The following discussion should be read in conjunction with our consolidated financial statements and notes to those consolidated financial statements, included elsewhere in this Annual Report on Form 10-K. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from our expectations. Factors that could cause such differences include those described in "Risk factors" and elsewhere in this Annual Report on Form 10-K.

Overview

We are a leading distributor of animal health products in the United States and Canada. We sell more than 40,000 products sourced from over 1,500 manufacturers to over 71,000 customers, as well as provide consultative services to our customers in the highly fragmented animal health products industry. Products we distribute include pharmaceuticals, vaccines, parasiticides, diagnostics, capital equipment, sanitizers, devices, supplies, and dairy lagoon treatment systems. Our principal customers are veterinarians, production animal operators and animal health product retailers. We believe our customers purchase from us due to our longstanding relationships with them, knowledge of their businesses, service and ability to assist them in their operations. We have a 325 person sales force, including 221 field sales representatives. We process daily shipments from our central replenishment and distribution facility located in Memphis, Tennessee and 59 distribution locations strategically located in the United States, Canada and Taiwan. Our corporate headquarters is located in the Dallas/Fort Worth metropolitan area.

Key factors and trends that have affected and we believe will continue to affect our operating results include:

• Overall growth in the dairy industry. According to the USDA over the last several years the demand for dairy products has increased. As a result, the demand for production animal health products in the dairy market has increased. We have capitalized on this demand with increased sales of our dairy related production animal health products. We anticipate that this trend of growth in the dairy market will continue in the future and that we will be able to fulfill the corresponding demand for related production animal health products, resulting in increased sales. Notwithstanding the overall historical trend, recently, the significant supply of dairy products, combined with soft demand due to the general economic downturn has decreased the profitability of our dairy customers. Our dairy customer's declining profitability has caused them to limit their spending on dairy related production animal health products, resulting in decreased sales.

• Consolidation by our customers in the dairy industry. The dairy market is undergoing significant consolidation resulting in a shift towards larger operations. According to the USDA, dairies with 500 or more cattle currently account for 58% of the milk producing cow population in the United States, as compared to 24% in 1997. Over the last several years we have leveraged our relationships with larger dairies and our national footprint to gain market share in the dairy-related production animal health products market. We anticipate that this trend of dairy consolidation will continue and we will seek to continue to gain market share.

• Increased focus on companion animal customers. According to Sundale Research, over the last several years the market for companion animal health products has increased to approximately $3.5 billion. We believe this growth has been and will continue to be driven by the following trends:

- widespread ownership of companion animals;

- increased importance of companion animals in households;

- growing awareness of companion animal health and wellness;

- technology migration from the human life science product sector into the practice of veterinary medicine;

- increased marketing programs sponsored by large pharmaceutical and companion animal nutrition companies; and

- prolonged companion animal life spans creating demand for geriatric companion animal care products.

Over the past three years, we have begun to penetrate the urban and suburban veterinarian markets. We believe that by leveraging our centralized procurement and inventory management model we are well positioned to develop a leading cost-to-serve position in the companion animal health products market and to continue to capture market share, resulting in increased sales and profitability. While we believe we are a leader in the companion animal health product market, the market is highly fragmented with numerous national, regional and local distributors, and a few of our competitors with bigger market share have greater financial and other resources than we do.

• Changes in consumer preferences. The demand for production animal health products is heavily dependent upon consumer demand for beef, dairy, poultry and swine. The food industry in general is subject to changing consumer trends, demands and preferences. For example, changes in consumer diets may negatively affect consumer demand for beef, dairy, poultry or swine, and therefore reduce the demand for our production animal health products. During the previous downturns in these markets, we experienced declines in sales.

We generate revenue from our customers in three ways. Over 99% of our revenue is generated through "buy/sell" transactions. The remainder comes from consignment and agency transactions. In the "buy/sell" transactions, we take title to inventory from our manufacturers. We sell products to customers and invoice them. "Buy/sell" transactions are advantageous to us over other sales methods because we take title to the inventory and are able to promote these products on behalf of manufacturers and effectively manage the pricing and distribution of these products. For our consignment sales, we do not take title to the products, but we do stock and ship products to, and invoice customers. For our agency sales, we transmit orders from our customers to our manufacturers. The manufacturer ships the product directly to our customers and compensates us with a commission payment for handling the order from our customer and providing customer service. Manufacturers may occasionally switch between the "buy/sell" and agency methods for particular products. Currently and for the past three fiscal years, only one product with material sales has required treatment as a consignment sale.

