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               UNITED STATES SECURITIES AND EXCHANGE COMMISSION

                            Washington, D.C. 20549



                             ____________________



                                   FORM 10-K



[X]  Annual Report Pursuant to Section 13 or 15 (d) of the Securities Exchange

     Act of 1934



     For the Fiscal Year Ended December 31, 1999 or



[_]  Transition Report Pursuant to Section 13 or 15 (d) of the Securities

     Exchange Act of 1934



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,                                  95051

              Building B,                                    (Zip Code)

        Santa Clara, California

 (Address of principal executive offices)



Registrant's telephone number, including area code: (408) 562-0250



Securities registered pursuant to Section 12 (b) of the Act:





                                                   Name of each exchange

        Title of each class                         on which registered

        -------------------                        ---------------------

               None                                          N/A



Securities registered pursuant to Section 12 (g) of the Act:



                        Common Stock, $0.001 par value

                               (Title of Class)



     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 if disclosure of delinquent filers pursuant to Item

405 of Regulation S-K is not contained herein, and will not be contained, to the

best of registrant's knowledge, in definitive proxy or information statements

incorporated by reference in Part III of this Form 10-K or any amendment to this

Form 10-K. [_]



     The aggregate market value of voting stock held by non-affiliates of the

registrant, based upon the closing sale price of the Common Stock on March 20,

2000, as reported on the NASDAQ National Market, was approximately $69,285,002.

The number of shares of Common Stock outstanding as of March 20, 2000:

13,356,145.



                      DOCUMENTS INCORPORATED BY REFERENCE



     Part III of this Form 10-K incorporates information by reference from the

Registrant's definitive proxy statement to be filed with the Securities and

Exchange Commission within 120 days after the close of the fiscal year.



     This report, including all exhibits and attachments, contains 48 pages. The

exhibit index is on pages 45 & 46.



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                                    PART I



Item 1.   BUSINESS



     This Report on Form 10-K contains certain forward looking statements

regarding future events with respect to Applied Imaging Corp. Actual events or

results may differ materially as a result of the factors described herein and in

the documents incorporated herein by reference, including, in particular, those

factors described under "Additional Risk Factors."



The Company



     Applied Imaging Corp ("Applied Imaging" or the "Company") was

incorporated in California in July 1986, and reincorporated in Delaware in

October 1996. Applied Imaging develops, manufactures and markets automated

genetic testing systems for use in cancer testing, prenatal testing and other

genetic testing applications along with automated imaging systems used in cancer

pathology and cancer research. The Company's cytogenetic instrumentation

business, which has sold approximately 1600 systems to over 800 sites in more

than 35 countries since the Company's inception, markets microscopic image

analysis systems that enable laboratories to automate the analysis of

chromosomal abnormalities associated with conditions ranging from Down Syndrome

to breast cancer. The Company also markets imaging systems designed for use in

plant and animal genetic research programs. The Company has recently introduced

a research system to detect micrometastatic cancer cells in bone marrow, lymph

node and blood samples from cancer patients. This technology allows physicians

to better determine the initial staging of cancer cases and to then detect

disease recurrence earlier than is currently possible. It is also used for other

cancer research applications.



     According to the Company's own analysis of its primary competitors'

publicly available financial data, Applied Imaging is the leading provider of

automated chromosomal image analysis systems to clinical and research

laboratories worldwide. The Company's CytoVision(TM) and Quips(R) systems are

widely utilized because of their ability to analyze human chromosome

preparations using powerful software classification algorithms and a specialized

user interface. These systems also incorporate the capability to analyze and

record images produced by advanced genetic research assays that employ

fluorescent in situ hybridization ("FISH") or comparative genomic hybridization

("CGH") methods. The Company is also developing specialized reagent products

that can be optimized for use on the Company's installed base of imaging systems

as one aspect of its business strategy.



     The Company's Micrometastasis Detection System (MDS /TM/) couples the

ability to find rare cellular events with the capability to genetically

characterize these cells using FISH technology and specific DNA probes. It is

currently being sold to cancer researchers to detect and genetically

characterize cancer cells found in bone marrow, lymph nodes and stem cell

transplant samples. The Company has established a commercial relationship with

Nexell Therapeutics, Inc. to distribute their Cytonex staining kit for the

detection of cytokeratin-positive cells including carcinoma cells in blood and

bone marrow specimens worldwide. This stain is utilized in conjunction with the

MDS. Further basic research is being conducted by the Company into the use of

its micrometastasis detection platform as a method of detecting circulating

cancer cells in peripheral blood.



     The Company previously pursued a prenatal genetic screening development

program focused on the isolation of specific fetal cells from a blood sample

taken from the expectant mother. While substantial research progress was made

towards the development of a reliable method for non-invasive prenatal

diagnosis, the Company has concluded that its methods do not currently

constitute a commercially viable system for this purpose. Accordingly, the

Company has shifted its research efforts and resources to its cancer imaging

programs, with a focus on the detection of rare micrometastatic cancer cells in

a variety of sample types. The Company believes that certain of its cell

enrichment and image analysis research conducted and products developed for

fetal cell analysis are directly applicable to these cancer testing

applications.



Genetic Disorders and Testing Applications



     All genetic information in an organism is contained in its chromosomes,

made up of strands of DNA and associated protein molecules. DNA is comprised of

paired nucleotide bases and genetic information is encoded by the specific order

of the nucleotide bases within units called genes. Genes are organized linearly

along the chromosomes and carry the required information for the synthesis of

the proteins that provide the structural components of cells and tissues, as

well as the enzymes needed for the basic biochemical and physiological functions

of the cells. Chromosomal studies allow clinicians to examine genetic

rearrangements at both a macro level, while studying all chromosomes of a





patient simultaneously, or at a micro level, while examining specific DNA probes

for individual genes or chromosomes.



Cancer Genomics



     Chromosomal analysis is often performed for clinical and research purposes

for the precise characterization of many different types of cancers. Cancer

cells frequently demonstrate complex chromosomal abnormalities. The specific

patterns of these chromosomal abnormalities may be associated with certain well-

defined cancers. The chromosomal analysis of leukemias and lymphomas, for

example, provides researchers with supplementary information useful in the

staging or precise classification of the disease and may also provide useful

prognostic indicators. Similarly, advanced chromosomal analyses may allow a

researcher to assess new disease in a patient to determine if it may be a

recurrence of a previous cancer or an entirely different neoplasm.



Other Chromosomal Disorders



As in cancer, prenatal chromosomal disorders may occur when genes or portions of

genes move between chromosomes (chromosomal translocations), when portions of

chromosomes and the genes they contain are missing or when an abnormal number of

chromosomes are present in the cell. Chromosomes can be seen with the aid of a

microscope and, when stained with certain dyes, reveal light and dark bands

reflecting regional variations in the DNA of the cell. Differences in size and

banding pattern allow the chromosomes to be distinguished from each other or may

identify a chromosomal disorder. The most common prenatal chromosomal disorder,

Down Syndrome, also known as trisomy 21, occurs when there are three copies of

chromosome 21 in the human genome. Other clinical syndromes caused by the most

common chromosomal abnormalities may result in mental retardation, impaired

physical development and abnormal sexual development.



Micrometastasis Detection



Micrometastasis is the spread of cancer away from the primary tumor that is not

detectable with routine testing methods. Typically, these metastases are too

limited in size to be observed using routine examination techniques. The

majority of cancers with micrometastases are attributable to a subset of cancer

known as carcinomas, a malignant growth that arises from epithelial cells found

in the skin or the lining of body organs. Carcinomas tend to infiltrate into

adjacent tissue and then spread (metastasize) to distant organs such as bone,

liver, lung or the brain. The initial application for micrometastases testing is

found among patients at the time of initial diagnosis for breast, prostate,

colorectal and gastric carcinomas. When micrometastatic cells are identified in

distant locations, the staging of the patient's disease will typically change to

reflect the presence of distant metastases, an indication of much more advanced

disease. This testing is expected to be performed in addition to normal staging

parameters and will aid in the most appropriate diagnosis and treatment of these

patients.



     The Company has developed a micrometastasis detection system designed to

provide researchers and clinicians with the ability to identify micrometastatic

cancer cells in bone marrow, lymph nodes or blood specimens. The Company is

currently involved in a collaborative study with a leading European cancer

center to determine the prognostic significance of micrometastatic staging in a

population of over nine hundred breast cancer patients. The micrometastasis

detection system incorporates (i) an automated scanning microscope and image

analysis system, (ii) monoclonal primary antibodies specific to micrometastatic

cells and (iii) a colorimetric detection reagent.



Prenatal Testing



     Prenatal testing is the process of detecting certain types of chromosomal

disorders in a fetus at an early stage of pregnancy. Definitive prenatal testing

is currently performed invasively, by extracting fetal cells and inspecting the

chromosomes within such cells to diagnose specific genetic disorders. Prenatal

testing is one of the most common uses of the Company's existing genetic testing

systems.



     Fetal cells are obtained by one of two common procedures, amniocentesis or

chorionic villus sampling. Once the sample is extracted it is forwarded to a

cytogenetic laboratory, where the cells are cultured and deposited on a

microscope slide. The slide is then examined under a microscope in order to

locate and analyze a number of cells undergoing active cell division. At this

point, the chromosome complement of an individual cell is visible under the

microscope.



                                       2





     Chromosome analysis without the advantage of an automated imaging system is

both tedious and time consuming. Typically, a laboratory technologist scans the

slide manually to locate cells undergoing active division. Once these metaphase

cells are found, they are photographed using a camera attached to the

microscope. This photograph is then printed and each chromosome is manually cut

out of the photograph, arranged in order and pasted on a sheet to show the two

sets of 23 chromosomes present in the cell. This visual presentation of the

chromosomes is called a karyotype. Laboratories may eliminate many of these

steps and substantially improve their efficiency by using an automated image

analysis system to scan the slides for cells in metaphase, to automatically

classify the chromosomes, to present them on a video display for review and

acceptance and to print final karyotype records.



Current Cytogenetic Products



     In the United States, approximately 500,000 total cytogenetic test

procedures are performed annually. Cytogenetic testing includes prenatal

screening for genetic disorders using amniotic fluid or chorionic villus

sampling. The most rapidly growing segment of cytogenetic testing includes those

tests for the diagnosis and prognosis of cancerous conditions using bone marrow,

blood and tissue samples. The Company currently manufactures, markets and sells

its CytoVision and Quips automated instruments for a wide range of these

cytogenetic applications. The Company's primary cytogenetic products are

described below. The Company has sold systems to over 800 sites worldwide in

more than 35 countries. The Company's primary cytogenetic products currently

sell for prices ranging from $20,000 to $200,000, depending upon the

instrument's capabilities and final system configurations.



     CV ChromoScan(TM) System



     The CytoVision ChromoScan is the Company's most comprehensive system for

automated chromosome analysis. The ChromoScan integrates many of the key

features of the Company's earlier products into one system capable of automated

microscope slide scanning, advanced chromosome analysis and fluorescent image

processing. The ChromoScan allows laboratories to automatically scan slides to

locate specific cells for chromosome analysis. This eliminates one of the most

tedious and time-consuming aspects of cytogenetic analysis: that of manual slide

scanning. The system accomplishes this in the background while simultaneously

allowing the technologist to process and analyze images previously identified.

The Company believes that no other commercially available system for cytogenetic

analysis incorporates this same range of features in one integrated and

automated package.



     CytoVision(TM) System



     The CytoVision system is a comprehensive chromosome analysis system that

integrates standard karyotyping capability with advanced FISH imaging

technologies, including color chromosome analysis techniques (in the CV

ChromoFluor(TM)). The system's computerized image capture and analysis

capabilities incorporate pattern recognition and automated chromosome

classification algorithms. The system provides automated karyotyping

capabilities, automatic separation of touching or overlapping chromosomes (a

common occurrence), a variety of user-defined image enhancement features, report

annotation capabilities and full screen display options. The DNA probe imaging

capability of the CytoVision detects and analyzes signals from DNA probes that

have been applied to cell nuclei. CytoVision systems enhance images of often-

faint fluorescent DNA probes and provide the operator with a range of optimized

analytical tools. The systems may also be upgraded to detect genetic

amplifications and deletions in tumor cells utilizing a research technique known

as comparative genomic hybridization ("CGH").



     Quips(R) Systems



The Applied Imaging Quips systems offer advanced FISH imaging tools to

researchers worldwide. These systems were among the first to incorporate high

sensitivity digital imaging capabilities along with the ability to analyze new

DNA probe techniques such as M-FISH and interphase cytogenetics. Based on the

Apple(R) PowerMac platform, Quips systems allow researchers who have developed

techniques on Apple systems to continue their research with the most current

hardware and software solutions for the Macintosh. The Quips product line was

acquired by the Company as one part of a 1999 strategic alliance with Vysis,

Inc., the leading provider of DNA probe reagents for cancer and prenatal

testing.



