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UNITED STATES 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 June 30, 2003


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: 0-21371


APPLIED IMAGING CORP.
(Exact name of registrant as specified in its charter)


Delaware 77-0120490
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)


2380 Walsh Avenue, Building B,
Santa Clara, California 95051
(Address of principal executive offices including zip code)

(408) 562-0250

(Registrant's telephone number, including area code)

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

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

As of July 25, 2003 there were 15,960,839 shares of the Registrant's Common
Stock outstanding.


APPLIED IMAGING CORP.

INDEX



Page

PART I. FINANCIAL INFORMATION


Item 1. Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets as of
June 30, 2003 and December 31,2002 3

Condensed Consolidated Statements of Operations and Comprehensive
Income (Loss) for the three and six months ended June 30, 2003
and 2002 4

Condensed Consolidated Statements of Cash Flows for the
six months ended June 30, 2003 and 2002. 5

Notes to Condensed Consolidated Financial Statements 6-10

Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 11-15

Item 3. Quantitative and Qualitative Disclosures about Market Risk
Derivatives and Financial Instruments 16


Item 4. Disclosure Controls and Procedures 16


PART II. OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders 17

Item 5. Other Information 17

Item 6. Exhibits and Reports on Form 8-K 17-18

Signatures 19

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

APPLIED IMAGING CORP. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(In thousands)



June 30, December 31,
2003 2002
----------- -----------
(Unaudited)
ASSETS

Current assets:
Cash and cash equivalents $ 3,107 $ 2,897
Restricted cash 165 156
Trade accounts receivable, net 5,425 7,155
Inventories 1,502 1,759
Prepaid expenses and other current assets 508 289
----------- -----------
Total current assets 10,707 12,256
Property and equipment, net 864 1,014
Goodwill 2,364 2,364
Other assets 62 62
----------- -----------
Total assets $ 13,997 $ 15,696
=========== ===========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable $ 2,072 $ 2,372
Accrued expenses 1,576 1,562
Bank debt 1,449 2,175
Deferred revenue, current 2,795 2,880
----------- -----------
Total current liabilities 7,892 8,989

Deferred revenue, non-current 275 333
----------- -----------
Total liabilities 8,167 9,322
----------- -----------

Stockholders' equity:

Common stock 16 16
Additional paid-in capital 49,206 49,151
Accumulated other comprehensive loss (367) (367)
Accumulated deficit (43,025) (42,426)
----------- -----------
Total stockholders' equity 5,830 6,374
----------- -----------
Total liabilities and stockholders' equity $ 13,997 $ 15,696
=========== ===========


The accompanying notes are an integral part of these unaudited
condensed consolidated financial statements.
3

APPLIED IMAGING CORP. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
and Comprehensive Income (Loss)
(in thousands, except per share data)
(Unaudited)


Three months ended Six months ended
June 30, June 30,
-------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------

Revenues $ 4,815 $ 5,345 $ 10,230 $ 10,192
Cost of revenues 2,001 2,031 4,165 3,836
--------- --------- --------- ---------
Gross profit 2,814 3,314 6,065 6,356
--------- --------- --------- ---------

Operating expenses:
Research and development 934 856 1,781 1,678
Sales and marketing 1,790 1,700 3,645 3,436
General and administrative 456 634 1,269 1,331
Restructuring - - - 222
--------- --------- --------- ---------
Total operating expenses 3,180 3,190 6,695 6,667
--------- --------- --------- ---------
Operating income (loss) (366) 124 (630) (311)
Other income (expense), net 35 26 31 (31)
--------- --------- --------- ---------
Net income (loss) (331) 150 (599) (342)

Other comprehensive loss
Change in unrealized loss on
short-term investments - - - (2)
--------- --------- --------- ---------

Comprehensive income (loss) $ (331) $ 150 $ (599) $ (344)
========= ========= ========= =========

Net income (loss) per share
- basic $ (0.02) $ 0.01 $ (0.04) $ (0.02)
========= ========= ========= =========
- diluted $ (0.02) $ 0.01 $ (0.04) $ (0.02)
========= ========= ========= =========
Weighted average shares outstanding
- basic 15,940 15,851 15,927 15,739
========= ========= ========= =========
- diluted 15,940 16,229 15,927 15,739
========= ========= ========= =========


The accompanying notes are an integral part of these unaudited
condensed consolidated financial statements.
4

