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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

For the transition period from _________________ to _______________________

Commission file number: 0-22427

HESKA CORPORATION
(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (970) 493-7272

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

         Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
   Yes   [     ] No  [ X  ]

         The number of shares of the Registrant’s Common Stock, $.001 par value, outstanding at May 13, 2005 was 49,454,101

HESKA CORPORATION

FORM 10-Q

QUARTERLY REPORT

TABLE OF CONTENTS

           i-STAT is a registered trademark of i-STAT Corporation. SPOTCHEM is a trademark of Arkray, Inc. TRI-HEART is a registered trademark of Schering-Plough Animal Health Corporation in the United States. HESKA, ALLERCEPT, AVERT, E.R.D.-HEALTHSCREEN, E-SCREEN, IMMUCHECK, PERIOCEUTIC, SOLO STEP, VET/E-SIG AND VET/OX are registered trademarks and CBC-DIFF, ERD, FELINE ULTRANASAL, G2 DIGITAL, THYROMED and VET/IV are trademarks of Heska Corporation in the United States and/or other countries. This 10-Q also refers to trademarks and trade names of other organizations.

HESKA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands except per share amounts)
(unaudited)

See accompanying notes to condensed consolidated financial statements.

HESKA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)

See accompanying notes to condensed consolidated financial statements.

HESKA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

See accompanying notes to condensed consolidated financial statements.

HESKA CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
(UNAUDITED)

1.        ORGANIZATION AND BUSINESS

          Heska Corporation (“Heska” or the “Company”) discovers, develops, manufactures, markets, sells, distributes and supports veterinary products. Heska’s core focus is on the canine and feline companion animal health markets. The Company has devoted substantial resources to the research and development of innovative products in these areas, where it strives to provide high value products for unmet needs in veterinary medicine.

          Heska is comprised of two reportable segments, Core Companion Animal Health and Other Vaccines, Pharmaceuticals and Products. The Core Companion Animal Health segment includes diagnostic and monitoring instruments and supplies as well as single use diagnostic and other tests, vaccines and pharmaceuticals, primarily for canine and feline use. These products are sold directly by the Company as well as through independent third party distributors and other distribution relationships. The Other Vaccines, Pharmaceuticals and Products segment (“OVP”), previously reported as the Diamond Animal Health segment, includes private label vaccine and pharmaceutical production, primarily for cattle but also for other animals including small mammals, horses and fish. All OVP products are currently sold by third parties under third party labels.

          The Company has incurred annual net losses since its inception and anticipates that it will continue to incur net losses in the near term as it introduces new products, expands its sales and marketing capabilities and continues its research and development activities. Cumulative net losses from inception of the Company in 1988 through March 31, 2005, have totaled $211.4 million. During the three months ended March 31, 2005, the Company incurred a loss of approximately $1.3 million and operations provided cash of approximately $324,000.

          The Company’s primary short-term needs for capital are based on its continuing research and development efforts, its sales, marketing and administrative activities, working capital associated with increased product sales and capital expenditures relating to maintaining and developing its manufacturing operations. The Company’s ability to achieve sustained profitable operations will depend primarily upon its ability to successfully market its products, commercialize products that are currently under development and develop new products. Many of the Company’s products are subject to long development and regulatory approval cycles and there can be no guarantee that the Company will successfully develop, manufacture or market these products. There also can be no guarantee that the Company will attain quarterly, annual, or sustained profitability in the future.

           The Company has a credit facility agreement with Wells Fargo Business Credit, Inc. (“Wells Fargo”) which expires on May 31, 2006. Under this agreement, the Company is required to comply with various financial and non-financial covenants in order to borrow. On May 10, 2005 the Company signed an amended agreement under which Wells Fargo waived certain historical events of non-compliance, including with a covenant on March 31, 2005. If the Company fails to comply with the covenants, Wells Fargo may, at its discretion, make all amounts due to them, immediately due and payable. The Company’s latest projections indicate that it is not probable that it will remain in compliance with all of its debt covenants through the next 12 months. The Company has begun discussions with Wells Fargo, discussed below, including regarding modification of the covenants under this agreement. There can be no guarantee that Wells Fargo will, as it has historically, modify the Company’s covenants. As a result, all debt obligations, including those to Wells Fargo and others that are cross- collateralized with Wells Fargo, totaling approximately $1.7 million have been reflected as current portion on long-term debt in the March 31, 2005 balance sheet. The Company has begun discussions with Wells Fargo and other lenders regarding an amended or new credit facility agreement which would involve increased borrowings against certain of the Company’s assets.

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

          The accompanying unaudited condensed consolidated financial statements are the responsibility of the Company’s management and have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the instructions to Form 10-Q and rules and regulations of the Securities and Exchange Commission (the “SEC”). The condensed consolidated balance sheet as of December 31, 2004 and March 31, 2005, and the condensed consolidated statements of operations and cash flows for the three months ended March 31, 2004 and 2005 are unaudited, but include, in the opinion of management, all adjustments (consisting of normal recurring adjustments) which the Company considers necessary for a fair presentation of its financial position, operating results and cash flows for the periods presented. All material intercompany transactions and balances have been eliminated in consolidation. Although the Company believes that the disclosures in these financial statements are adequate to make the information presented not misleading, certain information and footnote disclosures normally included in complete financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the SEC.

          Results for any interim period are not necessarily indicative of results for any future interim period or for the entire year. The accompanying financial statements and related disclosures have been prepared with the presumption that users of the interim financial information have read or have access to the audited financial statements for the preceding fiscal year. Accordingly, these financial statements should be read in conjunction with the audited financial statements and the related notes thereto for the year ended December 31, 2004, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 31, 2005.

Use of Estimates

          The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Significant estimates are required when establishing the allowance for doubtful accounts and the provision for excess/obsolete inventory, in determining the period over which the Company’s obligations are fulfilled under agreements to license product rights and/or technology rights and in evaluating long-lived assets for impairment.

Reclassifications

           Certain prior year numbers have been reclassified to be consistent with the current year presentation. These reclassifications include certain amortized fees previously reflected as Research, Development and Other Revenue which are now included in Product Revenue and certain costs previously reflected as Research and Development Expenses which are now included in Cost of Research, Development and Other Revenue.

Basic and Diluted Net Loss Per Share

          Basic net loss per common share is computed using the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed using the sum of the weighted average number of shares of common stock outstanding, and, if not anti-dilutive, the effect of outstanding common stock equivalents (such as stock options and warrants) determined using the treasury stock method. Since inception, due to the Company’s annual net losses, all potentially dilutive securities are anti-dilutive and as a result, basic net loss per share is the same as diluted net loss per share for all periods presented. At March 31, 2004 and 2005,

securities that have been excluded from diluted net loss per share because they would be anti-dilutive are outstanding options to purchase 8,796,261 and 11,224,247 shares, respectively, of the Company’s common stock.

Stock Based Compensation

          The Company accounts for its stock-based compensation plans using the intrinsic value method in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations, and follows the disclosure provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”) and SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (“SFAS No. 148”). Statement of Financial Accounting Standards No. 123 “Share-Based Payments” (SFAS No. 123R) was revised in December 2004 and the Company had planned to adopt this standard under the modified prospective of adoption beginning July 1, 2005. On April 14, 2005, the SEC deferred the date of required adoption for SFAS No. 123R for companies in Heska’s position to fiscal years beginning after June 15, 2005. The Company intends to adopt this standard beginning January 1, 2006. At March 31, 2005, the Company had two stock-based compensation plans. The Company recorded compensation expense of $23,000 and $21,000 related to the Company’s restricted stock for the three months ended March 31, 2004 and 2005, respectively.

          Had compensation expense for the Company’s stock-based compensation plans been based on the fair value at the grant dates for awards under those plans, consistent with the methodology of SFAS No. 123, the Company’s net loss and net loss per share for the three months ended March 31, 2004 and 2005 would approximate the pro forma amounts as follows (in thousands, except per share amounts):

           On February 24, 2005, the Company’s Board of Directors considered the significant impact that the use of fair values, rather than intrinsic values, would have on the Company’s future results of operations, as well as factors including that the management team had requested that their salaries be frozen for 2005, many non-management employees’ 2005 raises were to be at below market levels, no management bonus payouts were made for 2004 and the 2005 management incentive plan calls for a performance in excess of the Company’s internal budget before any bonus payments are made, and authorized the Company’s Stock Option Committee, which currently consists solely of the Company’s Chief Executive Officer, to accelerate the vesting of any outstanding but unvested stock options with a strike price that is not “in-the-money” through June 30, 2005 at its discretion. On March 30, 2005, the Company’s Stock Option Committee exercised its discretion and accelerated the vesting of outstanding but unvested stock options with a strike price greater than or equal to $0.82. This action effected approximately 750,000 options, approximately 55,000 of which were held by the Company’s Directors and Executive Officers. These options were not “in-the-money” at that time, and therefore, there was no compensation expense recorded in accordance with APB No. 25 as a result of this modification. However, for pro forma purposes in accordance with SFAS No. 123, the remaining unamortized compensation expense related

to these options, calculated under SFAS No. 123 of approximately $540,000 was recorded in the first quarter of 2005 and included in the table above. In addition, during the first quarter of 2005, options for approximately 2.1 million shares were issued and immediately vested.

