Pet DRx (VETS) 10-Q 2008 Q2 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2008

OR

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

For the transition period from            to

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)

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

     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. Yesþ       Noo

     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.

Large accelerated filero      Accelerated filero
Non-accelerated filero      (Do not check if a smaller reporting company)                         Smaller reporting companyþ

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso       Noþ

     At June 30, 2008, there were 23,659,037 shares of the Registrant’s common stock outstanding.

INDEX

	Page
Part I. Financial Information.
Item 1. Financial Statements.
Condensed Consolidated Balance Sheets as of June 30, 2008 and December 31, 2007		1
Condensed Consolidated Statements of Operations for the three months and six months ended June 30, 2008 and 2007		2
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2008 and 2007		3
Notes to Condensed Consolidated Financial Statements		5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		14
Item 3. Quantitative and Qualitative Disclosures About Market Risk		20
Item 4. Controls and Procedures		21
Part II. Other Information
Item 1. Legal Proceedings		22
Item 1A. Risk Factors		22
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		22
Item 3. Defaults Upon Senior Securities		22
Item 4. Submission of Matters to a Vote of Security Holders		22
Item 5. Other Information		22
Item 6. Exhibits		22
EX-31.1 SECTION 302 CERTIFICATION OF THE CEO
EX-31.2 SECTION 302 CERTIFICATION OF THE CFO
EX-32.1 SECTION 906 CERTIFICATION OF THE CEO
EX-32.2 SECTION 906 CERTIFICATION OF THE CFO

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements.

PET DRX CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value and number of shares)

	June 30,			December 31,
	2008			2007
	(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents	$	9,045		$	2,005
Trade accounts receivable, net		238			179
Inventory		1,138			1,268
Prepaid expenses and other		905			910
Due from related parties		115			238
Total current assets		11,441			4,600
Property and Equipment, net		8,105			7,887
Other assets:
Goodwill		49,190			49,190
Other intangible assets, net		6,707			7,145
Other		303			1,020
Total assets	$	75,746		$	69,842
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Current portion of long-term obligations, net of debt discount	$	2,320		$	1,533
Accounts payable		663			6,481
Accrued payroll and other expenses		4,288			5,577
Accrued income taxes		—			189
Due to a related party		96			356
Obligations under capital leases, current portion		416			520
Total Current liabilities		7,783			14,656
Long-term liabilities:
Convertible debt		3,097			11,361
Term notes, less current portion and net of debt discount		5,701			21,532
Obligations under capital leases, less current portion		398			531
Deferred rent		146			97
Other		73			145
Total long-term liabilities		9,415			33,666
Total liabilities		17,198			48,322
Stockholders’ equity
Preferred stock, par value $0.0001, 10,000,000 shares authorized
Series A: 0 and 9,925,000 shares outstanding as of June 30, 2008 and December 31, 2007, respectively		—			1
Common stock, par value $0.0001, 90,000,000 shares authorized, 23,659,037 and 4,247,632 shares outstanding as of June 30, 2008 and December 31, 2007, respectively net of 1,361,574 and 0 treasury shares at June 30, 2008 and December 31, 2007, respectively		2			1
Additional paid-in capital		86,696			41,402
Accumulated deficit		(28,150	)		(19,884	)
Total stockholders’ equity		58,548			21,520
Total liabilities and stockholders’ equity	$	75,746		$	69,842

See Notes to Condensed Consolidated Financial Statements

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PET DRX CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2008			2007			2008			2007
Revenue	$	17,922		$	17,730		$	35,757		$	28,403
Direct costs		16,123			16,350			31,737			26,369
Depreciation and amortization expense		501			546			999			839
Stock-based compensation expense		25			5			41			7
Hospital contribution		1,273			829			2,980			1,188
Selling, general and administrative expense		3,507			2,855			7,007			5,417
Depreciation and amortization expense		51			62			88			70
Stock-based compensation expense		379			78			632			96
Loss from operations		(2,664	)		(2,166	)		(4,747	)		(4,395	)
Other income (expense):
Interest income		121			28			338			76
Interest expense		(2,735	)		(1,124	)		(3,887	)		(1,472	)
Loss before provision for income taxes		(5,278	)		(3,262	)		(8,296	)		(5,791	)
Provision/(benefit) for income taxes		(41	)		5			(31	)		10
Net loss	$	(5,237	)	$	(3,267	)	$	(8,265	)	$	(5,801	)
Basic and diluted loss per common share	$	(.22	)	$	(0.77	)	$	(.36	)	$	(1.45	)
Weighted average shares used in computing basic and diluted loss per share		23,655			4,248			23,204			3,998

See Notes to Condensed Consolidated Financial Statements

2

PET DRX CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Six Months Ended June 30,
	2008			2007
Cash flows provided by (used in) operating activities:
Net loss	$	(8,265	)	$	(5,801	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		1,085			908
Amortization of debt amendment costs		182			186
Amortization of debt discount		1,803
Share-based compensation		673			102
Impairment of fixed assets		88			—
Deferred rent		49			(5	)
Changes in operating assets and liabilities:
Accounts receivable		(59	)		145
Inventory		130			(52	)
Prepaid expenses and other		96			71
Accounts payable		(5,818	)		4,002
Accrued payroll and other expenses		(493	)		769
Income taxes		(174	)		(217	)
Other		(16	)		—
Net cash provided by (used in) operating activities		(10,719	)		108
Cash flows used in investing activities:
Property and equipment additions		(950	)		(4,609	)
Payments made on prior acquisitions		(356	)		(3,940	)
Capitalized costs associated with successful acquisitions		(16	)
Business acquisitions, net of cash received		—			(16,832	)
Net cash used in investing activities		(1,322	)		(25,381	)

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	Six Months Ended June 30,
	2008			2007
Cash flow provided by financing activities:
Net proceeds from merger with XLNT		36,316			—
Deferral of debt waiver fees		(182	)		—
Proceeds from term loan with preferred stock warrants		—			13,978
Repurchases of preferred stock and common stock warrants		—			(25	)
Proceeds from Series B preferred stock, net of expenses paid in cash		—			13,560
Payments on notes payable		(16,815	)		(1,249	)
Payments on capital lease obligations		(238	)		(156	)
Net cash provided by financing activities		19,081			26,108
Increase in cash and cash equivalents		7,040			835
Cash and cash equivalents at beginning of period		2,005			3,968
Cash and cash equivalents at end of period	$	9,045		$	4,803
Supplemental disclosures:
Cash paid during the period for:
Income taxes	$	215		$	46
Interest	$	2,992		$	1,140
Schedule of non-cash investing and financing activities:
Detail of acquisitions:
Fair value of assets acquired	$	—		$	29,936
Cash paid for acquisitions and related direct costs		—			(16,832	)
Obligations to sellers of acquired hospitals, notes payable and assumed liabilities	$	—		$	13,104
Building acquired:
Purchase price	$	—		$	930
Cash paid		—			(430	)
Mortgage held by seller		—			500
Deferred costs and accrued liabilities associated with merger of XLNT recorded to additional paid-in-capital on January 4, 2008 (Date of Merger)	$	700		$	—
Conversion of Convertible Notes to Equity	$	8,305		$	1,495
Retirement of debt to offset related party receivable	$	16		$	—
Conversion of Series A and Series B preferred stock to common stock	$	1		$	—