Contracts with manufacturers are generally negotiated annually on a calendar year basis. Sales growth goals are negotiated and used to determine rebate achievement. Manufacturer rebates are classified in our accompanying consolidated statements of operations as a reduction of direct cost of products sold. Manufacturer rebates that are based on quarterly, trimester or annual goals have sales performance tracked continually versus the goal, and rebate income is adjusted accordingly when minimum hurdles are achieved.

Results of Operations

The following table summarizes historical results of operations for the period from July 1, 2006 to June 30, 2009, on an actual basis and as a percentage of net sales.

Our gross profit may not be comparable to those of other entities, since some entities include all of the costs related to their distribution network in cost of goods sold and others, like us, report non-direct costs in selling, general, and administrative expenses, and salaries, wages, commissions, and related benefits. Further, the cost of our operations may not decline as rapidly as our decline in net sales, negatively impacting our profitability.

Summary consolidated results of operations table
                                                              Year ended June 30,
(dollars in thousands)                                 2007          2008          2009

Net sales                                            $ 629,534     $ 716,542     $ 666,948

Direct cost of products sold                           507,997       579,485       552,994

Gross profit                                           121,537       137,057       113,954

Selling, general, and administrative expenses
(includes salary, wages,
commission, and related benefits)                       88,117       101,849       100,451
Acquisition costs                                            6            37             3
Depreciation and amortization                            6,504         7,349         8,223
Goodwill impairment                                          -             -        25,164

Operating income (loss)                                 26,910        27,822       (19,887 )

Other income (expense):
Interest expense                                       (18,307 )     (10,277 )      (8,761 )
Other income                                               582           964           786

Income (loss) before income taxes                        9,185        18,509       (27,862 )

Income tax benefit (expense)                            (3,957 )      (7,408 )         734

Net income (loss)                                    $   5,228     $  11,101     $ (27,128 )

Net sales                                                100.0 %       100.0 %       100.0 %

Direct cost of products sold                              80.7 %        80.9 %        82.9 %

Gross profit                                              19.3 %        19.1 %        17.1 %

Selling, general, and administrative expenses
(includes salary, wages,
commission, and related benefits)                         14.0 %        14.2 %        15.1 %
Acquisition costs                                          0.0 %         0.0 %         0.0 %
Depreciation and amortization                              1.0 %         1.0 %         1.2 %
Goodwill impairment                                          -             -           3.8 %

Operating income (loss)                                    4.3 %         3.9 %        -3.0 %

Other income (expense):
Interest expense                                          -2.9 %        -1.4 %        -1.3 %
Other income                                               0.1 %         0.1 %         0.1 %

Income (loss) before income taxes                          1.5 %         2.6 %        -4.2 %

Income tax benefit (expense)                              -0.7 %        -1.0 %         0.1 %

Net income (loss)                                          0.8 %         1.6 %        -4.1 %

Net sales. Net sales decreased $49.6 million, or 6.9%, to $666.9 million for the year ended June 30, 2009, from $716.5 million for the year ended June 30, 2008. The decrease in net sales was primarily attributable to lower spending by production animal customers whose profits have been constrained by fluctuating commodity prices and the general economic slowdown, and was partially offset by $12.2 million of incremental sales from the acquisition of Kane Veterinary Supplies, Ltd. (Kane) in the second quarter of fiscal 2008. The number of field sales representatives decreased to 221 as of June 30, 2009, from 242 as of June 30, 2008, primarily as a result of consolidation of underperforming sales territories.

Gross profit. Gross profit decreased $23.1 million, or 16.9%, to $114.0 million for the year ended June 30, 2009, from $137.1 million for the year ended June 30, 2008. Gross profit as a percentage of sales was 17.1% for the year ended June 30, 2009, compared to 19.1% for the year ended June 30, 2008. The decrease in gross profit resulted from the decline in sales combined with lower gross profit margins driven by declines in manufacturer rebates.

