibles at two of our hospitals. Further increasing our expenses were duplicative staff costs incurred during the first quarter of 2008 as the Company moved its headquarters to Tennessee from California, the build-out of the Company’s infrastructure as a result of the Merger and our public company reporting responsibilities, the $0.5 million non-cash impairment charges taken in

the third and fourth quarter of 2008 related to the Assets Held for Sale, and increased non-cash stock compensation expense, offset by the substantial decrease in professional fees that were largely incurred in 2007 in preparation for the Merger.

In 2007, the Company also had recorded a $3.7 million one-time impairment charge for the goodwill and intangibles assets at South Bay, which has been recorded in the loss from discontinued operations in the accompanying consolidated statement of operations.

Interest income

		For The Years Ended
		December 31,
		2008				2007				%Change
Interest income		$	0.3			$	0.1				192	%
As a percentage of total net revenues from continuing operations			0.5	%			0.2	%

Interest income in 2008 was $0.3 million compared to $0.1 million in 2007, resulting from larger cash balances on hand at banking institutions in the first half of 2008 as a direct result of the $36.4 million in net proceeds received through the Merger in January 2008.

Interest Expense

		For The Years Ended
		December 31,
		2008				2007				%Change
Interest expense		$	4.6			$	3.8				18.4	%
As a percentage of total net revenues from continuing operations			6.7	%			6.4	%

Interest expense increased by $0.7 million in 2008 compared to 2007, which was primarily attributable to one-time charges incurred in 2008 related to the Company paying off all loans with Fifth Street in June 2008, including a $1.4 million charge to interest expense to eliminate the debt discounts associated with the loans, a $0.2 million charge related to the write-off of the debt amendment costs incurred in February 2008, and a $0.2 million charge to interest expense resulting from a prepayment penalty that was incurred on the payoff of the $12 million Fifth Street loan. These costs were partially offset by lower interest expense in 2008 on the outstanding principal of the Fifth Street loans themselves due to the payoff in June 2008 as well as lower interest expense incurred on the convertible notes that were outstanding as of 2007, as approximately $8.3 million of the outstanding notes were converted to common stock in conjunction with the Merger.

Restatement of three and nine months ended September 30, 2009

		For The Three Months Ended												For The Twelve Months Ended
		December 31,												December 31,
										%												%
		2009				2008				Change				2009				2008				Change
Gain on Change in Fair Value of Warrant Liabilities		$	4.2			$	—				—	%		$	0.8			$	—				—	%
As a percentage of total net revenue			28.4	%			—	%							1.2	%			—	%

The gain on change in fair value of warrant liabilities of $4.2 million for the three months ended December 31, 2009 was primarily a result of the Company’s stock price decreasing from $0.58 on September 30, 2009 to $0.28 on December 31, 2009, offset by a $0.5 million loss related to the mark-to-market adjustment from August 31, 2009 to September 30, 2009 as a result of the Company’s restatement discussed in further detail below and in Note 21. The gain on change in fair value of warrant liabilities of $0.8 million for the twelve months ended December 31, 2009 was primarily driven by the decrease in the Company’s stock price from January 1, 2009 to December 31, 2009, in which it decreased from $0.36 to $0.28.

The Company began treating certain of its convertible debt and common stock warrants as derivative liabilities beginning on January 1, 2009 as a result of new accounting guidance issued by the FASB in determining whether certain financial instruments are considered indexed to the Company’s stock. Upon the adoption of the new guidance, the Company determined that certain of its convertible debt and warrants, including the Financing Warrants issued in connection with the 12% Senior Notes, should be accounted as a derivative liability. As such, the Company established the fair value of those warrants that required derivative treatment as a liability on the consolidated balance sheet and has been modifying the fair value amount by recording mark-to-market adjustments through Gain on Change in Fair Value of Warrant Liabilities in the consolidated statement of operations every reporting period.

On August 31, 2009, the Company amended the anti-dilution provision of the Financing Warrants such that if the Company ever issued additional securities at a price below $0.10 (the exercise price of the Financing Warrants), the holders of the Financing Warrants would have their exercise price of the Financing Warrants lowered to that new price only if that price was also below the Company’s current stock price on the date the additional securities are issued. The Company originally believed that this modification allowed these warrants to be considered indexed to the Company’s stock; and therefore, modified its accounting for those Financing Warrants on August 31, 2009 by recording a mark-to-market adjustment for the warrants as of August 31, 2009 and then charging the remaining liability amount to additional paid-in-capital. The Company then did not make any fair value adjustments to the warrants from August 31, 2009 to September 30, 2009.