See Notes to Condensed Consolidated Financial Statements

4

PET DRX CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements of Pet DRx Corporation and subsidiaries (“Pet DRx,” the “Company,” “we,” “us” or “our”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim reporting. As permitted under those rules and regulations, certain footnotes or other financial information that are normally required by accounting principles generally accepted in the United States (“GAAP”) can be condensed or omitted. In our opinion, the condensed consolidated financial statements include all normal and recurring adjustments necessary for fair presentation and represent our accounts after the elimination of intercompany transactions. Interim results are not necessarily indicative of expected results for a full year.

     The unaudited information included in this Quarterly Report on Form 10-Q should be read in conjunction with our consolidated financial statements and the notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2007 and our Quarterly Report on Form 10-Q for the three months ended March 31, 2008 and XLNT Veterinary Care, Inc.’s consolidated financial statements and the notes thereto contained in our Current Report on Form 8-K/A (Amendment No. 1) filed with the SEC on April 4, 2008.

2. New Accounting Pronouncements

     In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements(“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements. However, it eliminates inconsistencies in the guidance provided in previous accounting pronouncements. The Company adopted SFAS No. 157 on January 1, 2008. The adoption had no impact on our condensed consolidated financial statements.

     In February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115(“SFAS No. 159”), which permits entities to choose to measure many financial instruments and certain other items at fair value. The Company adopted SFAS No. 159 on January 1, 2008. The adoption had no impact on our condensed consolidated financial statements.

     In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51,” (SFAS 160). SFAS 160 amends Accounting Research Bulletin 51, “Consolidated Financial Statements to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary.” This standard defines a noncontrolling interest, sometimes called a minority interest, as the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. SFAS 160 requires, among other items, that a noncontrolling interest be included in the consolidated statement of financial position within equity separate from the parent’s equity; consolidated net income to be reported at amounts inclusive of both the parent’s and noncontrolling interest’s shares and, separately, the amounts of consolidated net income attributable to the parent and noncontrolling interest all on the consolidated statement of income; 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. SFAS 160 becomes effective for the Company on January 1, 2009. We are currently evaluating the impact SFAS No. 160 could have on our consolidated financial statements.

     In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” (SFAS 141(R)). SFAS 141(R) replaces SFAS No. 141, “Business Combinations,” (SFAS 141) and retains the fundamental requirements in SFAS 141, including that the purchase method be used for all business combinations and for an acquirer to be identified for each business combination. This standard defines 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. SFAS 141(R) requires an acquirer in a business combination, including business combinations achieved in states (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 of that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. SFAS 141(R) becomes effective for the Company for any business combination with an acquisition date

5

on or after January 1, 2009. We are currently evaluating the impact SFAS 141(R) could have on our consolidated financial statements.

3. Merger with XLNT Veterinary Care, Inc.

     Pursuant to the Second Amended and Restated Agreement and Plan of Merger dated October 23, 2007 (the “Merger Agreement”), on January 4, 2008, a wholly-owned subsidiary of Echo Healthcare Acquisition Corp. (“Echo”) merged with and into XLNT Veterinary Care, Inc. (“XLNT”) and Echo changed its name to Pet DRx Corporation (the “Merger”). As a result of the Merger, the Company received approximately $36.3 million in proceeds from capital that was raised through the initial public offering of Echo in 2006, net of certain costs incurred in connection with completing the Merger.

     The Merger was accounted for under the reverse acquisition application of the equity recapitalization method of accounting in accordance with U.S. generally accepted accounting principles for accounting and financial reporting purposes. Under this method of accounting, Pet DRx was treated as the “acquired” company for financial reporting purposes. In accordance with the guidance applicable to these circumstances, the Merger was considered to be a capital transaction in substance. Accordingly, for accounting purposes, the Merger was treated as the equivalent of XLNT issuing stock for the net monetary assets of Pet DRx, accompanied by a recapitalization. The net monetary assets of Pet DRx were stated at their fair value, essentially equivalent to historical costs, with no goodwill or other intangible assets recorded. The accumulated deficit of XLNT only was carried forward after the Merger. All common stock share amounts for all periods presented have been adjusted to reflect the Merger. Acquisition expenses incurred by XLNT were recorded as equity. During the second quarter of 2008, the Company recorded an additional $56,000 of trailing Merger-related expenses to additional paid-in-capital.

     In connection with the Merger, the following equity transactions were completed:

• All Series A convertible preferred stock of XLNT was converted to XLNT common stock at a 1:1 ratio and all Series B convertible preferred stock of XLNT was converted to XLNT common stock at a 1:100 ratio;

• Certain holders of XLNT’s convertible debentures converted approximately $8.3 million of debentures into approximately 1.7 million shares of XLNT common stock;

• A holder of XLNT’s Series B warrants exercised a warrant for 1,647 shares of Series B convertible preferred stock of XLNT which was subsequently converted to XLNT common stock at a 1:100 ratio;

• XLNT issued 416,728 shares of XLNT common stock to certain investors who purchased shares of Echo common stock in privately negotiated transactions with various Echo stockholders who were stockholders of Echo as of the record date for Echo’s Special Meeting of Stockholders and who had voted against the Merger and submitted their shares for conversion (the “Inducement Shares”);

• Each outstanding share of XLNT common stock (including those issued in connection with the Merger on conversion of preferred stock, convertible debentures, the exercise of warrants and the Inducement Shares) was converted to .771 shares of Pet DRx common stock;

• Pet DRx reserved approximately 3.16 million of additional shares of common stock for future issuance upon the exercise of outstanding options and warrants and the conversion of convertible notes previously issued by XLNT;

• Pet DRx placed approximately 1.6 million shares of common stock into escrow to satisfy any indemnification claims that may arise from such Merger;

• Certain executives of the Company were granted options to purchase 424,480 shares of the Company’s common stock in the aggregate at an exercise price of $6.70 per share in accordance with the terms of their respective employment agreements; and

• The stockholders of Pet DRx approved the 2007 Stock Incentive Plan.

