The following discussion should be read in conjunction with our condensed consolidated financial statements and notes thereto provided under Part I, Item 1 of this Quarterly Report on Form 10-Q (the "Form 10-Q"). The Company's disclosure and analysis in this Form 10-Q contain some forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that set forth anticipated results based on management's plans and assumptions. From time to time, the Company also provides forward-looking statements in other materials it releases to the public, as well as oral forward-looking statements. Such statements give the Company's current expectations or forecasts of future events; they do not relate strictly to historical or current facts. The Company has tried, wherever possible, to identify such statements by using words such as "anticipate," "estimate," "expect," "project," "intend," "plan," "believe," "will," "target", "forecast" and similar expressions in connection with any discussion of future operating or financial performance or business plans or prospects. In particular, these include statements relating to future actions, business plans and prospects, future performance or results of current and anticipated services, sales efforts, expenses, interest rates, the outcome of contingencies, such as legal proceedings, and financial results.
The Company cannot guarantee that any forward-looking statement will be realized. Achievement of future results is subject to risks, uncertainties and potentially inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could differ materially from past results and those anticipated, estimated or projected. Investors should keep this in mind as they consider forward-looking statements. Factors that may cause our plans, expectations, future financial condition and results to change are described under the heading "Risk Factors" in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2008 filed with the SEC on March 31, 2009.
The forward-looking information set forth in this Quarterly Report on Form 10-Q is as of March 31, 2009, and the Company undertakes no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise. Investors are advised, however, to consult any further disclosures the Company makes on related subjects in its reports to the SEC filed after March 31, 2009 at the SEC's website at www.sec.gov .
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 March 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:
• recruit and retain top veterinary professionals;

• provide high quality veterinary care to our customers;

• increase veterinary hospital visits through advertising, market positioning, consumer education, wellness programs and branding;

• 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;

• 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;

• pursue acquisitions of additional veterinary hospitals, with a focus on continuing to develop "hub and spoke" networks that will improve customer service; and

• 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. For example, 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
(Amounts relate to continuing operations unless otherwise note)
For the three month period ended March 31, 2009, net revenue was $16.7 million, a decrease of 3.9% over the same time period in the prior year. The net loss for the three month period ended March 31, 2009 was approximately $21,000, versus a net loss in the prior year first quarter of $2.9 million. Basic and diluted net loss per share was $(0.00) for the three months ended March 31, 2009 as compared to a net loss per share of $(0.13) for the three months ended March 31, 2008.
The revenue decrease in the first three months of 2009 versus 2008 was primarily due to a decrease in volume of business resulting from the economic decline in the U.S. during the first quarter of 2009. The decrease in net loss and net loss per share was primarily a result of a decrease in selling, general, and administrative expenses partially as a result of the Company not incurring certain duplicative staff and occupancy costs while relocating its headquarters as it did in the first quarter of 2008, as well as other reductions in staffing and overhead expenditures. Additionally, as a result of the Company adopting EITF 07-5 during the first quarter of 2009, the Company recorded a $2.0 million gain on change of fair value of warrant liabilities during the quarter. No gain or loss on warrant liabilities was recorded in the three months ended March 31, 2008.
Cash used in operations for the three months ended March 31, 2009 was $1.2 million compared with $7.7 million in the first three months ended March 31, 2008. The cash used in operations during the three months ended March 31, 2009 was primarily due to the net loss of $21,000, the $2.0 million gain on change in fair value of warrant liabilities, and the $1.6 million reduction in accrued payroll and other expenses during the quarter, offset by non-cash expenses for depreciation and amortization as well as debt discount amortization. Cash used in continuing operations in the first quarter of 2008 was primarily a result of the $3.0 million net loss incurred in that period coupled with the $5.9 million reduction in accounts payable and the Company aggressively paid down its working capital deficit after the merger with PVGI.

Cash used in investing activities during the first quarter of 2009 and 2008 was for purchases of property and equipment at the corporate headquarters and various animal hospital locations. Cash provided by financing activities in the first quarter of 2009 was primarily a result of the $6.5 million received from the sale by the Company of the Senior Notes. Cash provided by financing activities in the first quarter of 2008 was principally the result of the $36.4 million of net proceeds received on January 4, 2008 when the Company completed the Merger.
We had a working capital deficit of $0.9 million at March 31, 2009 as compared to a working capital deficit of $7.2 million at December 31, 2008. Results of Our Operations
Three Months Ended March 31, 2009 and 2008
(In millions, except percentages)
Revenue
Continuing Operations:

                               For The Three Months ended
                                       March 31,
                                 2009              2008         % Change
                  Revenue    $     16.7        $     17.4         (3.9 )%