The Company subsequently discovered that the amendment to the Financing Warrants did not fully satisfy the FASB’s guidance on determining whether an instrument is indexed to an entity’s own stock, which was a requirement for the Company to discontinue its treatment of the Financing Warrants as derivative instruments. The Company has re-examined the accounting treatment in light of this discovery and now concludes that the more appropriate accounting treatment is to have not discontinued the derivative treatment of the Financing Warrants at September 30, 2009 and to continue treating them as derivatives going forward. As such, the Company has restated its financial statements related to the three and nine months ended September 30, 2009 to account for the Financing Warrants as derivative liabilities. The restated amounts include a reversal of the $6,900,000 charge we had originally recorded to additional paid-in-capital (in stockholders’ equity) relating to the outstanding warrant liability for the Financing Warrants and reclassified that amount back to warrant liabilities (in long-term liabilities) as well as we recorded the mark-to-mark adjustment of the liability from August 31, 2009 (the date of our last adjustment prior to changing our accounting) and September 30, 2009, which was $450,000 and has been recorded to gain in change in fair value of warrant liabilities in the accompanying consolidated statement of operations. See Note 21 for further information relating to the restatement. The Financing Warrants will continue to be treated as derivative liabilities in future reporting periods.

The following table sets forth unaudited balance sheet at September 30, 2009 and statement of operations data for the three and nine months ended September 30, 2009. The quarter ended September 30, 2009 has been restated with comparisons to the results as previously reported.

		As Reported				As Restated
		September 30,				September 30,
		2009				2009
		(unaudited)				(unaudited)
Current assets			5,973				5,973
Long-term assets			62,504				62,504
Total assets			68,477				68,477
Current liabilities			9,975				9,975
Long-term liabilities			12,637				19,987
Total liabilities			22,612				29,962
Stockholders’ equity			45,865				38,515
Total liabilities and stockholders’ equity			68,477				68,477

		As Reported								As Restated
		For the three				For the nine				For the three				For the nine
		months ended				months ended				months ended				months ended
		September 30,				September 30,				September 30,				September 30,
		2009				2009				2009				2009
		(unaudited)				(unaudited)				(unaudited)				(unaudited)
Revenue			15,734				49,158				15,734				49,158
Direct Costs			14,488				44,375				14,488				44,375
Hospital Contribution			1,246				4,783				1,246				4,783
Selling, general, and administrative expenses			1,644				6,204				1,644				6,204
Loss from operations			(398	)			(1,421	)			(398	)			(1,421	)
Gain/(Loss) on change in fair value of warrant liabilities			144				(3,449	)			(306	)			(3,899	)
Interest expense, net			(1,532	)			(4,315	)			(1,532	)			(4,315	)
Loss before provision for income taxes			(1,786	)			(9,185	)			(2,236	)			(9,635	)
Tax provision			23				28				23				28
Net Loss			(1,809	)			(9,213	)			(2,259	)			(9,663	)

Liquidity and Financial Condition

(Results discussed relate to continuing operations unless stated otherwise)

Cash Flows from Operating Activities

Our largest source of operating cash flows is cash collections from our customers for purchases of veterinary healthcare services. We usually receive payment at the time of service. Our primary uses of cash for operating activities include compensation for hospital and corporate personnel, facility related expenditures including purchases of inventory, and costs associated with outside support and services.

Cash used in operating activities was $2.2 million, $11.7 million, and $2.6 million for the years ended December 31, 2009, 2008, and 2007, respectively.

Cash used in operating activities during 2009 of $2.2 million was largely driven by the $30.3 million net loss incurred during 2009 and reduction of $2.8 million in accounts payable and accrued liabilities, offset by non-cash expenses incurred during the year in the amount of $22.5 million, $2.9 million, and $4.1 million for impairment change to goodwill, depreciation and amortization, and amortization of debt discounts, respectively. Further offsetting the net loss and reduction in current liabilities was the $0.9 million of interest expense that was accrued back to the principal of their respective loans.

Cash used in operating activities during 2008 of $11.7 million was impacted by a $19.4 million net loss from continuing operations and a $4.7 million decrease in accounts payable as the Company used a portion of the proceeds received from the Merger with PVGI to pay off its working capital deficit buildup from the prior year. Offsetting these amounts were non-cash expenses of $2.5 million for depreciation and amortization, $1.9 million of amortization from debt discounts associated primarily with the Fifth Street loans that were paid off in June 2008, and $1.6 million for share-based compensation expense, as well as a $1.2 million increase in accrued payroll and other expenses due to higher wages and workers compensation liabilities at the end of 2008 as compared to the end of 2009.