6

4. Goodwill and Other Intangible Assets

     Goodwill represents the excess of the cost of an acquired entity over the net of the fair value of identifiable assets acquired and liabilities assumed. The goodwill balance at June 30, 2008 was $49.2 million. No adjustments were made to goodwill during the three or six month period ended June 30, 2008.

     In addition to goodwill, we had amortizable intangible assets at June 30, 2008 and December 31, 2007 as follows (in thousands):

	As of June 30, 2008							As of December 31, 2007
	Gross					Net		Gross					Net
	Carrying		Accumulated			Carrying		Carrying		Accumulated			Carrying
	Amount		Amortization			Amount		Amount		Amortization			Amount
Covenants not-to-compete	$	323	$	(190	)	$	133	$	323	$	(140	)	$	183
Non-contractual customer relationships		7,975		(1,401	)		6,574		7,975		(1,013	)		6,962
Total	$	8,298	$	(1,591	)	$	6,707	$	8,298	$	(1,153	)	$	7,145

     Amortization expense related to intangible assets was approximately $0.2 million and $0.4 million for the three month and six month periods ended June 30, 2008, respectively, and was $0.2 million and $0.4 million for the three and six month periods ended June 30, 2007, respectively.

     The estimated amortization expense related to intangible assets for each of the five succeeding years and thereafter as of June 30, 2008 is as follows (in thousands):

Remainder of 2008	$	436
2009		851
2010		736
2011		776
2012		776
Thereafter		3,132
Total	$	6,707

5. Property and Equipment

     Property and equipment, net at June 30, 2008 and December 31, 2007 is as follows (in thousands):

	June 30,			December 31,
	2008			2007
Buildings	$	4,177		$	4,177
Leasehold improvements		570			524
Equipment		2,579			2,484
Furniture and equipment		605			402
Computer equipment & software		2,012			1,639
Construction-in-progress		74			—
Total property and equipment		10,017			9,226
Less-accumulated depreciation and amortization		(1,912	)		(1,339	)
Total property and equipment, net	$	8,105		$	7,887

7

     Depreciation and amortization expense, including the amortization of property under capital leases, for the three and six months ended June 30, 2008 was $0.3 and $0.6 million, respectively and was $0.2 million and $0.5 million, for the three and six months ended June 30, 2007, respectively.

6. Long-Term Obligations

     Long-term obligations consisted of the following at June 30, 2008 and December 31, 2007 (in thousands):

		June 30,			December 31,
		2008			2007
Convertible notes	Convertible notes payable, maturing from
	2010 to 2012, secured by assets and stock
	of certain subsidiaries, various interest
	rates ranging from 6.0% to 12.0% (net of
	debt discount)	$	3,097		$	11,292
Promissory notes	Notes payable, maturing from 2008 to
	2012, secured by assets and stock of
	certain subsidiaries, various interest rates
	ranging from 6.5% to 15.0% (net of debt
	discount)		7,845			22,900
Earn-out notes	Notes payable, various maturities through
	2010, interest rates ranging from none
	to 6.5%		176			234
	Total debt obligations		11,118			34,426
	Less-current portion, net of debt discount		(2,320	)		(1,533	)
	Long-term portion	$	8,798		$	32,893

     The future payments under long-term obligations as of June 30, 2008 are as follows:

Remainder of 2008	$	1,204
2009		2,216
2010		4,377
2011		1,715
2012		1,680
Thereafter		45
Total	$	11,237

Convertible Notes

     On January 4, 2008, in conjunction with the Merger with XLNT, several of the convertible note holders, including St. Cloud Capital Partners, L.P., converted approximately $8.3 million of their notes to 1,721,153 shares of XLNT common stock in accordance with their agreements. The debt discount related to the St. Cloud Capital Partners, L.P. convertible note of approximately $0.1 million was charged to interest expense in the condensed consolidated statement of operations in the first quarter of 2008.

8

Amendment to Credit Agreement for $12.0 million term loan with Fifth Street

     On February 19, 2008, XLNT entered into the First Amendment (the “First Amendment”) dated as of February 19, 2008 to Credit Agreement and Loan Documents dated as of March 29, 2007 with Fifth Street Mezzanine Partners II, L.P. (“Fifth Street”). The $12.0 million term loan made pursuant to this credit agreement was secured by the inventory, chattel paper, accounts receivable, equipment and general intangibles of the Company and matured on March 8, 2010, with a one-time option at the election of the Company to renew for an additional year. The First Amendment, among other things, changed the interest rate on the term loan from 12.0% to 15.0%, beginning March 1, 2008. The additional 3% interest accrued and was added to the principal balance of the loan. The First Amendment also modified the financial covenants and ratios required under the credit agreement and waived the Company’s default of the prior financial covenants and ratios for the fiscal quarter ending December 31, 2007 and the Company’s requirement for financial covenants and ratios for the fiscal quarter ending March 31, 2008. Upon execution of the First Amendment, the Company paid Fifth Street a $120,000 restructuring fee which was deferred to Other Assets in the accompanying condensed balance sheet.

     In connection with the First Amendment, Pet DRx entered into a an amended Security Agreement (the “Security Agreement”) dated February 19, 2008 with Fifth Street whereby Pet DRx granted Fifth Street a security interest in all of its assets.

     Amendment to Credit Agreement for $4.0 million term loan with Fifth Street

     On February 19, 2008, XLNT and Fifth Street entered into the Second Amendment (the “Second Amendment”) dated as of February 19, 2008 to Credit Agreement and Loan Documents dated June 29, 2007 and as amended by the First Amendment dated November 27, 2007. The $4.0 million term loan made pursuant to this credit agreement was secured by certain real estate owned by the Company and matured on March 8, 2010. The Second Amendment, among other things, changed the interest rate on the term loan from 12.0% to 15.0%, beginning March 1, 2008. The additional interest accrued and was added to the principal balance of the loan. The Second Amendment also modified the financial covenants and ratios required under the Credit Agreement and waived the Company’s default of the prior financial covenants and ratios for the fiscal quarter ending December 31, 2007 and the Company’s requirement for financial covenants and ratios for the fiscal quarter ending March 31, 2008. Upon execution of the Second Amendment, the Company paid Fifth Street a $36,381 restructuring fee, which was deferred to Other Assets in the accompanying condensed balance sheet.

     Retirement of term loans with Fifth Street

     On June 12, 2008, the Company elected to prepay its $4.0 million Credit Agreement with Fifth Street and paid $3.7 million for all outstanding principal, interest, and fees. No early termination payments were incurred as a result of the termination. As a result of the payoff, the Company recorded a one-time charge to interest expense of $0.3 million to eliminate its remaining debt discount related to this loan in the accompanying condensed statement of operations.