Selling, general, and administrative expenses. Selling, general, and administrative expenses, excluding depreciation and amortization, decreased $1.4 million, or 1.4%, to $100.5 million for the year ended June 30, 2009, from $101.9 million for the year ended June 30, 2008. The decrease was primarily the result of a decrease in variable selling and distribution expenses driven by lower sales volume combined with cost reduction efforts, partially offset by the $2.7 million bad debt provision resulting from a dispute with a manufacturer regarding a rebate receivable and $1.8 million of accelerated stock option expenses resulting from the May 2009 voluntary forfeiture of 1.0 million options by senior management. The $2.7 million bad debt provision, $1.8 million of accelerated stock option expenses, and the fixed nature of certain expenses such as salaries, rent, and computer related costs drove an increase in selling, general and administrative expenses as a percentage of sales from 14.2% for the year ended June 30, 2008, to 15.1% for the year ended June 30, 2009. Without the $2.7 million bad debt provision and the $1.8 million of accelerated stock option expenses, selling, general and administrative expenses as a percentage of sales would have totaled 14.4% for the year ended June 30, 2009.

Depreciation and amortization. Depreciation and amortization increased from $7.3 million for the year ended June 30, 2008, to $8.2 million for the year ended June 30, 2009. The increase results primarily from increased amortization of intangible assets driven by purchase price allocations for the acquisition of Kane.

Goodwill impairment. The Company's stock price and market capitalization declined significantly in the past year, and the Company experienced no growth in the current year and anticipates slower growth rates in the future. These factors are significant to the annual impairment test, and as a result, the Company recorded an impairment charge of $25.2 million as of June 30, 2009, to reduce the carrying value of goodwill.

Other expenses. Other expenses decreased $1.3 million, or 14.4%, to $8.0 million for the year ended June 30, 2009, from $9.3 million for the year ended June 30, 2008. The decrease in other expenses was due to a decrease in interest expense of $1.5 million to $8.8 million in the year ended June 30, 2009, as compared to $10.3 million in the year ended June 30, 2008. This decrease was due to lower average interest rates and less debt outstanding than in the prior year.

Income tax expenses. Income tax expense decreased $8.1 million to a tax benefit of $0.7 million for the year ended June 30, 2009, from a $7.4 million tax expense for the year ended June 30, 2008. Excluding permanent differences resulting from goodwill impairment, stock-based compensation and other non-deductable items, the adjusted effective tax rate was 37.7% and 37.9% for the years ended June 30, 2008 and 2009, respectively.

Fiscal 2008 compared to fiscal 2007

Net sales. Net sales increased $87.0 million, or 13.8%, to $716.5 million for the year ended June 30, 2008, from $629.5 million for the year ended June 30, 2007. The increase in net sales was primarily attributable to $60.2 million, or 69.2%, of sales from seven acquisitions completed during the second, third and fourth quarters of 2007 and the second quarter of 2008, the addition of new customers, continued expansion into new territories, and increased sales to existing customers.

Gross profit. Gross profit increased $15.5 million, or 12.8%, to $137.0 million for the year ended June 30, 2008, from $121.5 million for the year ended June 30, 2007. The increase in gross profit resulted from sales growth, but was partially offset by a reduction in vendor rebates. Gross profit as a percentage of sales was 19.1% for the year ended June 30, 2008, compared to 19.3% for the year ended June 30, 2007. The decrease in gross profit as a percentage of sales was due to a reduction in vendor rebates.

Selling, general, and administrative expenses. Selling, general, and administrative expenses, excluding depreciation and amortization, increased $13.7 million, or 15.6%, to $101.8 million for the year ended June 30, 2008, from $88.1 million for the year ended June 30, 2007. The increase was the result of an increase in variable selling and distribution expenses driven by sales volume combined with $0.6 million of increased Sarbanes-Oxley Section 404 implementation costs, $1.1 million of increased public company related expenses, $1.1 million of increased stock option expenses, $1.0 million of severance obligations accrued primarily for the Company's former Senior Vice President and Chief Operating Officer, and $0.5 million of increased health care costs, all partially offset by the inclusion in the prior year of $2.8 million of non-recurring legal expenses related to the settlement of a dispute with a vendor. The fixed nature of other corporate expenses helped to offset these increases, resulting in only a slight increase in selling, general and administrative expenses as a percentage of sales from 14.0% for the year ended June 30, 2007, to 14.2% for the year ended June 30, 2008.

