10-Q

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[ X ]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended September 30, 2005
	OR
[    ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________________ to _______________________

Commission file number: 000-22427

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

Delaware	77-0192527
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification Number)
3760 Rocky Mountain Avenue
Loveland, Colorado	80538
(Address of principal executive offices)	(Zip Code)

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 a shell company (as defined in Rule 12b-2 of the Exchange Act).
   Yes   [     ] No  [ X  ]

         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 November 11, 2005 was 49,952,057

HESKA CORPORATION

FORM 10-Q

QUARTERLY REPORT

TABLE OF CONTENTS

		Page
	PART I.   FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Condensed Consolidated Balance Sheets (Unaudited) as of       December 31, 2004 and September 30, 2005	2
	Condensed Consolidated Statements of Operations (Unaudited) for the      three months and nine months ended September 30, 2004 and 2005	3
	Condensed Consolidated Statements of Cash Flows (Unaudited) for the      nine months ended September 30, 2004 and 2005	4
	Notes to Condensed Consolidated Financial Statements (Unaudited)	5
Item 2.	Management's Discussion and Analysis of Financial Condition and       Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4.	Controls and Procedures	33
	PART II.   OTHER INFORMATION
Item 1.	Legal Proceedings	35
Item 2.	Changes in Securities and Use of Proceeds	35
Item 3.	Defaults Upon Senior Securities	35
Item 4.	Submission of Matters to a Vote of Security Holders	35
Item 5.	Other Information	35
Item 6.	Exhibits	35
Signatures		36

           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 (“SPAH”) in the United States. HESKA, ALLERCEPT, AVERT, E.R.D.-HEALTHSCREEN, E-SCREEN, IMMUCHECK, 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)

ASSETS
	December 31, 2004		September 30, 2005
Current assets:
Cash and cash equivalents	$	4,982	$	5,096
Accounts receivable, net of allowance for doubtful accounts of           $95 and $116, respectively		10,634		9,753
Inventories, net		11,726		10,367
Other current assets		1,100		772
Total current assets		28,442		25,988
Property and equipment, net		7,925		7,857
Intangible assets, net		1,499		1,569
Goodwill		643		727
Other assets		215		310
Total assets	$	38,724	$	36,451

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	6,697		$	5,280
Accrued liabilities		3,187			2,101
Current portion of deferred revenue		2,708			2,488
Line of credit		10,375			9,948
Current portion of long-term debt		302			1,141
Total current liabilities		23,269			20,958
Long-term debt, net of current portion		1,466			2,897
Deferred revenue, net of current portion, and other		11,410			10,695
Total liabilities		36,145			34,550
Commitments and contingencies
Stockholders’equity:
Preferred stock, $.001 par value, 25,000,000 shares authorized; none issued          or outstanding		--			--
Common stock, $.001 par value, 75,000,000 shares authorized; 49,338,636 and          49,837,818 shares issued and outstanding, respectively		49			50
Additional paid-in capital		212,533			212,829
Deferred compensation		(67	)		(7	)
Accumulated other comprehensive income (loss)		170			(24	)
Accumulated deficit		(210,106	)		(210,947	)
Total stockholders’equity		2,579			1,901
Total liabilities and stockholders’ equity	$	38,724		$	36,451

See accompanying notes to condensed consolidated financial statements.

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

	Three Months Ended September 30,					Nine Months Ended September 30,
	2004			2005		2004			2005
Revenue, net:
Product revenue, net:
Core companion animal health	$	12,494		$	15,487	$	39,916		$	41,667
Other vaccines, pharmaceuticals and products		3,001			3,497		9,429			10,324
Total product revenue, net		15,495			18,984		49,345			51,991
Research, development and other		444			356		1,131			1,068
Total revenue		15,939			19,340		50,476			53,059
Cost of revenue:
Cost of products sold		9,827			11,358		31,803			33,167
Cost of research, development and other		112			304		341			771
Total cost of revenue		9,939			11,662		32,144			33,938
Gross profit		6,000			7,678		18,332			19,121
Operating expenses:
Selling and marketing		3,598			3,484		11,838			10,711
Research and development		1,307			884		4,591			3,061
General and administrative		1,805			1,838		5,875			5,687
Total operating expenses		6,710			6,206		22,304			19,459
Income (loss) from operations		(710	)		1,472		(3,972	)		(338	)
Interest and other expense, net		166			238		286			503
Net income (loss)	$	(876	)	$	1,234	$	(4,258	)	$	(841	)
Basic and diluted net income (loss) per share	$	(0.02	)	$	0.02	$	(0.09	)	$	(0.02	)
Shares used to compute basic net income (loss) per share		49,042			49,817		48,981			49,573
Shares used to compute diluted net income (loss) per share		49,042			50,133		48,981			49,573

See accompanying notes to condensed consolidated financial statements.

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

	Nine Months Ended September 30,
	2004			2005
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net loss	$	(4,258	)	$	(841	)
Adjustments to reconcile net loss to cash provided by (used in) operating activities:
Depreciation and amortization		1,029			1,319
Amortization of intangible assets		107			117
Stock based compensation		69			58
(Gain) loss on disposal of assets		(11	)		17
Unrealized (gain) on foreign currency translation		--			(64	)
Changes in operating assets and liabilities:
Accounts receivable		2,739			836
Inventories		(636	)		1,328
Other current assets		(1,030	)		322
Accounts payable		919			(1,407	)
Accrued liabilities		(397	)		(1,074	)
Deferred revenue and other long-term liabilities		1,337			(935	)
Other		(4	)		(20	)
Net cash provided by (used in) operating activities		(136	)		(344	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from licensing of technology and product rights		400			--
Purchase of property and equipment		(852	)		(1,268	)
Capitalized patent costs		(458	)		(187	)
Net cash provided by (used in) investing activities		(910	)		(1,455	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock		241			299
Proceeds from (repayments of) line of credit borrowings, net		1,856			(427	)
Proceeds from (repayments of) debt and capital lease obligations		(634	)		2,270
Net cash provided by (used in) financing activities		1,463			2,142
EFFECT OF EXCHANGE RATE CHANGES ON CASH		(19	)		(229	)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		398			114
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		4,877			4,982
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	5,275		$	5,096
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest	$	416		$	724

See accompanying notes to condensed consolidated financial statements.

HESKA CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 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, stand alone 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”) 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 a net loss for the full year 2005. Cumulative net losses from inception of the Company in 1988 through September 30, 2005, have totaled $210.9 million. During the three months ended September 30, 2005, the Company recognized net income of approximately $1.2 million and operations used cash of approximately $1.7 million. During the nine months ended September 30, 2005, the Company incurred a loss of approximately $841 thousand and operations used cash of approximately $344 thousand.

          The Company’s primary short-term needs for capital are based on its continuing sales and marketing, general and administrative and research and development activities, working capital associated with expected 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. There can be no guarantee that the Company will attain quarterly, annual, or sustained profitability in the future.

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 September 30, 2005, the condensed consolidated statements of operations for the three months and nine months ended September 30, 2004 and 2005 and the condensed consolidated statements of cash flows for the nine months ended September 30, 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 amount 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, in determining the need for a valuation allowance on certain deferred tax assets 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 totaling approximately $97 thousand and $32 thousand for the nine and three months ending September 30, 2004, respectively, 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 totaling approximately $341 thousand and $112 thousand for the nine and three months ended September 30, 2004, respectively, which are now included in Cost of Research, Development and Other Revenue.

Basic and Diluted Net Income (Loss) Per Share

          Basic net income (loss) per common share is computed using the weighted average number of common shares outstanding during the period. Diluted net income (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. Due to the Company’s net losses for the three and nine months ended September 30, 2004 and the nine months ended September 30, 2005, all potentially dilutive securities were anti-dilutive and as a result, basic net loss per share is the same as diluted net loss per share for those periods. For the three and nine months ended September 30, 2004 and the nine months ended September 30, 2005, securities that have been excluded from diluted net loss per share because they would be anti-dilutive are outstanding options to purchase 9,492,060 and 10,852,063 shares, respectively, of the Company’s common stock. For the three months ended September 30, 2005, the Company reported net income and therefore, dilutive common stock equivalent securities, as computed using the treasury stock method, were added to basic weighted average shares outstanding for the period to derive the weighted average shares for the diluted earnings per share calculation. Common stock equivalent securities that were anti-dilutive for the three months ended September 30, 2005, and therefore excluded, were outstanding options to purchare 9,142,192 shares. These securities are anti-dilutive primarily due to exercise prices greater than the average value of the Company’s common stock during the three months ended September 30, 2005. Should the Company’s stock price increase, the number of common stock equivalents considered to be dilutive will increase.