     On June 30, 2008, the Company elected to prepay its $12.0 million Credit Agreement with Fifth Street and paid $12.5 million for all outstanding principal, interest, and fees. Also included in that payoff amount was a one-time pre-payment penalty of $0.2 million, which was recorded to interest expense in the accompanying condensed consolidated statement of operations. Additionally, as a result of the payoff, the Company recorded a one-time charge to interest expense of $1.1 million to eliminate its remaining debt discount related to this loan in the accompanying condensed statement of operations.

     Additionally, as a result of the payoff of these loans, the Company also recorded a one-time charge to interest expense in the amount of approximately $0.2 million in the accompanying condensed statement of operations to eliminate the deferred debt amendment costs described above that had been recorded in Other Assets in the accompanying condensed balance sheet.

     Retirement of partial term loan to satisfy related party receivable

     During the second quarter of 2008, the Company agreed to retire approximately $16,000 of a term loan owed to a related party in exchange as payment for a receivable owed from that party to the Company.

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7. Stockholders’ Equity

     In conjunction with the Merger on January 4, 2008, each share of XLNT’s Series A convertible preferred stock was converted to one share of XLNT common stock and each share of XLNT’s Series B convertible preferred stock was converted to 100 shares of XLNT common stock. In addition, approximately $8.3 million of convertible notes were converted to 1,721,153 shares of XLNT common stock. See Note 6 for further information. Additionally, a holder of XLNT’s Series B warrants exercised a warrant for 1,647 shares of Series B convertible preferred stock of XLNT, which was subsequently converted to XLNT common stock at a 1:100 ratio. As well, XLNT issued 416,728 shares of XLNT common stock to certain investors who purchased shares of Echo common stock in privately negotiated transactions with various Echo stockholders who were stockholders of Echo as of the record date for Echo’s Special Meeting of Stockholders and who had voted against the Merger and submitted their shares for conversion (the “Inducement Shares”).

     Following these conversions, exercises and issuances, each outstanding share of XLNT common stock was converted to 0.771 shares of Pet DRx common stock.

     As of June 30, 2008, there were 90,000,000 shares of common stock of Pet DRx authorized and 23,659,037 shares outstanding.

Common Stock Warrants

     The Company has issued warrants to purchase common shares of the Company either as compensation for consultants and vendors or as additional incentive for investors and lenders. The value of warrants issued for compensation is accounted for as a non-cash expense to the Company at the fair value of the warrants issued. The value of warrants issued in conjunction with financing events is either a reduction in paid-in capital for common issuances or as a discount for debt issuances. The Company values the warrants at fair value as calculated by using the Modified Black-Scholes-Merton option-pricing model. At December 31, 2007, the Company had 1,258,994 common stock warrants at a weighted average price of $2.50, which upon the Merger occurring, were converted to 970,684 Pet DRx common stock warrants at a weighted average price of $3.24.

     In conjunction with the Merger, 90,300 of Series B preferred stock warrants were converted to 69,621 of Pet DRx common stock warrants.

     On April 7, 2008, Fifth Street exercised 57,825 of its warrants into 56,383 shares of common stock in a cashless exercise.

     The following table summarizes all activities of common stock warrants during the six month period ended June 30, 2008:

	Number of
	Common			Weighted
	Stock			Average
	Warrants			Price
Outstanding, December 31, 2007		970,684		$	3.24
Pet DRx warrants assumed in Merger		7,645,833			6.00
Granted		—			—
Series B Preferred Stock warrants converted to common stock warrants		69,621			0.00
Exercised		—			—
Cancelled		—			—
Outstanding, March 31, 2008		8,686,138		$	5.64
Granted		—
Exercised		(57,825	)		0.00
Cancelled		—
Outstanding and Exercisable, June 30, 2008		8,628,313		$	5.68

10

     The following table summarizes information about the warrants outstanding at June 30, 2008:

			Remaining
			Contractual
Exercise	Warrants		Life
Price	Outstanding		(years)
$2.72		168,459		7.33
$3.11		740,160		7.58
$6.00		7,645,833		1.75
$6.16		62,065		9.25
$0.00		11,796		8.88
		8,628,313

8. Calculation of Loss Per Common Share

     Basic and diluted net loss per share is presented in conformity with FASB’s SFAS 128, “Earnings Per Share”, for all periods presented. Basic net loss per share excludes dilution and is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted net loss per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shares in the losses of the Company.

     The following common stock equivalents were excluded from the calculation of diluted loss per share since their effect would have been anti-dilutive (in thousands):

	Three Months Ended
	June 30
	2008		2007
Convertible debenture notes, if converted to common stock		372		1,735
Warrants for common stock		8,628		908
Warrants for preferred stock, if exercised and converted to common stock		—		173
Preferred shares, if converted to common stock		—		10,153
Options for common stock		2,651		355
Total		11,651		13,324

     Options and warrants, had they been dilutive, would have been included in the computation of diluted net loss per share using the treasury stock method.

     Basic and diluted loss per common share was calculated as follows (in thousands, except per share amounts):

	Three Months Ended						Six Months Ended
	June 30						June 30
	2008			2007			2008			2007
Net loss		($5,237	)		($3,267	)		($8,265	)		($5,801	)
Weighted average common shares outstanding:
Basic		23,655			4,248			23,204			3,998
Effect of dilutive common stock equivalents		—			—			—			—
Diluted		23,655			4,248			23,204			3,998
Basic and diluted loss per common share		($0.22	)		($0.77	)		($0.36	)		($1.45	)

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9. Share-Based Compensation

     We account for stock options granted to nonemployees on a fair-value basis in accordance with Emerging Issues Task Force Abstract No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. As a result, the amount of share-based compensation expense recorded for nonemployee options with vesting or other performance criteria is affected each reporting period by changes in the estimated fair value of our common stock.

     Effective January 1, 2006, we adopted SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123(R)”), which requires 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 SFAS No. 123(R) 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.

     SFAS No. 123(R) 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 SFAS No. 123(R), we did not recognize any income tax benefits resulting from the exercise of stock options.