The $2.6 million of net cash used in operating activities for 2007 resulted from the $12.4 million net loss, $0.8 million increase in prepaid expenses and other assets, $0.4 million decrease in inventory, and $0.3 million increase in taxes payable, which were substantially offset by $5.2 million and $3.1 million increases in accounts payable and accrued payroll and other expenses, respectively, as PVGI was building up a working capital deficit prior to the Merger and $1.7 million of non-cash expenses for depreciation and amortization.

Cash Flows from Investing Activities

Cash provided by investing activities in 2009 was $0.4 million, while cash used in investing activities in 2008 and 2007 was $5.5 million and $24.5 million, respectively.

Cash provided by investing activities in 2009 of $0.4 million was a result of the $0.8 million net proceeds received from selling one of its buildings, offset by $0.4 million of property and equipment purchased at various hospital locations during the year.

Cash used in investing activities in 2008 of $5.5 million was mainly due to the $3.0 million used for the acquisition of Valley Animal Medical Center in July 2008 as well as $2.1 million spent on capital expenditures at the various animal hospitals.

Cash used in investing activities for 2007 was attributable to the acquisition of five veterinary hospitals for $14.3 million plus $2.5 million for South Bay, payments of $3.9 million related to prior year acquisitions, and the purchases of $5.0 million of property and equipment, including the purchase and installation of practice management systems at twenty-two of our hospitals. Offsetting this cash used in investing activities were the proceeds of $1.2 million from the sale of a building in December 2007.

Cash Flows from Financing Activities

Cash provided by financing activities was $2.7 million, $17.0 million, and $25.1 million in 2009, 2008 and 2007, respectively.

Cash provided by financing activities of $2.7 million in 2009 was primarily the result of the $6.5 million the Company raised from the issuance of the Senior Notes in the first quarter of 2009, offset by $3.4 million of recurring term loan and capital lease payments during the year.

Cash provided by financing activities in 2008 of $17.0 million was a result of the $36.4 million of net proceeds received in the Merger with PVGI, offset by $18.7 million of payments made on term loans, including $16.2 million used to prepay the Fifth Street loans in June 2008, as well as monthly capital lease payments.

Cash provided by financing activities in 2007 principally consisted of the issuance of preferred stock and debt financing. In February 2007, PVGI completed the issuance of 25,007 shares of a Series B convertible preferred stock offering for cash proceeds of $13.6 million, net of issuance costs of $1.5 million. In 2007, PVGI received net proceeds of $14.9 million from the issuance of two loans with Fifth Street. These proceeds were partially offset by $3.4 million of principal payments on term loans and capital leases.

Cash Flows from Discontinued Operations

Cash used in discontinued operations in 2008 was primarily due to a $0.5 million build-up in accounts payable at the end of the year offset by a $0.6 million net loss. In 2007, there was a small increase in cash driven by a $0.6 million increase in accounts payable and accrued liabilities as well as the non-cash charge of $3.7 million for the impairment of goodwill and intangible assets, which offset the $4.1 million net loss from discontinued operations for that year. There were no cash flows from discontinued operations in 2009.

Off-Balance Sheet Arrangements

As of December 31, 2009, we did not have any off-balance sheet arrangements as defined in item 303(a)(4)(ii) of Regulation S-K.

Debt Covenants

On March 30, 2009, the Company entered into the First Amendment (the “Amendment”) dated as of March 30, 2009 to the Huntington Promissory Note dated November 2, 2005. The First Amendment waives the Company’s future covenant requirements through the term of the Huntington Promissory Note. The Company does not have any other financial covenants with any of its other outstanding loans.

Other Metrics

The non-GAAP metric of adjusted earnings before interest, gain on change in fair value of warrant liabilities, income taxes, depreciation and amortization (“Adjusted EBITDA”) is an important performance measure for us and we believe that it is a useful metric to investors and management of the ability of our business to generate cash and to repay and incur additional debt. Computations of Adjusted EBITDA may differ from company to company. Therefore, Adjusted EBITDA should be used as a compliment to, and in conjunction with, our consolidated financial statements included elsewhere in this report. Adjusted EBITDA was unfavorably impacted in 2009 by the $22.5 million impairment charge to goodwill.