APPLIED IMAGING CORP. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)


Six months ended June 30,
-------------------------
2003 2002
---------- ----------

Cash flows from operating activities:
Net loss $ (599) $ (342)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 321 297
Provision for doubtful accounts (100) (10)
Loss on sale of fixed assets 2 61
Changes in operating assets and liabilities:
Trade accounts receivable 1,830 (1,636)
Inventories 257 (191)
Prepaid expenses and other current assets (219) 70
Accounts payable (300) 309
Accrued expenses 14 205
Deferred revenue (143) (181)
---------- ----------
Net cash provided by (used in)
operating activities: 1,063 (1,418)
---------- ----------
Cash flows from investing activities:
Proceeds from sale and maturities of investments - 650
Goodwill - (20)
Purchases of property and equipment (173) (292)
---------- ----------
Net cash provided by (used in)
investing activities: (173) 338
---------- ----------
Cash flows from financing activities:
Net proceeds from issuance of common stock 55 1,075
Restricted cash (9) (1)
Bank and other loan proceeds 6,511 5,855
Bank and other loan payments (7,237) (5,567)
Capital lease payments, principal portion - (14)
---------- ----------
Net cash provided by (used in)
financing activities: (680) 1,348
---------- ----------


Net increase in cash and cash equivalents 210 268

Cash and cash equivalents at beginning of period 2,897 2,538
---------- ----------
Cash and cash equivalents at end of period $ 3,107 $ 2,806
========== ==========


The accompanying notes are an integral part of these unaudited
condensed consolidated financial statements.
5


APPLIED IMAGING CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


NOTE 1 - Basis of Presentation

The accompanying condensed consolidated financial statements include the
accounts of Applied Imaging Corp. and subsidiaries (the "Company", "we", "us",
"our") for the three and six months ended June 30, 2003 and 2002. These
financial statements are unaudited and reflect all adjustments, consisting only
of normal recurring adjustments, which are, in the opinion of management,
necessary for a fair presentation of our financial position, operating results
and cash flows for those interim periods presented. The results of operations
for the three and six months ended June 30, 2003 are not necessarily indicative
of results to be expected for the fiscal year ending December 31, 2003. These
condensed consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto, for the year ended
December 31, 2002, contained in our 2002 annual report on Form 10-K.

Liquidity: We expect negative cash flow from operations to continue through at
least 2003, as we continue research and development of new applications for our
SPOT(TM) and Ariol(TM) systems, conduct clinical trials required for the U.S.
Food and Drug Administration ("FDA") clearance of new products, expand our
marketing, sales and customer support capabilities, and add additional
infrastructure. Wecurrently estimate that our capital resources will enable us
to meet our capital needs for at least the next twelve months.

However, expenditures required to achieve growth and profitability in the
long term may be greater than projected or the cash flow generated from
operations may be less than projected. As a result, our long-term capital needs
may require us to try to obtain additional funds through equity or debt
financing, collaborative or other arrangements with other companies, bank
financing and other sources. We have expended and will continue to expend
substantial amounts of money for research and development, preclinical testing,
conducting clinical trials for FDA clearance of new products, capital
expenditures, working capital needs and manufacturing and marketing of our
products. Our future research and development efforts, in particular, are
expected to include development of additional applications of our current
cytogenetic products and additional applications for the SPOT(TM) and Ariol(TM)
systems, which may require additional funds.

There can be no assurance that we will be able to obtain additional debt
or equity financing if needed and on terms acceptable to us. If adequate and
acceptable funding is not available, we could be required to delay development
or commercialization of certain products, to license to third parties the rights
to commercialize certain products or technologies that we would otherwise seek
to commercialize internally, or to reduce the marketing, customer support, or
other resources devoted to product development. Accordingly, our failure to
obtain sufficient funds on acceptable terms when needed could have a material
adverse effect on our ability to achieve our long-term business objectives.

We have a one-year loan agreement with Silicon Valley Bank ("SVB") that
is effective through September 27, 2003 with borrowing capability of up to $3.5
million depending on the level of certain of our North American accounts
receivable. The loan agreement includes the requirement for us to maintain a
minimum level of tangible net worth. On January 31, 2003, the loan agreement was
amended to reduce the minimum level of tangible net worth that we had to
6


maintain through the end of the loan agreement. The amendment also provided us
with a waiver of our non-compliance with the requirement to maintain a minimum
level of tangible net worth as at December 31, 2002.