     On December 28, 2007, the Securities and Exchange Commission (“SEC”) staff published Staff Accounting Bulletin No. 110 (SAB 110), which updates SAB 107 and provides the SEC staff’s views on a variety of matters relating to stock-based payments. SAB 110 requires stock-based compensation to be classified in the same expense line items as cash compensation. Information about stock-based compensation included in the results of operations for the three and six months ended June 30, 2008 and 2007 is as follows (in thousands):

	Three Months Ended				Six Months Ended
	June 30				June 30
	2008		2007		2008		2007
Direct costs	$	25	$	5	$	41	$	7
Selling, general and administrative and marketing	$	379	$	78	$	632	$	96
Total	$	404	$	83	$	673	$	103

Stock Option Activity

     A summary of our stock option activity is as follows (in thousands, except weighted-average exercise price and weighted-average remaining contractual life):

									Weighted
	Stock								Average
	Options						Weighted		Remaining
	Available			Stock			Average		Contractual		Aggregate
	for			Options			Exercise		Life		Intrinsic
	Grant			Outstanding			Price		(years)		Value
Balance as of December 31, 2007		487			1,618		$	5.40		9.40	$	22
Authorized under Pet DRx 2007 Stock Incentive Plan		2,700			—
Granted		(1,082	)		1,082			6.56
Exercised		—			—			—
Forfeited or canceled		15			(15	)		6.16
Balance as of March 31, 2008		2,120			2,685		$	5.85		9.49	$	375
Authorized		—			—			—
Granted		(8	)		8			6.50
Exercised		—			—			—
Forfeited or canceled		41			(41	)		6.16
Balance as of June 30, 2008		2,153			2,652		$	5.85		9.38	$	187
Exercisable at June 30, 2008		—			241		$	5.97		9.13	$	26

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     The following table summarizes information about the options outstanding at June 30, 2008 (in thousands, except exercise prices and the weighted average remaining contractual life):

					Weighted
					Average		Weighted				Weighted
			Number		Remaining		Average		Number		Average
Range of			Outstanding		Contractual Life		Exercise		Exercisable		Exercise
Exercise Prices			As of 06/30/08		(years)		Price		As of 06/30/08		Price
$2.17	$	2.17		21		6.79	$	2.17		16	$	2.17
$3.11	$	3.11		15		7.72	$	3.11		8	$	3.11
$3.18	$	3.18		347		9.42	$	3.18		0	$	0.00
$5.71	$	5.71		163		8.16	$	5.71		41	$	5.71
$6.16	$	6.16		1,015		9.33	$	6.16		13	$	6.16
$6.26	$	6.26		80		9.63	$	6.26		0	$	0.00
$6.50	$	6.50		587		9.78	$	6.50		151	$	6.50
$6.70	$	6.70		424		9.53	$	6.70		12	$	6.70
$2.17	$	6.70		2,652		9.38	$	5.85		241	$	5.97

     As of June 30, 2008, there was $3.1 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements related to stock options consisting of $3.1 million related to employee and director grants and approximately $12,000 related to consultant grants. The costs are expected to be recognized over a weighted-average period of 2.4 years.

Calculation of Fair Value

     The fair value of options granted to employees is estimated on the date of grant using the Black-Scholes option pricing model. We amortize the fair value of employee options on a straight-line basis over the requisite service period. The fair value of options to nonemployees is estimated throughout the requisite service period using the Black-Scholes option pricing model and the amount of share-based compensation expense recorded is affected each reporting period by changes in the estimated fair value of the underlying common stock until the options vest.

     The following assumptions were used to determine the fair value of those options valued during the three months ended June 30, 2008 and year ended December 31, 2007:

	Three months
	ended			Year ended
	June 30,			December 31,
	2008			2007
Weighted-average volatility (1)		44.5	%		46.0	%
Expected dividends		0.0	%		0.0	%
Expected term — employees (2)	5.5 years			6.1 years
Expected term — nonemployees (2)	10.0 years			10.0 years
Risk-free rate — employees (3)		3.3	%		4.4%-4.8	%
Risk-free rate — nonemployees		3.5	%		4.5%-5.2	%

(1)	In 2007 and 2008, we estimated the volatility of our common stock on the valuation date based on historical volatility of the common stock of a peer group of public companies as the Company has limited stock price history and it would not be practical to use internal volatility.
(2)	The expected term represents the period of time that we expect the options to be outstanding. We estimate the expected term for employees based on the simplified method permitted under SAB No. 110. The expected term presented for nonemployees is based upon option expiration date at the date of grant.
(3)	The risk-free interest rate is based on the implied yield in effect on U.S. Treasury zero-coupon issues with equivalent remaining terms.

     We use historical data to estimate pre-vesting option forfeitures. We recognize share-based compensation only for those awards that we expect to vest.

10. Contingencies

     From time to time, the Company is involved in legal and administrative disputes and proceedings arising in the ordinary course of business, which management believes are not material to the conduct of the Company’s business. With respect to these ordinary matters, management believes that the Company has made adequate accruals for related costs.

11. Subsequent Events

     On July 11, 2008, the Company acquired all of the stock of Valley Animal Medical Center (“Valley Animal”) for a total purchase price of $4.8 million. The Company paid $2.9 million in cash upon closing and assumed $1.9 million of convertible promissory notes, bearing a 7% interest rate, which are convertible into Pet DRx common stock at $6.50 per share. The effective date of the acquisition was July 1, 2008. Annual revenues from Valley Animal are expected to be in excess of $4 million. In conjunction with the acquisition, the Company capitalized approximately $16,000 of outside legal fees to Other Assets in the accompanying condensed consolidated balance sheet at June 30, 2008.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

     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 thisForm 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. Some factors that may cause our plans, expectations, future financial condition and results to change are described under the heading “Risk Factors” in Item 2.01 of our Current Report onForm 8-K/A (Amendment No. 1) filed on April 4, 2008.

     The forward-looking information set forth in this Quarterly Report onForm 10-Q is as of June 30, 2008, 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 June 30, 2008 at the SEC’s website atwww.sec.gov.

Overview

Merger with XLNT Veterinary Care, Inc.

     Pursuant to the Second Amended and Restated Agreement and Plan of Merger dated October 23, 2007 (the “Merger Agreement”), on January 4, 2008, a wholly-owned subsidiary of Echo Healthcare Acquisition Corp. (“Echo”) merged (the “Merger”) with and into XLNT Veterinary Care, Inc. (“XLNT”), with XLNT surviving as a wholly-owned subsidiary of Echo. In conjunction with the Merger, Echo changed its name to Pet DRx Corporation. As a result of the Merger, the Company received approximately $36.3 million in proceeds from capital that was raised through the initial public offering of Echo in 2006, net of certain costs incurred in connection with completing the Merger.

     The Merger was accounted for under the reverse acquisition application of the equity recapitalization method of accounting in accordance with U.S. generally accepted accounting principles for accounting and financial reporting purposes. Under this method of accounting, Pet DRx was treated as the “acquired” company for financial reporting purposes. See Note 3 to the condensed consolidated financial statements. Accordingly, following the Merger, the consolidated financial statements of the Company depict the operating results of XLNT, including the acquisition of Echo from the date of the consummation of the Merger, and include the historical financial statements from prior year periods of XLNT without regard for the financial statements of Echo for such prior periods. All common stock share amounts for all periods presented have been adjusted to reflect the Merger. Acquisition expenses incurred by XLNT were recorded as equity and those incurred by Pet DRx were charged to expense. During the second quarter ended June 30, 2008, the Company recorded an additional $56,000 of trailing Merger-related expenses to additional paid-in capital.