The following table presents a reconciliation of our computation of Adjusted EBITDA to Net Loss from Continuing Operations for the twelve months ended December 31, 2009, 2008 and 2007 (in thousands):

		Year Ended December 31,
		2009				2008				2007
Net loss from continuing operations		$	(30,341	)		$	(19,448	)		$	(12,365	)
Depreciation			1,863				1,318				932
Amortization			1,041				1,138				801
Gain on change in fair value of warrant liabilities			(750	)			—				—
Interest expense, net			5,773				4,207				3,725
Provision/(benefit) for income taxes			36				(21	)			44
Adjusted EBITDA		$	(22,378	)		$	(12,806	)		$	(6,863	)

Additionally, the Company also reviews the non-GAAP metric of hospital contribution before depreciation and amortization expense (“Hospital EBITDA”) as an ability of our hospitals being able to individually generate cash without the burden of corporate spending. Computations of Hospital EBITDA may differ from company to company. Therefore, Hospital EBITDA should be used as a compliment to, and in conjunction with, our consolidated financial statements included elsewhere in this report.

The following table presents a reconciliation of our computation of Hospital EBITDA for the twelve months ended December 31, 2009, 2008 and 2007 (in thousands):

		Year Ended December 31,
		2009				2008				2007
Hospital contribution		$	5,820			$	3,774			$	3,835
Depreciation at hospitals			1,038				1,149				943
Amortization at hospitals			1,041				1,135				799
Hospital EBITDA		$	7,899			$	6,058			$	5,577

The Company believes that the foregoing non-GAAP financial measures improve the transparency of the Company’s disclosure and provides a meaningful presentation of the Company’s results from its core hospital operations excluding the impact of items not related to the Company’s ongoing core hospital operations.

Critical Accounting Policies and Estimates

Several accounting policies that are critical to our financial position and results in operations require significant judgments and estimates on the part of management. For a summary of our accounting policies, including the accounting policies discussed below, see Note 2 to our historical consolidated financial statements included in this Form 10-K. These critical accounting policies and estimates include:

			w valuation of goodwill and other intangible assets;
			w accounting for stock options; and
			w accounting for income taxes.

Valuation of Goodwill and other Intangible Assets

Goodwill

Goodwill represents the excess of the cost of an acquired entity over the net of the amounts assigned to identifiable assets acquired and liabilities assumed.

In accordance with the FASB’s guidance on goodwill and intangible assets, we have determined that we have one reporting unit, Animal Hospitals, and we estimate annually, or sooner if circumstances indicate an impairment may exist, the fair market value of our reporting unit, and compare its estimated fair market value against its net book value to determine if our goodwill is impaired.

Other Intangible Assets

In addition to goodwill, we acquire other identifiable intangible assets in our acquisitions, including, but not limited to, covenants-not-to-compete, client lists, lease related assets and customer relationships. We value these identifiable intangible assets at estimated fair value. We use independent valuation experts to advise and assist us in determining what identifiable assets we have acquired in an acquisition as well as how to estimate the fair value of those assets. Our estimated fair values are based on generally accepted valuation techniques such as market comparables, discounted cash flow techniques or replacement costs. These valuation methods involve the use of significant assumptions such as the timing and amount of future cash flows, risks, appropriate discount rates, and the useful lives of intangible assets.

Subsequent to acquisition, we test our identifiable intangible assets for impairment as part of a broader test for impairment of long-lived assets under the FASB’s guidance on accounting for the impairment or disposal of long-lived assets, whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

The recognition and measurement of an impairment loss under this accounting guidance also involves a two-step process:

First we identify potential impairment by estimating the aggregate projected undiscounted future cash flows associated with an asset or asset pool and compare that amount with the carrying value of those assets. If the aggregate projected cash flow is greater than our carrying amount, there is no impairment and the second step is not needed.

When we test for impairment, the cash flows that are used contain our best estimates, which include appropriate and customary assumptions.

If we identify a potential impairment in the first step, we are then required to write the assets down to fair value with a corresponding charge to earnings. If the fair value is greater than carrying value, there is no adjustment. We may be required to make significant estimates in determining the fair value of some of our assets.

Impairment of Goodwill and Other Intangible Assets

During the fourth quarter of 2009, in conjunction with our annual impairment test of goodwill, we recorded a goodwill impairment charge of $22.5 million. The factors that caused us to record the impairment were primarily the decreased revenues sustained in 2009 from the decline in the U.S. economy coupled with the increased amount of debt incurred by the Company. The fair market valuation of the reporting units was based on an income and market approach.