          The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model, with the following weighted average assumptions for options granted in the three months ended March 31, 2004 and 2005. The estimated total fair value of the options granted during the three months ended March 31, 2004 was approximately $1,498,000. The estimated total fair value of the options granted during the three months ended March 31, 2005 was approximately $1,041,000.

          A summary of the Company's stock option plans is as follows:

          The following table summarizes information about stock options outstanding and exercisable at March 31, 2005:

3.       RESTRUCTURING AND OTHER OPERATING EXPENSES

           At March 31, 2005, The Company had approximately $6,000 of accrued restructuring expenses included in accrued liabilities on its balance sheet. These remaining expenses will be recognized during the three months ending June 30, 2005.

           Shown below is a reconciliation of restructuring costs for the three months ended March 31, 2004 (in thousands):

4.        SEGMENT REPORTING

          The Company is comprised of two reportable segments, Core Companion Animal Health (“CCA”) and Other Vaccines, Pharmaceuticals and Products (“OVP”). The Core Companion Animal Health segment includes diagnostic and monitoring instruments and supplies, as well as single use diagnostic and other tests, vaccines and pharmaceuticals, primarily for canine and feline use. These products are sold directly by the Company as well as through independent third party distributors and other distribution relationships. Core Companion Animal Health segment products manufactured at the Des Moines, Iowa production facility included in OVP’s assets are transferred at cost and are not recorded as revenue for OVP. The Other Vaccines, Pharmaceuticals and Products segment includes private label vaccine and pharmaceutical production, primarily for cattle, but also for other animals including small mammals, horses and fish. All OVP products are currently sold by third parties under third party labels.

          Additionally, the Company generates non-product revenue from sponsored research and development projects for third parties, licensing of technology and royalties. These revenues are allocated as appropriate between CCA and OVP.

          Summarized financial information concerning the Company’s reportable segments is shown in the following table (in thousands):

5.        COMPREHENSIVE INCOME

          Comprehensive income includes net income plus the results of certain stockholders’ equity changes not reflected in the Condensed Consolidated Statements of Operations. Such changes include primarily foreign currency translation items. Total comprehensive loss for the three months ended March 31, 2004 and 2005 was $2,036,000 and $1,370,000, respectively.

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

          This discussion contains forward-looking statements that involve risks and uncertainties. Such statements, which include statements concerning future revenue sources and concentration, gross profit margins, selling and marketing expenses, research and development expenses, general and administrative expenses, capital resources, additional financings or borrowings and additional losses, are subject to risks and uncertainties, including, but not limited to, those discussed below and elsewhere in this Form 10-Q, particularly in “Factors that May Affect Results,” that could cause actual results to differ materially from those projected. The forward-looking statements set forth in this Form 10-Q are as of May 16, 2005, and we undertake no duty to update this information.

     Overview

          We discover, develop, manufacture, market, sell, distribute and support veterinary products. Our business is comprised of two reportable segments, Core Companion Animal Health, which represented 80% and 76% of fiscal year 2004 and first quarter 2005 product revenue, respectively, and Other Vaccines, Pharmaceuticals and Products, previously reported as Diamond Animal Health, which represented 20% and 24% of fiscal year 2004 and first quarter 2005 product revenue, respectively.

          The Core Companion Animal Health segment includes diagnostic and monitoring instruments and supplies as well as single use diagnostic and other tests, vaccines and pharmaceuticals, primarily for canine and feline use.

          Diagnostic and monitoring instruments and supplies represented approximately 45% and 44% of our fiscal year 2004 and first quarter 2005 product revenue, respectively. Many products in this area involve placing an instrument in the field and generating future revenue from consumables, including items such as supplies and service, as that instrument is used. A loss of or disruption in supply of consumables we are selling to an installed base of instruments could substantially harm our business. Historically, most revenue growth from consumables has resulted from an increased number of instruments in the field and not greater revenue per instrument. Major products in this area include our handheld electrolyte instrument, our chemistry instrument and our hematology instrument and their affiliated consumables. All products in this area are supplied by third parties, who typically own the product rights and supply the product to us under marketing and/or distribution agreements. In many cases, we have collaborated with a third party to adapt a human instrument for veterinary use.

          Single use diagnostic and other tests, vaccines and pharmaceuticals represented approximately 35% and 32% of our fiscal year 2004 and first quarter 2005 product revenue, respectively, with the majority of revenue coming from diagnostic and other tests. Since items in this area are single use by their nature, our aim is to build customer satisfaction and loyalty for each product, generate repeat annual sales from existing customers and expand our customer base in the future. Major products in this area include our heartworm diagnostic tests, our heartworm preventive, our allergy diagnostic tests and our allergy immunotherapy. Products in this area are both supplied by third parties and manufactured by us.

          We consider the Core Companion Animal Health segment to be our core business and devote most of our management time and other resources to improving the prospects for this segment. Maintaining a continuing, reliable and economic supply of products we currently obtain from third parties is critical to our success in this area. Virtually all of our sales and marketing expenses are in the Core Companion Animal Health segment. The majority of our research and development spending is dedicated to this segment, as well. We have devoted substantial resources to the research and development of innovative products in Core Companion Animal Health, where we strive to provide high value products for unmet needs and advance the state of veterinary medicine.

          All our Core Companion Animal Health products are ultimately sold to or through veterinarians. In many cases, veterinarians will markup their costs to the end user. The acceptance of our products by veterinarians is critical to our success. Core Companion Animal Health products are sold directly by us as well as through independent third party distributors and other distribution relationships. In 2002, we implemented a new distribution model for our Core Companion Animal Health products which relies on third party distributors for a greater portion of our sales. We believe that one of our largest competitors, IDEXX Laboratories, Inc. (“IDEXX”), effectively prohibits its distributors from selling competitors’ products, including our diagnostic instruments and heartworm diagnostic tests. We believe the IDEXX restrictions limit our ability to engage national distributors to sell our full line of products and significantly restrict our ability to market our products to veterinarians.

          While we have decreased operating expenses over the past several years and intend to continue to exercise disciplined expense control, we expect operating expenses to increase as we grow our business in the intermediate term. We intend to reach sustained profitability through a combination of revenue growth and expense control. Accordingly, we closely monitor product revenue growth trends in our Core Companion Animal Health segment. While we experienced a 9% decline in product revenue in this segment for the first quarter of 2005 as compared to the first quarter of 2004, we expect to return to continued growth in this segment as compared to historical results beginning in the second quarter of 2005. Product revenue in our Core Companion Animal Health segment grew 11% in 2004 as compared to 2003 and has grown at a compounded annual growth rate of over 21% since 1998, our first full year as a public company.

          The Other Vaccines, Pharmaceuticals and Products segment (“OVP”) includes our 168,000 square foot USDA- and FDA-licensed production facility in Des Moines, Iowa. We view this facility as a strategic asset which will allow us to control our cost of goods on any vaccines and pharmaceuticals that we may commercialize in the future. We are increasingly integrating this facility with our operations elsewhere. For example, virtually all our U.S. inventory is now stored at this facility and fulfillment logistics are handled there. Core Companion Animal Health segment products manufactured at this facility are transferred at cost and are not recorded as revenue for OVP. We view OVP reported revenue as revenue primarily to cover the overhead costs of the facility and to generate incremental cash flow to fund our Core Companion Animal Health segment.

          OVP includes private label vaccine and pharmaceutical production, primarily for cattle but also for other animals including small mammals, horses and fish. All OVP products are sold by third parties under third party labels.