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General

     We are a provider of primary and specialty care veterinary services to companion animals through a network of fully-owned veterinary hospitals. As of June 30, 2008, we owned and operated twenty-four veterinary hospitals in the State of California.

     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. We offer a full range of general medical treatment for pets, including (i) preventative care, such as vaccinations, examinations, spaying, 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, and other services.

     We are developing “hub and spoke” systems, whereby we will develop larger, fully equipped veterinary hospitals, providing a wide range of medical, diagnostic and non-medical services at the “hub,” and use traditional smaller general practices as “spokes” to feed patients to the “hub” units desiring the broader array of more specialized services that a general practice is not equipped to provide. We also intend to enter into affiliate relationships with veterinary hospitals not owned by us that may become “feeder spokes” for our “hub” units.

     In June 2008, the Company consolidated four of its animal hospitals into two locations. As a result, the Company recorded approximately $0.1 million of exit-related costs in the accompanying condensed statement of operations. However, the Company does expect to see a favorable impact in the second half of 2008 to hospital margins through reduced staff and occupancy costs.

Seasonality

     The practice of veterinary medicine is subject to seasonal fluctuation. In particular, demand for veterinary services is significantly 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.

Overview of Our Financial Results

     The first six months of 2008 was a period of significant change for us. Following the completion of the Merger and the hiring of a new senior management team, we began to implement certain practices which we believe will allow the Company to grow more profitably both in the near and long-term. Centralization of purchasing and beginning to align staff costs appropriately were both contributing factors to improved same-store hospital contribution margins in the first six months of 2008. Future improvements in these areas, combined with the establishment of an acquisition pipeline, are factors that we believe will lead to an increase in profitability for Pet DRx. While the veterinarian industry is somewhat resistant to economic downturns, we have experienced a small reduction in foot traffic into our hospitals during this six month period ended June 30, 2008, which we believe is directly tied to the current recessionary-like economy in the United States.

     For the three month period ended June 30, 2008, net revenue was $17.9 million, an increase of 1% over the same time period in the prior year. The net loss for the three month period ended June 30, 2008 was ($5.2 million), an increase of 60% over the three months ended June 30, 2007. Basic and diluted net loss per share was ($.22) for the three months ended June 30, 2008 and was ($.55) less than the basic and diluted net loss per share for the same time period in the prior year.

     For the six month period ended June 30, 2008, net revenue was $35.8 million, an increase of 26% over the same time period in the prior year. The net loss for the six month period ended June 30, 2008 was ($8.3 million), an increase of 42% over the six months ended June 30, 2007. Basic and diluted net loss per share was ($.36) for the six months ended June 30, 2008 and was ($1.09) less than the basic and diluted net loss per share for the same time period in the prior year.

     The revenue increase in the first three and six months of 2008 versus 2007 was primarily due to the acquisition of six veterinary hospitals late in the first quarter of 2007. Additionally, a price increase in the first

15

quarter of 2008 has overcome a small reduction in volume leading to positive same store revenue growth. The increase in net loss was primarily a result of an increase in direct costs due to the six acquisitions that were made late in the first quarter last year and were owned for a full six months in 2008, increased SG&A costs as a result of the Company building its infrastructure and relocating its headquarters from San Jose, California to Brentwood, TN, and higher interest expense as a result of one-time charges to interest expense related to the payoff of the loan with Fifth Street in June 2008, offset by higher revenues from the six acquisitions mentioned previously. Net loss per share decreased primarily due to the increased number of common shares outstanding as a result of the Merger.

     Cash used in operations for the six months ended June 30, 2008 was $10.7 million as opposed to cash provided by operations in the first six months ended June 30, 2007 of $0.1 million. The cash used in operations during the six months ended June 30, 2008 was primarily due to the net loss of $8.3 million incurred in that time period and the payments of $5.8 million of past due accounts payable when the Company was funded from the Merger during the first quarter of 2008. Cash provided by operations in the first quarter of 2007 was a result of the Company building up its payables and other accrued expenses during the quarter offset by a loss of $5.8 million in that time period. Cash used in investing activities during the first six months of 2008 was primarily for purchases of equipment for various hospitals. Cash used in investing activities during the same time period a year ago primarily was for the six acquisitions made during the first quarter of 2007 and capital purchases for those businesses. Additionally, $4.0 million was invested to settle up outstanding amounts from previous acquisitions. Cash provided by financing activities in the first six months of 2008 was principally the result of the $36.3 million of net proceeds received on January 4, 2008 when the Company completed the Merger, offset by payments on term notes and capital leases including the payoff of all outstanding amounts under the Fifth Street Loans. See Note 6 in the accompanying condensed consolidated financial statements. Cash provided by financing activities in the first six months of 2007 was from the $14.0 million net proceeds from the issuances of the $12 million and $3 million notes with Fifth Street Mezzanine Partners II, L.P. and $13.6 million from the issuance of Series B preferred stock, offset by payments on certain term loans.

     We had a working capital surplus of $3.7 million at June 30, 2008 as compared to a working capital deficit of $10.1 million at December 31, 2007. The June 30, 2008 working capital was favorably impacted because of the net proceeds received from the completion of the Merger offset by the payoff of the Fifth Street Loans and the loss from operations incurred in the first six months of 2008.

Results of Our Operations

Three and Six Months Ended June 30, 2008 and 2007

Revenue

	For The Three Months ended							For The Six Months ended
	June 30,							June 30,
					%							%
	2008		2007		Change			2008		2007		Change
	(In millions, except percentages)							(In millions, except percentages)
Revenues	$	17.9	$	17.7		1.1	%	$	35.8	$	28.4		25.9	%

     Revenues for the three months ended June 30, 2008 were up approximately $0.2 million or 1.1% compared to the same three month period one year ago primarily due to pricing increases that took effect during the first quarter of 2008, offset by a small decrease in volume. Further decreasing our organic growth rate was the loss of practicing veterinarians and increased competition from nearby hospitals at one of our hospital locations. Our growth rate, not including this one location, was 3.2%. The large increase in revenue for the six months ended June 30, 2008 of $7.4 million or 25.9% primarily related the acquisition of six animal hospitals acquired during the end of the first quarter of 2007 coupled with the aforementioned price increase in the first quarter of 2008.