During the fourth quarter of 2008, we recorded a goodwill impairment of $4.0 million and an impairment of $0.6 million of certain long-lived assets at two of our animal hospitals. The factors that caused us to record the impairments were the loss of key veterinarians and increased competition in the area of those animal hospitals. The fair market valuation of the reporting units was based on an income and market approach.

During the fourth quarter of 2007, we recorded a goodwill impairment of $2.9 million and an impairment of $0.8 million of certain long-lived assets at one of our animal hospitals, South Bay. The factors that caused us to record the impairments were the loss of key veterinarians coupled with increasing competition in the area of that hospital;

both substantially driving down the existing customer base. In the fourth quarter of 2008, the Company closed the South Bay facility permanently.

Accounting for Stock Options

Prior to January 1, 2006, we accounted for our share-based payments to our employees and directors (hereafter referred to collectively as “employees”) under the intrinsic value method. Under that method, when options are granted with a strike price equal to or greater than market price on date of issuance, there is no impact on earnings either on the date of grant or thereafter, absent modification to the options. Accordingly, we recognized no share-based compensation expense in periods prior to January 1, 2006.

Effective January 1, 2006, we adopted the FASB’s most recent guidance on share-based compensation, which required us to measure the cost of share-based payments granted to our employees, including stock options, based on the grant-date fair value and to recognize the cost over the requisite service period, which is typically the vesting period. We adopted this guidance using the modified prospective transition method, which requires us to recognize compensation expense for share-based payments granted or modified on or after January 1, 2006. Additionally, we are required to recognize compensation expense for the fair value of unvested share-based awards at January 1, 2006 over the remaining requisite service period. Operating results from prior periods have not been restated.

This guidance also requires the benefits of tax deductions from the exercise of options in excess of the compensation cost for those options to be classified as cash provided by financing activities. Prior to the adoption of this guidance, we did not recognize any income tax benefits resulting from the exercise of stock options.

Accounting for Income Taxes

We are required to estimate our federal income taxes as well as income taxes in each state in which we operate. This process requires that management estimate the current tax exposure as well as assess temporary differences between the accounting and tax treatment of assets and liabilities, including items such as accruals and allowances not currently deductible for tax purposes. The income tax effects of the differences identified are classified as current or long-term deferred tax assets and liabilities in our consolidated balance sheets. Management’s judgments, assumptions and estimates relative to the current provision for income taxes takes into account current tax laws, its interpretation of current tax laws and possible outcomes of current and future audits conducted by domestic tax authorities. Changes in tax laws or management’s interpretation of tax laws, including the provisions of the American Jobs Creation Act of 2004, and the resolution of current and future tax audits could significantly impact the amounts provided for income taxes in our balance sheet and results of operations. We must also assess the likelihood that deferred tax assets will be realized from future taxable income and, based on this assessment, establish a valuation allowance if required. As of December 31, 2009, management determined the valuation allowance to be approximately $17.3 million based upon uncertainties related to our ability to recover certain deferred tax assets. These deferred tax assets are primarily related to net operating losses and may be subject to significant annual limitation under certain provisions of the Internal Revenue Code. Management’s determination of valuation allowance is based upon a number of assumptions, judgments and estimates, including forecasted earnings, future taxable income and the relative proportions of revenue and income before taxes in the various jurisdictions in which we operate. Future results may vary from these estimates, and at this time, it cannot be determined if we will need to establish an additional valuation allowance and if so, whether it would have a material impact on our financial statements.

Recent Accounting Pronouncements

Adopted

On January 1, 2009, Pet DRx adopted changes issued by the FASB to fair value accounting and reporting as it relates to nonfinancial assets and nonfinancial liabilities that are not recognized or disclosed at fair value in the financial statements on at least an annual basis. These changes define fair value, establish a framework for measuring fair value in GAAP, and expand disclosures about fair value measurements. This guidance applies to other GAAP that require or permit fair value measurements and is to be applied prospectively with limited exceptions. The adoption of these changes, as it relates to nonfinancial assets, had no impact on the Company’s consolidated financial statements.