At June 30, 2003 we had used $1,449,000 of the SVB facility with $303,000
available but not used. The interest rate on the facility was 6.25% at June 30,
2003, computed as the SVB prime rate plus 2 percent. The loan is collateralized
by substantially all of the assets of the U.S. corporation and requires us to
maintain a minimum level of tangible net worth amounting to $3.6 million at June
30, 2003. Other loan covenants include the need to maintain insurance on our
property, monthly reporting to SVB, the need to obtain SVB approval for any
extraordinary action and a limitation on the U.S. corporation's ability to
transfer more than $600,000 to a subsidiary. We were not in compliance with the
SVB loan covenant regarding tangible net worth as of June 30, 2003, for which we
obtained a waiver from SVB.

We collateralize various credit card, and bank guarantees (used for
customs clearance purposes) with cash deposits at an international bank in the
United Kingdom. This amounted to (pound)100,000 ($165,000) at June 30, 2003.

NOTE 2 - Inventories (in thousands)


Balance as of June 30, 2003 December 31, 2002
-------------------- --------------------

Raw materials $ 1,164 $ 1,210
Work in process 185 306
Finished goods 153 243
-------------------- --------------------
Total $ 1,502 $ 1,759
==================== ====================


NOTE 3 - Net income (loss) per share

The computation of basic and diluted net income (loss) per share ("EPS")
for the three and six months ended June 30, 2003 and June 30, 2002 is determined
by dividing net income (loss) as reported as the numerator by the number of
shares included in the denominator as shown in the following table (in
thousands):


Three months ended June 30, Six months ended June 30,
---------------------------- ----------------------------
2003 2002 2003 2002
----------- ------------ ------------ ------------


Weighted average shares outstanding - basic 15,940 15,851 15,927 15,739
Dilutive shares - stock options - 378 - -
----------- ------------ ------------ ------------
Weighted average shares outstanding - diluted 15,940 16,229 15,927 15,739
=========== ============ ============ ============




Securities excluded from the computation of EPS because their effect on
EPS was antidilutive, but could dilute basic EPS in future periods are as
follows (in thousands):



Three months ended June 30, Six months ended June 30,
----------------------------- ----------------------------
2003 2002 2003 2002
------------- ------------- ------------ --------------

Options 3,113 1,059 3,113 2,980
Warrants 1,222 651 1,222 651

------------- ------------- ------------ --------------
Total 4,335 1,710 4,335 3,631
============= ============= ============ ==============

7


NOTE 4 - Stock Based Compensation

We account for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25,"Accounting for Stock Issued to Employees." Under APB No. 25,
compensation expense is based on the difference, if any, between the fair value
of our stock and the exercise price on the date of the grant.

We account for equity instruments issued to non-employees in accordance
with the provisions of Statement of Financial Accounting Standards ("SFAS") No.
123 "Accounting for Stock-based Compensation" and Emerging Issues Task Force
("EITF") Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to
Other Than Employees for Acquiring or in Conjunction With Selling Goods and
Services."

We have adopted the pro forma disclosure provisions of SFAS No. 148
"Accounting for Stock-Based Compensation Transition and Disclosure" for the 1998
Stock Plan and Employee Stock Purchase Plan. The fair value of the stock options
granted to employees is calculated using the Black-Scholes option pricing model
as of the date of grant. Had compensation cost for our stock-based compensation
plans been determined in a manner consistent with the fair value approach
described in SFAS No. 123, our net income (loss) and net income (loss) per share
as reported would have been changed to the pro forma amounts indicated below (in
thousands, except per share data):



Three months ended Six months ended
June 30, June 30,
-------------------- --------------------
2003 2002 2003 2002
--------- --------- --------- ---------

Net income (loss):
As reported............................... $ (331) $ 150 $ (599) $ (342)
Stock-based employee compensation expense
determined under fair-value method (135) (187) (336) (345)
--------- --------- --------- ---------
Pro forma................................. $ (466) $ (37) $ (935) $ (687)
========= ========= ========= =========
Net income (loss) per share:
As reported - basic:...................... $ (0.02) $ 0.01 $ (0.04) $ (0.02)
========= ========= ========= =========