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	Comparative Analysis Three							Comparative Analysis Six
	months ended							months ended
					%							%
	2008		2007		Change			2008		2007		Change
	In millions, except percentages)							(In millions, except percentages)
Same-store revenue (1)	$	9.7	$	9.6		1	%	$	19.4	$	19.0		2	%
Net acquired revenue (2)	$	8.2	$	8.1		1	%	$	16.4	$	9.4		74	%
Total	$	17.9	$	17.7		1	%	$	35.8	$	28.4		26	%

(1)	Same-store revenue was calculated using animal hospital operating results for the 18 animal hospitals that we owned for the full six month period ended June 30, 2007.
(2)	Net acquired revenue represents the revenue from the six animal hospitals acquired during the three month period ended March 31, 2007. Fluctuations in net acquired revenue occur due to the volume, size and timing of acquisitions during the three months ended March 31, 2007.

Same-store revenue growth resulted primarily from increased pricing. Prices are reviewed periodically throughout the year for each hospital and adjustments are made based on market considerations, demographics and our costs.

Direct Costs

	For The Three Months Ended									For The Six Months Ended
	June 30,									June 30,
							%									%
	2008			2007			Change			2008			2007			Change
	(In millions, except percentages)									(In millions, except percentages)
Total direct costs	$	16.6		$	16.9			(2	%)	$	32.8		$	27.2			20	%
Hospital Contribution Margin as a percentage of total net revenue		7.1	%		4.5	%					8.3	%		4.2	%

     Direct costs decreased $0.3 million or 2% in the three month period ended June 30, 2008 as compared to the same time period in 2007. The decrease in direct costs was primarily due to a 6.7% decrease in cost of goods sold due to the centralization of purchasing in the first quarter of 2008, a 4.8% decrease in staff payroll due to the reduced headcount at the hospitals and a large reduction in professional and other outside contractor fees at the hospital locations. These decreases were offset somewhat by a 7.3% increase in veterinary payroll costs due to timing of payments and an 18.8% increase in occupancy costs. The increase in direct costs for the six month time period ended June 30, 2008 versus June 30, 2007, was primarily the result of additional costs associated with the six veterinary hospitals acquired late in the first quarter of 2007, which accounted for an increase of $6.6 million. Offsetting this increase was a decrease in same-store direct costs of $1.0 million. This decrease was 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 and led to an 11.6% decrease in cost of goods sold. Further

17

decreasing same-store direct costs was a decrease in hospital staff costs as management has continued to align staff costs to be consistent with the industry standard.

     Further reductions in staff costs in the second half of the year along with the consolidation of four of our hospitals into two will allow the Company to continue to see improvement in hospital contribution margin through the remainder of 2008.

Selling, General and Administrative

	For The Three Months									For The Six Months
	Ended June 30,									Ended June 30,
							%									%
	2008			2007			Change			2008			2007			Change
	(In millions, except percentages)									(In millions, except percentages)
Selling, general and administrative	$	3.9		$	3.0			31	%	$	7.7		$	5.6			38	%
As a percentage of total net revenue		22.0	%		16.7	%					21.6	%		19.6	%

     SG&A increased $0.9 million, or 31%, for the three months ended June 30, 2008 as compared to the same time period in the prior year, resulting primarily from expansion of corporate staff costs in the fourth quarter of 2007 as a result of the Company building its corporate infrastructure to support both current and future operations and costs associated with being a public company. Management feels it now substantially has the appropriate infrastructure in place and that the acquisition of new animal hospitals will not likely demand that the Company hire significant personnel in the near term. Further increasing corporate SG&A expense was the large quarter over quarter increase resulting from non-cash stock compensation expense arising from the large grants of options to certain member of the Board of Directors during the first quarter of 2008. Offsetting these increases was a large decrease in professional fees as the Company completed its Merger on January 4, 2008 and was no longer incurring professional fees associated with that transaction in the three month period ended June 30, 2008.

     SG&A costs for the six month period ended June 30, 2008 compared to the same time period one year ago was largely due to the duplicative staff costs incurred during the first quarter of 2008 as the Company moved its headquarters to Brentwood, TN from San Jose, CA, the build-out of the Company’s infrastructure, and the increased non-cash stock compensation expenses offset by the substantial decrease in professional fees that were largely incurred in 2007 in preparation of the Merger.

Interest income

	For The Three Months									For The Six Months
	Ended June 30,									Ended June 30,
							%									%
	2008			2007			Change			2008			2007			Change
	(In millions, except percentages)									(In millions, except percentages)
Interest income	$	0.1		$	0.0			332	%	$	0.3		$	0.1			345	%
As a percentage of total net revenue		0.7	%		0.1	%					0.9	%		0.3	%

     The increase in interest income for the three and six months ended June 30, 2008 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 those time periods primarily driven by the $36.3 million in net proceeds received from the Merger with Echo on January 4, 2008.

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Interest Expense

	For The Three Months									For The Six Months
	Ended June 30,									Ended June 30,
							%									%
	2008			2007			Change			2008			2007			Change
	(In millions, except percentages)									(In millions, except percentages)
Interest expense	$	2.7		$	1.1			142	%	$	3.9		$	1.5			163	%
As a percentage of total net revenue		15.3	%		6.4	%					10.9	%		5.2	%

     Interest expense for both the three and six month period ended June 30, 2008 increased as compared to the same time periods one year ago primarily due to the interest expense incurred on the $16.0 million of debt that we borrowed in late first quarter 2007 from Fifth Street Mezzanine Partners II, L.P. Additionally, due to the payoff of all loans with Fifth Street in June 2008, the Company had to record a one-time charge of $1.4 million to interest expense to eliminate the debt discounts associated with those loans as well as a $0.2 million charge related to the write-off of the debt amendment costs incurred in February 2008. Finally, the Company incurred a $0.2 million prepayment penalty on the $12 million loan and charged that to interest expense in the accompanying condensed consolidated statement of operations as well.

Liquidity and Capital Resources

     As of June 30, 2008, we had cash and cash equivalents of $9.0 million and working capital of $3.7 million. Management believes that the Company has sufficient cash to meet its operating needs for 2008, subject to the number of acquisitions that it intends to close during the year.

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 purchase of inventory, and costs associated with outside support and services.

     Cash used in operating activities for the first six months of 2008 was $10.7 million as opposed to cash that was provided by operating activities in the same time period one year ago of $0.1 million. The $10.7 million of net cash used in operating activities for the first six months of 2008 resulted from the $8.3 million net loss, $5.8 million decrease in accounts payable as the Company paid its large balance down with the net proceeds received in the Merger with XLNT, and a $0.5 million decrease in accrued payroll and other expenses. These fluctuations were offset somewhat by the $1.1 million, $1.8 million and $0.7 million of non-cash expenses from depreciation and amortization, amortization of debt discounts and stock-based compensation, respectively. The net cash provided by operating activities in the first six months of 2007 was a result of an increase in accounts payable and accrued expenses of $4.0 million and $0.8 million, respectively and $0.9 million of non-cash expenses from depreciation and amortization, offset by a $5.8 million net loss for period.