On January 1, 2009, Pet DRx adopted changes issued by the FASB to consolidation accounting and reporting. These changes establish accounting and reporting for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This guidance defines a noncontrolling interest, previously called a minority interest, as the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. These changes require, among other items, that a noncontrolling interest be included in the balance sheet within equity separate from the parent’s equity; separately, the amounts of consolidated net income attributable to the parent and noncontrolling interest all on the consolidated statement of operations; and if a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be measured at fair value and a gain or loss be recognized in net income based on such fair value. The adoption of these changes had no impact on the Company’s consolidated financial statements as the Company does not have any noncontrolling interest in any of its subsidiaries.

On January 1, 2009, Pet DRx adopted changes issued by the FASB to disclosures about derivative instruments and hedging activities. These changes require enhanced disclosures about an entity’s derivative and hedging activities, including (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for, and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The adoption of these changes did not have an impact on the Company’s consolidated financial statements as the Company is not involved in any hedging activities.

On January 1, 2009, Pet DRx adopted changes issued by the FASB to accounting for business combinations. While retaining the fundamental requirements of accounting for business combinations, including that the purchase method be used for all business combinations and for an acquirer to be identified for each business combination, these changes define the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control instead of the date that the consideration is transferred. These changes require an acquirer in a business combination, including the business combinations achieved in stages (step acquisition), to recognize the assets acquired, liabilities assumed, and any noncontrolling interest in the acquire at the acquisition date, measured at their fair values as of that date, with limited exceptions. This guidance also requires the recognition of assets acquired and the liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. Additionally, these changes require acquisition-related costs to be expensed in the period in which the costs are incurred and the services are received instead of including such costs as part of the acquisition price. The adoption of these changes did not have an impact to the Company’s consolidated financial statements as the Company has not completed any acquisitions in 2009.

On January 1, 2009, Pet DRx adopted changes issued by the FASB on accounting for business combinations. These changes apply to all assets acquired and liabilities assumed in a business combination that arise from certain contingencies and requires (i) an acquirer to recognize at fair value, at the acquisition date, an asset acquired or liability assumed in a business combination that arises from a contingency if the acquisition-date fair value of that asset or liability can be determined during the measurement period otherwise the asset or liability should be recognized at the acquisition date if certain defined criteria are met; (ii) contingent consideration arrangements of an acquire assumed by the acquirer in a business combination be recognized initially at fair value; (iii) subsequent measurements of assets and liabilities arising from contingencies be based on a systematic and rational method depending on their nature and contingent consideration arrangements be measured subsequently; and (iv) disclosures

of the amounts and measurement basis of such assets and liabilities and the nature of the contingencies. The adoption of these changes had no impact to the Company’s consolidated financial statements as the Company has not made any acquisitions in 2009.

On January 1, 2009, Pet DRx adopted changes issued by the FASB on derivative accounting, specifically in identifying whether an instrument or embedded feature is indexed to an entity’s own stock. Prior to the change, the FASB specified that a contract that would otherwise meet the definition of a derivative but is both (a) indexed to the Company’s own stock and (b) classified in stockholders’ equity in the statement of financial position would not be considered a derivative financial instrument. The change now provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus some instruments or embedded features that weren’t originally considered derivatives may now be considered derivatives. See Note 18 for further information.

On January 1, 2009, Pet DRx adopted changes issued by the FASB to accounting for intangible assets. These changes amend the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset in order to improve the consistency between the useful life of a recognized intangible asset in a business combination. The adoption of these changes had no impact on the Company’s consolidated financial statements.

On June 30, 2009, Pet DRx adopted changes issued by the FASB to accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued, otherwise known as “subsequent events.” Specifically, these changes set forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. The adoption of these changes had no impact to the Company’s consolidated financial statements.

On June 30, 2009, Pet DRx adopted additional changes issued by the FASB to fair value accounting. These changes provide additional guidance for estimating fair value when the volume and level of activity for an asset or liability have significantly decreased and includes guidance for identifying circumstances that indicate a transaction is not orderly. This guidance is necessary to maintain the overall objective of fair value measurement, which is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The adoption of these changes had no impact on the Company’s consolidated financial statements.

On June 30, 2009, Pet DRx adopted changes issued by the FASB to the recognition and presentation of other-than-temporary impairments. These changes amend existing other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities. The adoption of these changes had no impact on the Company’s consolidated financial statements.

On June 30, 2009, Pet DRx adopted changes issued by the FASB to fair value disclosures of financial instruments. These changes require a publicly traded company to include disclosures about the fair value of its financial instruments whenever it issues summarized financial information for interim reporting periods. Such disclosures include the fair value of all financial instruments, for which it is practicable to estimate that value, whether recognized or not recognized in the financial statements; the related carrying amount of these financial instruments; and the method(s) and significant assumptions used to estimate the fair value. Other than the required disclosures, the adoption of these changes had no impact to the Company’s consolidated financial statements.