Stock Based Compensation

          The Company accounts for its stock-based compensation plans using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), 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 and promulgated in December 2004. The Company intends to adopt this standard when required. 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 originally intended to adopt SFAS No. 123R beginning on July 1, 2005, but based on the SEC’s action on April 14, 2005 currently intends to adopt this standard on January 1, 2006. The Company intends to adopt SFAS No. 123R under the modified prospective method of adoption. At September 30, 2005, the Company had two stock-based compensation plans. The Company recorded compensation expense related to the Company’s restricted stock of $69 thousand and $58 thousand for the nine months ended September 30, 2004 and 2005, respectively and $23 thousand and $19 thousand for the three months ended September 30, 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 income (loss) and net income (loss) per share for the three and nine months ended September 30, 2004 and 2005 would approximate the pro forma amounts as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2005			2004			2005
	(in thousands, except per share amounts)						(in thousands, except per share amounts)
Net income (loss) as reported	$	(876	)	$	1,234		$	(4,258	)	$	(841	)
Stock-based employee compensation        expense included in the determination of        net income (loss), as reported		23			19			69			58
Stock-based employee compensation         expense, as if the fair value based method         had been applied to all awards		(514	)		(83	)		(1,470	)		(2,050	)
Net income (loss), pro forma	$	(1,367	)	$	1,170		$	(5,659	)	$	(2,833	)
Net income (loss) per share:
Basic and diluted - as reported	$	(0.02	)	$	0.02		$	(0.09	)	$	(0.02	)
Basic and diluted - pro forma	$	(0.03	)	$	0.02		$	(0.12	)	$	(0.06	)

          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 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. In May 2005, the Company’s Board of Directors extended the discretionary acceleration of vesting options to Decmeber 31, 2005. 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 thousand options, approximately 55 thousand 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 thousand was recorded in the first quarter of 2005 and included in the table above. In addition, options to purchase approximately 49 thousand shares and approximately 2.5 million shares were granted with immediate vesting during the three months and nine months ending September 30, 2005, respectively.

          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 and nine months ended September 30, 2004 and 2005. The estimated total fair value of the options granted during the three months and nine months ended September 30, 2004 was approximately $84 thousand and $2.9 million, respectively. The estimated total fair value of the options granted during the three months and nine months ended September 30, 2005 was approximately $20 thousand and $1.2 million, respectively.

	Three Months Ended                        September 30,				Nine Months Ended                        September 30,
	2004		2005		2004		2005
Risk-free interest rate		3.24%		4.06%		3.63%		4.03%
Expected lives		4.3 years		2.8 years		4.6 years		2.9 years
Expected volatility		72%		83%		76%		86%
Expected dividend yield		0%		0%		0%		0%

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

	Year Ended December 31,					Nine Months Ended September 30,
	2004					2005
	Options			Weighted Average Exercise Price		Options			Weighted Average Exercise Price
Outstanding at beginning of period		7,954,648		$	1.5163		9,350,959		$	1.4509
Granted at market		2,575,830		$	1.8890		2,513,650		$	0.8722
Granted above market		418		$	2.6300		--		$	--
Cancelled		(792,963	)	$	3.8742		(670,965	)	$	1.6576
Exercised		(386,974	)	$	0.7476		(341,581	)	$	0.6094
Outstanding at end of period		9,350,959		$	1.4509		10,852,063		$	1.3306
Exercisable at end of period		7,939,567		$	1.5532		10,532,624		$	1.3506

          The following table summarizes information about stock options outstanding and exercisable at September 30, 2005:

	Options Outstanding						Options Exercisable
Exercise Prices	Number of Options Outstanding at September 30, 2005		Weighted Average Remaining Contractual Life in Years		Weighted Average Exercise Price		Number of Options Exercisable at September 30, 2005		Weighted Average Exercise Price
$0.34 - $0.80		2,077,942		7.48	$	0.6373		1,758,503	$	0.6314
$0.81 - $0.88		2,113,680		9.38	$	0.8772		2,113,680	$	0.8772
$0.92 - $1.20		2,391,832		6.27	$	1.0563		2,391,832	$	1.0563
$1.21 - $1.69		2,133,108		7.31	$	1.4198		2,133,108	$	1.4198
$1.75 - $13.75		2,135,501		6.86	$	2.6721		2,135,501	$	2.6721
$0.34 - $13.75		10,852,063		7.43	$	1.3306		10,532,624	$	1.3506

3.        RESTRUCTURING AND OTHER OPERATING EXPENSES

          At September 30, 2005, the Company had no remaining accrued restructuring expenses.

          Shown below is a rollforward of accrued restructuring costs for the nine months ended September 30, 2004 (in thousands):

	Balance at December 31, 2003		Payments for the Nine Months Ended September 30, 2004			Balance at September 30, 2004
Leased facility closure costs	$	51	$	(27	)	$	24
Products and other		70		(40	)		30
Total	$	121	$	(67	)	$	54

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, stand alone 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 product rights and royalties. These revenues are attributed as appropriate between CCA and OVP.

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

	Total Core Companion Animal Health			Total Other Vaccines, Pharmaceuticals and Products		Total
Three Months Ended September 30, 2004:
Total revenue	$	12,761		$	3,178	$	15,939
Operating income (loss)		(1,069	)		359		(710	)
Total assets		22,596			15,813		38,409
Capital expenditures		90			205		295
Depreciation and amortization		126			239		365

Three Months Ended September 30, 2005:
Total revenue	$	15,786	$	3,554	$	19,340
Operating income		1,039		433		1,472
Total assets		23,691		12,760		36,451
Capital expenditures		170		20		190
Depreciation and amortization		199		238		437

	Total Core Companion Animal Health			Total Other Vaccines, Pharmaceuticals and Products		Total
Nine Months Ended September 30, 2004:
Total revenue	$	40,845		$	9,631	$	50,476
Operating income (loss)		(4,595	)		623		(3,972	)
Total assets		22,596			15,813		38,409
Capital expenditures		511			341		852
Depreciation and amortization		311			718		1,029

Nine Months Ended September 30, 2005:
Total revenue	$	42,546		$	10,513	$	53,059
Operating income (loss)		(1,329	)		991		(338	)
Total assets		23,691			12,760		36,451
Capital expenditures		828			440		1,268
Depreciation and amortization		563			756		1,319

5.        COMPREHENSIVE INCOME (LOSS)

          Comprehensive income (loss) includes net income (loss) plus the results of certain stockholders’ equity changes not reflected in the Condensed Consolidated Statements of Operations. Such changes primarily include foreign currency translation items. Total comprehensive loss for the three months ended September 30, 2004 was $874,000 and total comprehensive income for the three months ended September 30, 2005 was $1.370 million. Total comprehensive loss for the nine months ended September 30, 2004 and 2005 was $4.269 million and $1.034 million, 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, gross margins, selling and marketing expenses, research and development expenses, general and administrative expenses and capital needs, 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 anticipated herein. The forward-looking statements set forth in this Form 10-Q are as of November 14, 2005, and we undertake no duty, and specifically disclaim any obligation, 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 81% and 80% of our product revenue for 2004 and the nine months ended September 30, 2005, respectively, and Other Vaccines, Pharmaceuticals and Products, which represented 19% and 20% of our product revenue for 2004 and the nine months ended September 30, 2005, respectively.