As reported - diluted:.................... $ (0.02) $ 0.01 $ (0.04) $ (0.02)
========= ========= ========= =========
Pro forma - basic:........................$ (0.03) $ (0.00) $ (0.06) $ (0.04)
========= ========= ========= =========
Pro forma - diluted:......................$ (0.03) $ (0.00) $ (0.06) $ (0.04)
========= ========= ========= =========


The fair value of each option is estimated on the date of grant using the
fair value method with the following weighted-average assumptions:


Three months ended Six months ended
June 30, June 30,
-------------------- -----------------------
2003 2002 2003 2002
--------- --------- ---------- ----------

Risk-free interest rate 1.78% 3.77% 2.01% 3.75%
Expected life (in years) 3 3 3 3
Dividend Yield -% -% -% -%
Expected volatility 79% 122% 85% 129%

8


All of the above assumptions were used for the Employee Stock Purchase
Plan except that the expected life is six months.


NOTE 5 - Product Warranty

We generally warrant our products against defects for a period of one year and
record a liability for such product warranty obligations at the time of sale
based upon historical experience. We do not provide separately priced extended
warranty coverage. However, we sell separately priced service contracts to
provide additional service coverage on our systems when the warranty period
expires. The related revenue on the service contracts is recognized on a
straight-line basis over the life of the service contract, which is generally
one year. Costs associated with services performed under the service contract
obligation are expensed as incurred.

Changes in product warranty obligations for the six months ended June 30, 2003
are as follows (in thousands):


Balance as of December 31, 2002 $127

Add accruals for warranties issued 16

Less costs incurred under warranties issued (32)
-----------
Balance as of June 30, 2003 $111
===========

NOTE 6 - Restructuring

In January 2002, we instituted a series of actions to reduce our
operating costs. We consolidated our manufacturing and engineering facilities
and are closing our League City, Texas office. We recorded a restructuring
charge of $222,000 in the first quarter of 2002 that was reflected in the
Condensed Consolidated Statement of Operations and Comprehensive Loss as a
separate line item under operating expenses. This charge is related to the costs
of terminating 12 employees ($130,000) and closing the League City, Texas office
($90,000). The employee separation costs were all cash and the League City
office costs were made up of $40,000 in cash charges and $50,000 in non-cash
charges. All payments were made in 2002, and the reserve balance was zero at
June 30, 2003 and December 31, 2002.

NOTE 7 - Recent Accounting Pronouncements

In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51."
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective immediately for all new variable interest entities created or acquired
after January 31, 2003. For variable interest entities created or acquired prior
to February 1, 2003, the provisions of FIN 46 must be applied for the first
interim or annual period beginning after June 15, 2003. We do not have any
ownership in any variable interest entities as of June 30, 2003. We will apply
the consolidation requirement of FIN 46 in future periods if we should own any
interest in any variable interest entity.
9

In November 2002, the Emerging Issues Task Force ("EITF") reached a
consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables."
EITF Issue No. 00-21 provides guidance on how to account for arrangements that
involve the delivery or performance of multiple products, services and/or rights
to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. We
believe the adoption of this standard will have no material impact on our
financial statements.
10

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

The following discussion should be read in conjunction with the attached
condensed consolidated financial statements and notes, and with our audited
financial statements and notes for the fiscal year ended December 31, 2002.

This quarterly report contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. These
forward-looking statements include statements relating to operating performance,
the adequacy of our current capital resources and the timing of future capital
requirements. Our actual results could differ materially from those predicted in
the forward-looking statements as a result of risks and uncertainties including,
but not limited to, those discussed in this quarterly report and those discussed
under "Item 1 - Business, Additional Factors That Might Affect Future Results,"
and under "Item 7 - Management's Discussion And Analysis Of Financial Condition
And Results Of Operations; Factors that May Affect Future Results," commencing
on pages 11 and 23, respectively, in our Annual Report on Form 10-K for the
fiscal year ended December 31, 2002. These risks and uncertainties include, but
are not limited to, competition, medical device regulation, general economic
conditions in the United States and internationally, adverse changes in the
specific markets for our products or reimbursement levels to our clinical
customers, adverse changes in customer order patterns, the effectiveness of our
sales force, pricing pressures, risks associated with foreign operations, delay
or failure to launch new products, failure to reduce costs or improve operating
efficiencies, the availability of debt or equity financing when needed, and the
sufficiency of our capital resources to meet our capital needs. You should not
rely on these forward-looking statements, which reflect our position as of the
date of this report. We are under no obligation to revise or update any
forward-looking statements.