Depreciation and amortization. Depreciation and amortization increased from $6.5 million for the year ended June 30, 2007, to $7.3 million for the year ended June 30, 2008. The increase results primarily from increased amortization of intangible assets driven by the acquisition of Kane in the second quarter of fiscal 2008 and adjustments to the purchase price allocations of the acquisitions completed during the second, third, and fourth quarters of 2007.

Other expenses. Other expenses decreased $8.4 million, or 47.5%, to $9.3 million for the year ended June 30, 2008, from $17.7 million for the year ended June 30, 2007. The decrease in other expenses was due to a decrease in interest expense of $8.0 million to $10.3 million in the year ended June 30, 2008, as compared to $18.3 million in the year ended June 30, 2007. This decrease was due to $2.4 million of debt issue cost write-offs and early extinguishment penalties incurred in the year ended June 30, 2007 as compared to $0.3 million of debt issue cost write-offs in the year ended June 30, 2008, combined with lower interest rates and decreased debt outstanding following the Company's initial public offering.

Income tax expenses. Income tax expense increased $3.5 million to $7.4 million for the year ended June 30, 2008, from $3.9 million for the year ended June 30, 2007. The effective tax rate was 40.0% and 43.1% for the years ended June 30, 2008 and 2007, respectively. This decrease in the effective tax rate was primarily attributable to a decrease in the Canadian tax rate in the year ended June 30, 2008, combined with an unfavorable blended state tax rate in the year ended June 30, 2007.

Seasonality of operating results

Historically, our quarterly sales and operating results have varied significantly, and will likely continue to do so in the future. Seasonality has been caused by product usage, climate changes, promotions, rebates and announced price increases. Historically, sales have been higher during the spring and fall months due to increased sales of production animal health products. The transportation of production animals during the spring and fall months drives seasonal product usage. The transportation of production animals occurs during various times in the animal's life cycle. The cycle begins with the cow-calf stage where the calf is born and raised to six to eight months of age. At that point the calf moves to pasture for three to five months. The last movement occurs when the animal is placed in the feedyard. Movement and climate changes cause stress upon the animal, which increases the risk of disease. Thus, prior to each of these moves, the animal is typically treated for disease prevention. These buying patterns can also be affected by manufacturers' and distributors' marketing programs launched during the summer months, particularly in June, which can cause customers to purchase production animal health products in advance of actual usage. This kind of early purchasing may reduce the sales in the months these purchases typically would have been made. In the companion animal health products market, sales of flea, tick and heartworm products drive sales during the spring and summer months. See "Risk factors-Our quarterly operating results may fluctuate due to factors outside of management's control." Additionally, while we accrue rebates as they are earned, our rebates have historically been highest during the quarter ended December 31, since some of our manufacturers' rebate programs are designed to include targets to be achieved on calendar year sales. We anticipate that this trend with respect to manufacturers' rebate programs will continue, but just as in the fourth calendar quarter of 2008, we do not believe that it will have as strong an impact upon the quarter ended December 31, 2009, as it has in prior years due to manufacturers shifting growth goals from annual to quarterly or trimester goals and the elimination of an annual rebate program by a key vendor.

For the reasons and factors discussed above, our quarterly operating results may fluctuate significantly. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year, and our sales for any particular future period may decrease. In the future, operating results may fall below the expectations of securities analysts and investors. If this occurs, the price of our stock would likely decrease.