     Genus(TM)



The newest system introduced for cytogenetic research markets is the Company's

Genus system. Genus has been designed for the advanced analysis of plant and

animal genomes, a highly active area of basic research and commercial product

development. Adapting technology pioneered on the Company's CytoVision systems,

Genus allows researchers to apply well-established chromosome analysis

techniques to animals and plants that have wide variations in the makeup of

their chromosome complements. Initial market response to the introduction of

Genus has been very strong.



                                       3





     All of the products in the CytoVision family are compatible with one

another and can be integrated into a network with common data management

protocols. In addition to its analysis systems, the Company also sells a number

of peripherals including a range of high quality printers. A typical

installation will include a number of interconnected CytoVision systems and

components.



Current Cancer Pathology Products



     Micrometastasis Detection System (MDS(TM))



The MDS consists of a custom scanning microscopy system that has been optimized

for the analysis of bone marrow, lymph node and stem cell preparations to detect

rare cancer cells that have been stained by a variety of laboratory techniques.

Designed with fluorescent microscope capabilities fully integrated, the MDS

allows researchers to apply an extraordinarily wide range of DNA probes to

individual cells in order to characterize them at a molecular level.



     Cytonex(TM) ImmunoCytoChemistry Staining Kit



The Cytonex kit is an FDA-cleared reagent product intended to detect

cytokeratin-positive metastases in cancer patients with common epithelial tumors

(such as breast, prostate and colon cancer). The Company is actively pursuing

partners such as Nexell Therapeutics (the manufacturers of Cytonex) who offer

novel diagnostic reagents that are suited for use in conjunction with our

existing and planned cancer pathology systems.



Sales, Distribution and Marketing



     The Company currently sells its image analysis products to government and

private clinical laboratories, hospital laboratories, research institutions,

universities and pharmaceutical companies. These customers utilize the Company's

genetic imaging products for prenatal genetic screening and cancer research

studies.



     In North America, the Company sells its products directly to its customers.

The North American sales team is comprised of nine sales and application support

specialists. Outside of North America, the Company sells its products either

directly, through local agents who are remunerated on a commission basis or

through independent distributors. The Company manages its international sales

and distribution activities from Applied Imaging International Ltd., the

Company's wholly owned subsidiary located in the United Kingdom. The

international sales team is comprised of 15 sales and application support

professionals, based in the United Kingdom, France and Germany. The Company's

primary distributors are located in Australia, China, Italy, Japan, South Korea

and Spain. In addition, the Company has established a sales agency agreement

with Vysis, S.A. where Vysis' European affiliates sell the Company's products in

France, Germany, the United Kingdom and selected other markets through their

direct sales channels.



     Because the Company's products are technically sophisticated,

scientifically qualified and highly trained product specialists support the

Company's sales staff in all major markets. The Company offers an annual

instrument maintenance program to its customers through its dedicated support

organization. The Company's marketing activities include telemarketing, product

advertising and participation in trade shows and product seminars.



Manufacturing



     The Company assembles and tests components and subassemblies made by

outside vendors to the Company's specifications and manufactures only when it

believes significant value can be added. The Company's current products are

assembled from a combination of (i) commodity technology components such as

computers and monitors, (ii) custom subassemblies, such as automated filter

wheels, (iii) proprietary hardware for scanning microscopy, and (iv) operating

systems and proprietary applications software. Any disruption or delay in the

supply of components or custom subassemblies will have a material adverse effect

on the Company. While the Company typically uses components and subassemblies

that are available from alternate sources, any unanticipated interruption of the

supply of these components or subassemblies could require the Company to

redesign its products.



     The Company orders components and subassemblies to forecast and assembles

specific configurations on receipt of firm orders. The Company's research,

investigational and clinical products are subject to regulation by the FDA and

all products are subject to regulation by the U.S. Department of Commerce export

controls, primarily as they relate to the associated computers. The Company has

experienced no material difficulties in obtaining export licenses to date.



                                       4





     Under current law, if the Company manufactures finished devices in the

United States, it will be required to comply with the FDA's Quality System

Regulation and the State of California's current Good Manufacturing Practice

("GMP") regulations. In addition, the FDA and/or the California authorities may

inspect the Company's manufacturing facilities on a regular basis to determine

such compliance. Failure to comply with applicable FDA or other regulatory

requirements can result in fines, injunctions, civil penalties, recalls or

seizures of products, total or partial suspensions of production or criminal

prosecutions.



Research and Development



     The Company's research and development efforts include various research,

product development, clinical evaluation and testing, quality assurance,

regulatory and process development activities. The current focus of the

Company's research and development efforts is the continued enhancement of the

Company's micrometastasis detection system. In addition, the Company is

collaborating with outside investigators and other companies to develop new

cancer testing applications for the micrometastasis platform. The Company's

future research and development efforts are expected to include development of

additional applications of the Company's current cytogenetic products and

additional applications for the micrometastasis detection system. Development of

these applications may require additional funds and will be subject to

technological, clinical, regulatory and other risks associated with new medical

technologies. There can be no assurance that the Company will further develop

its micrometastasis testing system or any other future applications of such

technology.



     Research and development expenses were approximately $4.3 million, $6.7

million and $7.4 million in 1999, 1998 and 1997 respectively. Overall research

and development expenses have declined as the Company's development resources

have been shifted to concentrate on cancer imaging applications.



Patents and Proprietary Rights



     The Company actively seeks, when appropriate, protection for its products

and proprietary information by means of United States and foreign patents and

trademarks. The Company has one issued United States patent relating to its

CytoVision System and has corresponding issued patents in certain European

countries. The Company also has one United States patent relating to Multicolor

Fluorescent in situ Hybridization ("M-FISH") imaging techniques. In addition,

the Company has three United States patents concerning its technology for

enriching the concentration of fetal nucleated red blood cells from maternal

blood samples. Corresponding applications were filed through the Patent

Cooperation Treaty and preserve for the Company the right to file applications

in various countries. The Company relies upon trade secrets, know-how and

contractual arrangements to protect certain of its proprietary information and

products.



     The fields of life science instrumentation and genetic screening processes

are covered by many issued patents and patent applications. The Company was

previously notified that it may be infringing on certain patents pertaining to

highly specialized cytogenetic applications. Upon review, the Company does not

believe there is any merit to such a claim. The Company is not aware of any

other patents which it may be infringing; however, patent applications in the

United States remain confidential until a patent is issued, and, therefore, the

Company's products could infringe patents to be issued in the future. If the

Company's technology is determined to use products, processes or other subject

matter that is claimed under other existing U.S. or foreign patents, or if other

patents claiming subject matter utilized by the Company are issued, such

companies may bring infringement actions against the Company. The Company may be

required to obtain licenses to patents or proprietary rights of others. There

can be no assurance that any such license would be made available or, if

available, would be available on commercially acceptable terms. Failure to

obtain a required license could prevent the Company from commercializing its

products resulting in a material adverse affect on the Company's business,

financial condition and results of operations.



     The Company generally enters into confidentiality agreements with its

employees and consultants designed to both protect the Company's confidential

information and prevent the disclosure of confidential information of prior

employers and other parties. There can, however, be no assurance that the

Company's trade secrets or proprietary technology will not become known or be

independently developed by competitors in such a manner that the Company has no

practical recourse. Certain employees of and consultants to the Company are

subject to the terms of confidentiality agreements with respect to proprietary

information of their former employers. The failure of these persons to comply

with the terms of their agreements could result in assertion of claims against

the Company and such persons which, if successful, might restrict their roles

within the Company.



                                       5





     In October 1997, the Company entered into an exclusive worldwide licensing

agreement with the University of Cambridge for the commercialization of DNA-

probe technology developed by Cambridge researchers. The technology, known as

Cross Species Color Banding, has been utilized by the Company in an effort to

develop research test reagents to detect and analyze chromosomal aberrations.

The Company has developed an initial test kit for color banding analysis of

human chromosomes that has been made available for research use. The agreement

requires minimum annual royalty payments of $30,000 and the payment for specific

research related projects. The Company and the University of Cambridge are

currently in discussions regarding modifications to the terms of this agreement.



     In January 1998, the Company entered into a non-exclusive worldwide

agreement with Vysis, Inc. for the right to use certain CGH software products.

The agreement requires an initial payment of $5,000 and a royalty payment of

$500 for each CGH software product sold.



     The Company also relies upon trademarks to protect certain of its products,

and holds a United States trademark registration for the marks "CYTOSCAN" and

"RxFISH." Registrations for these marks and the mark "CYTOVISION" are held by

the Company in certain foreign jurisdictions.



     The Company also has certain other trademark rights in the United States

and other foreign countries. It is possible that third parties may allege

superior rights to one or more of the Company's trademarks, or close variations,

for those countries in which the Company is presently conducting business or may

do so in the future. The Company's rights to use and register its marks in a

given jurisdiction may depend on its rights relative to a third party's rights

as governed by the laws of the pertinent country. Factors utilized to determine

the relevant rights between parties include priority of the use or registration

of the mark, how close the respective marks are in appearance, sound and/or

meaning, as well as the goods to which they are applied. It is possible that the

Company could be prevented from using or registering its trademarks in certain

countries due to a superior third party right.



Competition



     The market for the Company's current cytogenetic products is highly

competitive. The Company believes that its primary competitors in this market

include Perceptive Scientific Instruments, Inc. (a subsidiary of International

Remote Imaging Systems, Inc.), Metasystems, Gmbh and Leica. The principal

competitive factors in this market are product features offered, ease of use,

clarity of output, customer service capabilities, price and installed base. The

Company believes it competes favorably with regard to these factors.



     The market for micrometastasis detection imaging systems is a new and under

development. The Company's primary competitors in this market are Chromavision,

Inc. and Metasystems.



     Certain of the Company's competitors have greater financial and technical

resources and production and marketing capabilities than the Company. There can

be no assurance that these competitors will not succeed in developing

technologies and products that are more effective, easier to use or less

expensive than those which are currently offered or being developed by the

Company or that would render the Company's technology and products obsolete and

noncompetitive. In addition, some of the Company's competitors have

significantly greater experience than the Company in conducting clinical

investigations of new diagnostic products and in obtaining FDA and other

regulatory clearances and approvals of products. Accordingly, the Company's

competitors may succeed in developing and obtaining regulatory approvals for

such products more rapidly than the Company.



Government Regulation



     The testing, manufacturing, labeling, distribution, sales, and marketing of

the Company's products are subject to government regulation in the United States

and in other countries. The Company believes that its future success will be

significantly dependent upon commercial sales of its micrometastasis detection

system. The Company currently markets this system for research purposes

globally. The Company is currently conducting clinical trials of its

micrometastasis system in the United States and Europe and plans to seek

regulatory clearance for specific clinical applications in the United States. In

the United States, the Company's products are also subject to regulation by

state authorities. The State of California's requirements in this area require

registration with the state and compliance with state GMP regulations.



     Noncompliance with applicable FDA requirements can result in, among other

things, fines, injunctions, civil penalties, recall or seizure of products,

total or partial suspension of production, distribution, sales, and marketing,

refusal of the government to grant approval of a PMA or clearance of a 510(k),

withdrawal of marketing approvals or



                                       6





clearances, a recommendation by the FDA that the manufacturer or distributor not

be permitted to enter into government contracts, and criminal prosecution. In

certain circumstances, the FDA also has the authority to order the manufacturer

or distributor of a device to repair, replace or refund the cost of the device.

Failure to comply with regulatory requirements in the United States or abroad

could have a material adverse effect on the Company's business, financial

condition and results of operations.



     Before a new medical device can be introduced into the market, the

manufacturer must obtain FDA clearance of a 510(k) or approval of a PMA, unless

the device is exempt from the requirement of such clearance or approval. A

510(k) clearance will be granted if the submitted information establishes that

the device is substantially equivalent to a legally marketed Class I or II

medical device or to a legally marketed Class III device that does not itself

require an approved PMA prior to marketing ("predicate device"). A 510(k) must

contain information to support a claim of substantial equivalence, which may

include laboratory test results or the results of clinical studies of the device

in humans. The FDA is required to review 510(k) submissions within 90 days, but

it generally takes from five to twelve months from the date of submission to

obtain 510(k) clearance from the FDA; it may take longer and 510(k) clearance

may never be obtained. The FDA may determine that a device is not

"substantially equivalent" to a predicate device, or that additional

information is needed before a substantial equivalence determination can be

made. Based on initial discussions with FDA officials, the Company plans to

submit a 510(k) application covering specific applications for its

micrometastasis detection system.



     In addition to domestic regulation of medical devices, the Company's

current products and its products under development are subject to corresponding

regulations governing safety processes, manufacturing processes and quality in

foreign jurisdictions in which it operates or such products are sold. Failure to

comply with applicable regulatory requirements can, among other consequences,

result in fines, injunctions, civil penalties, suspensions or loss of regulatory

approvals, product recalls, seizure of products, operating restrictions and

criminal prosecution. In addition, future governmental regulations may be

established that could prevent or delay regulatory approval of the Company's

products. The regulation of medical devices in a number of such jurisdictions

continues to develop and there can be no assurance that new laws or regulations

will not have a material adverse effect on the Company's business. Upon the

adoption of the "In Vitro Diagnostic Medial Device Directive of October 27,

1998, the European Community and its member countries currently are imposing

more substantial regulation on in vitro diagnostic devices and equipment-like

medical devices, and such regulation may affect the Company's current products

and products under development.