          We have developed our own line of bovine vaccines that are licensed by the USDA. We have a long-term agreement with a distributor, Agri Laboratories, Ltd., (“AgriLabs”), for the marketing and sale of certain of these vaccines which are sold primarily under the Titanium® and MasterGuard® brands which are registered trademarks of AgriLabs. This agreement generates a significant portion of OVP’s revenue. Subject to certain purchase minimums, under our long-term agreement, AgriLabs has the exclusive right to sell the aforementioned bovine vaccines in the United States, Africa, China, Mexico and Taiwan until at least December 2009. This exclusivity can be extended by us under certain conditions. OVP also produces vaccines and pharmaceuticals for other third parties.

           Additionally, we generate non-product revenues from sponsored research and development projects for third parties, licensing of technology and royalties. We perform these sponsored research and development projects for both companion animal and livestock product purposes.

     Critical Accounting Policies and Estimates

          Our discussion and analysis of our financial condition and results of operations is based upon the consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the

disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenue and expense during the periods. These estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. We have identified those critical accounting policies used in reporting our financial position and results of operations based upon a consideration of those accounting policies that involve the most complex or subjective decisions or assessment. We consider the following to be our critical policies.

                Revenue Recognition

                Allowance for Doubtful Accounts

                Inventories

                Capitalized Patent Costs

     Results of Operations

     Revenue

          Total revenue, which includes product revenue, sponsored research and development revenue and other revenue, increased 2% to $17.2 million for the three months ended March 31, 2005 as compared to $16.7 million for the corresponding period in 2004. Product revenue increased 3% to $16.8 million for the three months ended March 31, 2005 as compared to $16.4 million for the corresponding period in 2004.

          Product revenue from our Core Companion Animal Health segment decreased 9% to $12.9 million for the three months ended March 31, 2005 compared to $14.1 million for the corresponding period in 2004. This decrease was the result of decreased sales of our canine heartworm preventive; our current hematology instrument due to a systematic offer in the first quarter of 2004 but not in 2005 to customers who had purchased our previous hematology analyzer to upgrade to our new hematology analyzer; and instrument consumables to the installed base of our previous hematology instrument; offset in part by increased sales of our other instrument consumables.

          Product revenue from our Other Vaccines, Pharmaceuticals and Products segment (“OVP”) increased by 73% to $4.0 million for the three months ended March 31, 2005 as compared to $2.3 million for the corresponding period in 2004. This increase was due primarily to higher sales of our own line of bovine vaccines under our contract with Agri Laboratories, Ltd. (“AgriLabs”).

          Revenue from sponsored research and development and other decreased 1% to $318,000 for the three months ended March 31, 2005 from $322,000 for the corresponding period in 2004.

          For 2005, we expect to grow our Core Companion Animal Health segment revenue. We anticipate OVP revenue of approximately $12 million, a slight decline from 2004. We expect research, development and other revenue to decline slightly in 2005.

     Cost of Revenue

          Cost of revenue consists of two components: cost of products sold and cost of research, development and other revenue, both of which correspond to their respective revenue categories. Cost of revenue totaled $11.2 million for the first three months of 2005 compared to $10.6 million for the corresponding period in 2004. Gross profit decreased 4% to $5.9 million for the three months ended March 31, 2005 as compared to $6.1 million in the prior year corresponding period. Gross margin, i.e. gross profit divided by total revenue declined to 34.5% for the three months ended March 31, 2005 as compared to 36.7% in the corresponding period in 2004.

           Gross profit on product revenue decreased 3% to $5.8 million for the quarter ended March 31, 2005 from $6.0 million in the prior year period. Gross margin on product sales, i.e. gross profit on product revenue divided by product revenue, declined to 34.2% in the three months ended March 31, 2005 as compared to 36.2% in the

corresponding period in 2004. The decline was due to a larger percent of revenue from OVP, which tends to carry relatively low margins, as well as certain supplier price increases.

           Gross profit on research, development and other revenue decreased 26% to $139,000 for the quarter ended March 31, 2005 from $187,000 in the prior year period. The primary reason for the decrease is a greater proportion of technology or patent-related costs being expensed as incurred as these costs are in excess of the amount of remaining affiliated deferred licensing revenue in the quarter ended March 31, 2005 as compared to the prior year corresponding period.

           We expect gross margin on product sales to increase in the last nine months of 2005 as compared to the first three months and to be in the same range for the full year 2005 that it was in full year 2004. We expect gross profit on research, development and other revenue to decrease for full year 2005 as compared to full year 2004 as we expect a greater proportion of technology or patent-related costs will be expensed as incurred because the costs are in excess of remaining affiliated deferred licensing revenue. We expect gross profit to increase in 2005 as compared to 2004 as we expect total revenue to increase.

     Operating Expenses

          Selling and marketing expenses consist primarily of salaries, commissions and benefits for sales and marketing personnel and expenses related to product advertising and promotion. Selling and marketing expenses decreased 15% to $3.8 million in the three months ended March 31, 2005 as compared to $4.4 million in the corresponding period in 2004. Factors in the decrease include the heavier marketing spending related to the launch of our new hematology instrument in the first quarter of 2004 as well as lower amortization of demonstration instruments used by our sales force in the first quarter of 2005.

           Research and development expenses declined 28% to $1.2 million for the three months ended March 31, 2005 from $1.7 million during the corresponding period in 2004. This decline was primarily due to lower compensation and benefits costs, lower cost of clinical trials and lower expenses related to our new hematology instrument launch in January 2004.

          General and administrative expenses were $2.0 million in the three months ended March 31, 2005, down slightly from the prior year period.

           In 2005, we expect total operating expenses to decrease as compared to 2004.

     Interest and Other (Income) Expense, Net

          Other expense increased to $205,000 for the three months ended March 31, 2005 as compared to other income of $63,000 during the corresponding period in 2004. The increase in net other expense were due to higher interest expense in 2005 as we utilized more of our revolving line of credit, incurred higher interest rates on our borrowings and the receipt of certain prior years’ tax credits in 2004 which did not occur in 2005. We expect this line item to be a net expense for 2005 and to primarily consist of net interest expense. We expect net interest expense to increase in 2005 as compared to 2004 as we use our revolving credit facility more extensively and have higher interest rates on our outstanding loans due to the increase in interest rates resulting from our most recent modification to our credit facility agreement.

     Net Loss

          Our net loss decreased to $1.3 million in the three months ended March 31, 2005 compared to $2.0 million during the corresponding period in 2004. The improvement in 2005 from 2004 was the result of lower operating expenses, somewhat offset by lower gross margin. In 2005, we expect increased revenue and lower expenses to contribute to a lower net loss as compared to 2004.

     Liquidity and Capital Resources

          We have incurred negative cash flow from operations since our inception in 1988. For the three months ended March 31, 2005, we had a net loss of $1.3 million. During the three months ended March 31, 2005, our operations provided cash of $324,000. At March 31, 2005, we had $4.7 million of cash and cash equivalents, $1.8 million of working capital, $10.6 million of outstanding borrowings under our revolving line of credit agreement and we had fully utilized the available borrowing capacity based upon eligible accounts receivable and eligible inventory under the credit facility agreement. Our working capital has decreased from $5.2 million at December 31, 2004, to $1.8 million at March 31, 2005, primarily due to the classification of all our long-term debt obligations as current at March 31, 2005 because our projections indicate it is not probable we will meet our current Wells Fargo financial covenants through the next 12 months and decreases in accounts receivable and inventories and increased accounts payable and borrowings under our revolving line of credit.

          At March 31, 2005, we had outstanding obligations for long-term debt and capital leases totaling $1.7 million primarily related to a term loan with Wells Fargo Business Credit, Inc. (“Wells Fargo”) and a subordinated promissory note with a significant customer with the proceeds used for facilities enhancements. The term loan is secured by real estate and had an outstanding balance at March 31, 2005 of $1.1 million due in monthly installments of $17,658 plus interest, with a balloon payment of approximately $834,000 due on May 31, 2006. On March 31, 2005, the term loan had a stated interest rate of prime plus 2.75%. The subordinated promissory note is secured by our production facility, has a stated interest rate of prime plus 1.0% and a remaining balance of $500,000 payable in 2006. In addition, we have a promissory note to the City of Des Moines with an outstanding balance at March 31, 2005 of $86,000, due in monthly installments through June 2006. The promissory note has a stated interest rate of 3.0%. The note is secured by first security interests in essentially all of OVP’s assets and the lender has subordinated its first security interest to Wells Fargo. Our capital lease obligations totaled $32,000 at March 31, 2005. At March 31, 2005, all of our obligations for long-term debt are classified as current. The terms of our debt agreement includes provisions where non-compliance with certain covenants could, in specified circumstances, result in acceleration of the repayment of these borrowings. Our latest projections for the next 12 months indicate that it is not probable we will be able to achieve all of our existing covenants. We have begun negotiations with Wells Fargo regarding an amendment to our existing agreement, which would include a modification of the covenants, although there can be no guarantee that we will be successful in obtaining such an amendment. As a result, approximately $1.7 million has been reflected as current portion of long-term debt in the March 31, 2005 balance sheet.