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

          Diagnostic and monitoring instruments and supplies represented approximately 47% and 43% of our product revenue for 2004 and the nine months ended September 30, 2005. 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, stand alone diagnostic and other tests, vaccines and pharmaceuticals represented approximately 34% and 37%, respectively, of our product revenue for both 2004 and the nine months ended September 30, 2005. 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 provided 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. 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 our operating expenses in the first nine months of 2005 as compared to the corresponding period in 2004 and anticipate we will have lower operating expenses for full year 2005 than we did for full year 2004, 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. Product revenue for this segment grew 24% and 4%, respectively, for the three months and nine months ended September 30, 2005 as compared to the prior year periods. 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 20% since 1998, our first full year as a public company.

          The Other Vaccines, Pharmaceuticals and Products segment (“OVP”) includes our 168 thousand 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 managed there. Core Companion Animal Health segment products manufactured at this facility are transferred at cost and are not recorded as revenue for our OVP segment. 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.

          Our OVP 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 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 may be extended under certain conditions. Our OVP segment 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 product rights 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

We generate our revenue through the sale of products, licensing of technology product rights, royalties and sponsored research and development. Our policy is to recognize revenue when the applicable revenue recognition criteria have been met, which generally include the following:

• Persuasive evidence of an arrangement exists;

• Delivery has occurred or services rendered;

• Price is fixed or determinable; and

• Collectibility is reasonably assured.

Revenue from the sale of products is recognized after both the goods are shipped to the customer and acceptance has been received, if required, with an appropriate provision for estimated returns and allowances. We do not permit general returns of products sold. Certain of our products have expiration dates. Our policy is to exchange certain outdated, expired product with the same product. We reduce revenue for the estimated cost of replacing the expired product expected to be returned in the future, based on our historical experience, adjusted for any known factors that reasonably could be expected to change historical patterns, such as regulatory actions which allow us to extend the shelf lives of our products. Revenue from both direct sales to veterinarians and sales to independent third-party distributors are generally recognized when goods are shipped. Our products are shipped complete and ready to use by the customer. The terms of the customer arrangements generally pass title and risk of ownership to the customer at the time of shipment. Certain customer arrangements provide for acceptance provisions. Revenue for these arrangements is not recognized until the acceptance has been received or the acceptance period has lapsed. We reduce our product revenue by the estimated cost of any rebates, allowances or similar programs, which are used as promotional programs.

Recording revenue from the sale of products involves the use of estimates and management judgment. We must make a determination at the time of sale whether the customer has the ability to make payments in accordance with arrangements. While we do utilize past payment history, and, to the extent available for new customers, public credit information in making our assessment, the determination of whether collectibility is reasonably assured is ultimately a judgment decision that must be made by management. We must also make estimates regarding our future obligation relating to returns, rebates, allowances and similar other programs. The estimate of these obligations is partially based on historical experience, but it also requires management to estimate the amount of product that particular customers will purchase in a given period of time.

License revenue under arrangements to sell or license product rights or technology rights is recognized as obligations under the agreement are satisfied, which generally occurs over a period of time. Generally, licensing revenue is deferred and recognized over the estimated life of the related agreements, products, patents or technology. Nonrefundable licensing fees, marketing rights and milestone payments received under contractual arrangements are deferred and recognized over the remaining contractual term using the straight-line method. Revenue from licensing technology and product rights is reported in our Research, development and other revenue line item.

Recording revenue from license arrangements involves the use of estimates. The primary estimate made by management is determining the useful life of the related agreement, product, patent or technology. We evaluate all of our licensing arrangements by estimating the useful life of either the

product or the technology, the length of the agreement or the legal patent life and defer the revenue for recognition over the appropriate period.

Occasionally we enter into arrangements that include multiple elements. Such arrangements may include the licensing of technology and manufacturing of product. In these situations we must determine whether the various elements meet the criteria to be accounted for as separate elements. If the elements cannot be separated, revenue is recognized once revenue recognition criteria for the entire arrangement have been met or over the period that the Company’s obligations to the customer are fulfilled, as appropriate. If the elements are determined to be separable, the revenue is allocated to the separate elements based on relative fair value and recognized separately for each element when the applicable revenue recognition criteria have been met. In accounting for these multiple element arrangements, we must make determinations about whether elements can be accounted for separately and make estimates regarding their relative fair values.

                 Allowance for Doubtful Accounts

The Company maintains an allowance for doubtful accounts receivable based on client-specific allowances, as well as a general allowance. Specific allowances are maintained for clients which are determined to have a high degree of collectibility risk based on such factors, among others, as: (i) the aging of the accounts receivable balance; (ii) the client’s past payment experience; (iii) a deterioration in the client’s financial condition, evidenced by weak financial condition and/or continued poor operating results, reduced credit ratings, and/or a bankruptcy filing. In addition to the specific allowance, the Company maintains a general allowance for credit risk in its accounts receivable which is not covered by a specific allowance. The general allowance is established based on such factors, among others, as: (i) the total balance of the outstanding accounts receivable, including considerations of the aging categories of those accounts receivable; (ii) past history of uncollectible accounts receivable write-offs; and (iii) the overall creditworthiness of the client base. A considerable amount of judgment is required in assessing the realizability of accounts receivable. Should any of the factors considered in determining the adequacy of the overall allowance change, an adjustment to the provision for doubtful accounts receivable may be necessary.

                 Inventories

Inventories are stated at the lower of cost or market, cost being determined on the first-in, first-out method. Inventories are written down if the estimated net realizable value of an inventory item is less than its recorded value. We review the carrying cost of our inventories by product each quarter to determine the adequacy of our reserves for obsolescence. In accounting for inventories we must make estimates regarding the estimated net realizable value of our inventory. This estimate is based, in part, on our forecasts of future sales and shelf life of product.

                 Capitalized Patent Costs

The Company defers and capitalizes certain costs, including payments to third-party law firms for patent prosecution to expand the scope of its patents, related to the technology or patents underlying a variety of long-term licensing arrangements.  No internal costs are capitalized.  These capitalized costs are amortized over the same period as the licensing revenue related to those patents is recognized.  Costs in excess of the amount of remaining related deferred licensing revenue are not capitalized, but are expensed as incurred. The Company capitalized approximately $458 thousand and $187 thousand for the nine months ended September 30, 2004 and 2005, respectively and amortized approximately $107 thousand and $117 thousand for the same periods, respectively. The Company capitalized approximately $84 thousand and $127 thousand for the three months ended September 30, 2004 and 2005, respectively and amortized approximately $39 thousand and $40 thousand for the same periods, respectively.

     Results of Operations

     Revenue

          Total revenue consists of two components: 1) product revenue and 2) research, development and other revenue. Total revenue increased 5% to $53.1 million for the nine months ended September 30, 2005 as compared to $50.5 million for the corresponding period in 2004. Product revenue increased 5% to $52.0 million for the nine months ended September 30, 2005 as compared to $49.3 million for the corresponding period in 2004. Total revenue increased 21% to $19.3 million for the three months ended September 30, 2005 as compared to $15.9 million for the corresponding period in 2004. Product revenue increased 23% to $19.0 million for the three months ended September 30, 2005 as compared to $15.5 million for the corresponding period in 2004.

          Product revenue from our Core Companion Animal Health segment increased 4% to $41.7 million for the nine months ended September 30, 2005 as compared to $39.9 million for the corresponding period in 2004. Key factors in the increase were higher sales of our instrument consumables, our microalbumin laboratory packs, the latter of which we began to sell in 2005, and our heartworm preventive, somewhat offset by lower sales of our hematology instruments, due to an offer to certain customers who had previously purchased a hematology analyzer to upgrade to our new hematology analyzer in the first half of 2004 which was not repeated in the first half of 2005, and lower sales of our heartworm diagnostic tests. Product revenue from our Core Companion Animal Health segment was $15.5 million for the three months ended September 30, 2005, an increase of 24% as compared to $12.5 million for the corresponding period in 2004. Key factors in the increase were higher sales of our instrument consumables and our heartworm preventive.

          Product revenue from our Other Vaccines, Pharmaceuticals and Products segment (“OVP”) increased by 9% to $10.3 million for the nine months ended September 30, 2005 as compared to $9.4 million for the corresponding period in 2004. The increase in product revenue was primarily due to greater sales of bovine vaccines under our contract with AgriLabs, bulk bovine biologicals and fish vaccines, somewhat offset by decreased sales of small mammal vaccines. Product revenue from our OVP segment increased by 17% to $3.5 million for the three months ended September 30, 2005 as compared to $3.0 million for the corresponding period in 2004. Key factors in the increase were higher sales of bulk bovine biologicals and fish vaccines.