     Delays in receipt of clearances or approvals to market its products,

failure to receive these clearances or approvals, the loss of previously

received clearances or approvals or the determination that 510(k) clearance,

pre-market approval or other approval is required for a product being marketed

without such clearance or approval could have a material adverse effect on the

Company's business, financial condition and results of operations.



     In addition, laboratories who purchase the Company's current products could

be subject to the Clinical Laboratory Improvement Amendments of 1988 ("CLIA"),

which are intended to ensure the quality and reliability of medical testing

conducted in laboratories in the United States. The Company's products should

comply with CLIA regulations or the Company's ability to market its products

could be negatively affected.



     Marketed devices are subject to pervasive and continuing regulatory

oversight by the FDA and other agencies, including record-keeping requirements

and reporting of adverse experiences with the use of the device. Device

manufacturers are required to register their establishments and list their

devices with the FDA and certain state agencies. The Federal Food, Drug and

Cosmetic Act and certain state laws require that medical devices be manufactured

in accordance with the Quality System Regulations ("QSregs"). Manufacturing

facilities are subject to periodic inspection by the FDA and certain state

agencies on a periodic basis to monitor compliance with GMP, QSregs and other

requirements. If violations of the applicable regulations are noted during such

inspections of manufacturing facilities, the Company can be prohibited from

conducting further manufacturing, distribution and sale of the devices until the

violations are cured.



     The Company is also subject to other federal, state, local and foreign

laws, regulations and recommendations relating to safe working conditions and

good laboratory practices. The extent of government regulation that might result

from any future legislation or administrative action cannot be accurately

predicted. Failure to comply with any federal or state regulatory requirements

could have a material adverse effect on the Company's business, financial

condition and results of operations.



Third-Party Reimbursement and Health Care Reform



                                       7





     In the United States, the Company's products are purchased primarily by

medical institutions which then bill various third-party payors, such as private

insurance plans, Medicare, Medicaid, and other government programs ("Third-Party

Payors") for the health care services provided to their patients. Third-Party

Payors may deny reimbursement if they determine that the device used in a

treatment was unnecessary, inappropriate, experimental or investigational, used

for a non-approved indication, or not cost-effective and typically do not

reimburse for devices used for research and investigational purposes.

Accordingly, physicians must determine that the new clinical benefits of genetic

screening procedures justify the additional cost. The market for the Company's

current cytogenetic products could be adversely affected by changes in

governmental and private third-party payors' policies. The unavailability of

third-party coverage or the inadequacy of the reimbursement for medical

procedures using the Company's products would adversely affect the Company's

business, financial condition and results of operations. In both the United

States and internationally, Third-Party Payors are increasingly challenging the

prices charged for medical products and services. There can be no assurance that

reimbursement for the procedures using the Company's products will be available

or, if currently available, will continue to be available, or that future

reimbursement policies of payors will not adversely affect the Company's ability

to sell its products on a profitable basis. In addition, there can be no

assurance that third-party reimbursement will be available for diagnostic

procedures based on the Company's micrometastasis detection system.



     The levels of revenues and profitability of medical device companies may be

affected by the continuing efforts of governmental and Third-Party Payors to

contain or reduce the costs of health care through various means. In the United

States, there have been, and the Company expects that there will continue to be,

a number of federal and state proposals to implement government regulation of

health care costs. It is uncertain what legislative proposals will be adopted or

what actions federal, state or private payers for health care goods and services

may take in response to any health care reform proposals or legislation. The

Company cannot predict the effect health care reforms may have on its business,

and no assurance can be given that any such reforms will not have a material

adverse effect on the Company's business, financial condition and results of

operations. Further, to the extent that such proposals or reforms have a

material adverse effect on the business, financial condition and profitability

of the clinical and research laboratories, hospitals and other institutions that

comprise the Company's customer base, the Company's business, financial

condition and results of operations could be adversely affected.



Product Liability and Insurance



     The Company's business may involve the risk of product liability claims,

including those relating to inaccurate results from its screening products.

Although the Company has not experienced any product liability claims to date,

any such claims could have a material adverse impact on the Company. The Company

maintains product liability insurance at coverage levels which it deems

commercially reasonable; however, there can be no assurance that product

liability or other claims will not exceed such insurance coverage limits or that

such insurance will continue to be available on commercially acceptable terms,

or at all. Even if a product liability claim is not successful, the time and

expense of defending against such a claim may adversely affect the Company's

business, financial condition and results of operations.



Employees



     As of December 31, 1999, the Company had 85 employees, of whom 24 were

involved in research and development, 9 in manufacturing , 39 in sales,

marketing and customer service and 13 in finance and administration. As of

December 31, 1999, 38 of the employees were based in the United Kingdom, 43 in

the United States, 1 in Israel, 2 in France and 1 in Germany. A total of 5

employees hold Ph.Ds, and 1 employee is an M.D. The Company's employees include

a number of professional cytogeneticists who support and sell its product range.

The Company believes its relationship with its employees to be good.



Accumulated Deficit; Future Losses



     The Company expects its operating losses to continue in future periods as

it continues its efforts to market the micrometastasis detection system.



Quarterly Fluctuations



     The Company has experienced and expects to continue to experience

significant fluctuations in its quarterly operating results. Factors which may

have an influence on the Company's operating results in a particular quarter



                                       8





include (i) demand for the Company's products, new product introductions by the

Company or its competitors or transitions to new products; (ii) the timing of

orders and shipments for capital equipment sales; (iii) the mix of sales between

distributors and the Company's direct sales force; (iv) competition, including

pricing pressures; (v) the timing and amount of research and development

expenses, including clinical trial-related expenditures; (vi) seasonal factors;

(vii) foreign currency fluctuation; and (viii) the delay between incurrence of

expenses to develop new products, including related marketing and service

capabilities, and realization of benefits from such efforts. The Company

believes the pattern of fluctuating revenues is influenced by the budgetary

spending practices of the Company's customer base which consists primarily of

public and private clinical laboratories, research organizations and hospitals

operating on annual budgets. Due to the foregoing factors, it is likely that in

some future quarter the Company's operating results will be below the

expectations of public market analysts and investors. In such event, the price

of the Company's Common Stock would likely be materially adversely affected.



Additional Capital Requirements; No Assurance Future Capital will be Available



     The Company has expended and will continue to expend substantial funds for

research and development, preclinical testing, planned clinical investigations,

capital expenditures and manufacturing and marketing of its products. The timing

and amount of spending of such capital resources cannot be accurately determined

at this time and will depend upon several factors, including the progress of its

research and development efforts and planned clinical investigations, competing

technological and market developments, commercialization of products currently

under development, and market acceptance and demand for the Company's products.

To the extent required, the Company may seek to obtain additional funds through

equity or debt financing, collaborative or other arrangements with other

companies and from other sources. If additional funds are raised by issuing

equity securities, further dilution to stockholders would occur. There can be no

assurance that additional financing will be available when needed or on terms

acceptable to the Company. If adequate funds are not available, the Company

could be required to delay development or commercialization of certain of its

products, to license to third parties the rights to commercialize certain

products or technologies that the Company would otherwise seek to commercialize

for itself, or to reduce the marketing, customer support or other resources

devoted to certain of its products each of which could have a material adverse

effect on the Company's business, financial condition and results of operations.



Uncertainty of FDA or Other Regulatory Clearances or Approvals



     The testing, manufacturing, labeling, distribution, sale, and marketing, of

the Company's products are subject to government regulation in the United States

and other countries. The Company's Cytoscan products were marketed until 1994 in

the United States pursuant to pre-market notifications to the FDA under Section

510(k) of the Federal Food, Drug and Cosmetic Act ("510(k)"). A 510(k) pre-

market notification must be supported by appropriate data establishing, to the

satisfaction of the FDA, that a newly developed device is "substantially

equivalent" to a legally marketed device that does not itself require FDA

approval of a PMA. The Company's CytoVision product is the current model of the

Cytoscan product, marketed pursuant to the original 510(k) filing. The Company's

Quips products are marketed in the US pursuant to an original 510(k) clearance

obtained by Vysis, Inc. and its predecessor company.



     The Company is conducting clinical trials of its micrometastasis detection

system in the US and Europe in preparation for the anticipated submission of a

510(k) pre-market notification in the United States. There can be no assurance

that the results of these clinical trials will be sufficient to complete such an

notification within a specific time frame or, that once submitted, the FDA will

accept such notification.



     The regulation of medical devices continues to develop and there can be no

assurance that new laws or regulations will not have a material adverse effect

on the Company's business, financial condition and results of operations. Delays

in receipt of clearance or approvals to market its products, failure to receive

these clearances or approvals, the loss of previously received clearances or

approvals, the determination that 510(k) clearance, pre-market approval or other

approval is required for a product being marketed without such clearance or

approval, or failure to comply with existing or future regulatory requirements

could have a material adverse effect on the Company's business, financial

condition and results of operations.



Need to Comply with International Government Regulation



     The regulatory review process varies from country to country. Currently,

the Company's products are subject to pre-market approval in several of the

countries that are members of the European Union ("EU") and subject to other



                                       9





regulatory requirements in those and other countries. In addition, the

regulation of in vitro diagnostic devices ("IVDs") and other medical devices

continues to change. The Company may rely, in some circumstances, on its

international distributors for compliance with regulatory requirements in those

countries where the Company intends to use distributors. Any enforcement action

by regulatory authorities with respect to regulatory noncompliance may have a

material adverse effect on the Company's business, financial condition and

results of operations.



     The time required to obtain approval for sale in foreign countries may be

longer or shorter than that required for FDA clearance and the requirements may

differ. In addition, there may be foreign regulatory barriers other than

approval for sale. Certain countries and customers may require evidence of the

company's compliance with international quality standards promulgated by the

International Standards Organization ("ISO"). In February 2000, the Company

received preliminary notification that it had successfully completed a third-

party audit of its international operations in Newcastle, England and that,

subject to certain conditions, it would be recommended for certification under

ISO 9001 guidelines for manufacturing and distribution operations as well as ISO

9000-3 guidelines for software development practices.



     The Company has brought its currently sold instruments, as required, into

compliance with the European Parliament's Electromagnetic Compatibility

Directive (89/336/EEC) (the "ECD") and is entitled to apply the CE mark, with

respect to the ECD, to such instruments. The European Parliament has made a

distinction between Medical Devices ("MDs") and IVDs. The Company's instruments

are subject to the requirements or advantages of the In Vitro Diagnostic Medical

Device Directive (98/79/ec). There can be no assurance, however, that some or

all of the Company's products will not be redefined as MD's and made subject to

this Directive by the EU or its member states, which may have a material adverse

effect on the Company's business, financial condition, and results of

operations. There can be no assurance, moreover, that member states, or any

other European country, will not adopt other statutes or regulations that could

require approval to sale the Company products, or that will otherwise have a

material adverse effect on the Company's business, financial condition, or

results of operations.



     As required by the In Vitro Diagnostics medical Device Directive, the

Company's medical device products have the right to affix the CE mark approved,

and the Company is entitled to apply the CE mark. Depending on the complexity of

the electromagnetic compatibility of each product, the testing and certification

process may take a day to months and cost from the several hundred to several

thousand dollars.



Dependence upon Patents and Proprietary Technology; Risk of Infringement



The Company relies primarily upon trade secret protection and on its unpatented

proprietary know-how in the development and manufacturing of its products. There

can be no assurance that the Company's trade secrets or proprietary technology

will not become known or be independently developed by competitors in such a

manner that the Company has no practical recourse. Nor can there be any

assurance that others will not develop or acquire equivalent expertise or

develop products that render the Company's current or future products

noncompetitive or obsolete. There can be no assurance that the claims allowed

under its patents will be sufficiently broad to protect what the Company

believes to be its proprietary rights. In addition, there can be no assurance

that issued patents will not be disallowed or circumvented by competitors, or

that the rights granted thereunder will provide competitive advantages to the

Company. Companies have filed applications for, or have been issued patents

relating to, products or processes that may be competitive with certain of the

Company's products or processes. The Company is unable to predict how the courts

would resolve issues relating to the validity and scope of such patents.



     The validity and breadth of claims in medical technology patents involve

complex legal and factual questions and, therefore, may be highly uncertain. No

assurance can be given that any issued patent or patents based on pending patent

applications or any future patent application will exclude competitors, that any

of the Company's patents in which it has licensed rights will be held valid if

subsequently challenged or that others will not claim rights in or ownership of

the patents and other proprietary rights held or licensed by the Company.

Furthermore, no assurance can be given that others have not developed or will

not develop similar products, duplicate any of the Company's products or design

around any patents issued to or licensed by the Company or that may be issued in

the future to the Company. Since patent applications in the United States are

maintained in secrecy until patents issue, the Company also cannot be certain

that others did not first file applications for inventions covered by the

Company's pending patent applications, nor can the Company be certain that it

will not infringe any patents that may issue to others on such applications.