          At March 31, 2005, we also had a $12.0 million asset-based revolving line of credit with Wells Fargo which expires on May 31, 2006. At March 31, 2005, $10.6 million was outstanding under this line of credit. On May 10, 2005 we signed an amended agreement under which Wells Fargo waived certain historical events of non-compliance, including with a covenant as of March 31, 2005. Our ability to borrow under this facility varies based upon available cash, eligible accounts receivable and eligible inventory. On March 31, 2005, interest was charged at a stated rate of prime plus 2.75% and payable monthly. We are required to comply with various financial and non-financial covenants, and we have made various representations and warranties. Among the financial covenants is a requirement to maintain a minimum liquidity (cash plus excess borrowing base) of $1.5 million. Additional requirements include covenants for minimum capital monthly and minimum net income quarterly. We have begun discussions with Wells Fargo and other financial institutions regarding an amended or a new credit facility agreement, which would involve increased borrowings against certain of the Company’s fixed assets. We anticipate that any future covenants negotiated in an amended or a new credit facility agreement will result in our expectation of compliance, as has been the case with Wells Fargo in the past, although there can be no assurance thereof. Failure to comply with any existing or future covenants, representations or warranties could result in our being in default on the loan and could cause all outstanding amounts payable to Wells Fargo as well as others, including those discussed above, to become immediately due and payable or impact our ability to borrow under the agreement. Any default under the Wells Fargo agreement could also accelerate the repayment of our other borrowings. At March 31, 2005, we had fully utilized the available borrowing capacity based upon eligible accounts receivable and eligible inventory under the credit facility agreement.

          Net cash provided by operating activities was $324,000 for the three months ended March 31, 2005 as compared to using cash of $1.7 million during the corresponding period in 2004. The decrease in cash used by operations for the three months ended March 31, 2005 as compared to the same period of 2004 is due to an increase of $696,000 in accounts payable in 2005 compared to a decrease of $370,000 in 2004, an increase in depreciation and amortization of approximately $96,000, a larger decrease in accounts receivable of approximately $233,000 year over year and a decrease in inventories in 2005 as compared to an increase in 2004. Offsetting these increases in cash from operations, deferred revenue and other long-term liabilities decreased by $523,000 more in 2005 than 2004 due primarily to fewer fees being received in the first quarter of 2005. Our cash from operations fluctuates from period to period primarily due to our periodic net income (loss) and changes in working capital.

          Net cash flows from investing activities used cash of $726,000 in the three months ended March 31, 2005, compared to using $177,000 during the corresponding period in 2004, with the change due primarily to increased capital expenditures in 2005 compared to 2004 and proceeds from the licensing of technology and product rights totaling $400,000 in 2004 with no corresponding proceeds in 2005.

          Net cash flows from financing activities provided cash of $210,000 during the three months ended March 31, 2005 as compared to providing $2.2 million during the corresponding period in 2004. In both 2005 and 2004, the cash was provided primarily from net borrowings under our revolving credit facility.

          At March 31, 2005, we had total deferred revenue and other long-term liabilities, net of current portion, of approximately $11.0 million. Included in this total is approximately $10.9 million of deferred revenue related to up-front licensing fees that have been received for certain product rights and technology rights out-licensed during the three months ended March 31, 2005 and prior. These deferred amounts are being recognized on a straight-line basis over the remaining lives of the agreements, products, patents or technology. The remaining approximately $148,000 is related to pension liabilities for a defined benefit pension plan which was frozen in October 1992.

          Our primary short-term need for capital, which is subject to change, is to fund our operations, which consist of continued research and development efforts, our sales, marketing and administrative activities, working capital associated with increased product sales and capital expenditures relating to developing and expanding our manufacturing operations. Our future liquidity and capital requirements will depend on numerous factors, including the extent to which our marketing, selling and distribution efforts, as well as third parties who market, sell and distribute our products, are successful, the outcome of our discussion with Wells Fargo and other financial institutions regarding an amended or new credit facility agreement, the extent to which currently planned products and/or technologies under research or development are successfully developed and the extent of the market acceptance of new products, the timing of regulatory actions regarding our products, the costs and timing of expansion of sales, marketing and manufacturing activities, if any, the cost, timing and business management of current and potential acquisitions, if any, and contingent liabilities associated with such acquisitions, the procurement and enforcement of patents important to our business and the results of competition.

           If Wells Fargo were to reset all our covenants based on our current financial plan for 2005 and future forecasts we believe our available cash and cash equivalents, together with cash from operations and borrowings expected to be available under our revolving line of credit would be sufficient to fund our operations through 2005 and into 2006, although the margin for variation from our current financial plan is significantly less than management is comfortable with. Accordingly, we have decided to raise additional capital. We have begun discussions with Wells Fargo and other financial institutions regarding an amended or new credit facility including an increase in term loans on assets with historical appraised values significantly in excess of current affiliated debt, which would provide us with additional liquidity if successful. However, these discussions may not be successful and/or our actual results may differ from our current financial plan and future forecasts, which may require us to consider alternative strategies. We may be required to raise additional capital in the future. If necessary, we expect to raise these additional funds through one or more of the following: (1) sale of equity or debt securities; (2) sale of assets, products or marketing rights; and (3) licensing of technology. There is no

guarantee that additional capital will be available from these sources on acceptable terms, if at all, and certain of these sources may require approval by existing lenders. If we cannot raise the additional funds through these options on acceptable terms or with the necessary timing, management could also reduce discretionary spending to decrease our cash burn rate through actions such as delaying or canceling research projects or marketing plans. These actions would likely extend the then available cash and cash equivalents, and the then available borrowings for a limited time. See “Factors that May Affect Results.”

     Net Operating Loss Carryforwards

          As of December 31, 2004, we had a net domestic operating loss carryforward, or NOL, of approximately $169.5 million, a domestic alternative minimum tax credit of approximately $23,000 and a domestic research and development tax credit carryforward of approximately $584,000. The NOL and tax credit carryforwards are subject to alternative minimum tax limitations and to examination by the tax authorities. In addition, we had a “change of ownership” as defined under the provisions of Section 382 of the Internal Revenue Code of 1986, as amended (an “Ownership Change”). We believe the latest, and most restrictive, Ownership Change occurred at the time of our initial public offering in July 1997. We do not believe this Ownership Change will place a significant restriction on our ability to utilize our NOLs in the future. We also have net operating loss carryforwards in Switzerland of approximately $3.7 million related to losses previously recorded by Heska AG.

     Recent Accounting Pronouncements

          Recent accounting pronouncements that are relevant to us include Statement of Financial Accounting Standards (“SFAS”) No. 123R and SFAS No. 151.

SFAS No. 123R, “Share-Based Payment” (Revised 2004)

          Statement of Financial Accounting Standards No. 123 “Share-Based Payments” (“SFAS No. 123R”) was revised and promulgated in December 2004. On April 14, 2005, the SEC issued a release amending the compliance dates for SFAS No. 123R. Under the SEC’s new rule, companies in our position may implement SFAS No. 123R at the beginning of their next fiscal year, instead of the next reporting period as originally required under SFAS No. 123R, that begins after June 15, 2005. We originally intended to adopt SFAS No. 123R beginning on July 1, 2005 but based on the SEC’s action on April 14, 2005, we currently intend to adopt this standard on January 1, 2006 - the first day of our next fiscal year. We intend to adopt SFAS No. 123R under the modified prospective method of adoption at that time. Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), which became effective in 1996, allows for the continued measurement of compensation cost for stock-based compensation using the intrinsic value based method under Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB No. 25”), provided that pro forma disclosures are made of net income or loss, assuming the fair value based method of SFAS No. 123 had been applied. We have elected to account for our stock-based compensation plans under APB No. 25 and will continue to do so through the completion of our current fiscal year ending December 31, 2005. When we adopt SFAS No. 123R effective January 1, 2006, we will be required to recognize compensation expense using the fair value-based model for options that vest after December 31, 2005, including those that were granted prior to the effective date of SFAS No. 123R. This will result in recording compensation expense for periods after December 31, 2005. Historically, under APB No. 25, we recorded minimal amounts of stock-based compensation, and none related to grants of options. On February 24, 2005, our Board of Directors considered the significant impact that the use of fair values, rather than intrinsic values, would have on our future results of operations, as well as factors including that the management team had requested that their salaries be frozen for 2005, many non-management employees’ 2005 raises were to be at below market levels, no management bonus payouts were made for 2004 and the 2005 management incentive plan calls for a performance in excess of our internal budget before any bonus payments are made, and authorized our Stock Option Committee, which currently consists solely of our Chief Executive Officer, to immediately vest all options granted from that date through June 30, 2005 and to accelerate the vesting of any outstanding but unvested stock options with a strike price that is not “in-the-money” at its discretion (the aggregate authorization to the Stock