          Revenue from research, development and other decreased slightly for the nine months ended September 30, 2005 as compared to the corresponding period in 2004. Revenue from research, development and other decreased 20% to $356 thousand for the three months ended September 30, 2005 from $444 thousand for the corresponding period in 2004. Both decreases were primarily due to the reduced level of activity for research and development efforts performed for third parties.

          For 2005, we expect to grow our Core Companion Animal Health segment product revenue as compared to 2004. We anticipate OVP product revenue to increase slightly as compared to 2004. We expect research, development and other revenue to decline slightly in 2005 as compared to 2004.

     Cost of Revenue

          Cost of revenue consists of two components: 1) cost of products sold and 2) cost of research, development and other revenue, both of which correspond to their respective revenue categories. Cost of revenue totaled $33.9 million for the first nine months of 2005, a 6% increase as compared to $32.1 million for the corresponding period in 2004. Gross profit increased 4% to $19.1 million for the nine months ended September 30, 2005 as compared to $18.3 million in the prior year corresponding period. Gross Margin, i.e. gross profit divided by total revenue, declined slightly to 36.0% for the nine months ended September 30, 2005 as compared to 36.3% in the corresponding period in 2004. Cost of revenue totaled $11.7 million for the three months ended September 30, 2005, a 17% increase as compared to $9.9 million for the corresponding period in 2004. Gross profit increased 28% to $7.7 million for the three months ended September 30, 2005 as compared to

$6.0 million in the prior year corresponding period. Gross Margin increased to 39.7% for the three months ended September 30, 2005 as compared to 37.6% in the corresponding period in 2004.

          Cost of products sold increased 4% to $33.2 million in the nine months ended September 30, 2005 from $31.8 million in the prior year period. Gross profit on product revenue increased 7% to $18.8 million for the nine months ended September 30, 2005 from $17.5 million in the prior year period. Product Gross Margin, i.e. gross profit on product revenue divided by product revenue, increased to 36.2% in the nine months ended September 30, 2005 as compared to 35.6% in the corresponding period in 2004. Key factors in the improvement were higher sales and margins in our heartworm preventive product, where we now have taken in house certain manufacturing operations we previously outsourced, increased instrument consumable sales, which typically carry a higher than average gross margin and increased margins in our OVP segment, somewhat offset by certain supplier price increases. Cost of products sold increased 16% to $11.4 million in the three months ended September 30, 2005 as compared to $9.8 million in the prior year period. Gross profit on product revenue increased 35% to $7.6 million for the three months ended September 30, 2005 from $5.7 million in the prior year period. Product Gross Margin increased to 40.2% in the three months ended September 30, 2005 as compared to 36.6% in the corresponding period in 2004. Key factors in the improvement were higher sales and margins in our heartworm preventive product, where we now have taken in house certain manufacturing operations we previously outsourced, increased instrument consumable sales, which typically carry a higher than average gross margin, increased margins in our OVP segment and increased margins on our heartworm diagnostic products, somewhat offset by certain supplier price increases.

          Cost of research, development and other revenue increased 126% to $771 thousand in the nine months ended September 30, 2005 as compared to $341 thousand in the prior year period. Gross profit on research, development and other revenue decreased 62% to $297 thousand for the nine months ended September 30, 2005 from $790 thousand in the prior year period. Other Gross Margin, i.e. gross profit on research, development and other revenue divided by research, development and other revenue, declined to 27.8% for the nine months ended September 30, 2005 as compared to 69.9% in the prior year period. The primary reason for the decrease is a greater proportion of patent-related costs being expensed as incurred in the nine months ended September 30, 2005 as compared to the prior year period when certain patent-related costs were capitalized. Cost of research, development and other revenue increased 171% to $304 thousand in the three months ended September 30, 2005 as compared to $112 thousand in the prior year period. Gross profit on research, development and other revenue decreased 85% to $52 thousand for the three months ended September 30, 2005 from $332 thousand in the prior year period. Other Gross Margin declined to 14.3% for the three months ended September 30, 2005 as compared to 74.8% in the prior year period. The primary reason for the decrease is a greater proportion of patent-related costs being expensed as incurred in the three months ended September 30, 2005 as compared to the prior year corresponding period when certain patent-related costs were capitalized.

          We expect Gross Margin to increase slightly in 2005 as compared to 2004, primarly due to a slight increase in Product Gross Margin. We expect Other Gross Margin to decrease for 2005 as compared to 2004 as we expect a greater proportion of patent related costs will be expensed as incurred.

     Operating Expenses

          Total operating expenses decreased 13% to $19.5 million in the nine months ended September 30, 2005 as compared to $22.3 million in the prior year period. Total operating expenses decreased 8% to $6.2 million in the three months ended September 30, 2005 as compared to $6.7 million in the prior year period.

          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 10% to $10.7 million in the nine months ended September 30, 2005 as compared to $11.8 million in the corresponding period in 2004. The decrease was primarily due to higher costs related to the launch of our new hematology instrument in the nine months ended September 30, 2004. Selling and marketing expenses decreased 3% to $3.5 million in the three months ended September 30, 2005 as compared to $3.6 million in the

corresponding period in 2004. The decrease was primarily due to higher costs related to the launch of our new hematology instrument and higher outside consulting fees in the three months ended September 30, 2004.

          Research and development expenses declined 33% to $3.1 million for the nine months ended September 30, 2005 from $4.6 million during the corresponding period in 2004. The decline was primarily due to lower costs on clinical trials and lower compensation and benefits costs primarily due to reductions in headcount. Research and development expenses declined 32% to $884 thousand for the three months ended September 30, 2005 from $1.3 million during the corresponding period in 2004. A key factor in the decline was lower personnel costs.

          General and administrative expenses were $5.7 million in the nine months ended September 30, 2005, down 3% from $5.9 million in the prior year period. Key factors in the decrease include lower consulting and legal expenses, somewhat offset by increased rent expense. General and administrative expenses were up slightly in the three months ended September 30, 2005 as compared to the prior year period.

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

     Interest and Other Expense, Net

          Interest and other expense increased $217 thousand to $503 thousand for the nine months ended September 30, 2005 as compared to interest and other expense of $286 thousand during the corresponding period in 2004. The increase in interest and other expense was due to higher interest expense in 2005 as we utilized more of our revolving line of credit and incurred higher interest rates on our borrowings as well as the receipt of certain prior years’ tax credits in 2004 which did not occur in 2005. These increases in interest expense were partially offset by gains on foreign currency translation of approximately $175 thousand for the nine months ended September 30, 2005. This foreign currency translation gain resulted primarily from transactions in the first nine months of 2005 whereby funds were transferred from a Swiss subsidiary of Heska to the United States-based parent company, via an intercompany receivable/payable and certain inventory transactions involving non-U.S. dollar currencies. Because this intercompany loan is to be repaid in the foreseeable future, changes in the amount receivable by the Swiss subsidiary resulting from changes in foreign currency exchange rates must be recorded through earnings or loss. For the nine months ended September 30, 2005, the impact of the foreign currency exchange rate changes resulted in a gain. It is reasonably possible that future changes could result in a loss which would also be reflected in earnings or loss. Interest and other expense increased to $238 thousand for the three months ended September 30, 2005 as compared to $166 thousand during the corresponding period in 2004 due to higher utilization of our revolving line of credit, higher interest rates on our borrowings and $2.5 million of additional term loan borrowings from Wells Fargo Business Credit, Inc. (“Wells Fargo”) in the latter period.

          We expect this line item to be a net expense for 2005 and to primarily consist of net interest expense. We expect this line item 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 modifications to our credit facility agreement as well as the additional $2.5 million of term loan borrowings from Wells Fargo.