                                       10





     In addition, patent applications in foreign countries are maintained in

secrecy for a period after filing. Publication of discoveries in the scientific

or patent literature tends to lag behind actual discoveries and the filing of

related patent applications. The Company has not conducted an extensive search

of patents issued to other companies, research or academic institutions, or

others, and no assurances can be given that such patents do not exist, have not

been filed, or could not be filed or issued, which contain claims relating to

the Company's technology, products or processes. Patents issued and patent

applications filed in the United States or internationally relating to medical

devices are numerous and there can be no assurance that current and potential

competitors and other third parties have not filed or in the future will not

file applications for, or have not received or in the future will not receive,

patents or obtain additional proprietary rights relating to products or

processes used or proposed to be used by the Company. There are pending

applications, which if issued with claims in their present form, might provide

proprietary rights to third parties relating to products or processes used or

proposed to be used by the Company. The Company may be required to obtain

licenses to patents or proprietary rights of others.



     The medical device industry in general, and the industry segment that

includes products for prenatal diagnostic screening in particular, have been

characterized by substantial competition. Litigation regarding patent and other

intellectual property rights, whether with or without merit, could be time

consuming and expensive to respond to and could divert the Company's technical

and management personnel. The Company may be involved in litigation to defend

against claims of infringement by the Company, to enforce patents issued to the

Company, or to protect trade secrets of the Company. If any relevant claims of

third-party patents are held as infringed and not invalid in any litigation or

administrative proceeding, the Company could be prevented from practicing the

subject matter claimed in such patents, or would be required to obtain licenses

from the patent owners of each such patent, or to redesign its products or

processes to avoid infringement. In addition, in the event of any possible

infringement, there can be no assurance that the Company would be successful in

any attempt to redesign its products or processes to avoid such infringement.

Accordingly, an adverse determination in a judicial or administrative proceeding

or failure to obtain necessary licenses could prevent the Company from

manufacturing and selling its products, which would have a material adverse

effect on the Company's business, financial condition and results of operations.

Costly and time-consuming litigation brought by the Company may be necessary to

enforce patents issued to the Company, to protect trade secrets or know-how

owned by the Company, or to determine the enforceability, scope and validity of

the proprietary rights of others.



Need to Manage Growth



     Significant future growth in the Company's sales and expansion in the scope

of its operations, should they occur, may place considerable strain on the

Company's management, financial, manufacturing and other capabilities,

procedures and controls. There can be no assurance that any existing or

additional capabilities, procedures or controls will be adequate to support the

Company's operations or that its capabilities, procedures or controls will be

designed, implemented or improved in a timely and cost-effective manner. Failure

to implement, improve and expand such capabilities, procedures and controls in

an efficient manner at an appropriate pace could have a material adverse effect

on the Company's business, financial condition and results of operations.



Dependence on Distributors



     Outside of North America and the United Kingdom, the Company relies

substantially on independent distributors and sales agents to market and sell

its products. There can be no assurance that distributors and agents will devote

adequate resources to support sales of the Company's products. Moreover,

agreements with a number of its distributors require that the Company indemnify

such distributors against costs, expenses and liabilities relating to litigation

regarding the Company's products and, despite these obligations of the Company,

distributors may decide to reduce or end their selling efforts until an

infringement dispute is resolved or settled.



Reliance on International Sales and Operations



     The Company has significant international operations based in the United

Kingdom, employing at December 31, 1999, approximately 39 employees. In 1999,

1998 and 1997, approximately 60%, 63% and 59% respectively, of the Company's

total revenues were derived from customers and distributors outside of the

United States and Canada. The Company expects that international sales of

cytogenetic products will continue to account for a significant portion of its

revenues. Changes in overseas economic conditions, currency exchange rates,

foreign tax laws, or tariffs or other trade regulations could have a material

adverse effect on the Company's business, financial condition and results of



                                       11





operations. The international nature of the Company's business subjects it and

its representatives, agents and distributors to laws and regulations of the

foreign jurisdictions in which it operates or in which its products are sold.

The regulation of medical devices in a number of such jurisdictions,

particularly in the European Community, continues to develop and there can be no

assurance that new laws or regulations will not have a material adverse effect

on the Company's business. The laws of certain foreign countries may not protect

the Company's intellectual property rights to the same extent, as do the laws of

the United States.



     Currently, most of the Company's international sales are denominated in

U.S. dollars, U.K. pounds sterling or European Currency Units (ECUs). The

Company has significant operations in the U.K., and therefore, incurs

significant operating expenses denominated in U.K. pounds. Accordingly, the

Company has not historically attempted to reduce the risk of currency

fluctuations by hedging, as changes in exchange rates between the U.S. dollar

and the U.K. pound sterling immaterially affect the Company's results of

operations. However, there can be no assurance that the Company will not be

disadvantaged with respect to its competitors operating in a foreign country by

foreign currency exchange rate fluctuations that make the Company's products

more expensive relative to those of local competitors.



     For 1999, net sales to customers located in European countries accounted

for 60% of the Company's total sales. The unification of the European countries,

including the standardization of European currencies, as well as other factors,

could contribute to certain countries in the region experiencing banking,

currency and other difficulties that could, ultimately, impact the Company's

sales in Europe.



International Availability of Third-Party Reimbursement; Health Care Reform and

Related Matters



     In the United States, hospitals, physicians and other health care providers

that purchase medical devices generally rely on Third-Party Payors, and other

sources of reimbursement for health care costs to reimburse all or part of the

cost of the procedure in which the medical device is being used. Certain Third-

Party Payors are moving toward a managed care system in which they contract to

provide comprehensive health care for a fixed cost per person. The fixed cost

per person established by these Third-Party Payors may be independent of the

hospital's cost incurred for the specific case and the specific devices used.

Medicare and other Third-Party Payors are increasingly scrutinizing whether to

cover new products and the level of reimbursement for covered products. Because

the Company's fetal cell screening technology is currently under development and

has not received FDA clearance or approval, uncertainty exists regarding the

availability of third-party reimbursement for procedures that would use the

Company's fetal cell screening technology. Failure by physicians, hospitals and

other potential users of the Company's products or products currently under

development to obtain sufficient reimbursement from Third-Party Payors for the

procedures in which the Company's products or products currently under the

development are intended to be used could have a material adverse effect on the

Company's business, financial condition and results of operations.



     Third-Party Payors that do not use prospectively fixed payments

increasingly use other cost-containment processes that may pose administrative

hurdles to the use of the Company's products and products currently under

development. In addition, Third-Party Payors may deny reimbursement if they

determine that the device used in a treatment is unnecessary, inappropriate,

experimental, used for a non-approved indication or is not cost-effective.

Potential purchasers must determine that the clinical benefits of the Company's

products justify the additional cost or the additional effort required to obtain

prior authorization or coverage and the uncertainty of actually obtaining such

authorization or coverage.



     If the Company obtains the necessary foreign regulatory registrations or

approvals, market acceptance of the Company's products and products currently

under development in international markets would be dependent, in part, upon the

availability of reimbursement within prevailing health care payment systems.

Reimbursement and health care payment systems in international markets vary

significantly by country, and include both government-sponsored health care and

private insurance. There can be no assurance that any international

reimbursement approvals will be obtained in a timely manner, if at all. Failure

to receive international reimbursement approvals could have a material adverse

effect on market acceptance of the Company's products in the international

markets in which such approvals are sought.



     The Company believes that in the future, reimbursement will be subject to

increased restrictions both in the United States and in international markets.

The Company believes that the overall escalating cost of medical products and

services will continue to lead to increased pressures on the health care

industry, both foreign and domestic, to reduce the cost of products and

services, including the Company's products and products currently under

development. There can be no assurance in either United States or international

markets that third-party reimbursement and coverage will be



                                       12





available or adequate, that future legislation, regulation or reimbursement

policies of Third-Party Payors will not otherwise adversely affect the demand

for the Company's products or products currently under development or its

ability to sell its products on a profitable basis. The unavailability of Third-

Party Payor coverage or the inadequacy of reimbursement could have a material

adverse effect on the Company's business, financial condition and results of

operations. In addition, fundamental reforms in the health care industry in the

United States and Europe continue to be considered, and there can be no

assurance that such reform will not materially adversely affect the Company's

business, financial condition and results of operations.



Risk of Removal From the NASDAQ National Market



     The shares of the Company's Common Stock are quoted on the NASDAQ National

Market. If the Company should continue to experience losses from operations, it

may be unable to maintain the standards for continued quotation on the NASDAQ

National Market, and the shares of Common Stock could be subject to removal from

the NASDAQ National Market. Trading, if any, in the Common Stock would therefore

be conducted on the NASDAQ SmallCap Market, which is a significantly less liquid

market than the NASDAQ National Market. As a result, an investor could find it

more difficult to dispose of the Company's Common Stock. NASDAQ has recently

promulgated new rules which make continued listing of companies on both the

NASDAQ National Market and the NASDAQ SmallCap Market more difficult and has

significantly increased its enforcement efforts with regard to the standards for

such listing. In addition, if the Company's Common Stock were removed from the

NASDAQ National Market and not qualify for listing on the NASDAQ SmallCap

Market, the Company's Common Stock could be subject to the so-called "penny

stock" rules that impose additional sales practice and market making

requirements on broker-dealers who sell and/or make a market in such securities.

Consequently, failure to qualify for listing on, or removal from, the NASDAQ

SmallCap Market, if it were to occur, could affect the ability or willingness of

broker-dealers to sell and/or make a market on the Company's Common Stock and

the ability of purchasers of the Company's Common Stock to sell their securities

in the secondary market. In addition, if the market price of the Company's

Common Stock is less than $5.00 per share, the Company may become subject to

certain penny stock rules even if still quoted on the NASDAQ SmallCap Market.

Such rules may further limit the market liquidity of the Common Stock and the

ability of investors to sell such Common Stock in the secondary market.



Dependence Upon Key Personnel



     The Company's future success depends in significant part upon the continued

service of certain key scientific, technical and management personnel, and its

continuing ability to attract and retain highly qualified scientific, technical

and managerial personnel. Competition for such personnel is intense and there

can be assurance that the Company can retain its key scientific, technical and

managerial personnel or that it can attract, assimilate or retain other highly

qualified scientific, technical and managerial personnel in the future. Key

employees of the Company include Jack Goldstein, Ph.D., its Chairman and Chief

Executive Officer, Carl Hull, President and Chief Operating Officer, Padraig

O'Kelly, Vice President-Operations, Dan Bowman, Vice President-Americas and

Guido Guidetti- Vice President-International. The Company has no key man

insurance. The Company has taken steps to retain its key employees, including

the granting of stock options that vest over time. Additionally, the Company has

entered into employment agreements with Dr. Goldstein, Mssrs.. Hull, Bowman and

Guidetti. The loss of key personnel especially if without advanced notice, or

the inability to hire or retain qualified personnel could have a material

adverse effect upon the Company's business, results of operations and financial

condition.



Risk of Software Defects



     The Company's cytogenetic and micrometastasis detection products currently

under development involve a software component that facilitates the detection of

chromosomal and genetic abnormalities through the interaction of certain imaging

algorithms with the genetic sample under examination. The software, including

any new versions that may be released, may contain undetected errors or

failures. There can be no assurance that, despite testing by the Company and

current and potential customers, errors will not be found in the software

components of the Company's products, resulting in loss or delay in market

acceptance, which could have a material adverse effect on the Company's

business, financial condition and results of operations.



Product Liability Risk; Possible Insufficiency of Insurance



                                       13





     The manufacture and sale of the Company's products involves the risk of

product liability claims. There can be no assurance that the coverage limits of

the Company's insurance policies will be adequate. The Company intends to

evaluate its coverage on a regular basis and in connection with the introduction

of products currently under development. Such insurance is expensive and may not

be available on acceptable terms, in sufficient amount of coverage, or at all. A

successful claim brought against the Company in excess of its insurance coverage

would have a material adverse effect on the Company's business, results of

operations and financial condition.



Control by Certain Stockholders



     Certain stockholders, including certain executive officers and directors of

the Company and their affiliates, own approximately 71% of the outstanding

Common Stock. As a result, these stockholders will, to the extent they act

together, continue to have the ability to exert significant influence and

control over matters requiring the approval of the Company's stockholders,

including the election of a majority of the Company's Board of Directors.



Possible Volatility of Stock



     The market prices for securities of medical diagnostic instrument companies

have historically been highly volatile. Announcements of technological

innovations or new products by the Company or its competitors, developments

concerning proprietary rights, including patents and litigation matters,

publicity regarding actual or potential results with respect to products under

development by the Company or others, regulatory developments in both the United

States and foreign countries and public concern as to the safety of new

technologies, changes in financial estimates by securities analysts or failure

of the Company to meet such estimates and other factors, may have a significant

impact on the market price of the Common Stock. In addition, the Company

believes that fluctuations in its operating results may cause the market price

of its Common Stock to fluctuate, perhaps substantially.