Option Committee to be known as the “Vesting Authorization”) through June 30, 2005; for similar reasons and understanding the SEC had issued a release amending the compliance date for SFAS No. 123R, on May 9, 2005 our Board of Directors approved the extension of the Vesting Authorization to our Stock Option Committee from June 30, 2005 to December 31, 2005. On March 30, 2005 our Stock Option Committee exercised its discretion and accelerated the vesting of outstanding but unvested stock options with a strike price greater than or equal to $0.82. These options were not “in-the-money” at that time, and therefore, there was no compensation expense recorded in accordance with APB No. 25 as a result of this modification. However, for pro forma purposes, in accordance with SFAS No. 123, the remaining unamortized compensation related to these options will be reported in the footnotes to our first quarter 2005 financial statements. This action effected approximately 750,000 options, approximately 55,000 of which were held by our Directors and Executive Officers. Had this action not been taken, and had all approximately 750,000 options continued to vest according to the vesting schedules in place prior to the acceleration, we would have recorded incremental compensation related to these options of approximately $275,000 on a pro forma basis for the nine months ending December 31, 2005. This follows a similar action for similar reasons in December 2004 under which approximately 2.2 million outstanding but unvested stock options were immediately vested. Had the December action not been taken, and had all approximately 2.2 million options continued to vest according to the vesting schedules in place prior to the acceleration, we would have recorded incremental compensation related to these options of approximately $870,000 on a pro forma basis for the year ending December 31, 2005. We also have an employee stock purchase plan under which we will recognize compensation expense under SFAS No. 123R beginning on January 1, 2006.

           There are four key inputs to the Black-Scholes model which we use to value our options: expected term, expected volatility, risk-free interest rate and expected dividends, all of which require us to make estimates. Our estimates for these inputs may not be indicative of actual future performance and changes to any of these inputs can have a material impact on the resulting fair value calculated for the option. Our expected term input was estimated based on our historical time from grant to exercise experience for all employees in 2005 and a software program to which an input was our current employee exercise experience in 2004; we treated all employees in one grouping in both years. Our expected volatility input was estimated based on our historical stock price volatility in 2005 and a combination of our historical price volatility and a peer group volatility in 2004. Our risk-free interest rate input was determined based on the U.S. Treasury yield curve at the time of option issuance in both 2005 and 2004. Our expected dividends input was zero in both 2005 and 2004. Different assumptions could materially impact the resulting option value calculated. In the first quarter of 2005, we reported pro forma employee stock option compensation of approximately $1.685 million on approximately 3.0 million stock options. The underlying assumptions of these stock options, weighted by number of options and stock fair value at the time of grant, were as follows: expected term of 3.3 years, expected volatility of 95%, risk-free interest rate of 3.8% and expected dividends of zero. A tranche of “at-the-money” options granted under these assumptions in the same number as above would require a fair value price of approximately $0.90 per share (the “Benchmark Tranche”) to yield the same value as above (the “Benchmark Value”). The following table represents the approximate change, in dollars, of the value of the Benchmark Tranche under different expected term and expected volatility assumptions assuming all other inputs are the same. For example, the Benchmark Tranche is approximately 3.0 million “at-the-money” options with a fair market stock value of $0.90 per share, and if the Benchmark Tranche is valued using an expected term of 3.3 years, expected volatility of 95%, a risk-free interest rate of 3.8% and expected dividends of zero, we obtain a fair value of approximately $1.685 million - the Benchmark Value. If we value the Benchmark Tranche under the same assumptions, except we assume an expected term of 5.0 years instead of 3.3 years and an expected volatility of 60% instead of 95.0%, we obtain a value of approximately $1.443 million, or a decrease of approximately $242,000 as compared to the Benchmark Value. All amounts in the table below are in thousands of dollars.

          The current period pro forma compensation expense of approximately $1.685 million may not be indicative of the future impact of SFAS No. 123R. We currently have approximately $85,000 of compensation cost underlying employee stock options granted that has not yet been recognized, approximately $80,000 of which is to be recognized in 2006 assuming all options vest according to the vesting schedules currently in place. The Compensation Committee of our Board of Directors is currently considering alternatives regarding different forms of long-term compensation for future use, including the continued use of stock options. The decisions of the Compensation Committee of our Board of Directors regarding stock options is likely to be a key factor in the future impact of SFAS No. 123R on our financial statements.

     Factors That May Affect Results

          Our future operating results may vary substantially from period to period due to a number of factors, many of which are beyond our control. The following discussion highlights these factors and the possible impact of these factors on future results of operations. If any of the following factors actually occur, our business, financial condition or results of operations could be harmed. In that case, the price of our common stock could decline and you could experience losses on your investment.

           We have historically not generated positive cash flow from operations and may need additional capital and any required capital may not be available on acceptable terms or at all.

           If Wells Fargo were to reset all our covenants based on our current financial projections for 2005 and future forecasts we believe our available cash and cash equivalents, together with cash from operations and borrowings expected to be available under our revolving line of credit should be sufficient to fund our operations through 2005 and into 2006, although the margin for variation from our current plan is significantly less than management is comfortable with. Accordingly, we have decided to raise additional capital. We have begun discussions with Wells Fargo and other financial institutions regarding an amended or new credit facility including an increase in term loans on assets with historical appraised values significantly in excess of current affiliated debt, which would provide us with additional liquidity if successful. However, these discussions may not be successful and our actual results may differ from our current financial plan for 2005, and we may be required to consider alternative strategies. We may be required to raise additional capital in the future. If necessary, we expect to raise these additional funds through one or more of the following: (1)  sale of equity or debt securities; (2)  sale of assets, products or marketing rights; and (3)  licensing of technology. There is no guarantee that additional capital will be available from these sources on acceptable terms, if at all, and certain of these sources may require approval by existing lenders. If we cannot raise the additional funds through these options on acceptable terms or

with the necessary timing, management could also reduce discretionary spending to decrease our cash burn rate through actions such as delaying or canceling research projects or marketing plans. These actions would likely extend the then available cash and cash equivalents, and then available borrowings for a limited time.

          Additional capital may not be available on acceptable terms, if at all. The public markets may be unreceptive to equity financings and we may not be able to obtain additional private equity or debt financing. Furthermore, amounts we expect to be available under our existing revolving line of credit may not be available and other lenders could refuse to provide us with additional debt financing. Furthermore, any additional equity financing would likely be dilutive to stockholders and additional debt financing, if available, may include restrictive covenants and increased interest rates that would limit our currently planned operations and strategies. Alternatively, we may have to relinquish rights to certain of our intellectual property, products or marketing rights if we are required to obtain funds through collaborative agreements or otherwise. If adequate funds are not available, we may be required to curtail our operations significantly and reduce discretionary spending to extend the currently available cash resources, which would likely have a material adverse effect on our business, financial condition and our ability to continue as a going concern.

           We must maintain various financial and other covenants under our credit facility agreement in order to borrow and fund our operations.

          Under our credit facility agreement with Wells Fargo, we are required to comply with various financial and non-financial covenants in order to borrow under that agreement. The borrowings under this credit facility are essential to continue to fund our operations. Among the financial covenants is a requirement to maintain minimum liquidity (cash plus excess borrowing base) of $1.5 million in 2005. Additional requirements include covenants for minimum capital monthly and minimum net income quarterly. We do not believe we will be able to meet all of the current Wells Fargo covenants in the future. We have begun discussions with Wells Fargo regarding an amended credit facility agreement, which would include renegotiated covenants. Wells Fargo has granted us several historical waivers of non-compliance to these covenants, the most recent of which was on May 10, 2005. However, there can be no assurance we will be able to obtain similar waivers or other modifications if needed in the future.