Results of Operations
Revenues. Our revenues are derived primarily from the sale of products, service
contracts, software maintenance and grant revenues. Revenues for the three and
six months ended June 30, 2003 were $4.8 million and $10.2 million,
respectively, compared to $5.3 million and $10.2 million for the corresponding
periods in 2002. The 10% decrease in revenues in the second quarter was due
primarily to the loss of Ariol(TM) sales that we attribute to the impact in the
U.S. of the FDA Warning Letter that we received in April regarding FDA concerns
about some of our Ariol(TM) promotional materials. We responded to the issues
raised by the FDA and, in June, received correspondence from the FDA that the
agency concluded our response was adequate to ensure compliance. Nevertheless,
the Warning Letter caused some clinical customers in the U.S. to defer sales
decisions and resulted in the sales return of an existing order.

Sales of systems were $3.6 million and $7.7 million in the three and six
months ended June 30, 2003, respectively, compared to $4.1 million and $7.8
million for the corresponding periods in 2002. The decrease in systems sales was
due primarily to the impact in the U.S. of the FDA Warning Letter as discussed
above.

Service contract, software maintenance and grant revenues were $1.2
million and $2.5 million in the three and six months ended June 30, 2003,
respectively, compared to $1.2 million and $2.4 million for the corresponding
periods in 2002. The increase in the first six months was due primarily to grant
revenues received in the first quarter from the agreement with the Sanger
Institute in the U.K. There were no grant revenues in the first half of 2002.

Cost of revenues. Cost of revenues includes direct material and labor costs,
manufacturing overhead, installation costs, warranty-related expenses and
post-warranty service and application support expenses. Costs of revenues for
the three and six months ended June 30, 2003 were $2.0 million and $4.2 million,
respectively, compared to $2.0 million and $3.8 million for the corresponding
11

periods in 2002. Cost of revenues, as a percentage of total revenues, for the
three and six months ended June 30, 2003 were 42% and 41%, respectively,
compared to 38% for the corresponding prior year periods. The increase is
primarily due to the sale of a number of our Ariol(TM) systems during 2003 at a
lower gross margin percent for market development purposes.

Research and development expenses. Research and development expenses for the
three and six months ended June 30, 2003 were $934,000 and $1.8 million,
respectively, compared to $856,000 and $1.7 million in the comparative prior
year periods. This increase in the second quarter and first half is due
primarily to $50,000 of incremental spending in support of the Sanger Institute
project and $40,000 in costs associated with hiring additional research staff.

Sales and marketing expenses. Sales and marketing expenses for the three and six
months ended June 30, 2003 were $1.8 million and $3.6 million, respectively,
compared to $1.7 million and $3.4 million for the comparative prior year
periods. This increase in sales and marketing expenses in the second quarter is
due primarily to the unfavorable impact ($90,000) of the weakening of the U.S.
dollar on our U.K.-based sales and marketing expenses. In the first half, there
was also the impact of a $104,000 increase in the first quarter in commissions
paid to our distributors outside North America.

General and administrative expenses. General and administrative expenses for the
first quarter and first half of 2003 were $456,000 and $1.3 million,
respectively, compared to $634,000 and $1.3 million in the comparative prior
year periods. The 28% reduction in general and administrative expenses in the
second quarter was primarily due to the receipt of a grant (net effect of
$170,000) in the U.K. that was treated as an offset to rent expense in the
second quarter. In the first half of the year, the decrease in general and
administrative costs in the second quarter was offset by increased costs in the
first quarter associated with additional legal and accounting costs related to
the restatement of our 2001 and 2002 financial statements.

Restructuring. There were no restructuring costs in the first half of 2003. The
restructuring costs in the first quarter of 2002 were due to a series of actions
taken to rationalize our operations to provide a lower operating cost while
increasing efficiencies. We are closing our League City, Texas office and have
consolidated our manufacturing and engineering facilities. We recorded a
restructuring charge of $222,000 in the first quarter of 2002 that was due to
the costs of terminating 12 employees ($132,000) and closing the League City,
Texas office ($90,000.)