Potential Adverse Effect of Shares Eligible for Future Sale



     According to Forms 13D and 13G filed by the Company's stockholders,

approximately 3,133,567 shares of the Company's Common Stock (representing

approximately 24% of the total shares outstanding) are held by affiliates and

are therefore subject to volume limitations pursuant to Rule 144. In the event

any of such stockholders cease to be affiliates (for example, by resigning from

the Board of Directors and holding less than 10% of the shares outstanding), (i)

certain of the shares held by such stockholders will be eligible for immediate

resale in the public market and (ii) pursuant to Rule 144(k), certain of such

shares will no longer be subject to the manner of sale and volume limitations of

Rule 144 and will be eligible for resale in the public market after 90 days from

the date such stockholder ceases to be an affiliate. Any sale of a substantial

number of shares may have the effect of depressing the trading price of the

Company's publicly traded stock, which would lower the Company's value and make

it more difficult for the Company to raise capital.



Significant Restrictions on Change in Control



     Certain provisions of the Company's current Certificate of Incorporation

and Bylaws may have the effect of making it more difficult for a third party to

acquire, or discouraging a third party from attempting to acquire, control of

the Company. Such provisions could limit the price that certain investors might

be willing to pay in the future for shares of the Company's Common Stock.

Certain of these provisions provide for the elimination of the right of

stockholders to act by written consent without a meeting and specify procedures

for director nominations by stockholders and submission of other proposals for

consideration at stockholder meetings. In addition, the Company has adopted a

Preferred Shares Rights Agreement, sometimes referred to as a poison pill,

designed to prevent hostile takeovers not approved by the Board of Directors.

Also, the Company is authorized to issue 6,000,000 shares of undesignated

Preferred Stock. Such shares of Preferred Stock may be issued by the Company

without stockholder approval upon such terms as the Company's Board of Directors

may determine. The issuance of Preferred Stock may have the effect of delaying,

deferring or preventing a change of control of the Company, may discourage bids

for the Company's Common Stock at a premium over the market price of the Common

Stock and may adversely affect the market price of the voting and other rights

of, the holders of Common Stock. At present, the Company has no plans to issue

any of the Preferred Stock. The rights of the holders of Common Stock will be

subject to, and may be adversely affected by, the rights of the holders of any

Preferred Stock that may be issued in the future. The issuance of Preferred

Stock, while providing desirable flexibility in connection with possible

acquisitions and other corporate purposes, could have the effect of making it

more difficult for a third party to acquire a majority of the outstanding voting

stock of the Company. Certain provisions of Delaware law applicable to the

Company could also delay or make more difficult a



                                       14





merger, tender offer or proxy contest involving the Company, including Section

203 of the Delaware General Corporation Law, which prohibits a Delaware

corporation from engaging in any business combination with any interested

stockholder for a period of three years unless certain conditions are met.



Item 2.   PROPERTIES



     In the United States, Applied Imaging leases an approximately 14,000 square

foot facility in Santa Clara, California, under a lease, which terminates in

November 30, 2000. In the United Kingdom, Applied Imaging International Ltd.

("AII") leases an approximately 12,500 square foot facility in Newcastle, which

lease terminates in July 2008. The Company believes that its facilities are

adequate to meet its requirements through 2000.



Item 3.   LEGAL PROCEEDINGS



     The Company is not party to any legal proceedings.



Item 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



     Not applicable.



                                       15





                                    PART II



Item 5.   MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS



     The Company's Common Stock is traded on the NASDAQ National Market under

the symbol "AICX." The following table sets forth the range of the high and low

sale prices by quarter as reported on the NASDAQ National Market for the periods

indicated.



                                         High      Low

                                        -------  -------

1999

First Quarter                           2 1/4      3/8

Second Quarter                          3          3/4

Third Quarter                           1 5/8      3/4

Fourth Quarter                          1 13/16    11/16



1998



First Quarter                           4 1/4      1 7/8

Second Quarter                          3 9/16     1 7/8

Third Quarter                           3          2

Fourth Quarter                          3 1/8      1 1/4



     As of March 8, 2000, the number of common stockholders of record was 154.

The Company currently intends to retain any earnings for use in its business and

has not in the past, nor does it anticipate paying in the foreseeable future any

cash dividends.



                                       16





Item 6.   SELECTED FINANCIAL DATA



     The following selected consolidated financial data should be read in

conjunction with the Company's audited consolidated financial statements and

related notes thereto and with Management's Discussion and Analysis of Financial

Condition and Results of Operations, which are included elsewhere in this Form

10-K. The consolidated statement of operations data for the year ended

December 31, 1999 and the consolidated balance sheet data at December 31, 1999

are derived from, and are qualified by reference to, the consolidated

financial statements which have been audited by PricewaterhouseCoopers LLP and

the consolidated statement of operations data for the years ended December 31,

1998 and 1997 and the consolidated balance sheet data at December 31, 1998,

are derived from, and are qualified by reference to, the consolidated

financial statements which have been audited by KPMG LLP and are included in

this Form 10-K. The consolidated statement of operations data for the years

ended December 31, 1996 and 1995 and the consolidated balance sheet data

December 31, 1997, 1996 and 1995 are derived from audited consolidated

financial statements which have also been audited by KPMG LLP.







                                                                                     Year Ended December 31,

                                                             --------------------------------------------------------------------

                                                                 1999          1998          1997          1996          1995

                                                             ------------  ------------  ------------  ------------  ------------

                                                                         (In thousands, except per share data)

                                                                                                      

Consolidated Statement of Operations Data:

Revenues:

     Product sales.......................................    $     11,475  $      9,034  $     10,457  $      9,259  $      8,106

     Software maintenance and service....................           2,655         2,650         2,677         2,663         2,692

                                                             ------------  ------------  ------------  ------------  ------------

          Total revenues.................................          14,130        11,684        13,134        11,922        10,798

     Cost of revenues....................................           6,686         6,010         6,284         5,974         5,484

                                                             ------------  ------------  ------------  ------------  ------------

          Gross profit...................................           7,444         5,674         6,850         5,948         5,314

                                                             ------------  ------------  ------------  ------------  ------------

Operating Expenses:

     Research and development............................           4,299         6,662         7,381         3,667         2,919

     Sales and marketing.................................           5,232         4,950         3,740         3,088         2,918

     General and administrative..........................           2,876         2,722         3,639         2,088         2,094

     Amortization of Intangibles.........................             124             -             -             -             -

     Restructuring costs.................................             818           353             -             -             -

                                                             ------------  ------------  ------------  ------------  ------------

     Total operating expenses............................          13,349        14,687        14,760         8,843         7,931

                                                             ------------  ------------  ------------  ------------  ------------

     Operating loss......................................          (5,905)       (9,013)       (7,910)       (2,895)       (2,617)

     Other (expense) income..............................            (104)          541           398            14            71

                                                             ------------  ------------  ------------  ------------  ------------

Net loss.................................................    $     (6,009) $     (8,472) $     (7,512) $     (2,881) $     (2,546)

                                                             ============  ============  ============  ============  ============

Net loss per share basic and diluted.....................    $      (0.50) $      (0.86) $      (1.03) $      (1.43) $      (2.46)

                                                             ============  ============  ============  ============  ============



Consolidated shares used to calculate Basic and

diluted net loss per share...............................          11,930         9,850         7,324         2,020         1,033



                                                                                     Year Ended December 31,

                                                             --------------------------------------------------------------------

                                                                 1999          1998          1997          1996          1995

                                                             ------------  ------------  ------------  ------------  ------------

                                                                                        (In thousands)

                                                                                                      

Balance Sheet Data:

     Cash, cash equivalents and short-term investments...    $      8,406  $     11,728  $      8,378  $     12,318  $      5,156

     Working capital.....................................           7,132        10,753         7,171        10,700         3,249

     Total assets........................................          19,744        18,808        14,714        16,473         9,373

     Non-current portion of bank debt....................           1,167             -             -             -             -

     Non-current of deferred revenues....................             518             -             -             -             -

     Non-current of notes payable........................             250             -             -             -             -

     Lease obligation....................................              37            64            89           229           231

     Accumulated deficit.................................         (34,013)      (28,004)      (19,533)      (12,021)       (9,140)

     Total stockholders' equity..........................           8,612        12,343         8,943        12,005         4,714





                                       17





Item 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

          RESULTS OF OPERATIONS



     The information set forth in this Item 7 below contains forward-looking

statements, (designated by an *), and the Company's actual results could differ

materially from those anticipated in these forward-looking statements as a

result of certain factors, including those set forth below under "Factors That

May Affect Future Results," and those set forth under Item One on this document,

including "Additional Risk Factors".



Overview



     Since its inception in 1986, the Company has principally been engaged in

the design, development, manufacture and marketing of automated genetic testing

systems for use in cancer testing, prenatal testing and other genetic testing

applications. The Company's genetic imaging instrumentation products include

systems that enable laboratories to automate many aspects of the detection of

chromosomal abnormalities associated with conditions such as cancer and Down

Syndrome. The Company also markets imaging systems used to detect the presence

of rare cancer cells in various tissues and to then genetically characterize

these cells. The Company sells its systems to government and private clinical

laboratories, research institutions, universities and pharmaceutical companies,

and has sold such systems to approximately 800 sites in over 35 countries.



     The Company previously pursued a prenatal genetic screening development

program focused on the isolation of specific fetal cells from a blood sample

taken from the expectant mother. While substantial research progress was made

towards the development of a reliable method for non-invasive prenatal

diagnosis, the Company has concluded that its methods do not currently

constitute a commercially viable system for this purpose. Accordingly, the

Company has shifted its research efforts and resources to its cancer imaging

programs, with a focus on the detection of rare micrometastatic cancer cells in

a variety of sample types. The Company believes that certain of its cell

enrichment and image analysis products developed for fetal cell analysis are

directly applicable to these cancer testing applications.



     The operating results of the Company have fluctuated significantly in the

past on an annual and quarterly basis. The Company expects that its operating

results will fluctuate significantly from quarter to quarter and year to year in

the future and will depend on a number of factors, some of which may affect

future sales of the Company's cytogenetic products. These factors include, but

are not limited to, demand for the Company's products, timing of capital

equipment orders and shipments, competition and its related pricing pressures,

and seasonal factors, many of which are outside the Company's control.



     The Company markets its products worldwide from its operations in the

United States and the United Kingdom and performs research and development in

both the United States and the United Kingdom. Sales from the United States are

primarily to customers within the United States and Canada. Revenues in the

United Kingdom are generated by both shipments of products from the United

States directly to international customers and direct shipments to international

customers from the United Kingdom.



Results of Operations



Fiscal 1999 Compared With Fiscal 1998



     Revenues. Revenues increased to $14.1 million in 1999 from $11.7 million in

1998. This 21% increase in revenues is principally due to the acquisition of the

Vysis Quips(R) product line and the launch of two new products - Genus(TM) and

MDS(TM). Service contract and software maintenance revenues at $2.7 million was

the same as in 1998. In 1999, the Company recorded $99,000 of grant proceeds as

revenues compared to $287,000 in the prior year. Grant revenues fluctuate based

on the completion of milestones for existing programs and the receipt of any new

grant awards. For 1999 and 1998 revenues derived outside of North America were

approximately 60% and 63% of total revenues, respectively, reflecting increased

North American instrument sales during 1999.



     Cost of Revenues. Cost of revenues as a percent of total sales decreased to

47% in 1999 from 51% in 1998. The decrease in cost of revenues as a percentage

of total revenues is attributable to lower costs for raw materials and lower

licensing fees achieved by converting the CytoVision product line from Unix to

Windows NT(R) and, to a lesser extent, by increased average instrument selling

prices.



     Research and Development Expenses. Research and development expenses of

$4.3 million decreased approximately $2.4 million from 1998 levels. The decrease

is primarily due to reduced direct expenditures on the fetal



                                       18





cell isolation project. Reflecting this change, research and development costs

were 30% and 57% of total revenues for 1999 and 1998, respectively.



     Sales and Marketing Expenses. Sales and marketing expenses increased to

$5.2 million in 1999 from $5.0 million in 1998. In 1999 and 1998 sales and

marketing expenses as a percentage of total revenues were 37% and 42%,

respectively. The increase in spending in 1999 is primarily attributable to

investment in additional marketing and sales personnel to support the products

acquired from Vysis and to launch the Company's new instrumentation systems.



     General and Administrative Expense. General and administrative expenses in

1999 amounted to $3.1 million, increasing $400,000 over 1998. This increase was

primarily due to higher spending on quality assurance costs for ISO

certification and regulatory preparation for a 510(k) submission for the

Company's micrometastasis detection system and to fees associated with a

distributor shutdown.



     Amortization of Intangibles. The Company began amortizing in 1999 the

intangible assets which included goodwill and intellectual and software property

in connection with its acquisition in 1999 of the cytogenetic imaging business

of Vysis Inc. Total amortization in 1999 amounted to $124,000 representing a

partial year of amortization expense.



     Restructuring. To focus the Company on the execution of its sales and

marketing strategy and to transition from working in fetal cell research to work

in cancer metastasis, and to reduce operating costs, the Company eliminated 15

mostly R&D positions in 1999 at both its United States and United Kingdom

facilities. The reductions were made at both the United States and United

Kingdom facilities. The consolidated statement of operations for 1999 includes

an $818,000 charge relating to the severance costs of these terminated employees

and certain costs associated with discontinued products. As of December 31,

1999, $225,000 of these costs have been paid and the balance is expected to be

paid sometime in 2000. The estimated future annual cost savings as a result of

the restructuring is $1.1 million.