     Net Loss

          Our net loss decreased 80% to $841 thousand in the nine months ended September 30, 2005 compared to $4.3 million during the corresponding period in 2004. For the three months ended September 30, 2005, our net income was $1.2 million compared to a net loss of $876 thousand for the comparable period in 2004. The improvement in 2005 from 2004 was the result of a 23% increase in product revenue, a 28% increase in gross profit and an 8% decrease in operating expenses.

           In 2005, we expect increased revenue and lower operating expenses to contribute to a lower net loss for the full year as compared to 2004.

     Liquidity and Capital Resources

          We have incurred net cumulative negative cash flow from operations since our inception in 1988. For the nine months ended September 30, 2005, we had a net loss of $841 thousand. During the nine months ended September 30, 2005, our operations used cash of $344 thousand. At September 30, 2005, we had $5.1 million of cash and cash equivalents, $5.0 million of working capital, $9.9 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 slightly from $5.2 million at December 31, 2004, to $5.0 million at September 30, 2005.

          At September 30, 2005, we had a $12.0 million asset-based revolving line of credit which had a maturity date of June 30, 2009 as part of our credit and security agreement with Wells Fargo. At September 30, 2005, $9.9 million was outstanding under this line of credit. Our ability to borrow under this facility varies based upon available cash, eligible accounts receivable and eligible inventory. On September 30, 2005, interest was charged at a stated rate of prime plus 2.75% and was 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. 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 below, 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. We were in compliance with all financial covenants as of September 30, 2005. At September 30, 2005, our remaining available borrowing capacity based upon eligible accounts receivable and eligible inventory under our revolving line of credit was approximately $598 thousand.

          At September 30, 2005, we also had outstanding obligations for long-term debt and capital leases totaling approximately $4.0 million primarily related to three term loans with Wells Fargo and a subordinated promissory note with a significant customer with the proceeds used for facilities enhancements. One term loan is secured by real estate and had an outstanding balance at September 30, 2005 of approximately $958 thousand due in monthly installments of $17,658 plus interest, with a balloon payment of approximately $163 thousand due on June 30, 2009. The term loan had a stated interest rate of prime plus 2.75% on September 30, 2005. In July 2005, we borrowed an additional $2.5 million from Wells Fargo which was secured by machinery and equipment at our Des Moines, Iowa and Loveland, Colorado locations (the “Equipment Notes”). The Equipment Notes had a stated interest rate of prime plus 2.75% on September 30, 2005. Principal payments on the Equipment Notes of $46,296 plus interest are due monthly beginning February 1, 2006 with a balloon payment of approximately $694 thousand due upon maturity of the credit facility agreement on June 30, 2009. 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 thousand payable in May 2006 and the lender has subordinated its first security interest to Wells Fargo. In addition, we have a promissory note to the City of Des Moines with an outstanding balance at September 30, 2005 of approximately $52 thousand, due in monthly installments through June 2006. This promissory note has a stated interest rate of 3.0%. The note is secured by first security interests in essentially all of our OVP segment’s assets and the lender has subordinated its first security interest to Wells Fargo. Our capital lease obligations totaled approximately $29 thousand at September 30, 2005. 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.

          Net cash used in operating activities was $344 thousand for the nine months ended September 30, 2005 as compared to $136 thousand during the corresponding period in 2004. The increase in cash used by operations for the nine months ended September 30, 2005 as compared to the same period of 2004 is due to a decrease in

accounts payable of $1.4 million for the nine months ended September 30, 2005 compared to an increase of $919 thousand for the same period in 2004 due to greater payments to vendors; a decrease in accrued liabilities of $1.1 million for the nine months ended September 30, 2005 as compared to a decrease of $397 thousand for the same period in 2004 due to greater payments to vendors; a decrease of $935 thousand in deferred revenue and other long-term liabilities for the nine months ended September 30, 2005 as compared to an increase of $1.3 million for the same period in 2004 due to amounts being received from various transactions in 2004 which offset significant portions of the amortization during the first nine months of 2004 with no corresponding transactions in the same period of 2005; a smaller decrease in accounts receivable of $836 thousand for the nine months ended September 30, 2005 as compared to a decrease of $2.7 million for the same period in 2004 due to increased revenue in the third quarter of 2005; offset by the $3.4 million decrease in our net loss for the nine months ended September 30, 2005 as compared to the same period in 2004; a decrease in inventories of $1.3 million for the nine months ended September 30, 2005 as compared to an increase in inventories of $636 thousand for the same period last year due to greater revenue in the third quarter of 2005; and a decrease of approximately $322 thousand in other current assets for the nine months of 2005 as compared to an increase of $1.0 million for the same period in 2004 due to decreases in prepaid expenses of $391 thousand in 2005 as compared to increases of $516 thousand in 2004, primarily related to prepaid inventory items, prepaid insurance and prepaid marketing costs, as well as increases in other receivables in 2004. 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 $1.5 million in the nine months ended September 30, 2005, compared to $910 thousand during the corresponding period in 2004, with the change due primarily to increased capital expenditures in 2005 as compared to 2004, lower capitalized patent costs in 2005 as compared to 2004 and proceeds from the licensing of technology and product rights totaling $400 thousand in 2004 with no corresponding proceeds in 2005.

          Net cash flows from financing activities provided cash of $2.1 million during the nine months ended September 30, 2005 as compared to providing $1.5 million during the corresponding period in 2004. In 2005, the cash was provided primarily by the Equipment Notes. In 2004, the cash was provided primarily from net borrowings under our revolving line of credit.

          At September 30, 2005, we had net intangible assets of approximately $1.6 million related to deferred patent costs. These deferred patent costs are being recognized as research and development costs on a straight-line basis over the remaining lives of the agreements, products, patents or technology. We also had total deferred revenue and other long-term liabilities, net of current portion, of approximately $10.7 million. Included in this total is approximately $10.4 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 nine months ended September 30, 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 $289 thousand is related to pension liabilities for a defined benefit pension plan which was frozen in October 1992 and other long-term liabilities.

          Our primary short-term need for capital, which is subject to change, is to fund our operations, which consist of continued sales and marketing, general and administrative and research and development efforts, working capital associated with increased product sales and capital expenditures relating to maintaining and developing 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 those of third parties who market, sell and distribute our products, are successful in increasing revenue, the extent to which currently planned products and/or technologies under research or development are successfully developed, the extent of the market acceptance of any new products, changes required of us by regulatory bodies to maintain our operations and other factors.

          Based on our current operating plan, 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 2006. Our current operating plan anticipates we will be profitable in the

fourth quarter of 2005 and for 2006 as a whole. If our actual performance deviates from our operating plan, 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 securities; (2) refinancing of real property assets; (3) sale of assets, products or marketing rights; and (4) 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. See “Factors that May Affect Results.”

     Net Operating Loss Carryforwards

           Our net deferred tax assets, consisting primarily of net operating loss carryforwards, are completely offset by valuation allowances. As of December 31, 2004, we had a net domestic operating loss carryforward, or NOL, of approximately $170.2 million, a domestic alternative minimum tax credit of approximately $23 thousand and a domestic research and development tax credit carryforward of approximately $307 thousand. The NOL and tax credit carryforwards are subject to alternative minimum tax limitations and to examination by the tax authorities. In addition, we have 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 had net operating loss carryforwards in Switzerland of approximately $2.8 million at December 31, 2004 related to losses previously recorded by Heska AG, a Swiss subsidiary of Heska. We are currently evaluating our ongoing operations in Switzerland, including the tax implications thereof. During the fourth quarter of 2005, we intend to finalize our evaluation, and the possible outcome of such evaluation may be that all, or a portion, of this NOL would be determined to be realizable on a more-likely-than-not basis, and the related valuation allowance would be released, resulting in an income tax benefit. It is also possible that the Company could conclude that such NOLs will not be realized on such basis.

     Recent Accounting Pronouncements

          Recent accounting pronouncements that are relevant to us include Statement of Financial Accounting Standards (“SFAS”) No. 123R and SFAS No. 154.