          Failure to comply with any of the covenants, representations or warranties, or failure to modify them to allow future compliance, could result in our being in default under the loan and could cause all outstanding amounts, including amounts currently classified as long-term and loans with our other lenders, to become immediately due and payable or impact our ability to borrow under the agreement. We intend to rely on available borrowings under the credit agreement to fund our operations through May 2006. We have begun discussions with other financial institutions regarding a new credit facility to replace our agreement with Wells Fargo, if necessary, although there can be no assurance these discussions will be successful. If we are unable to borrow funds under our agreement with Wells Fargo or a new financial institution, we will need to raise additional capital from other sources to fund our cash needs and continue our operations, which capital may not be available on acceptable terms, or at all.

           Many of our expenses are fixed and if factors beyond our control cause our revenue to fluctuate, this fluctuation could cause greater than expected losses, cash flow and liquidity shortfalls as well as our stock price to decline.

          We believe that our future operating results will fluctuate on a quarterly basis due to a variety of factors which are generally beyond our control, including:

          We have high operating expenses for personnel, new product development and marketing. Many of these expenses are fixed in the short term. If any of the factors listed above cause our revenues to decline, our operating results could be substantially harmed and our current financial plan for 2005 contains very little margin for error versus our current capital position.

           Our common stock is listed on the Nasdaq SmallCap Market and we may not be able to maintain that listing, which may make it more difficult for you to sell your shares.

          Our common stock is listed on the Nasdaq SmallCap Market. We have received a communication from Nasdaq advising us that we have been afforded a “grace period” ending on November 1, 2005 to regain compliance with the $1.00 minimum bid requirement which would require us to have a minimum bid price of $1.00 or more for 10 consecutive business days. We cannot assure you that we will be able to obtain the aforementioned minimum bid price requirement or maintain our listing on the Nasdaq stock market, which includes additional quantitative and qualitative requirements in addition to a $1.00 minimum bid price such as market value of listed securities. In addition, the Nasdaq staff retains significant discretion in matters related to listing. If we are delisted from the Nasdaq SmallCap Market, our common stock will be considered a penny stock under the regulations of the Securities and Exchange Commission and would therefore be subject to rules that impose additional sales practice requirements on broker-dealers who sell our securities. The additional burdens imposed upon broker-dealers discourage broker-dealers from effecting transactions in our common stock, which could severely limit market liquidity of the common stock and your ability to sell our securities in the secondary market. This lack of liquidity would also make it more difficult for us to raise capital in the future.

           We may be unable to successfully market, sell and distribute our products.

          The market for companion animal healthcare products is highly fragmented. Because our Core Companion Animal Health proprietary products are generally available only by prescription and our medical instruments require technical training, we sell our Core Companion Animal Health products only ultimately to or through veterinarians. The acceptance of our products by veterinarians is critical to our success. Therefore, we may fail to reach a substantial segment of the potential market.

          We currently market our Core Companion Animal Health products in the United States to veterinarians through approximately 13 independent third-party distributors who carry our full line of companion animal products, approximately 11 independent third-party distributors who carry portions of our companion animal product line and through a direct sales force of approximately 43 individuals. To be successful, we will have to effectively market our products and continue to develop and train our direct sales force as well as sales personnel of our distributors and rely on other arrangements with third parties to market, distribute and sell our products. In addition, most of our distributor agreements can be terminated on 60 days notice and we believe that IDEXX Laboratories, Inc. (“IDEXX”), one of our largest competitors, effectively prohibits its distributors from selling competitive products, including our diagnostic instruments and heartworm diagnostic tests. We believe this restriction significantly limits our ability to engage national distributors to sell our full line of products and significantly restricts our ability to market our products to veterinarians. In 2002, one of our largest distributors informed us that they were going to carry IDEXX products and that they no longer would carry our diagnostic instruments and heartworm diagnostic tests. In late 2004, this distributor acquired another of our distributors. We believe IDEXX effectively prohibits this distributor from carrying our diagnostic instruments and heartworm diagnostic tests as a condition for having access to buy the IDEXX product line.

          We may not successfully develop and maintain marketing, distribution or sales capabilities, and we may not be able to make arrangements with third parties to perform these activities on satisfactory terms. If our marketing, sales and distribution strategy is unsuccessful, our ability to sell our products will be negatively impacted and our revenues will decrease.

           We anticipate future losses and may not be able to achieve sustained profitability.

          We have incurred net losses on an annual basis since our inception in 1988 and, as of March 31, 2005, we had an accumulated deficit of $211.4 million. Notwithstanding a profitable quarter in 2002 and 2003, we have never achieved profitability on an annual basis. Our ability to be profitable in future periods will depend, in part, on our ability to increase sales in our Core Companion Animal Health segment, including maintaining and growing our installed base of instruments and related consumables, to maintain or increase gross margins and to limit the increase in our operating expenses to a reasonable level. Even if we achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. If we cannot achieve or sustain profitability for an extended period, we may not be able to fund our expected cash needs or continue our operations.

          We operate in a highly competitive industry, which could render our products obsolete or substantially limit the volume of products that we sell. This would limit our ability to compete and achieve profitability.

          The market in which we compete is intensely competitive. Our competitors include independent animal health companies and major pharmaceutical companies that have animal health divisions. We also compete with independent, third party distributors, including distributors who sell products under their own private labels. In the point-of-care diagnostic testing market, our major competitors include IDEXX, Abaxis, Inc., AGEN Biomedical, Ltd. and Synbiotics Corporation. Other companies with a significant presence in the companion animal health market, such as Bayer AG, Intervet International B.V., Merial Ltd., Novartis AG, Pfizer Inc., Schering-Plough Corporation, Virbac S.A. and Wyeth (formerly American Home Products), may be marketing or developing products that compete with our products or would compete with them if developed. These and other competitors may have substantially greater financial, technical, research and other resources and larger, more established marketing, sales, distribution and service organizations than we do. Our competitors may offer broader product lines and have greater name recognition than we do. Our competitors may develop or market technologies or products that are more effective or commercially attractive than our current or future products or that would render our technologies and products obsolete. Further, additional competition could come from new entrants to the animal health care market. Moreover, we may not have the financial resources, technical expertise or marketing, distribution or support capabilities to compete successfully. Novartis has a marketing agreement with us, but the agreement does not restrict its ability to develop and market competing products. We believe that one of our largest competitors, IDEXX, effectively prohibits its distributors from selling competitive products, including our diagnostic instruments and heartworm diagnostic tests. The products manufactured by OVP for sale by third parties compete with similar products offered by a number of other companies, some of which have substantially greater financial, technical, research and other resources than us and may have more established marketing, sales, distribution and service organization’s than OVP’s customers. Competitors may have facilities with similar capabilities to OVP, which they may operate at a lower unit price to their customers, which could cause us to lose customers. If we fail to compete successfully, our ability to achieve sustained profitability will be limited and sustained profitability, or profitability at all, may not be possible.

           We may face costly intellectual property or other legal disputes, or our technology or that of our suppliers or collaborators may become the subject of legal action.

          Our ability to compete effectively will depend in part on our ability to develop and maintain proprietary aspects of our technology and either to operate without infringing the proprietary rights of others or to obtain rights to technology owned by third parties. We have United States and foreign-issued patents and are currently prosecuting patent applications in the United States and various foreign countries. Our pending patent

applications may not result in the issuance of any patents or any issued patents that will offer protection against competitors with similar technology. Patents we receive may be challenged, invalidated or circumvented in the future or the rights created by those patents may not provide a competitive advantage. We also rely on trade secrets, technical know-how and continuing invention to develop and maintain our competitive position. Others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets.

          We may become subject to additional patent infringement claims and litigation in the United States or other countries or interference proceedings conducted in the United States Patent and Trademark Office, or USPTO, to determine the priority of inventions. The defense and prosecution of intellectual property suits, USPTO interference proceedings, and related legal and administrative proceedings are costly, time-consuming and distracting. We may also need to pursue litigation to enforce any patents issued to us or our collaborative partners, to protect trade secrets or know-how owned by us or our collaborative partners, or to determine the enforceability, scope and validity of the proprietary rights of others. Any litigation or interference proceeding will result in substantial expense to us and significant diversion of the efforts of our technical and management personnel. Any adverse determination in litigation or interference proceedings could subject us to significant liabilities to third parties. Further, as a result of litigation or other proceedings, we may be required to seek licenses from third parties which may not be available on commercially reasonable terms, if at all.