     Other Income. In 1999 Other Income amounted to $158,000 compared to

$541,000 of Other Income in 1998. The Other Expense total for 1999 represented a

decrease in interest income of $97,000, increase in interest expense of $47,000,

an increase in foreign exchange loss of $211,000, and provision for taxes of

$31,000.



Fiscal 1998 Compared With Fiscal 1997



     Revenues. Revenues decreased to $11.7 million in 1998 from $13.1 million in

1997. The decrease in revenues was principally due to the economic crisis in

Asia, particularly Japan, as well as lower sales in North America. In 1998, the

Company recorded $287,000 of grant proceeds as revenues. For 1998 and 1997

revenues derived outside of North America were approximately 63% and 59% of

total revenues, respectively.



     Cost of Revenues. Cost of revenues as a percent to total sales increased to

51% in 1998 from 48% in 1997. The increase in cost of revenues as a percentage

of total revenues was attributable to lower instrument selling prices, as a

result of increased price competition for cytogenetic instrumentation products,

along with lower service revenues and increases to inventory reserves for

certain discontinued products.



     Research and Development Expenses. Research and development expenses of

$6.7 million decreased $719,000 from 1997 levels. The decrease was primarily due

to cost saving programs implemented throughout the year. Research and

development costs were 57% and 56% of total revenues for 1998 and 1997,

respectively.



     Sales and Marketing Expenses. Sales and marketing expenses increased to

$5.0 million in 1998 from $3.7 million in 1997. In 1998 and 1997 sales and

marketing expenses as a percentage of total revenues were 42% and 28%,

respectively. The increase in 1998 is primarily attributable to investment

spending for additional marketing and sales personnel to support the launch of

new products.



     General and Administrative Expense. General and administrative expenses in

1998 amounted to $2.7 million, decreasing $918,000 over 1997. The decrease is

primarily due to lower corporate staffing levels and lower costs for recruiting

and relocation.



     Restructuring. During the quarter ended June 30, 1998, plans were developed

to reduce operating costs by eliminating selected positions in both the United

States and United Kingdom facilities. The consolidated statement of operations

for 1998 includes a $353,000 charge relating to the severance costs of these

terminated employees. Substantially all of these costs have been paid.



     Other Income. In 1998, Other Income amounted to $541,000 which represented

an increase of $143,000 over 1997 which is primarily due to the interest income

derived from the increase in liquid assets of the Company as a result



                                       19





of the private placements of its common stock. The Other Income total for 1998

consisted of $579,00 of interest income, $92,000 of interest expense, foreign

exchange gain of $58,000 and other miscellaneous costs.



Factors That May Affect Future Results



     The Company's operating results may vary significantly depending on certain

factors, including adverse results in its clinical studies, delay in the

introduction or shipment of new products, increased competition, adverse changes

in the economic conditions in any of the several countries in which the Company

does business, a slower growth rate in the Company's target markets, order

deferrals in anticipation of new product releases, lack of market acceptance of

new products, the uncertainty of FDA or other domestic and international

regulatory clearances or approvals.



     Due to the factors noted above, the Company's future earnings and stock

price may be subject to significant volatility, particularly on a quarterly

basis. Any shortfall in revenues or earnings from levels expected by security

analysts could have an immediate and significant adverse effect on the trading

price of the Company's common stock.



Liquidity and Capital Resources



     As of December 31, 1999, the Company had cash, cash equivalents and short-

term investments of $8.4 million and working capital of $7.1 million, compared

to $11.7 million and $10.8 million, respectively, at December 31, 1998 and $8.4

million and $7.2 million, respectively, at December 31, 1997. For the year ended

December 31, 1999, cash used by operations totaled $5.0 million, compared to

$8.2 million and $7.1 million in 1998 and 1997 respectively. The decrease in

cash used by operations from 1998 to 1999 was primarily attributable to

reduced losses, increases in accounts payables and accruals. These were

partially offset by higher balances of accounts receivables which increased

$2.5 million in 1999 and inventories which increased to $1.4 million in 1999

from $1.2 million in 1998. In addition, the Company consumed $515,000 in 1999

for purchases of capital equipment compared to $744,000 for the comparable

prior year.



     In November 1999, the Company raised $2.0 million of additional equity via

a private placement of one million shares of its Common Stock at a price of

$2.00 per share. The investors also entered into a distribution agreement for

the Company's products. The price exceeded the closing price of the Company's

Common Stock as reported on the Nasdaq National Market System. As part of the

private placement, the Company recognized a deferred revenue of $720,000 to be

amortized over 50 months. As of December 31, 1999, the balance of the deferred

revenue as a result of this private placement is $691,000.



     In September 1999, the Company established a $2 million three-year term

loan from Silicon Valley Bank. The loan calls for monthly principal payments of

$55,556 plus interest. The loan bears interest at prime plus one and a quarter

percent and carries certain restrictive convenants that require the Company to

maintain certain levels of liquidity and minimum and maximum total liabilities

to tangible net worth ratios.



     In July 1999, the Company acquired certain cytogenetic instrumentation

assets of Vysis. Total consideration paid was $2,350,000 consisting of a cash

payment of one million dollars, installment payments of $500,000 due July 16,

2000 and $250,000 due January 16, 2001 and 497,368 shares of the Company's

Common Stock.



     Since its inception in July 1986 through December 1998, the Company has

generated an accumulated deficit of approximately $34 million. The Company

expects negative cash flow from operations to continue into at least 2000, as it

continues the development of its micrometastasis detection systems, conducts

clinical trials required for FDA clearance of new products, expands its

marketing, sales and customer support capabilities, and adds administrative

infrastructure.* The Company currently estimates that its capital resources will

enable it to meet its short-term capital needs and sustain it into 2001.* Long-

term capital needs of the Company may require it to raise additional debt or

equity financing. If adequate funds are not available, the Company 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 the Company would otherwise seek to commercialize itself, or

to reduce the marketing, customer support, or other resources devoted to certain

products.* There can be no assurance, however, that the Company will not be

required to seek capital at an earlier date. The timing and amount of spending

of such capital resources cannot be accurately determined at this time and will

depend on several factors, including but not limited to, the progress of its

research and development efforts and clinical investigations, the timing of

regulatory approvals or clearances, competing technological and market

developments, commercialization of products currently under development and

market acceptance and demand for the Company's products. In addition, as

opportunities arise, proceeds may also be



                                       20





used to acquire businesses, technologies or products that complement any such

acquisitions.* The Company may seek to obtain additional funds through equity or

debt financing, collaborative or other arrangements with other companies, and

from other sources.* No assurance can be given that additional financing will be

available when needed or on terms acceptable to the Company.



     Year 2000 Compliance



     The Company is knowledgeable of the issues associated with programming code

in existing computer systems that may have created potential incompatibilities

in computer systems beginning in the Year 2000. The Company began a Year 2000

problem assessment in 1997, establishing its Year 2000 Company Policy and

initiating product upgrade plans. The Company completed an assessment of its

internal Year 2000 risks and developed a series of upgrade and contingency

plans. No significant problems were encountered with the Company's products or

its internal business systems with the advent of Year 2000.



     Recent Accounting Pronouncements



     In December 1998, AcSEC released Statement of Position 98-9 or SOP 98-9,

Modification of SOP 97-2, Software Revenue Recognition. SOP 98-9 amends SOP 97-2

to require that an entity recognize revenue for multiple element arrangements by

means of the residual method when (1) there is no vendor-specific objective

evidence (VSOE) of the fair values of all the undelivered elements that are not

accounted for by means of long-term contract accounting, and (2) all revenue

recognition criteria of SOP 97-2 (other than the requirement for VSOE of the

fair value of each delivered element) are satisfied. The provisions of SOP 98-9

that extend the deferral of certain paragraphs of SOP 97-2 became effective

December 15, 1998. These paragraphs of SOP 97-2 and SOP 98-9 will be effective

for transactions that are entered into in fiscal years beginning after March 15,

1999. Retroactive application is prohibited. The Company is currently evaluating

the impact of the requirements of SOP 98-9 and the effects, if any, on its

current revenue recognition policies and does not expect any material impact

from its application.



     In December 1999, the Securities and Exchange Commission issued Staff

Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial

Statements." SAB 101 provides guidance for revenue recognition under certain

circumstances. The Company is currently evaluating the impact of SAB 101 on its

financial statements and related disclosures. The accounting and disclosures

prescribed by SAB 101 will be effective for the fiscal year ended December 31,

2000.



     In June 1998, the Financial Accounting Standards Board issued Statement of

Financial Accounting Standards No. 133, or SFAS 133, Accounting for Derivative

Instruments and Hedging Activities. SFAS 133 establishes new standards of

accounting and reporting for derivative instruments and hedging activities. SFAS

133 requires that all derivatives be recognized at fair value in the statement

of financial position, and that the corresponding gains and losses be reported

either in the statement of operations or as a component of comprehensive income,

depending on the type of hedging relationship that exits. SFAS 133 will be

effective for fiscal quarters beginning after June 15, 2000. The Company is

currently evaluating the impact of the requirements of SFAS 133 and the effects

if any on its financial statements and does not expect any material impact from

its application. The Company does not currently hold derivative instruments or

engage in hedging activities.



Item 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES  ABOUT MARKET RISK

          DERIVATIVES AND FINANCIAL INSTRUMENTS



     Foreign currency hedging instruments



     The Company transacts business in various foreign currencies. Accordingly,

the Company is subject to exposure from adverse movements in foreign currency

exchange rates. This exposure is primarily related to revenues and operating

expenses in the U.K. denominated in the respective local currency.



     The Company currently does not use financial instruments to hedge operating

expenses in the U. K. denominated in the respective local currency. Instead, the

Company believes that a natural partial hedge exits, because local currency

revenues will substantially offset the operating expenses denominated in the

respective local currency. The company assesses the need to utilize financial

instruments to hedge currency exposure on a ongoing basis. As of December 31,

1999 the Company had no hedging contracts outstanding.



                                       21





     The Company does not use derivative financial instruments for speculative

trading purposes, nor does the Company hedge its foreign currency exposure in a

manner that entirely offsets the effects of changes in foreign exchange rates.

The Company regularly reviews its hedging program and may as a part of this

review determine at any time to change its hedging program. See "Risk Factors--

Reliance on International Sales and Operations



     Fixed income investments



     The Company's exposure to market risks for changes in interest rates

relates primarily to investments in debt securities issued by U.S. government

agencies and corporate debt securities. The Company places its investments with

high credit quality issuers and, by policy, limits the amount of the credit

exposure to any one issuer.



     The Company's general policy is to limit the risk of principal loss and

ensure the safety of invested funds by limiting market and credit risk. All

highly liquid investments with a maturity of three months or less at the date of

purchase are considered to be cash equivalents; investments with maturities over

three months are considered to be short-term investments. The weighted average

pre-tax interest rate on the investment portfolio is approximately 5.6%.



                                       22





Item 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



                       Report of Independent Accountants



The Board of Directors

Applied Imaging Corp.:



     In our opinion, the accompanying consolidated balance sheet as of December

31, 1999 and the related consolidated statements of operations and comprehensive

loss, of stockholders' equity and of cash flows present fairly, in all material

respects, the financial position of Applied Imaging Corp. and its subsidiaries

at December 31, 1999, and the results of their operations and their cash flows

for the year then ended in conformity with accounting principles generally

accepted in the United States. In addition, in our opinion, the financial

statement schedule of valuation and qualifying accounts listed in the index

appearing under Item 14(a)(2) on page 45 presents fairly, in all material

respects, the information set forth therein when read in conjunction with the

related consolidated financial statements. These financial statements and

financial statement schedule are the responsibility of the Company's management;

our responsibility is to express an opinion on these financial statements and

financial statement schedule based on our audit. We conducted our audit of these

statements in accordance with auditing standards generally accepted in the

United States, which require that we plan and perform the audit to obtain

reasonable assurance about whether the financial statements are free of material

misstatement. An audit includes examining, on a test basis, evidence supporting

the amounts and disclosures in the financial statements assessing the accounting

principles used and significant estimates made by management, and evaluating the

overall financial statement presentation. We believe that our audit provides a

reasonable basis for the opinion expressed above. The financial statements of

the Company as of December 31, 1998 and for each of the two years in the period

ended December 31, 1998 were audited by other independent accountants whose

report dated February 5, 1999 expressed an unqualified opinion of those

statements.





PricewaterhouseCoopers LLP

San Jose, CA

January 28, 2000



                                       23





              Report of Independent Certified Public Accountants



The Board of Directors

Applied Imaging Corp.:



     We have audited the accompanying consolidated balance sheet of Applied

Imaging Corp. and its subsidiaries as of December 31, 1998, and the related

consolidated statements of operations, stockholders' equity, and cash flows for

the years ended December 31, 1998 and 1997. In connection with our audits of the

consolidated financial statements for the periods indicated above, we have also

audited the consolidated financial statement schedule of valuation and

qualifying accounts. These consolidated financial statements and financial

statement schedule are the responsibility of the Company's management. Our

responsibility is to express an opinion on these consolidated financial

statements and the related consolidated financial statement schedule based on

our audits.