Other income (expense), net. Other income of $35,000 in the second quarter of
2003 and $26,000 in the second quarter of 2002 were primarily the result of
foreign currency gains incurred in the translation of various balance sheet
items from foreign currencies into the U.S. dollar. Other income of $31,000 in
the first half of 2003 was primarily comprised of $40,000 in net interest
expense payable on our bank borrowings and $74,000 of foreign currency gains
incurred in the translation of various balance sheet items from foreign
currencies into the U.S. dollar. There was $31,000 of other expense in the first
half of 2002 primarily comprised of $43,000 of net interest expense $36,000 and
$24,000 of foreign currency gains incurred in the translation of various balance
sheet items from foreign currencies into the U.S. dollar.
12

Liquidity and Capital Resources

At June 30, 2003, we had cash, restricted cash and cash equivalents of
$3.3 million and working capital of $2.8 million compared to $3.1 million and
$3.3 million respectively at December 31, 2002. Restricted cash, which
collateralizes various credit card and bank guarantees in the United Kingdom,
amounted to $165,000 at June 30, 2003 and $156,000 at December 31, 2002.

Cash provided by operations for the six months ended June 30, 2003 was
$1.1 million compared to cash used in operations of $1.4 million for the first
six months of 2002. Changes in the components of cash used in operations
included: an increase in net loss amounting to $257,000 (a net loss of $599,000
in the first six months of 2003 versus a net loss of $342,000 in the first six
months of 2002), decreased requirements for trade accounts receivables of $3.5
million (a decrease of $1.8 million in 2003 reflecting improved collections
versus an increase of $1.7 million in 2002) and for inventories of $448,000 (a
decrease of $257,000 in 2003 reflecting a reduction in the components that had
been built up for new products, versus an increase of $191,000 in 2002 due to a
build-up in components for new products.) These decreases were partially offset
by increases in the need for funds for accounts payable and accrued expenses of
$609,000 and $191,000, respectively. Accounts payable decreased by $300,000 in
the first half of 2003 compared to an increase of $309,000 in the first half of
2002. The decrease in the first half of 2003 was due primarily to a reduction in
accounts payable to vendors supplying system components, reflecting lower
inventory at the end of the June 2003.

Trade accounts receivable as a percent of second quarter revenues were
113% at June 30, 2003 compared to 132% at June 30, 2002 and 130% at December 31,
2002 reflecting improved collections in the quarter. This strong relationship
between quarter-end receivables and that quarter's sales is primarily due to the
fact that most of our sales occur late in the quarter as is typical of a capital
equipment business. Although our payment terms are net 30 days, certain
customers, specifically government, university, Asian and European customers,
tend to take longer to pay their receivable balances.

Cash used in investing activities was $173,000 in the first six months of
2003 compared to cash provided by investing activities of $338,000 in the first
six months of 2002. This change was primarily due to a decrease in our
short-term investments of $650,000 in 2002 versus no change in 2003 since we no
longer have any short-term investments. We invested $173,000 for purchases of
capital equipment in the first six months of 2003 compared to $292,000 in the
first six months of 2002.

Cash used in financing activities was $680,000 in the first half of 2003,
primarily due to repayments on our bank line with SVB, compared to cash provided
by financing activities of $1.3 million in the first half of 2002. We received
$1.0 million from the issuance of common stock in a private placement in the
first half of 2002 and $288,000 from an increase in bank loans.

On January 31, 2002, we completed a private placement of 571,500 shares of
our common stock to an institutional investor (purchasing for three separate
funds) at a purchase price of $1.75 per share. On July 29, 2002, each investor
received a warrant exercisable for the number of shares of our common stock
equal to the number of shares of common stock purchased by that investor in the
January 31, 2002 financing. The warrants are exercisable for four years from
July 29, 2002 at a price of $2.25 per share. All warrants remain outstanding as
of June 30, 2003.

We have a one-year loan agreement with Silicon Valley Bank ("SVB") that
is effective through September 27, 2003 with borrowing capability of up to $3.5
million depending on the level of certain of our North American accounts
receivable. The loan agreement includes the requirement for us to maintain a
minimum level of tangible net worth. On January 31, 2003, the loan agreement was
13

amended to reduce the minimum level of tangible net worth that we had to
maintain through the end of the loan agreement. The amendment also provided us
with a waiver of our non-compliance with the requirement to maintain a minimum
level of tangible net worth as at December 31, 2002.