          We license technology from a number of third parties, including Synbiotics Corporation, Corixa Corporation, Roche Molecular Systems, Inc., New England Biolabs, Inc. and Hybritech Inc., as well as a number of research institutions and universities. The majority of these license agreements impose due diligence or milestone obligations on us, and in some cases impose minimum royalty and/or sales obligations on us, in order for us to maintain our rights under these agreements. Our products may incorporate technologies that are the subject of patents issued to, and patent applications filed by, others. As is typical in our industry, from time to time we and our collaborators have received, and may in the future receive, notices from third parties claiming infringement and invitations to take licenses under third party patents. We currently do not have any unresolved notices of infringement. Any legal action against us or our collaborators may require us or our collaborators to obtain one or more licenses in order to market or manufacture affected products or services. However, we or our collaborators may not be able to obtain licenses for technology patented by others on commercially reasonable terms, or at all, we may not be able to develop alternative approaches if unable to obtain licenses, or current and future licenses may not be adequate for the operation of our businesses. Failure to obtain necessary licenses or to identify and implement alternative approaches could prevent us and our collaborators from commercializing our products under development and could substantially harm our business.

          We may also face legal disputes relating to other areas of our business. These disputes may require significant expenditures on our part and could have material adverse consequences on our business in the case of an unfavorable ruling or settlement.

          We have granted third parties substantial marketing rights to certain of our existing products as well as products under development. If the third parties are not successful in marketing our products our sales may not increase.

          Our agreements with our corporate marketing partners generally contain no or very small minimum purchase requirements in order for them to maintain their exclusive or co-exclusive marketing rights. We are party to an agreement with SPAH which grants distribution and marketing rights in the U.S. for our canine heartworm preventive product, TRI-HEART Chewable Tablets. Novartis Agro K.K. markets and distributes our SOLO STEP CH heartworm test in Japan. Leo Animal Health A/S currently exclusively distributes both E.R.D.-HEALTHSCREEN Urine Tests and SOLO STEP CH in Europe. In addition, Nestle Purina Petcare has exclusive rights to license our technology for nutritional applications for dogs and cats. In addition, we have entered into agreements granting Novartis certain rights to market or co-market certain of the products that we are currently developing. One or more of these marketing partners may not devote sufficient resources to marketing our products. Furthermore, there is generally nothing to prevent these partners from pursuing alternative

technologies or products that may compete with our products. In the future, third-party marketing assistance may not be available on reasonable terms, if at all. If any of these events occur, we may not be able to commercialize our products and our sales will decline. In addition, our agreement with SPAH requires us to potentially pay termination penalties if we are unable to supply product over an extended period of time.

          We rely substantially on third-party suppliers. The loss of products or delays in product availability from one or more third-party supplier could substantially harm our business.

          To be successful, we must contract for the supply of, or manufacture ourselves, current and future products of appropriate quantity, quality and cost. Such products must be available on a timely basis and be in compliance with any regulatory requirements. Failure to do so could substantially harm our business.

          We currently rely on third party suppliers to manufacture those products we do not manufacture ourselves. We currently rely on third party suppliers for our veterinary diagnostic and patient monitoring instruments and consumable supplies for these instruments, for certain of our point-of-care diagnostic and other tests, for the manufacture of our allergy immunotherapy treatment products as well as other manufacturers for other products. Major suppliers who sell us products they manufacture which are responsible for more than 5% or more of our revenue are i-STAT Corporation (acquired in 2004 by Abbott Laboratories), Arkray, Inc., Boule Diagnostics International AB and Quidel. We often purchase products from our suppliers under agreements that are of limited duration or can be terminated on an annual basis. We believe we have agreements in place to ensure supply of our major product offerings through at least the end of 2005 and we believe we are in full compliance with such agreements. There can be no assurance, however, that our suppliers will be able to meet their obligations under these agreements or that we will be able to compel them to do so. Risks of relying on suppliers include:

          Potential problems with suppliers such as those discussed above could substantially decrease sales, lead to higher costs, damage our reputation with our customers due to factors such as poor quality goods or delays in order fulfillment, resulting in our being unable to effectively sell our products and substantially harm our business.

          We often depend on third parties for products we intend to introduce in the future. If our current relationships and collaborations are not successful, we may not be able to introduce the products we intend to in the future.

          We are often dependent on third parties and collaborative partners to successfully and timely perform research and development activities to successfully develop new products. For example, we jointly developed point-of-care diagnostic products with Quidel, and Quidel manufactures these products. In other cases, we have discussed Heska marketing in the veterinary market an instrument being developed by a third party for use in the human health care market. In the future, one or more of these third parties or collaborative partners may not complete research and development activities in a timely fashion, or at all. If these third parties or collaborative partners fail to complete research and development activities, or fail to complete them in a timely fashion, our ability to introduce new products will be impacted negatively and our revenues may decline.

           Interpretation of existing legislation, regulations and rules or implementation of future legislation, regulations and rules could cause our costs to increase or could harm us in other ways.

          Sarbanes-Oxley has increased our required administrative actions as a public company. The increase in general and administrative costs of complying with Sarbanes-Oxley will depend on how it is interpreted over time. Of particular concern are the level and timing of standards for internal control evaluation and reporting adopted under Section 404 of Sarbanes-Oxley. If our regulators and/or auditors adopt or interpret more stringent standards than we are anticipating, we and/or our auditors may be unable to conclude that our internal controls over financial reporting are designed and operating effectively, which could adversely affect investor confidence in our financial statements. Even if we and our auditors are able to conclude that our internal controls over financial reporting are designed and operating effectively in such a circumstance, our general and administrative costs are likely to increase. We may be required to obtain an audit of our internal controls for the year ending December 31, 2005 and, if so, our general and administrative costs are likely to increase. Actions by other entities, such as enhanced rules to maintain our listing on the Nasdaq SmallCap Market could also increase our general and administrative costs, as could further legislative action.

           The loss of significant customers could harm our operating results.

          Revenue from one contract with AgriLabs comprised approximately 17% and 15% of consolidated revenue in 2002 and 2003, respectively. Revenue from this customer represented less than 10% of our consolidated revenue for the year ended December 31, 2004 and for the three months ended March 31, 2004 and 2005, respectively. While we do not have any other customers who have represented more than 10% of revenues over the last three years, the loss of significant customers who, for example, are historically large purchasers or who are considered leaders in their field could damage our business and financial results. As an example, in late 2004 one of our largest distributors who has historically carried our full product line informed us they were being acquired by a distributor who does not carry our full product line. We believe purchases from the acquired distributor will be significantly lower in 2005 than in 2004, which we are unlikely to completely recover through direct sales and sales through other distributors.

          We depend on key personnel for our future success. If we lose our key personnel or are unable to attract and retain additional personnel, we may be unable to achieve our goals.

          Our future success is substantially dependent on the efforts of our senior management and other key personnel, particularly Dr. Robert B. Grieve, our Chairman and Chief Executive Officer. The loss of the services of members of our senior management or other key personnel may significantly delay or prevent the achievement of product development and other business objectives. Although we have an employment agreement with Dr. Grieve, he is an at-will employee, which means that either party may terminate his employment at any time without prior notice. If we lose the services of, or fail to recruit, key scientific and other personnel, the growth of our business could be substantially impaired. We do not maintain key person life insurance for any of our key personnel.

           Our stock price has historically experienced high volatility, which may increase in the future, and which could affect our ability to raise capital in the future or make it difficult for investors to sell their shares.

          The securities markets have experienced significant price and volume fluctuations and the market prices of securities of many microcap and smallcap companies have in the past been, and can in the future be expected to be, especially volatile. During the past 12 months, our closing stock price has ranged from a low of $0.56 to a high of $1.86. Fluctuations in the trading price or liquidity of our common stock may adversely affect our ability to raise capital through future equity financings. Factors that may have a significant impact on the market price and marketability of our common stock include:

          In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted. If a securities class action suit is filed against us, we would incur substantial legal fees and our management’s attention and resources would be diverted from operating our business in order to respond to the litigation.

           We must obtain and maintain costly regulatory approvals in order to market certain of our products.

          Many of the products we develop, market or manufacture are subject to extensive regulation by one or more of the USDA, the FDA, the EPA and foreign regulatory authorities. These regulations govern, among other things, the development, testing, manufacturing, labeling, storage, pre-market approval, advertising, promotion, sale and distribution of our products. Satisfaction of these requirements can take several years and time needed to satisfy them may vary substantially, based on the type, complexity and novelty of the product.

          The effect of government regulation may be to delay or to prevent marketing of our products for a considerable period of time and to impose costly procedures upon our activities. We have experienced in the past, and may experience in the future, difficulties that could delay or prevent us from obtaining the regulatory approval or license necessary to introduce or market our products. Such delays in approval may cause us to forego a significant portion of a new product’s sales in its first year due to seasonality and advanced booking periods associated with certain products. Regulatory approval of our products may also impose limitations on the indicated or intended uses for which our products may be marketed.