     We conducted our audits in accordance with generally accepted auditing

standards. Those standards require that we plan and perform the audit to obtain

reasonable assurance about whether the financial statements are free of material

misstatement. An audit includes examining, on a test basis, evidence supporting

the amounts and disclosures in the financial statements. An audit also includes

assessing the accounting principles used and significant estimates made by

management, as well as evaluating the overall financial statement presentation.

We believe that our audits provide a reasonable basis for our opinion.



     In our opinion, the consolidated financial statements referred to above

present fairly, in all material respects, the financial position of Applied

Imaging Corp. and subsidiaries as of December 31, 1998, and the results of their

operations and their cash flows for the years ended December 31, 1998 and 1997,

in conformity with generally accepted accounting principles. Also in our

opinion, the related consolidated financial statement schedule of valuation and

qualifying accounts, when considered in relation to the basic consolidated

financial statements taken as a whole, presents fairly, in all material

respects, the information set forth therein.





KPMG LLP

Mountain View, California

February 5, 1999





                                       24





                             APPLIED IMAGING CORP.

                               AND SUBSIDIARIES



                          Consolidated Balance Sheets

                (in thousands, except share and per share data)







                                                                                    December 31,

                                                                                --------------------

                                                                                  1999        1998

                                                                                --------    --------

                                                                                      

                                    Assets

Current assets:

     Cash and cash equivalents                                                  $  2,832    $  5,480

     Short-term investments                                                        5,574       6,248

     Trade accounts receivable (less allowance for doubtful accounts

       of $251,000 and $162,000 at December 31, 1999 and 1998 respectively)        6,187       3,821

     Related party receivables                                                       143         -

     Inventories                                                                   1,369       1,169

     Prepaid expenses and other current assets                                       187         436

                                                                                --------    --------

                  Total current assets                                            16,292      17,154

Property and equipment, net                                                        1,014       1,569

Intangibles, net                                                                   2,358         -

Other assets                                                                          80          85

                                                                                --------    --------

     Total assets                                                               $ 19,744    $ 18,808

                                                                                ========    ========



                     Liabilities and Stockholders' Equity



Current liabilities:

     Current portion of bank debt                                               $  1,709    $  1,045

     Current portion of capital lease obligation                                      34          34

     Current portion of related party notes payable                                  500         -

     Accounts payable                                                              2,226       1,572

     Accrued expenses                                                              3,166       2,519

     Deferred revenue, current                                                     1,525       1,231

                                                                                --------    --------

                  Total current liabilities                                        9,160       6,401



Long term liabilities:

     Bank debt, less current portion                                               1,167         -

     Related party notes payable, less current portion                               250         -

     Deferred revenues, non-current                                                  518         -

     Capital lease obligation, less current portion                                   37          64

                                                                                --------    --------

                  Total liabilities                                               11,132       6,465

                                                                                --------    --------



Commitments (Note 10)

Stockholders' equity:

     Preferred stock, $0.01 par value; 6,000,000 shares authorized; none

       issued and outstanding at December 31, 1999 and 1998                          -           -

     Common stock; $0.001 par value; 20,000,000 shares authorized;

       13,054,512 and 11,529,537 issued and outstanding December 31, 1999

       and 1998 respectively                                                          13          12

     Additional paid-in capital                                                   43,034      41,121

     Accumulated deficit                                                         (34,013)    (28,004)

     Deferred stock compensation                                                     (43)       (419)

     Accumulated other comprehensive loss                                           (379)       (367)

                                                                                --------    --------

                  Total stockholders' equity                                       8,612      12,343

                                                                                --------    --------

     Total liabilities and stockholders' equity                                 $ 19,744    $ 18,808

                                                                                ========    ========





  The accompanying notes are an integral part of these consolidated financial

                                  statements



                                       25







                                             APPLIED IMAGING CORP.

                                               AND SUBSIDIARIES



                         Consolidated Statements of Operations and Comprehensive Loss

                                     (in thousands, except per share data)



                                                                       Year Ended December 31,

                                                      ---------------------------------------------------------

                                                            1999                 1998                1997

                                                      ----------------     ----------------    ----------------

                                                                                      

Revenues:

     Product sales...............................     $         11,475     $         9,034     $         10,457

     Software maintenance and service............                2,655               2,650                2,677

                                                      ----------------     ----------------    ----------------

          Total revenues.........................               14,130              11,684               13,134

                                                      ----------------     ----------------    ----------------



Cost of revenues

     Product sales...............................                5,582               4,953                5,188

     Software maintenance and service............                1,104               1,057                1,096

                                                      ----------------     ----------------    ----------------

          Total cost of revenues.................                6,686               6,010                6,284

                                                      ----------------     ----------------    ----------------

          Gross Profit...........................                7,444               5,674                6,850

                                                      ----------------     ----------------    ----------------



Operating expenses:

     Research and development....................                4,299               6,662                7,381

     Sales and marketing.........................                5,232               4,950                3,740

     General and administrative..................                3,138               2,722                3,639

     Amortization of intangibles.................                  124                 -                    -

     Restructuring costs.........................                  818                 353                  -

                                                      ----------------     ----------------    ----------------

          Total operating expenses...............               13,611              14,687               14,760

                                                      ----------------     ----------------    ----------------

          Operating loss.........................               (6,167)             (9,013)              (7,910)

Other income (loss)..............................                  158                 541                  398

                                                      ----------------     ----------------    ----------------

          Net loss...............................               (6,009)             (8,472)              (7,512)

Other comprehensive loss, net of tax:

      Change in unrealized loss on short-term

        investments..............................                  (12)                  -                  -

                                                      ----------------     ----------------    ----------------

      Comprehensive loss.........................     $         (6,021)    $        (8,472)    $         (7,512)

                                                      ================     ================    ================

Net loss per share - basic and diluted...........     $          (0.50)    $         (0.86)    $          (1.03)

                                                      ================     ================    ================



Shares used to calculate basic and diluted net

loss per share                                                  11,930               9,850                7,324

                                                      ================     ================    ================





  The accompanying notes are an integral part of these consolidated financial

                                  statements.



                                       26









                                                       APPLIED IMAGING CORP.

                                                         AND SUBSIDIARIES



                                          Consolidated Statements of Stockholders' Equity

                                       For the years ended December 31, 1999, 1998 and 1997

                                                          (in thousands)



                                                                                                    Accumulated

                                                           Additional                  Deferred        other          Total

                                          Common Stock      paid-in    Accumulated       stock     comprehensive   stockholders'

                                       -----------------

                                       Shares     Amount    capital      deficit     compensation       loss          equity

                                       ------     ------   ----------  -----------   ------------  -------------   -------------

                                                                                              

Balances as of December 31,

   1996                                  6,824    $    7    $ 25,569   $   (12,021)   $  (1,183)    $   (367)       $  12,005



   Exercise of common stock options         34        -           72           -            -            -                 72

   Private placement                       796         1       3,940           -            -            -              3,941

   Employee stock purchase                  14        -           55           -            -            -                 55

   Amortization of deferred stock

     compensation                          -          -           -            -            382          -                382

   Net loss                                -          -           -         (7,512)         -            -             (7,512)

                                       -------    ------    --------   -----------    ---------     --------        ---------

Balances as of December 31,

   1997                                  7,668         8      29,636       (19,533)        (801)        (367)           8,943



   Exercise of common stock options          8        -           17           -            -            -                 17

   Private placement                     3,833         4      11,396           -            -            -             11,400

   Employee stock purchase                  20        -           48           -            -            -                 48

   Warrants extended                       -          -           24           -            -            -                 24

   Amortization of deferred stock

     compensation                          -          -           -            -            382          -                382

   Net loss                                -          -           -         (8,471)         -            -             (8,471)

                                       -------    ------    --------   -----------    ---------     --------        ---------

Balances as of December 31,

   1998                                 11,530        12      41,121       (28,004)        (419)        (367)          12,343



   Exercise of common stock options          6        -           10           -            -            -                 10

   Private placement                     1,000         1       1,280           -            -            -              1,281

   Employee stock purchase                  22        -           23           -            -            -                 23

   Vysis acquisition                       497        -          600           -            -            -                600

   Amortization of deferred stock

     compensation                          -          -          -             -            376          -                376



   Change in unrealized loss from

    short-term investments                 -          -          -             -            -            (12)             (12)



   Net loss                                -          -          -          (6,009)         -            -             (6,009)

                                       -------    ------    --------   -----------    ---------     --------        ---------



Balances as of December 31,

   1999                                 13,055    $   13    $ 43,034   $   (34,013)   $     (43)    $   (379)       $   8,612

                                       =======    ======    ========   ===========    =========     ========        =========





  The accompanying notes are an integral part of these consolidated financial

                                  statements.



                                       27









                                             APPLIED IMAGING CORP.

                                               AND SUBSIDIARIES



                                     Consolidated Statements of Cash Flows

                                                (in thousands)



                                                                                 For the year ended December 31,

                                                                                ---------------------------------

                                                                                   1999        1998        1997

                                                                                ---------   ---------   ---------

                                                                                               

Cash flows from operating activities:

   Net loss                                                                     $ (6,009)   $ (8,471)   $ (7,512)

   Adjustments to reconcile net loss to net cash

       used in operating activities:

       Depreciation & Amortization                                                 1,092         826         695

       Provision for doubtful accounts                                                89         -           -

       Amortization related to employee deferred

          stock compensation                                                         376         382         382

       Loss on sale of other assets                                                   41           5          29

       Changes in operating assets and liabilities:

          Trade accounts and related party receivable                             (2,598)       (463)     (1,904)

          Inventories                                                               (200)       (320)        (18)

          Prepaid expenses and other assets                                          249        (167)         68

          Accounts payable                                                           654        (183)         75

          Accrued expenses                                                           515          85       1,130

          Deferred revenue                                                           813          70         (62)

                                                                                ---------   ---------   ---------

          Net cash used in operating activities:                                  (4,978)     (8,236)     (7,117)

                                                                                ---------   ---------   ---------

Cash flows from investing activities:

   Purchase of short-term investments                                             (3,685)     (4,997)     (7,456)

   Proceeds from sale and maturities of investments                                4,347       4,209       1,996

   Proceeds from sale of fixed assets                                                 60          24         -

   Acquisition of assets                                                          (1,000)        -           -

   Purchases of equipment                                                           (515)       (631)     (1,119)

   Other assets                                                                        5         (17)        203

                                                                                ---------   ---------   ---------

       Net cash used in investing activities:                                       (788)     (1,412)     (6,376)

                                                                                ---------   ---------   ---------

Cash flows from financing activities:

   Net proceeds from issuance of common stock                                      1,314      11,489       4,068

   Bank loan proceeds/(payments) - net                                             1,831         721          38

   Capital lease payments, principal portion                                         (27)        -           (13)

                                                                                ---------   ---------   ---------

       Net cash provided by financing activities:                                  3,118      12,210       4,093

                                                                                =========   =========   =========

Net increase (decrease) in cash and cash equivalents                              (2,648)      2,562      (9,400)



Cash and cash equivalents at beginning of year                                     5,480       2,918      12,318

                                                                                ---------   ---------   ---------

Cash and cash equivalents at end of year                                        $  2,832    $  5,480    $  2,918

                                                                                =========   =========   =========

Supplemental disclosure of cash paid for interest:                              $    114    $     92    $     39

                                                                                =========   =========   =========



Supplemental disclosure of non-cash investing and financing activities:

   Equipment acquired through capital leases                                         -           -      $    135

                                                                                =========   =========   =========

   Accrual recorded for business acquired                                       $    132         -           -

                                                                                =========   =========   =========

   Stock issued in connection with acquisition                                  $    600         -           -

                                                                                =========   =========   =========

   Debt assumed for acquisition of intangible assets related to business

   acquired                                                                     $    750         -           -

                                                                                =========   =========   =========

   Unrealized loss from short-term investments                                  $    (12)        -           -

                                                                                =========   =========   =========







  The accompanying notes are an integral part of these consolidated financial

                                  statements.



                                       28





                             APPLIED IMAGING CORP.

                               AND SUBSIDIARIES



                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



(1)  Summary of the Company and Significant Accounting Policies



  The Company



     Applied Imaging Corp. (the Company) was incorporated in 1986 to develop,

manufacture, and market automated clinical analysis systems used by cytogenetic

laboratories in prenatal genetic screening. The Company sells its products to

government and private clinical cytogenetic laboratories, research institutions,

universities, and pharmaceutical companies located primarily in the United

States, Canada, Europe, and the Pacific Rim. The Company also markets imaging

systems designed for use in plant and animal genetic research programs. In

addition, the Company has recently introduced a research system to detect

micrometastatic cancer cells in bone marrow, lymph node and blood samples from

cancer patients. This technology allows physicians to better determine the

initial staging of cancer cases and to then detect disease recurrence earlier

than is currently possible.