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. We intend to adopt this standard when required. 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. 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. Upon adoption of SFAS No. 123R, we will be required to recognize compensation expense using the fair value-based model for options that vest after the effective date of SFAS No. 123R adoption, including those that were granted prior to the effective date of SFAS No. 123R adoption. This will result in recording compensation expense for periods after the effective date of SFAS No. 123R adoption. Historically, under APB No. 25, we have recorded minimal amounts of stock-based compensation. 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 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 are reported in the footnotes to our 2005 financial statements. This action effected approximately 750 thousand options, approximately 55 thousand of which were held by our Directors and Executive Officers. Had this action not been taken, and had all approximately 750 thousand 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 thousand 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 thousand 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 in 2005 based on our historical experience for time from option grant to option exercise for all employees and in 2004 based on a software program to which an input was our historical exercise experience for current employees; 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 nine months ended September 30, 2005, we had pro forma stock option compensation of approximately $1.953 million related to recogntion of the vesting of options to purchase approximately 3.5 million shares. The underlying assumptions made in valuing 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 3.78% 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 $0.87 per share (the “Benchmark Tranche”) to yield the same value as above (the “Benchmark Value”). The following table represents the approximate decrease, in thousands of 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 “at-the-money” options to purchase approximately 3.5 million shares with a fair market stock value of $0.87 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 3.78% and expected dividends of zero, we obtain a fair value of approximately $1.953 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%,

we obtain a value of approximately $1.674 million, or a decrease of approximately $279 thousand as compared to the Benchmark Value.

								Volatility
		15%		30%		45%		60%			75%			90%			105%			120%			135%			150%
	1		1,710		1,533		1,356		1,183			1,014			848			689			533			388			247
	2		1,575		1,335		1,098		865			643			431			233			53			(113	)		(265)
Time to	3		1,459		1,180		897		629			378			145			(67	)		(254	)		(417	)		(558)
Expiration	4		1,356		1,042		731		438			170			(74	)		(283	)		(466	)		(615	)		(738)
(in years)	5		1,257		922		590		279			0			(244	)		(449	)		(618	)		(752	)		(858)
	6		1,166		816		463		141			(141	)		(381	)		(576	)		(731	)		(851	)		(940)
	7		1,081		714		353		24			(258	)		(491	)		(678	)		(819	)		(922	)		(992)
	8		996		622		251		(81	)		(360	)		(586	)		(756	)		(883	)		(971	)		(1,031)
	9		918		537		159		(173	)		(449	)		(664	)		(823	)		(932	)		(1,010	)		(1,056)
	10		844		459		74		(258	)		(526	)		(728	)		(876	)		(975	)		(1,035	)		(1,074)

           Pro forma stock option compensation related to recognition of the vesting of options of approximately $1.953 million for the nine months ending on September 30, 2005 may not be indicative of the future impact of SFAS No. 123R. Assuming all options vest according to the vesting schedule currently in place, we currently have approximately $83 thousand of compensation cost to be recognized after 2005 underlying employee stock options currently outstanding, approximately $79 thousand of which is to be recognized in 2006. 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.

SFAS No. 154, "Accounting Changes and Error Corrections"

           Statement of Financial Accounting Standards No. 154 "Accounting Changes and Error Corrections" ("SFAS No. 154") was issued in May 2005 and is effective for us beginning on January 1, 2006. SFAS No. 154 requires that all voluntary changes in accounting principles are retrospectively applied to prior financial statements as if that principle had always been used, unless it is impracticable to do so. When it is impracticable to calculate the effects on all prior periods, SFAS No. 154 requires that the new principle be applied to the earliest period practicable. The adoption of SFAS No. 154 is not anticipated to have a material effect on our financial position or results of operations.

     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 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 September 30, 2005, we had an accumulated deficit of $210.9 million. Notwithstanding a profitable third quarter in 2005 and

our expectation of profitability in the fourth quarter of 2005 and for 2006 as a whole, 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 at least 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 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 to operate, 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 11 independent third-party distributors who carry our full line of Core Companion Animal Health products, approximately 12 independent third-party distributors who carry portions of our Core Companion Animal Health product line and through a direct sales force of approximately 28 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, 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 have historically not consistently 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 our actual performance deviates from our operating plan, which anticipates we will be profitable in the fourth quarter of 2005 and for 2006 as a whole, 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 securities; (2) refinancing of real property assets; (3) sale of assets, products or marketing rights; and (4) 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. The public markets may be unreceptive to equity financings and we may not be able to obtain additional private equity or debt financing. Any 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. We may not find any third parties interested in licensing our intellectual property or purchasing any of our assets, products or marketing rights in a timely manner, or at all. If we relinquish rights to certain of our intellectual property, or sell certain of our assets, products or marketing rights it may limit our future prospects. Additionally, 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, even if additional capital is available, it may not be of the magnitude required to meet our needs under these or other scenarios. If additional funds are required and are not available, it would likely have a material adverse effect on our business, financial condition and our ability to continue as a going concern.

           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:

• supply of products from third party suppliers or termination of such relationships;

• the introduction of new products by our competitors or by us;

• competition and pricing pressures from competitive products;

• our distribution strategy and our ability to maintain relationships with distributors;

• large customers failing to purchase at historical levels;

• fundamental shifts in market demand;

• manufacturing delays;

• shipment problems;

• regulatory and other delays in product development;

• product recalls or other issues which may raise our costs;

• changes in our reputation and/or market acceptance of our current or new products; and

• changes in the mix of products sold.

           We have high operating expenses for personnel, marketing and new product development. 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.

           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, Fort Dodge Animal Health (a division of Wyeth), Intervet International bv (a unit of Akzo Nobel N.V.), Merial Ltd., Novartis AG, Pfizer Inc., Schering-Plough Corporation and Virbac S.A., 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 our OVP segment 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 our OVP segment customers. Competitors may have facilities with similar capabilities to our OVP segment, 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 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 for the manufacture of 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 Global Business, Inc., Boule Medical AB and Quidel Corporation ("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:

• The loss of product rights upon expiration or termination of an existing agreement. Unless we are able to find an alternate supply of a similar product, we would not be able to continue to offer our customers the same breadth of products and our sales and operating results would likely suffer. In the case of an instrument supplier, we could also potentially suffer the loss of sales of consumable supplies, which could be significant if we have built a significant installed base, further harming our sales prospects and opportunities. Even if we were able to find an alternate supply, we would likely face increased competition from the product whose rights we lost being marketed by a third party or the former supplier and it may take us additional time and expense to gain the necessary approvals and launch an alternative product.

• High switching costs. If we need to change to other commercial manufacturing contractors for certain of our products, additional regulatory licenses or approvals must be obtained for these contractors prior to our use. This would require new testing and compliance inspections prior to sale thus resulting in potential delays. Any new manufacturer would have to be educated in, or develop substantially equivalent processes necessary for the production of our products. In addition, in certain lines of instruments, we would lose the consumable revenues from the installed base of those instruments if we were to switch to a competitive instrument.

• The involuntary or voluntary discontinuation of a product line. Unless we are able to find an alternate supply of a similar product in this or similar circumstances with any product, we would not be able to continue to offer our customers the same breadth of products and our sales would likely suffer. Even if we are able to identify an alternate supply, it may take us additional time and expense to gain the necessary approvals and launch an alternative product, especially if the product is discontinued unexpectedly.

• Inability to meet minimum obligations. Current agreements, or agreements we may negotiate in the future, may commit us to certain minimum purchase or other spending obligations. It is possible we

will not be able to create the market demand to meet such obligations, which could create an increased drain on our financial resources and liquidity. Some such agreements may require minimum purchases and/or sales to maintain product rights and we may be significantly harmed is we are unable to meet such requirements.

• Loss of exclusivity. Our agreements, or agreements we may negotiate in the future, with suppliers may require us to meet minimum annual sales levels to maintain our position as the exclusive distributor of these products. We may not meet these minimum sales levels in the future and maintain exclusivity over the distribution and sale of these products. If we are not the exclusive distributor of these products, competition may increase.

• Limited capacity or ability to scale capacity. If market demand for our products increases suddenly, our current suppliers might not be able to fulfill our commercial needs, which would require us to seek new manufacturing arrangements and may result in substantial delays in meeting market demand. If we consistently generate more demand for a product than a given supplier is capable of handling, it could lead to large backorders and potentially lost sales to competitive products that are readily available. This could require us to seek or fund new sources of supply.