At June 30, 2003 we had used $1,449,000 of the SVB facility with $303,000
available but not used. The interest rate on the facility was 6.25% at June 30,
2003, computed as the SVB prime rate plus 2 percent. The loan is collateralized
by substantially all of the assets of the U.S. corporation and requires us to
maintain a minimum level of tangible net worth amounting to $3.6 million at June
30, 2003. Other loan covenants include the need to maintain insurance on our
property, monthly reporting to SVB, the need to obtain SVB approval for any
extraordinary action and a limitation on the U.S. corporation's ability to
transfer more than $600,000 to a subsidiary. We were not in compliance with the
SVB loan covenant regarding tangible net worth as of June 30, 2003, for which we
obtained a waiver from SVB. We cannot assure you that we will be able to either
achieve the required tangible net worth or to obtain further waivers in the
future.

We collateralize various credit card, and bank guarantees (used for
customs clearance purposes) with cash deposits at an international bank in the
United Kingdom. This amounted to (pound)100,000 ($165,000) at June 30, 2003.

We expect negative cash flow from operations to continue through at least
2003, as we continue the research and development of new applications for our
SPOT(TM)and Ariol(TM) systems, conduct clinical trials required for FDA
clearance of new products, expand our marketing, sales and customer support
capabilities, and add additional infrastructure. We currently estimate that our
capital resources will enable us to meet our capital needs for at least the next
twelve months.

However, expenditures required to achieve growth and profitability in the
long term may be greater than projected or the cash flow generated from
operations may be less than projected. As a result, our long-term capital needs
may require us to try to obtain additional funds through equity or debt
financing, collaborative or other arrangements with other companies, bank
financing and other sources. We have expended and will continue to expend
substantial amounts of money for research and development, preclinical testing,
conducting clinical trials for FDA clearance of new products, capital
expenditures, working capital needs and manufacturing and marketing of our
products. Our future research and development efforts, in particular, are
expected to include development of additional applications of our current
cytogenetic products and additional applications for the SPOT(TM) and Ariol(TM)
systems, which may require additional funds.

There can be no assurance that we will be able to obtain additional debt
or equity financing if needed and on terms acceptable to us. If adequate and
acceptable funding is not available, we could be required to delay development
or commercialization of certain products, to license to third parties the rights
to commercialize certain products or technologies that we would otherwise seek
to commercialize internally, or to reduce the marketing, customer support, or
other resources devoted to product development. Accordingly, our failure to
obtain sufficient funds on acceptable terms when needed could have a material
adverse effect on our ability to achieve our long-term business objectives.

We transferred our listing from the Nasdaq National Market to the Nasdaq
SmallCap Market, which has less stringent listing requirements, as of February
4, 2003. As a result, we may find it more difficult to raise additional capital
should the need arise in the future.


Subsequent to the end of the quarter, we learned of a recent change in
U.S. Medicare reimbursement for the imaging component of certain pathology
tests. This change will reduce, for the balance of 2003, the payments (or
14

reimbursements) that clinical laboratory customers receive from Medicare for
certain pathology tests performed using automated imaging systems. The Centers
for Medicare & Medicaid Services ("CMS") have begun notifying laboratories that
they have made an NCCI edit for a specific image analysis procedural code
retroactive to April 1 this year. CMS has also indicated that they will
implement a new reimbursement ("CPT") code with a specific image analysis
component beginning January 1, 2004 at a yet-to-be-announced reimbursement
level. Although we are not yet able to quantify the impact of these changes on
our clinical laboratory customers in the U.S., it is possible that any
short-term uncertainty may reduce our Ariol(TM) placements in the U.S. until the
new reimbursement level is determined.

Recent Accounting Pronouncements

In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51."
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective immediately for all new variable interest entities created or acquired
after January 31, 2003. For variable interest entities created or acquired prior
to February 1, 2003, the provisions of FIN 46 must be applied for the first
interim or annual period beginning after June 15, 2003. We do not have any
ownership in any variable interest entities as of June 30, 2003. We will apply
the consolidation requirement of FIN 46 in future periods if we should own any
interest in any variable interest entity.