          Among the conditions for certain regulatory approvals is the requirement that our facilities and/or the facilities of our third party manufacturers conform to current Good Manufacturing Practices. Our manufacturing facilities and those of our third party manufacturers must also conform to certain other manufacturing regulations, which include requirements relating to quality control and quality assurance as well as maintenance of records and documentation. The USDA, FDA and foreign regulatory authorities strictly enforce manufacturing regulatory requirements through periodic inspections. If any regulatory authority determines that our manufacturing facilities or those of our third party manufacturers do not conform to appropriate manufacturing requirements, we or the manufacturers of our products may be subject to sanctions, including warning letters, manufacturing suspensions, product recalls or seizures, injunctions, refusal to permit products to be imported into or exported out of the United States, refusals of regulatory authorities to grant approval or to allow us to enter into government supply contracts, withdrawals of previously approved marketing applications, civil fines and criminal prosecutions. Any of these events, alone or in unison, could damage our business.

           Our future revenues depend on successful research, development, commercialization and market acceptance, any of which can be slower than we expect or may not occur.

          The research, development and regulatory approval process for many of our products is extensive and may take substantially longer than we anticipate. Research projects may fail. New products that we are developing for the veterinary marketplace may not perform up to our expectations. Because we have limited resources to devote to product development and commercialization, any delay in the research or development of one product or reallocation of resources to product development efforts that prove unsuccessful may delay or jeopardize the development of other product candidates. If we fail to successfully develop new products and bring them to market in a timely manner, our ability to generate additional revenue will decrease.

          Even if we are successful in the research and development of a product, we may experience delays in commercialization and/or market acceptance. For example, there may be delays in producing large volumes of a product or veterinarians may be slow to adopt a product. The latter is particularly likely where there is no comparable product available or historical use of such a product. For example, while we believe our E.R.D.-HEALTHSCREEN urine tests for dogs and cats represent a significant scientific breakthrough in companion animal annual health examinations, market acceptance of the product has been significantly slower than we anticipated. The ultimate adoption of a new product by veterinarians, the rate of such adoption and the extent veterinarians choose to integrate such a product into their practice are all important factors in the economic success of one of our new products and are factors that we do not control to a large extent. If our products do not achieve a significant level of market acceptance, demand for our products will not develop as expected and our revenues will be lower than we anticipate.

           Changes to financial accounting standards may affect our results of operations and cause us to change our business practices.

          We prepare our financial statements in conformance with United States generally accepted accounting principles, or GAAP. These accounting principles are established by and are subject to interpretation by the Financial Accounting Standards Board, the American Institute of Certified Public Accountants, the Securities and Exchange Commission and various bodies formed to interpret and create appropriate accounting policies. A change in those policies can have a significant effect on our reported results and may affect our reporting of transactions completed before a change is made effective. Changes to those rules may adversely affect our reported financial results or the way we conduct our business.

          We may face product returns and product liability litigation and the extent of our insurance coverage is limited. If we become subject to product liability claims resulting from defects in our products, we may fail to achieve market acceptance of our products and our sales could decline.

          The testing, manufacturing and marketing of our current products as well as those currently under development entail an inherent risk of product liability claims and associated adverse publicity. Following the introduction of a product, adverse side effects may be discovered. Adverse publicity regarding such effects could affect sales of our other products for an indeterminate time period. To date, we have not experienced any material product liability claims, but any claim arising in the future could substantially harm our business. Potential product liability claims may exceed the amount of our insurance coverage or may be excluded from coverage under the terms of the policy. We may not be able to continue to obtain adequate insurance at a reasonable cost, if at all. In the event that we are held liable for a claim against which we are not indemnified or for damages exceeding the $10 million limit of our insurance coverage or which results in significant adverse publicity against us, we may lose revenue, be required to make substantial payments which could exceed our financial capacity and/or lose or fail to achieve market acceptance. Furthermore, our agreements with some suppliers of our instruments contain limited warranty provisions, which may subject us to liability if a supplier fails to meet its warranty obligations if a defect is traced to our instrument or if we cannot correct errors reported during the warranty period. If our contractual limitations are unenforceable in a particular jurisdiction, a successful claim could require us to pay substantial damages.

           We may be held liable for the release of hazardous materials, which could result in extensive clean up costs or otherwise harm our business.

          Our products and development programs involve the controlled use of hazardous and biohazardous materials, including chemicals, infectious disease agents and various radioactive compounds. Although we believe that our safety procedures for handling and disposing of such materials comply with the standards prescribed by applicable local, state and federal regulations, we cannot eliminate the risk of accidental contamination or injury from these materials. In the event of such an accident, we could be held liable for any fines, penalties, remediation costs or other damages that result. Our liability for the release of hazardous materials could exceed our resources, which could lead to a shutdown of our operations. In addition, we may incur substantial costs to comply with environmental regulations if we choose to expand our manufacturing capacity.

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

          Market risk represents the risk of loss that may impact the financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. We are exposed to market risk in the areas of changes in United States and foreign interest rates and changes in foreign currency exchange rates as measured against the United States dollar. These exposures are directly related to our normal operating and funding activities.

     Interest Rate Risk

          The interest payable on certain of our lines of credit and other borrowings is variable based on the United States prime rate and, therefore, is affected by changes in market interest rates. At March 31, 2005, approximately $12.0 million was outstanding on these lines of credit and other borrowings with a weighted average interest rate of 8.19%. We also had approximately $4.7 million of cash and cash equivalents at March 31, 2005, the majority of which was invested in liquid interest bearing accounts. We completed an interest rate risk sensitivity analysis based on the above and an assumed one-percentage point increase/decrease in interest rates. If market rates increase/decrease by one percentage point, we would experience an increase/decrease in annual interest expense of approximately $73,000 based on our outstanding balances as of March 31, 2005.

     Foreign Currency Risk

          Our investment in foreign assets consists primarily of our investment in our European subsidiary. Foreign currency risk may impact our results of operations. In cases where we purchase inventory in one currency and sell corresponding products in another, our gross margin percentage is typically at risk based on foreign currency exchange rates. In addition, in cases where we may be generating operating income in foreign currencies, the magnitude of such operating income when translated into U.S. dollars will be at risk based on foreign currency exchange rates. Our agreements with suppliers and customers vary significantly in regard to the existence and extent of currency adjustment and other currency risk sharing provisions. We had no foreign currency hedge transactions in place on March 31, 2005.

          We have a wholly-owned subsidiary in Switzerland which uses the Swiss Franc as its functional currency. We purchase inventory in foreign currencies, primarily Japanese Yen and Euros, and sell corresponding products in U.S. dollars. We also sell products in foreign currencies, primarily Japanese Yen and Euros, where our inventory costs are in U.S. dollars. Based on our results of operations for the most recent 12 months, if foreign currency exchange rates were to strengthen/weaken by 25% against the dollar, we would expect a resulting pre-tax loss/gain of approximately $1.2 million.

Item 4.

CONTROLS AND PROCEDURES

     (a)   Evaluation of Disclosure Controls and Procedures. Our management, with the participation of our chief executive officer and our chief financial officer, evaluated the effectiveness of our disclosure controls and procedures, as defined by Rule 13a-15 of the Exchange Act, as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our chief executive officer and our chief financial officer have concluded that our disclosure controls and procedures are adequate to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.  

     (b)   Changes in Internal Control over Financial Reporting. There was no change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

          If, as of June 30, 2005, we meet the definition of “accelerated filer,” as defined by Rule 12b-2 of the Exchange Act, we will be required by the Sarbanes-Oxley Act of 2002 to include an assessment of our internal control over financial reporting and attestation from our independent registered public accounting firm in our Annual Report on Form 10-K for our fiscal year ending December 31, 2005. If, however, we are not deemed an “accelerated filer” at that time, we will not have to include such assessment and attestation until our Annual Report on Form 10-K for our fiscal year ended December 31, 2006.

PART II. OTHER INFORMATION

Item 1.    Legal Proceedings

                 From time to time, we may be involved in litigation relating to claims arising out of our operations. As of March 31, 2005, we were not party to any legal proceedings that are expected, individually or in the aggregate, to have a material effect on our business, financial condition or operating results.

Item 2.   Changes in Securities and Use of Proceeds

                 None.

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

                (a)   Exhibits

                Notes
                H  Confidential treatment has been requested with respect to certain portions of this agreement.  

HESKA CORPORATION

SIGNATURES

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

                             HESKA CORPORATION