On September 30, 2009 Pet DRx adopted changes issued by the FASB to the authoritative hierarchy of GAAP. These changes establish the FASB Accounting Standard Codification™ (Codification) as the source of authoritative

accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of the financial statements in conformity with GAAP. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The FASB will no longer issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts; instead the FASB will issue Accounting Standards Updates. Accounting Standards Updates will not be authoritative in their own right as they will only serve to update the Codification. These changes and the Codification itself do not change GAAP. Other than the manner in which new accounting guidance is referenced, the adoption of these changes had no impact to the Company’s consolidated financial statements.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Not applicable to smaller reporting companies.

Item 8. Financial Statements and Supplementary Data.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES

Pet DRx Corporation and Subsidiaries

Report of Independent Registered Public Accounting Firm.			36
Consolidated Balance Sheets as of December 31, 2009 and 2008.			37
Consolidated Statements of Operations for the years ended December 31, 2009, 2008, and 2007.			38
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2009, 2008, and 2007.			39
Consolidated Statements of Cash Flows for the years ended December 31, 2009, 2008, and 2007.			41
Notes to Consolidated Financial Statements.			44

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders
Pet DRx Corporation and subsidiaries

We have audited the accompanying consolidated balance sheets of Pet DRx Corporation and subsidiaries (the “Company”) as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pet DRx Corporation and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.

We were not engaged to examine management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting and, accordingly, we do not express an opinion thereon.

As discussed in Note 18 to the consolidated financial statements, the Company has adopted the provisions of ASC 815-40-15, “Evaluating Whether an Instrument Involving a Contingency Is Considered Indexed to an Entity’s Own Stock” on January 1, 2009.

/s/ SingerLewak LLP

SingerLewak LLP
Irvine, CA
March 31, 2010

PET DRx CORPORATION AND SUBSIDIARIES

		December 31,				December 31,
		2009				2008
ASSETS
Current assets:
Cash and cash equivalents		$	2,650			$	1,723
Trade accounts receivable, net			385				369
Inventory			901				1,154
Prepaid expenses and other			1,155				1,719
Assets held for sale			—				900
Due from related parties			—				32
Assets of discontinued operations			—				1
Total current assets			5,091				5,898
Property and equipment, net			6,306				7,422
Other assets:
Goodwill			26,525				49,373
Other intangible assets, net			5,663				6,704
Restricted cash			425				500
Other			290				447
Total assets		$	44,300			$	70,344
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term obligations, net of debt discount		$	2,853			$	3,718
Accounts payable			1,583				2,394
Accrued payroll and other expenses			4,740				6,551
Due to a related party			—				96
Obligations under capital leases, current portion			320				312
Deferred rent, current portion			9				—
Liabilities of discontinued operations			—				55
Total current liabilities			9,505				13,126
Long-term liabilities:
Convertible debt, less current portion, net of debt discount			11,257				4,949
Term notes, less current portion			1,726				3,687
Warrant liabilities			2,914				—
Obligations under capital leases, less current portion			369				361
Deferred rent, less current portion			549				355
Other			—				83
Total long term liabilities			16,815				9,435
Total liabilities			26,320				22,561
Stockholders’ equity:
Common stock, par value $0.0001, 90,000,000 shares authorized, 23,714,460 and 23,660,460 shares outstanding as of December 31, 2009 and 2008, respectively, net of 1,361,574 treasury shares at December 31, 2009 and 2008, respectively			2				2
Additional paid-in-capital			86,345				87,686
Accumulated deficit			(68,367	)			(39,905	)
Total stockholders’ equity			17,980				47,783
Total liabilities and stockholders’ equity		$	44,300			$	70,344