In November 2002, the Emerging Issues Task Force ("EITF") reached a
consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables."
EITF Issue No. 00-21 provides guidance on how to account for arrangements that
involve the delivery or performance of multiple products, services and/or rights
to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. We
believe the adoption of this standard will have no material impact on our
financial statements.
15

Item 3. Quantitative and Qualitative Disclosures about Market Risk Derivatives
and Financial Instruments.

For the six months ended June 30, 2003, there were no material changes
from the disclosures made in our Form 10-K for the year ended December 31, 2002.
We maintain our funds as cash or cash equivalents, primarily in money market
investments with a maturity of less than 90 days. We invested these funds at an
average interest rate of 1.06% during the second quarter of 2003. These
investments are not subject to interest rate risk.

Item 4. Disclosure Controls and Procedures.

(a) Evaluation of disclosure controls and procedures. Based on their
evaluation as of the end of the period covered by this Quarterly Report on Form
10-Q, our chief executive officer and chief financial officer have concluded
that our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")) are
effective to ensure that information required to be disclosed by us in reports
that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in Securities and Exchange
Commission rules and forms.

(b) Changes in internal control over financial reporting. There were
no significant changes in our internal control over financial reporting or in
other factors during our last fiscal quarter that have materially affected, or
are reasonably likely to materially affect, our internal control over financial
reporting.
16


PART II - OTHER INFORMATION

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

The Company solicited proxies for an annual meeting of stockholders
("Annual Meeting") on May 16, 2003 to all of the Company's stockholders.

The election of directors was conducted and the following nominees were
elected: Jack Goldstein and Carl Hull. The vote with respect to each nominee was
as follows:
Votes
-----------------------------------
Name For Witheld
--------------------- ------------- --------------

Jack Goldstein 14,521,429 29,372
Carl Hull 14,464,229 86,572

Continuing directors whose terms of office extended beyond the Annual
Meeting were: John F. Blakemore, Jr., Andre F. Marion, G. Kirk Raab and Pablo
Valenzuela.

PricewaterhouseCoopers LLP was ratified as the independent accountants of
the Company for the fiscal year ending December 31, 2003 with 14,448,861 votes
in favor, 95,992 votes against and 5,948 abstentions.

An amendment of the Company's Employee Stock Purchase Plan (the "Plan")
was approved to increase the number of shares available for issuance under the
Plan by 200,000 shares. The amendment was approved with 14,298,478 votes in
favor, 225,423 votes against and 26,900 abstentions.


Item 5: Other Information

In March 2003, we received a warning letter from the FDA regarding our
promotional material for specific applications on the Ariol(TM) system. The
letter required us to modify our promotional practices for specific applications
of the Ariol(TM) system until we obtained relevant required FDA clearances. We
responded to the FDA's letter and subsequently received a letter from the FDA,
dated June 16, 2003, concluding that our response appeared to be adequate in
order to ensure compliance with the Federal Food, Drug, and Cosmetic Act as it
relates to marketing the Ariol(TM) system.

In May 2003, the Audit Committee approved the retention of
PricewaterhouseCoopers LLP, our independent accountants, to assist us with the
internal controls requirements of Section 404 of the Sarbanes-Oxley Act.

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits.

Exhibit No. Description
31-1 Chief Executive Officer's Certification Pursuant to 15 U.S.C. Section 7241
31-2 Chief Financial Officer's Certification Pursuant to 15 U.S.C. Section 7241
32-1 Certificate of Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32-2 Certificate of Chief Financial Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
17



(b) Reports on Form 8-K

On May 13, 2003, we filed a Current Report on Form 8-K which contained
as an exhibit a copy of our press release announcing earnings for the first
quarter of fiscal 2003.

On June 20, 2003, we filed a Current Report on Form 8-K to disclose
that we had received a letter, dated June 16, 2003, from the Food and Drug
Administration concluding that our response to the FDA's warning letter
regarding our marketing of the Ariol device appeared to be adequate in order to
ensure compliance with the Federal Food, Drug, and Cosmetic Act as it relates to
marketing the Ariol(TM) system.


18


APPLIED IMAGING CORP.


SIGNATURES



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



APPLIED IMAGING CORP.
(Registrant)




Date: August 4, 2003 By: /S/ CARL HULL
--------------------------
Carl Hull
President and
Chief Executive Officer


Date: August 4, 2003 By: /S/ BARRY HOTCHKIES
-------------------------
Barry Hotchkies
Executive Vice President, Chief Financial Officer


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