   Revenues decreased $0.7 million, or 3.9%, during the three months ended
March 31, 2009 as compared to the same time period in the prior year. The
revenue decrease was primarily due to decreased volumes as a result of the
economic environment of the U.S. during the first quarter of 2009.
Direct Costs
Continuing Operations:

                                                             For The Three Months Ended       March 31,
                                                              2009                2008             % Change
Total direct costs                                        $     15.0          $     15.6              (3.6 )%
Hospital Contribution Margin as a percentage of                 10.1 %              10.3 %
total net revenue

Direct costs decreased $0.6 million, or 3.6%, in the first three months of 2009 as compared to the first three months of 2008. The decrease in direct costs was primarily due to lower staff payroll in 2009 as a result of the three hospital consolidations the Company completed in 2008, as well as improvements in adjusting staff levels to be in line with the lower revenue levels. As a result of the consolidations, the Company was able to reduce certain duplicative staff costs at those animal hospital locations.
Direct costs include depreciation and amortization of $0.6 million and $0.5 million for the three months ended March 31, 2009 and 2008, respectively.

Selling, General and Administrative ("SG&A")

                                                 For The Three Months
                                                   Ended March 31,
                                                  2009           2008       % Change
       Selling, general and administrative     $     2.3        $  3.8       (38.4 )%
       As a percentage of total net revenue         14.0 %        21.8 %

SG&A expenses decreased by $1.5 million, or 38.4%, for the three months ended March 31, 2009 as compared to the same time period in the prior year. The year of 2008 was a year of transition for the Company, which resulted in increased SG&A costs. During the first quarter of 2008, the Company incurred larger costs as a result of the relocation of its headquarters from San Jose, California to Brentwood, Tennessee. Payroll, travel, and occupancy related costs for the three months ended March 31, 2009 were down approximately $0.6 million, $0.2 million, and $0.1 million, respectively, as a result of the Company not incurring costs from having duplicative occupancy and staff costs, as well as higher travel expenses resulting from recurring travel by executives between locations. Further reducing SG&A costs in 2009 was a reduction in professional fees of $0.5 million as a result of the Company having transitioned to a full time corporate staff versus predominately using contract labor in San Jose and a reduction in payroll and related costs that resulted from the decreases in the corporate staff size.

Interest income

                                                For The Three Months
                                                   Ended March 31,
                                                 2009           2008        % Change
      Interest income                         $    0.0        $    0.2       (98.9 )%
      As a percentage of total net revenue         0.0 %           1.2 %

The decrease in interest income for the three months ended March 31, 2009 as compared to the same time period in the prior year was a result of a significant decrease of cash on hand, since the $36.3 million of proceeds, net of certain closing costs, associated with the Merger, were on deposit at a banking institution for the majority of the three months ended March 31, 2008, while in the first quarter of 2009, there was minimal cash on hand.

Interest Expense

                                             For The Three Months Ended
                                                      March 31,
                                               2009                2008         % Change
  Interest expense                         $      1.3           $      1.2          15.7 %
  As a percentage of total net revenue            8.0 %                6.6 %

The increase in interest expense of 15.7% from the three months ended March 31, 2009 compared to 2008 was a result of the Company's Senior Notes that were sold by the Company during the first quarter of 2009. As a result of the significant debt discounts associated with the Senior Notes, the Company amortized approximately $0.6 million to interest expense during the quarter as well as accrued another $0.1 million in interest expense. Additionally, as a result of the amendment to the Huntington Loan, the Company recorded a one-time charge to interest expense of $0.3 million for the value of the warrants granted to Huntington Capital as well as the restructuring charges incurred as a result of the amendment to the Huntington Loan.
Interest expense in 2008 was primarily driven by the $16.0 million term loans that were outstanding with Fifth Street Mezzanine Partners II L.P., which was paid off by the Company in June 2008.

Gain on change in fair value of warrant liabilities

                                                             For The Three Months
                                                               Ended March 31,
                                                             2009             2008         % Change
Gain on change in fair value of warrant liabilities       $     2.0         $  -                 -%
As a percentage of total net revenue                           11.8 %          -%