See Notes to Consolidated Financial Statements

PET DRx CORPORATION AND SUBSIDIARIES

		Year ended December 31,
		2009				2008				2007
Revenue		$	63,947			$	68,295			$	60,287
Direct costs			58,127				64,521				56,452
Hospital contribution			5,820				3,774				3,835
Selling, general and administrative expense before impairment charges			8,537				13,965				12,680
Impairment of goodwill and intangibles			22,506				4,580				—
Impairment of Assets Held for Sale			59				491				—
Selling, general and administrative expenses			31,102				19,036				12,680
Loss from operations			(25,282	)			(15,262	)			(8,845	)
Other income (expense):
Gain on change in fair value of warrant liabilities			750				—				—
Interest income			12				344				118
Interest expense			(5,785	)			(4,551	)			(3,843	)
Gain on sale of building			—				—				249
Loss before provision (benefit) for income taxes			(30,305	)			(19,469	)			(12,321	)
Provision (benefit) for income taxes			36				(21	)			44
Loss from continuing operations			(30,341	)			(19,448	)			(12,365	)
Loss from discontinued operations, net of tax			—				(565	)			(4,066	)
Loss on disposition of discontinued operations, net of tax			—				(8	)			—
Loss from discontinued operations, net of tax			—				(573	)			(4,066	)
Net loss		$	(30,341	)		$	(20,021	)		$	(16,431	)
Basic and diluted loss per common share
Loss from continuing operations		$	(1.28	)		$	(0.83	)		$	(3.00	)
Loss from discontinued operations		$	(0.00	)		$	(0.02	)		$	(0.98	)
Net loss per share		$	(1.28	)		$	(0.85	)		$	(3.98	)
Shares used for computing basic and diluted loss per share			23,675				23,433				4,124

See Notes to Consolidated Financial Statements

PET DRx CORPORATION AND SUBSIDIARIES

		Preferred								Preferred
		Stock A								Stock B								Common Stock
																										Additional
																										Paid-in-				Accumulated
		Shares				Amount				Shares				Amount				Shares				Amount				capital				Deficit				Total
Balance as of December 31, 2006			7,652,175			$	1				—			$	—				3,560,864			$	—			$	24,747			$	(3,453	)		$	21,295
Sale of Preferred B for cash, net			—				—				25,391				—				—				—				13,644				—				13,644
Repurchase of common stock			—				—				—				—				(4,819	)			—				(25	)			—				(25	)
Exercise of warrants			—				—				1,270				—				—				—				—				—				—
Common stock issued upon debt conversion			—				—				—				—				691,587				1				1,495				—				1,496
Warrants issued as debt discount			—				—				—				—				—				—				1,371				—				1,371
Stock compensation expense			—				—				—				—				—				—				170				—				170
Net loss			—				—				—				—				—				—				—				(16,431	)			(16,431	)
Balance as of December 31, 2007			7,652,175			$	1				26,661			$	—				4,247,632			$	1			$	41,402			$	(19,884	)		$	21,520
Net proceeds from IPO received as a result of merger with PVGI			—				—				—				—				—				—				36,355				—				36,355
Conversion of Preferred A and B stock to common stock			(7,652,175	)		$	(1	)			(26,661	)			—				10,318,275				1				—				—				—
Pet DRx shares assumed in Merger			—				—				—				—				8,750,000				—				—				—				—
Exercise of warrants			—				—				—				—				57,806				—				—				—				—
Common stock issued upon debt conversion			—				—				—				—				1,327,024				—				8,305				—				8,305
Inducement shares issued in Merger with PVGI			—				—				—				—				321,297				—				—				—				—
Stock compensation expense			—				—				—				—				—				—				1,624				—				1,624
Shares retained in Treasury			—				—				—				—				(1,361,574	)			—				—				—				—
Net loss			—				—				—				—				—				—				—				(20,021	)			(20,021	)
Balance as of December 31, 2008			—				—				—				—				23,660,460			$	2			$	87,686			$	(39,905	)		$	47,783
Issuance of stock as payment of earn-out note			—				—				—				—				30,000				—				16				—				16

		Preferred								Preferred
		Stock A								Stock B								Common Stock
																										Additional
																										Paid-in-				Accumulated
		Shares				Amount				Shares				Amount				Shares				Amount				capital				Deficit				Total
Reclassification of warrants from equity to liabilities			—				—				—				—				—				—				(5,543	)			—				(5,543	)
Issuance of warrants			—				—				—				—				—				—				3,646				—				3,646
Exercise of stock options			—				—				—				—				24,000				—				5				—				5
Cumulative adjustment to beginning retained earnings for warrant liability			—				—				—				—				—				—				—				1,879				1,879
Stock compensation expense			—				—				—				—				—				—				535				—				535
Net loss			—				—				—				—				—				—				—				(30,341	)			(30,341	)
Balance as of December 31, 2009			—				—				—				—				23,714,460			$	2			$	86,345				($68,367	)		$	17,980