Cash Flows from Investing Activities

     Cash used in investing activities of $1.3 million during the first six months of 2008 was primarily for purchases of equipment at various hospital locations. Cash used in investing activities for the first six months of 2007 was due to the $16.8 million of net cash used to acquire six veterinary hospitals during the first quarter of 2007, $4.6 million of cash used to purchase capital expenditures during the six month period ended June 30, 2007 and an additional $3.9 million of payments made to settle up previous acquisitions.

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Acquisition Program

     Effective July 1, 2008, the Company closed on its first successful acquisition of 2008 when it acquired 100% of the stock of Valley Animal Medical Center. This acquisition in the Coachella Valley further gives Pet DRx a significant position and an enhancement in its “hub and spoke” strategy in that market bringing the total number of hospitals in the region to eight.

     While we continue to acquire veterinary clinics in the California markets, we continue to look in other regions of the United States as well.

     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. Typically, we target “spoke” acquisition candidates with annual revenues in excess of $1.0 million and “hub” acquisition candidates with annual revenues in excess of $4.0 million.

     The consideration paid in our acquisitions may consist of cash, common stock, warrants and/or debentures, including convertible debentures.

Cash Flows from Financing Activities

     Cash provided by financing activities during the first six months of 2008 was primarily attributable to the $36.3 million of net proceeds received from the Merger, offset by $16.8 million of payments on term notes primarily relating to the payoff of all outstanding borrowed amounts from Fifth Street, $0.2 million of payments to Fifth Street Mezzanine Partners II, L.P. in association with the amendment of their loans to us, and $0.2 million of payments made on certain capital leases. Cash provided by financing activities in the first six months of 2007 principally consisted of net proceeds of $14.0 million from the issuance of the $12 million term loan and additional $3 million loan with Fifth Street Mezzanine Partners II, L.P. in March 2007 and June 2007, respectively, $13.6 million from the net proceeds obtained from the issuance of shares of Series B convertible preferred stock, offset by $1.2 million of payments made on other term loans, and $0.2 million of payments made on capital leases.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

     Not Applicable.

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Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

     We carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, regarding the effectiveness of the design and operation of our disclosure controls and procedures. Based upon this evaluation, our principal executive officer and principal financial officer concluded, as of the end of the period covered by this Quarterly Report on Form 10-Q, June 30, 2008, that our disclosure controls and procedures were effective.

Internal Control over Financial Reporting

     On January 4, 2008, we completed the Merger, pursuant to which XLNT became a wholly-owned subsidiary of Echo and Echo changed its name to Pet DRx. See Note 3 to the condensed consolidated financial statements contained in Part I, Item 1 of this Quarterly Report on Form 10-Q for further details relating to the Merger.

     Because XLNT was a private company until the consummation of the Merger, XLNT was not required to comply with Section 404 of the Sarbanes-Oxley Act of 2002, and was therefore not required to make an assessment of the effectiveness of its internal control over financial reporting. As a private company, XLNT was also not required to maintain disclosure controls and procedures. Further, its independent registered public accounting firm was not engaged to express, nor has it expressed, an opinion on the effectiveness of XLNT’s internal control over financial reporting. However, in connection with the audits of XLNT’s consolidated financial statements for the years ended December 31, 2007 and 2006, XLNT’s independent registered public accounting firm informed XLNT that it had identified material weaknesses in XLNT’s internal control over financial reporting. See “Risk Factors — The Company’s management and auditors have identified material weaknesses and a significant deficiency in XLNT’s internal controls that, if not properly remediated, could result in material misstatements in the financial statements of the Company and the inability of management to provide its report on the effectiveness of the Company’s internal controls as required by the Sarbanes-Oxley Act of 2002, either of which could cause investors to lose confidence in our reported financial information and have a negative effect on the trading price of our stock” in Item 2.01 of our Current Report on Form 8-K/A (Amendment No. 1) filed on April 4, 2008.

     As a result of the Merger, our recently hired accounting staff and new management team are currently in the process of assessing and integrating XLNT’s internal control over financial reporting. Accordingly, certain changes have been made and will continue to be made to our internal control over financial reporting until such time as this integration is complete. There have been no other changes in our internal control over financial reporting that occurred during the second fiscal quarter of 2008 that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II: OTHER INFORMATION

Item 1. Legal Proceedings.

     We are involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our financial position, results of operations or liquidity.

Item 1A. Risk Factors.

     In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in “Item 2.01. Completion of Acquisition or Disposition of Assets — Risk Factors” in our Current Report on Form 8-K/A (Amendment No. 1) filed on April 4, 2008 (the “Form 8-K/A”), which could materially affect our business, financial condition and/or future results. The risks described in our Form 8-K/A are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

     On April 7, 2008, we issued 56,383 shares of common stock of the Company upon the exercise of warrants held by Fifth Street Mezzanine Partners II, L.P. (“Fifth Street”). Fifth Street exercised such warrants on a cashless basis by surrendering its right to receive 1,442 shares of common stock of the Company in lieu of paying the exercise price of $0.10 per share in cash. Each share surrendered was valued at $4.014 per share, representing the average of the closing bid and asked prices of our common stock on the OTC Bulletin Board for the ten trading days prior to the exercise date. The shares of common stock of the Company were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended. No commissions or other remuneration were paid in connection with this issuance.

Item 3. Defaults Upon Senior Securities.

     None.

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

     None.

Item 5. Other Information.

     None.

Item 6. Exhibits.

31.1*	Section 302 Certification from Steven T. Johnson.
31.2*	Section 302 Certification from Gregory J. Eisenhauer.
32.1*	Section 906 Certification from Steven T. Johnson.
32.2*	Section 906 Certification from Gregory J. Eisenhauer.

* Filed or furnished herewith.

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SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	PET DRX CORPORATION
Date: August 14, 2008	By:	/s/ Steven T. Johnson
		Steven T. Johnson
		President and Chief Operating Officer

     Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Name	Position	Date
/s/ Steven T. JohnsonSteven T. Johnson	President and Chief Operating Officer		August 14, 2008
/s/ Gregory J. EisenhauerGregory J. Eisenhauer	Executive Vice President and Chief Financial Officer		August 14, 2008

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EXHIBIT INDEX

31.1*	Section 302 Certification from Steven T. Johnson.
31.2*	Section 302 Certification from Gregory J. Eisenhauer.
32.1*	Section 906 Certification from Steven T. Johnson.
32.2*	Section 906 Certification from Gregory J. Eisenhauer.

* Filed or furnished herewith.

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