Consolidated statements of operations for the quarter (unaudited)

                       September 30,       December 31,      March 31,      June 30,       September 30,       December 31,      March 31,       June 30,
(in thousands)             2007                2007             2008          2008             2008                2008             2009           2009

Net sales             $       164,365     $      203,230     $  170,650     $ 178,297     $       169,023     $      184,477     $  150,931      $ 162,517
Direct cost of
products sold                 135,734            163,326        137,815       142,610             138,723            152,209        125,602        136,460

Gross profit                   28,631             39,904         32,835        35,687              30,300             32,268         25,329         26,057
Selling, general,
and
administrative
expenses(1)                    22,917             26,262         25,546        27,124              25,618             24,397         22,227         28,209
Acquisition costs                   -                  -              -            37                   -                  -              -              3
Depreciation and
   amortization                 1,645              1,712          1,924         2,068               2,076              2,054          2,039          2,054
Goodwill
impairment                          -                  -              -             -                   -                  -              -         25,164

Operating income
(loss)                          4,069             11,930          5,365         6,458               2,606              5,817          1,063        (29,373 )
Other income
(expense):
  Other income                    287                266            219           192                 229                189            206            162
  Interest expense             (2,647 )           (2,719 )       (2,492 )      (2,419 )            (2,334 )           (2,289 )       (1,877 )       (2,261 )

Income (loss)
before income
   taxes                        1,709              9,477          3,092         4,231                 501              3,717           (608 )      (31,472 )
Income tax benefit
(expense)                        (688 )           (3,930 )       (1,215 )      (1,575 )              (217 )           (1,448 )          284          2,115

Net income (loss)     $         1,021     $        5,547     $    1,877     $   2,656     $           284     $        2,269     $     (324 )    $ (29,357 )

(1) Includes salaries, wages, commissions, and related benefits.

The decline in sales during the fourth quarter of 2009 was primarily attributable to lower spending by production animal customers whose profits have been constrained by fluctuating commodity prices and the general economic slowdown. The decrease in gross profit during the fourth quarter of 2009 resulted from the decline in sales combined with lower gross profit margins driven by declines in manufacturer rebates. The increase in selling, general and administrative expenses during the fourth quarter of 2009 was the result of the $2.7 million bad debt provision and $1.8 million of accelerated expense driven by the voluntary forfeiture of options by senior management, both partially offset by a decrease in variable selling and distribution expenses driven by lower sales volume combined with cost reduction efforts. The Company's stock price and market capitalization declined significantly in the past year, and the Company experienced no growth in the current year and anticipates slower growth rates in the future. These factors are significant to the annual impairment test, and as a result, the Company recorded an impairment charge of $25.2 million as of June 30, 2009, to reduce the carrying value of goodwill.

Liquidity and capital resources

The Company's primary sources of liquidity are cash flows generated from operations and borrowings under the Company's revolving credit facility. Funds are expended to provide working capital that enables the Company to maintain adequate inventory levels to promptly fulfill customer needs and expand operations. The Company expects its capital resources to be sufficient to meet anticipated cash needs for at least the next twelve months, and it expects cash flows from operations to be sufficient to reduce outstanding borrowings under the Company's revolving credit agreement.

Operating activities. For the year ended June 30, 2009, net cash provided by operating activities was $21.8 million, and was primarily attributable to a decrease in working capital of $11.9 million and $40.3 million of net non-cash costs, partially offset by $27.1 million of net losses and a change in deferred income taxes of $3.2 million. The change in working capital included a decrease in accounts receivable of $6.0 million and a decrease in inventories of $8.4 million, partially offset by a decrease in accounts payable of $2.9 million. The decrease in accounts receivable resulted from a decline in sales from the prior year. The decrease in inventories resulted from the decline in sales that caused a reduction in purchasing and drove the corresponding decrease in accounts payable. The non-cash costs included $25.2 million of goodwill impairment, $8.2 million of depreciation and amortization, $0.7 million of debt issue cost amortization, $3.2 million of bad debt expense, and $3.2 million of stock-based compensation. The bad debt expense included a $2.7 million provision resulting from a dispute with a manufacturer regarding a rebate receivable. Stock-based compensation included the impact of $1.8 million of accelerated expense as a result of the voluntary forfeiture of 1.0 million options by senior management in May 2009.

For the year ended June 30, 2008, net cash provided by operating activities was $6.0 million, and was primarily attributable to $11.1 million in net income, $9.9 million of net non-cash costs, and a change in deferred income taxes of $1.2 million, all partially offset by an increase in working capital of $16.4 million. The non-cash costs included $7.3 million of depreciation and amortization, $0.8 million of debt issue cost amortization, $0.7 million of bad debt expense, and $1.3 million of stock-based compensation. The debt issue cost amortization includes the write-off of $0.3 of debt issue costs resulting from . . .