• Inconsistent or inadequate quality control. We may not be able to control or adequately monitor the quality of products we receive from our suppliers. Poor quality items could damage our reputation with our customers.

• Regulatory risk. Our manufacturing facility and those of some of our third party suppliers are subject to ongoing periodic unannounced inspection by regulatory authorities, including the FDA, USDA and other federal and state agencies for compliance with strictly enforced Good Manufacturing Practices, regulations and similar foreign standards, and we do not have control over our suppliers’ compliance with these regulations and standards. Violations could potentially lead to interruptions in supply that could cause us to lose sales to readily available competitive products.

• Developmental delays. We may experience delays in the scale-up quantities needed for product development that could delay regulatory submissions and commercialization of our products in development, causing us to miss key windows of opportunity.

• Limited intellectual property rights. We may not have intellectual property rights, or may have to share intellectual property rights, to the products themselves and any improvements to the manufacturing processes or new manufacturing processes for our products.

           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. Even if these third parties are successful in their research and development activities, we may not be able to come to an economic agreement

with them. If these third parties or collaborative partners fail to complete research and development activities, fail to complete them in a timely fashion, or if we are unable to negotiate economic agreements with such third parties or collaborative partners, our ability to introduce new products will be impacted negatively and our revenues may decline.

           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 Corixa Corporation, Hybritech Inc., New England Biolabs, Inc., Roche Molecular Systems, Inc. and Synbiotics Corporation, 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. For example, on September 9, 2005, United Vaccines, Inc. (“United”), a customer of our OVP segment, filed a lawsuit in Wisconsin against our Diamond Animal Health, Inc. subsidiary (“Diamond”) and Heska Corporation alleging various claims, including breach of contract and breach of warranty, and demanding compensatory and punitive damages. On October 20, 2005, we filed a motion to

dismiss certain claims against Diamond and all claims against Heska, as well an answer to United’s claims, affirmative defenses and counterclaims on behalf of Diamond. While we intend to pursue the matter vigorously and believe we are entitled to damages from United and that United is not entitled to damages from Heska or Diamond, there can be no assurance the ultimate resolution of this case will reflect our current beliefs.

           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. AgriLabs has the exclusive right to sell certain of our bovine vaccines in the United States, Africa, China, Mexico and Taiwan. 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 may be nothing to prevent these partners from pursuing alternative technologies or products that may compete with our products in current or future agreements. 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 agreements with SPAH and AgriLabs requires us to potentially pay penalties if we are unable to supply product over an extended period of time.

           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 $1.37. 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:

• stock sales by large stockholders or by insiders;

• our quarterly operating results, including as compared to our revenue, earnings or other guidance and in comparison to historical results;

• termination of our third party supplier relationships;

• announcements of technological innovations or new products by our competitors or by us;

• litigation;

• regulatory developments, including delays in product introductions;

• developments in our relationships with collaborative partners;

• developments or disputes concerning patents or proprietary rights;

• availability of our revolving line of credit and compliance with debt covenants;

• releases of reports by securities analysts;

• changes in regulatory policies;

• economic and other external factors; and

• general market conditions.

           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, it is likely 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.

           The loss of significant customers could harm our operating results.

           Revenue from one customer, SPAH, accounted for approximately 13% of our consolidated revenue for the three months ended September 30, 2005. No other customer accounted for more than 10% of our consolidated revenue for the three months ended September 30, 2004 or either of the nine month periods ended September 30, 2004 and 2005. Revenue from our contract with AgriLabs comprised approximately 15% of consolidated revenue in 2003. 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. No single customer accounted for more than 10% of our consolidated accounts receivable balance at either September 30, 2004 or 2005.

           Our common stock is listed on the Nasdaq Capital 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 Capital Market. The Nasdaq has several quantitative and qualitative requirements companies must comply with to maintain this listing, including a $1.00 minimum bid price. While we believe we are currently in compliance with all Nasdaq requirements, we have not always been able to maintain compliance in the past and there can be no assurance we will maintain compliance in the future. For example, on May 5, 2005, we received a communication from Nasdaq advising us that we had failed to comply with the minimum $1.00 per share bid price requirement for 20 consecutive business days and that we had been afforded a 180 calendar day "grace period" to regain compliance with the $1.00 minimum bid requirement. While we received a communication from Nasdaq on November 1, 2005, stating we have regained compliance and the matter is closed, there can be no assurance we will continue to meet the minimum bid price requirement in the future. In another example, on July 7, 2005, we received a communication from Nasdaq advising us that we failed to comply with the $35 million minimum market value of listed securities required for 10 consecutive trading days and that we had been afforded a 30 calendar day "grace period" in order to regain compliance. While we received a communication from Nasdaq on August 4, 2005 stating we had regained compliance and the matter is closed, there can be no assurance we will continue to meet the minimum market value of listed securities requirement in the future. If we are delisted from the Nasdaq Capital Market, our common stock will be considered a penny stock under the regulations of the SEC 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 may 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 must maintain various financial and other covenants under our credit facility agreement in order to borrow and fund our operations.

           Under our credit and security agreement with Wells Fargo, as amended in July 2005 and under prior agreements, we are required to comply with various financial and non-financial covenants in order to borrow under the agreement. The availability of borrowings under this agreement 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. Additional requirements include covenants for minimum capital monthly and minimum net income quarterly. We believe we will be able to maintain compliance with all these covenants, and covenants we may negotiate in the future, although there can be no assurance thereof. We have not always been

able to maintain compliance with all covenants in the past, including in the first four months of 2005 and on June 30, 2005. Wells Fargo granted us a waiver of non-compliance in each case. 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 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 and security agreement to fund our operations in the future. If we are unable to borrow funds under this agreement, we will need to raise additional capital from other sources to continue our operations, which capital may not be available on acceptable terms, or at all.

           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, 2006 if we are an accelerated filer as defined by Rule 12b-2 of the Securities and Exchange Act of 1934 and, if so, our general and administrative costs are likely to increase in 2006. Actions by other entities, such as enhanced rules to maintain our listing on the Nasdaq Capital Market could also increase our general and administrative costs, as could further legislative action.

           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. In addition, certain of our agreements require us to pay penalties if we are unable to supply products, including for failure to maintain regulatory approvals. Any of these events, alone or in unison, could damage our business.

           Our future revenues depend on successful research, development, commercialization and/or 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.

           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 our 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 personnel, the growth of our business could be substantially impaired. We do not maintain key person life insurance for any of our key personnel.

           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 SEC 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 September 30, 2005, approximately $13.4 million was outstanding on these lines of credit and other borrowings with a weighted average interest rate of 9.18%. We also had approximately $5.1 million of cash and cash equivalents at September 30, 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 net interest expense of approximately $83 thousand based on our outstanding balances as of September 30, 2005. We had no interest rate hedge transactions in place on September 30, 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 September 30, 2005.

          We have a wholly-owned subsidiary in Switzerland which uses the Swiss Franc as its functional currency. In addition, due to borrowings by our United States entity from our Swiss subsidiary, we will be required to report changes in the translated amount of this intercompany borrowing through earnings. 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 $1.1 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.

          At September 30, 2005, we did not meet the definition of “accelerated filer,” as defined by Rule 12b-2 of the Exchange Act and, therefore, we will not 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.

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. On September 9, 2005, United Vaccines, Inc. (“United”), a customer of our OVP segment, filed a lawsuit in Wisconsin against our Diamond Animal Health, Inc. subsidiary (“Diamond”) and Heska Corporation alleging various claims, including breach of contract and breach of warranty, and demanding compensatory and punitive damages. On October 20, 2005, we filed a motion to dismiss certain claims against Diamond and all claims against Heska, as well an answer to United’s claims, affirmative defenses and counterclaims on behalf of Diamond. While we intend to pursue the matter vigorously and believe we are entitled to damages from United and that United is not entitled to damages from Heska or Diamond, there can be no assurance the ultimate resolution of this case will refelct our current beliefs.