The increase in gain on change in fair value of warrant liabilities was a result of the Company adopting EITF 07-5 and the decrease in the fair market value of the Company's common stock during the first quarter of 2009. Liquidity and Capital Resources
As of March 31, 2009, we had cash and cash equivalents of $6.1 million and working capital deficit of $0.9 million. Management believes that the Company has sufficient cash to meet its operating needs for 2009. 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 corporate and hospital personnel, facilities related expenditures including the purchase of inventory, and costs associated with outside support and services.
Cash used in continuing operating activities for the first three months of 2009 was $1.2 million as compared to $7.7 million in the same time period one year ago. The $1.2 million of net cash used in operating activities for the first quarter of 2009 resulted from the $21,000 net loss, the $2.0 million gain on change in fair value of warrant liabilities, and the $1.6 million decrease in accrued payroll and other expenses as the Company paid down certain expenses that it had accumulated while the Company was anticipating the closing of the sale of the Senior Notes. These fluctuations were offset somewhat by the $0.7 million and $1.0 million of non-cash expenses from depreciation and amortization and amortization of debt discounts, respectively. The net cash used in continuing operating activities in the first quarter of 2008 was a result of the $2.9 million net loss incurred in that time period, $5.9 million decrease in accounts payable as the Company paid its large balance down with the net proceeds received in the Merger with PVGI, and a $0.5 million decrease in prepaid expenses, partially offset by the $0.5 million, $0.4 million and $0.3 million of non-cash expenses from depreciation and amortization, amortization of debt discounts and stock-based compensation, respectively. Cash Flows from Investing Activities
Cash used in investing activities of $0.1 million during the first quarter of 2009 was for purchases of equipment at various hospital locations. Cash used in investing activities for the first quarter of 2008 of $0.3 million also was for purchases of equipment. The reduction in spending on capital equipment is a result of management's increased focus on cash management. Cash Flows from Financing Activities
Cash provided by financing activities during the first quarter of 2009 was primarily attributable to the $6.5 million of net proceeds received from the sale of the Senior Notes, offset by $0.5 million of payments on term notes issued in prior years in conjunction with the purchase of animal hospitals and $0.3 million of fees incurred in connection with issuance of the Senior Notes. Cash provided by financing activities during the first quarter of 2008 was primarily attributable to the $36.4 million of net proceeds received from the Merger with PVGI, offset by $0.6 million of payments on term notes issued in prior years in conjunction with the purchase of animal hospitals, $0.2 million of payments to Fifth Street Mezzanine Partners II, L.P. in association with the amendment of their loans to us, and $0.1 million of payments made on certain capital leases.

Non-GAAP Financial Measures
Adjusted EBITDA
The non-GAAP metric of earnings before interest, gain on change in fair value of warrant liabilities, income taxes, depreciation and amortization ("Adjusted EBITDA") is an important and useful measure for us, which we use to measure our liquidity. We use Adjusted EBITDA to monitor our ability to repay our existing debt and incur additional debt. We believe that it is a useful metric to investors because it provides them with a view of the Company's liquidity from management's perspective. We believe that investors benefit from having access to the same financial measures that management uses in evaluating our liquidity. Because computations of Adjusted EBITDA may differ from company to company, Adjusted EBITDA presented below may not be comparable with similarly titled measures of other companies. Therefore, Adjusted EBITDA should be used as a compliment to, and in conjunction with, our condensed consolidated financial statements included elsewhere in this report.
Adjusted EBITDA increased $1.4 million from the first quarter of 2008 to the three months ended March 31, 2009 primarily from the reduced spending in selling, general, and administrative expenses. The following table presents a reconciliation of our computation of Adjusted EBITDA to Net Income (Loss) for the three months ended March 31, 2009 and 2008 (in thousands):

                                                        March 31,       December 31,
                                                          2009              2008

 Net loss                                              $       (21 )   $       (3,028 )

 Depreciation                                                  412                305
 Amortization                                                  266                224
 Gain on change in fair value of warrant liabilities        (1,972 )                -
 Interest expense                                            1,333              1,152
 Income taxes                                                    5                  9


 Adjusted EBITDA                                       $        23     $       (1,338 )

Hospital EBITDA
Additionally, non-GAAP metric of hospital contribution before depreciation and amortization expense ("Hospital EBITDA") is an important and useful measure for us, which we use to measure individual hospital performance. We use Hospital EBITDA to assess the ability of our animal hospitals to generate cash without the burden of corporate spending. We believe that it is a useful metric to investors because it provides them with a view of the Company's individual hospital operations from management's perspective. We believe that investors benefit from having access to the same financial measures that management uses in evaluating our individual hospital performance. Because computations of Hospital EBITDA may differ from company to company, Hospital EBITDA presented below may not be comparable with similarly titled measures of other companies. Therefore, Hospital EBITDA should be used as a compliment to, and in conjunction with, our condensed consolidated financial statements included elsewhere in this report.
Hospital EBITDA decreased approximately $11,000 from the first quarter of 2008 to the first quarter of 2009 primarily from the 3.9% decrease in revenues in the three months ended March 31, 2009 as compared to the same time period one year ago. The following table presents a reconciliation of our computation of Hospital EBITDA to Hospital Contribution for the three months ended March 31, 2009 and 2008 (in thousands):

                                           March 31,      December 31,
                                             2009             2008

              Hospital contribution       $     1,683     $       1,792

              Depreciation at hospitals           325               274
              Amortization at hospitals           266               219


              Hospital EBITDA             $     2,274     $       2,285