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

Number	Notes	Description
10.1		Director Compensation Policy.
31.1		Certification Under Section 302 of Sarbanes-Oxley Act.
31.2		Certification Under Section 302 of Sarbanes-Oxley Act.
32.1		Certification Under Section 906 of Sarbanes-Oxley Act.

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

Date:                           November 14, 2005 By    /s/  Robert B. Grieve     
         ROBERT B. GRIEVE
         Chairman of the Board and Chief Executive Officer
         (on behalf of the Registrant and as the Registrant’s
         Principal Executive Officer)

Date:                           November 14, 2005 By    /s/  Jason A. Napolitano     
        JASON A. NAPOLITANO
        Executive Vice President and Chief Financial Officer
        (on behalf of the Registrant and as the Registrant’s
        Principal Financial Officer)

EX-10

Exhibit 10.1

HESKA CORPORATION

DIRECTOR COMPENSATION POLICY

           Effective January 1, 2006, non-employee directors of Heska Corporation, a Delaware corporation (the “Company”) shall receive the following compensation for their service as a member of the Board of Directors (the “Board”) of the Company:

Initial Grant for New Directors

          An automatic grant of options valued at $30,000 to purchase shares of common stock of the Company as of the date of first becoming a member of the Board at an exercise price equal to the fair market value of the common stock on the last trading date immediately preceding the date of grant, subject to a maximum grant of options covering 40,000 shares in any given calendar year. Initial grants are subject to vesting over a period of four years in equal annual installments commencing on the date of grant, subject to the non-employee director’s continued service to the Company through the vesting dates. These options are immediately exercisable, but if “early exercised,” unvested shares shall remain subject to the Company’s right of repurchase at the exercise price upon termination of service prior to the fourth anniversary of the date of grant.

Annual Grant for Continuing Board Members

          An automatic annual grant to continuing non-employee directors of options valued at $30,000 to purchase shares of common stock of the Company shall be granted on the date of each Company annual meeting of stockholders at an exercise price equal to the fair market value of the common stock on the last trading date immediately preceding the date of grant, subject to a maximum grant of options covering 40,000 shares in any given calendar year. Annual grants for continuing Board members vest in full on the first anniversary of the date of grant, subject to the non-employee director’s continued service to the Company through the vesting date. These options are immediately exercisable, but if “early exercised,” remain subject to the Company’s right of repurchase at the exercise price upon termination of service prior to the first anniversary of the date of grant.

          No new non-employee director may receive an initial grant and the annual grant for continuing Board members in the same calendar year.

Annual Grant for Board Committee Chairpersons

          An automatic annual grant to continuing non-employee directors who serve as Chairperson of the Company’s Audit, Compensation or Corporate Governance committees shall be made of options valued at $2,000 to purchase shares of common stock of the Company as of the date of the annual meeting of stockholders at an exercise price equal to the fair market value of the common stock on the last trading date immediately preceding the date of grant, subject to a maximum grant of options covering 2,000 shares in any given calendar year. Annual grants for Board committee chairpersons vest in full on the first anniversary of the date of grant, subject to the non-employee director’s continued service to the Company through the vesting date. These options are immediately exercisable, but if “early exercised,” remain subject to the Company’s right of repurchase at the exercise price upon termination of service prior to the first anniversary of the date of grant.

Annual Grant for Board Committee Assignments

          An automatic annual grant to continuing non-employee directors who serve as members of the Company’s Audit, Compensation or Corporate Governance committees, including as Chairperson, shall be made of options valued at $1,000 to purchase shares of common stock of the Company as of the date of the annual meeting of stockholders at an exercise price equal to the fair market value of the common stock on the last trading date immediately preceding the date of grant, subject to a maximum grant of options covering 2,000 shares in any calendar year. Annual grants for Board committee assignments vest in full on the first anniversary of the date of grant, subject to the non-employee director’s continued service to the Company through the vesting date. These options are immediately exercisable, but if “early exercised,” remain subject to the Company’s right of repurchase at the exercise price upon termination of service prior to the first anniversary of the date of grant.

Director Compensation for Attendance at Board and Board Committee Meetings

          In Person Board and Committee Meetings

          Non-employee directors shall be entitled to receive a fee of $2,000.00 per day for any in person meeting of the Board or any in person meeting of any committee of the Board. The fee of $2,000.00 per day shall be payable irrespective of (i) the number of Board or committee meetings in a given day and (ii) of the length of any such meetings.

          Those non-employee directors who elect to receive such meeting fees in equity, will be entitled to receive a fully vested option valued at $2,000 to purchase shares of common stock of the Company at an exercise price equal to the fair market value of such common stock on the last trading date immediately preceding the date of grant. The date of grant will be the first Monday or first business day of the week immediately following the conclusion of such in person Board meeting or, where in person Board meetings and Board committee meetings occur in succession, following conclusion of all such meetings.

           Telephonic Board and Board Committee Meetings

          Non-Employee directors will be entitled to receive a fee of $500.00 for each telephonic Board or committee meeting they attend. Where there is more than one Board or Board committee telephonic meeting in a single day, non-employee directors shall receive a $500.00 payment for each meeting attended, irrespective of the length of such meeting or meetings.

          Those non-employee directors who elect to receive such meeting fees in equity, will be entitled to receive a fully vested option valued at $500 to purchase shares of common stock of the Company at an exercise price equal to the fair market value of such common stock on the last trading date immediately preceding the date of grant. The date of grant will be the first Monday or first business day of the week immediately following the conclusion of such telephonic Board or committee meeting.

          Cash vs. Equity Election for Meeting Fees

          Non-employees directors may elect to receive fees for meeting attendance in the form of a cash payment or in the form of a fully vested stock option as described above. Such election shall be made on an annual basis and shall be irrevocable for the year in question. Such irrevocable election must be made in the fiscal year prior to the applicable year in question for incumbent directors and following appointment to the Board for new directors. Cash payments for meeting attendance will be made following the fiscal quarter in which the meetings are held.

Option Valuation

          The value for all options to purchase shares of common stock of the Company issued to non-employee directors shall be determined in accordance with the Company’s option valuation policy at the time of issuance.

Provisions Applicable to All Non-Employee Director Equity Compensation Grants

          Any unvested shares underlying non-employee director option grants shall become fully vested in the event of: (1) the termination of the non-employee director’s services because of death, total and permanent disability or retirement at or after age 65; or (2) a change in control occurs with respect to the Company while such non-employee director is a member of the Board.

          All grants shall be subject to the terms and conditions of the Company’s 1997 Stock Incentive Plan or 2003 Equity Incentive Plan, as applicable, and the terms of the Stock Option Agreement issued thereunder.

Amended January 31, 2003
Further Amended November 6-7, 2003
Further Amended December 2, 2004
Further Amended February 24, 2005
Further Amended August 25, 2005

EX-31

Exhibit 31.1

CERTIFICATION

I, Robert B. Grieve, Chief Executive Officer of Heska Corporation, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Heska Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:           November 14, 2005 /s/   Robert B. Grieve     
ROBERT B. GRIEVE
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)

EX-31

Exhibit 31.2

CERTIFICATION

I, Jason A. Napolitano, Chief Financial Officer of Heska Corporation, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Heska Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15e)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:           November 14, 2005 /s/   Jason A. Napolitano     
JASON A. NAPOLITANO
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)

EX-32

Exhibit 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, Robert B. Grieve, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Heska Corporation on Form 10-Q for the quarterly period ended September 30, 2005 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Form 10-Q fairly presents in all material respects the financial condition and results of operations of Heska Corporation.

By:             /s/  Robert B. Grieve     
Name:       ROBERT B. GRIEVE
Title:         Chairman of the Board and
                  Chief Executive Officer

I, Jason A. Napolitano, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Heska Corporation on Form 10-Q for the quarterly period ended September 30, 2005 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Form 10-Q fairly presents in all material respects the financial condition and results of operations of Heska Corporation.

By:             /s/  Jason A. Napolitano     
Name:        JASON A. NAPOLITANO
Title:          Executive Vice President and
                   Chief Financial Officer

A signed original of this written statement required by Section 906 has been provided to Heska Corporation and will be retained by Heska Corporation and furnished to the Securities and Exchange Commission or its staff upon request.