  Principles of Consolidation



     The accompanying consolidated financial statements include the accounts of

the Company and its wholly owned subsidiaries, Applied Imaging International,

Limited (United Kingdom) and Applied Imaging, Limited (Israel). All significant

intercompany accounts and transactions have been eliminated in consolidation.



  Foreign Exchange



     The Company accounts for its foreign operations in accordance with

Statement of Financial Accounting Standards (SFAS) No. 52, Foreign Currency

Translation. Prior to April 1994, the functional currency for Applied Imaging

International, Limited was the British pound and, accordingly, translation

adjustments resulting from the conversion of the subsidiary's financial

statements into U.S. dollars were accumulated and reported as a separate

component of stockholders' equity. Beginning in April 1994, certain operational

and organizational changes within the Company caused the functional currency for

the Company's subsidiary to become the U.S. dollar. Therefore, monetary assets

and liabilities of the subsidiary are remeasured to the U.S. dollar at year-end

exchange rates while nonmonetary items are remeasured at historical rates.

Revenue and expense accounts related to monetary assets and liabilities are

remeasured at the average rates in effect during the year. Revenue and expenses

related to non-monetary assets and liabilities are translated at historical

rates. Foreign currency gains and losses resulting from the conversion of the

subsidiary's financial statements into U.S. dollars are currently recognized in

the consolidated statement of operations. The functional currency of Applied

Imaging, Limited is also the U.S. dollar.



  Use of Estimates



     The preparation of financial statements in conformity with generally

accepted accounting principles requires management to make estimates and

assumptions that affect the reported amounts of assets and liabilities, the

disclosure of contingent assets and liabilities at the date of the financial

statements, and the reported amounts of revenues and expenses during the

reporting period. Actual results could differ from those estimates.



  Comprehensive Income



     In accordance with Statement of Financial Accounting Standards (SFAS)

No.130 Reporting Comprehensive Income, the Company is required to classify items

of other comprehensive income, by their nature (e.g. unrealized gains or losses

on securities) in a financial statement. For the year ended December 31, 1999

the component of comprehensive loss includes an unrealized loss on short-term

investments. The components of other comprehensive income in prior years include

foreign currency adjustment. The accumulated balance of other comprehensive

income from prior periods are reported as 'Accumulated other comprehensive

income' and displayed separately from accumulated deficit and additional paid-in

capital in the equity section of the balance sheet.



                                       29





                    APPLIED IMAGING CORP. AND SUBSIDIARIES



            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)



  Revenue Recognition



     The company recognizes revenue on product sales upon shipment and

concurrently accrues for expected hardware warranty expenses and establishes

reserves for product returns. Revenue attributable to software maintenance and

support, is deferred and recognized ratably over the term of the maintenance

agreement, generally one year.



     In October 1997, the American Institute of Certified Public Accountants

("AICPA") issued Statement of Position ("SOP") 97-2, Software Revenue

Recognition. SOP 97-2 applies to the sales of products that contain software

elements that are more than incidental to the product as a whole. The Company

adopted SOP 97-2 effective January 1, 1998. SOP 97-2 generally requires revenue

attributable to software elements to be allocated to the elements based on their

fair values. The fair value of an element must be based on the evidence which is

specific to the vendor. The revenue allocated to software products is recognized

upon shipment of the product. The revenue attributable to maintenance and

support is recognized ratably over the term of the maintenance agreement. There

was no change to the Company's accounting for revenues as a result of the

adoption of SOP 97-2.



     In February 1998, the AICPA issued SOP 98-4, Deferral of the Effective Date

of SOP 97-2. The SOP defers the effective date for applying the provisions

regarding vendor-specific objective evidence of fair value ("VSOE") until the

AICPA can reconsider what constitutes such VSOE. There was no change to the

Company's accounting for revenues as a result of the adoption of SOP 98-4.



     In December 1998, the AICPA issued SOP 98-9, Software Revenue Recognition,

with Respect to Certain Arrangements, which requires recognition of revenue

using the "residual method" in a multiple-element arrangement when fair value

does not exist for one of more of the delivered elements in the arrangement.

Under the residual method, the total fair value of the undelivered elements is

deferred and subsequently recognized in accordance with SOP 97-2. The Company

does not expect a change to its accounting for revenues as a result of the

provisions of SOP 98-9.



  Research and Development Expenditures



     Research and development expenditures are charged to expense as incurred.



  Loss per Share



     Basic and diluted net loss per share are computed using the weighted

average number of outstanding shares of common stock. There were no reconciling

items of the numerators and denominators of the basic and diluted EPS

computation. Shares excluded from the computation of EPS because their effect on

EPS was antidilutive, but could dilute basic EPS in future periods are as

follows:







                                     1999                                 1998                                    1997

                       -------------------------------      -------------------------------         -------------------------------

                                          Weighted                             Weighted                                Weighted

                                          average                              average                                 average

                         Shares        exercise price         Shares        exercise price            Shares        exercise price

                       -------------------------------      -------------------------------         -------------------------------

                                                                                                 

Options..............     1,988,568       $  2.10               1,787,405       $  2.32                1,199,272         $  4.04

Warrants.............       313,010          5.10                 577,909          5.17                  681,744            5.18

                       ------------                         ------------                            ------------



   Total.............     2,301,578                            2,365,314                               1,881,016

                       ============                         ============                            ============





                                       30





                    APPLIED IMAGING CORP. AND SUBSIDIARIES



            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)



  Cash Equivalents and Short-Term Investments



     All investments with original maturities at date of purchase of three

months or less are considered by the Company to be cash equivalents.



  Short-Term Investments



     Short-term investments consist of investments acquired with maturities

exceeding three months. While the Company's intent is to hold debt securities to

maturity, consistent with SFAS No. 115, Accounting for Certain Investments in

Debt and Equity Securities, the Company has classified all securities as

available-for-sale, as the sale of such securities may be required prior to

maturity to implement management strategies. Such securities are reported at

fair value with unrealized gains or losses excluded from earnings and reported

as a separate component of stockholders' equity, net of applicable taxes. As of

December 31, 1999, the difference between the fair value and the amortized cost

of available-for-sale securities was recorded as unrealized gains or losses in

stockholders' equity.



     As of December 31, 1999 and 1998, the Company's short-term investments

consisted of the following (in thousands):







                                                     1999                      1998

                                ------------------------------------------   --------

                                   Amortized      Unrealized      Fair        Fair

                                     Cost            Loss         Value       Value

                                ------------------------------------------   --------

                                                                 

Corporate bonds...............     $   5,586       $    (12)     $   5,574   $  6,248

                                   =========       ========      =========   ========





     As of December 31, 1999, the maturities of the short-term investments are

as follows: $3,596,000 within one year and $1,978,000 more than one year. There

were no realized gains or losses in 1999 or 1998.



  Inventories



     Inventories are stated at the lower of cost (first in, first out) or

market.



  Property and Equipment



     Property and equipment are stated at cost less accumulated depreciation.

Depreciation is provided using the straight-line method over the estimated

useful lives of the respective assets, generally three to five years.

Recoverability of property and equipment is measured by comparison of its

carrying amount to future net cash flows the property and equipment are expected

to generate. If such assets are considered to be impaired, the impairment to be

recognized is measured by the amount by which the carrying amount of the

property and equipment exceeds its fair market value. To date, the Company has

made no adjustments to the carrying values of its long-lived assets. When assets

are disposed of, the cost and related accumulated depreciation are removed from

the accounts and the resulting gains or losses are included in other income or

loss.



  Intangibles



     Intangible assets, which include goodwill and intellectual and software

property in connection with the acquisition of the cytogenetic imaging

instrumentation business of Vysis Inc., was $2.5 million at December 31, 1999.

Intangible



                                       31





                    APPLIED IMAGING CORP. AND SUBSIDIARIES



            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)



assets are being amortized on a straight line basis over 10 years. Accumulated

amortization was $124,000 as of December 31, 1999. The Company periodically

assesses the recoverability of intangible assets by determining whether the

amortization of the asset balance over its remaining life can be recovered

through undiscounted future operating cash flows of the acquired operation. The

amount of impairment, if any, is measured based on projected discounted future

operating cash flows and is recognized as a write down of the asset.



  Capitalized Software Costs



     Computer software development costs incurred subsequent to the

determination of product technological feasibility are capitalized in accordance

with the provisions of SFAS No. 86, Accounting for the Cost of Computer Software

to be Sold, Leased or Otherwise Marketed. Amortization of these capitalized

costs is provided using the greater of the ratio of revenues generated in the

period over total future revenues of the product, or the straight-line method

over the estimated market life of the related products, generally three years,

commencing when the product becomes generally available to customers. For the

years ended December 31, 1999, 1998 and 1997, software development costs

incurred subsequent to the establishment of technological feasibility have not

been material. The net book value of capitalized costs is not significant and is

included in other assets in the consolidated balance sheets.



  Stock Based Compensation



     The Company uses the intrinsic-value method to account for its stock-based

compensation arrangements. The Company accounts for equity instruments issued to

non-employees in accordance with the provisions of SFAS 123 and Emerging Issues

Task Force Issue No. 96-18, "Accounting for equity instruments that are issued

to other than employees, or in conjunction with selling goods and services."



  Income Taxes



     The Company uses the asset and liability method of accounting for income

taxes. Deferred tax assets and liabilities are recognized for the future tax

consequences attributable to differences between the financial statement

carrying amount of existing assets and liabilities and their respective tax

bases. Deferred tax assets and liabilities are measured using enacted tax rates

expected to apply to taxable income in the years in which those temporary

differences are expected to be recovered or settled. A valuation allowance is

provided to reduce the deferred tax assets when it is more likely than not that

all or a portion of the deferred tax assets will not be realized.



  Fair Value of Financial Instruments



     Financial instruments consist principally of cash equivalents, short-term

investments, trade receivables, notes receivable, accounts payable, and bank

debt. The carrying amounts of these financial instruments approximate fair

value.



     Financial instruments that potentially subject the Company to

concentrations of credit risk are accounts receivable, cash equivalents and

short-term investments which the Company places with high-credit qualified

financial institutions and, by policy, limits the amount of credit exposure to

any one financial institution. The Company sells its products to government and

private clinical cytogenetic laboratories, research institutions, universities,

and pharmaceutical companies located primarily in the United States, Canada,

Europe, and the Pacific Rim. The Company's credit risk is concentrated primarily

in the United States and Europe. The Company does not have a significant

concentration of credit risk with any single customer. The Company performs on-

going credit evaluations of its customer's financial condition and, generally

requires no collateral from its customers. The Company maintains an allowance

for doubtful accounts to cover potential credit losses.



                                       32





                    APPLIED IMAGING CORP. AND SUBSIDIARIES



            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)



Recent Accounting Pronouncements



     In December 1998, AcSEC released Statement of Position 98-9 or SOP 98-9,

Modification of SOP 97-2, Software Revenue Recognition. SOP 98-9 amends SOP 97-2

to require that an entity recognize revenue for multiple element arrangements by

means of the residual method when (1) there is no vendor-specific objective

evidence (VSOE) of the fair values of all the undelivered elements that are not

accounted for by means of long-term contract accounting, and (2) all revenue

recognition criteria of SOP 97-2 (other than the requirement for VSOE of the

fair value of each delivered element) are satisfied. The provisions of SOP 98-9

that extend the deferral of certain paragraphs of SOP 97-2 became effective

December 15, 1998. These paragraphs of SOP 97-2 and SOP 98-9 will be effective

for transactions that are entered into in fiscal years beginning after March 15,

1999. Retroactive application is prohibited. The Company is currently evaluating

the impact of the requirements of SOP 98-9 and the effects, if any, on its

current revenue recognition policies and does not expect any material impact

from its application.



     In December 1999, the Securities and Exchange Commission issued Staff

Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial

Statements." SAB 101 provides guidance for revenue recognition under certain

circumstances. The Company is currently evaluating the impact of SAB 101 on its

financial statements and related disclosures. The accounting and disclosures

prescribed by SAB 101 will be effective for the fiscal year ended December 31,

2000.



     In June 1998, the Financial Accounting Standards Board issued Statement of

Financial Accounting Standards No. 133, or SFAS 133, Accounting for Derivative

Instruments and Hedging Activities. SFAS 133 establishes new standards of

accounting and reporting for derivative instruments and hedging activities. SFAS

133 requires that all derivatives be recognized at fair value in the statement

of financial position, and that the corresponding gains and losses be reported

either in the statement of operations or as a component of comprehensive income,

depending on the type of hedging relationship that exits. SFAS 133 will be

effective for fiscal quarters beginning after June 15, 2000. The Company is

currently evaluating the impact of the requirements of SFAS 133 and the effects

if any on its financial statements and does not expect any material impact from

its application. The Company does not currently hold derivative instruments or

engage in hedging activities.



(2)  Related Party Receivable



     As a results of the acquisition by the Company of the intellectual and

software property related to the cytogenic imaging instrumentation business of

Vysis Inc., the Company had Vysis maintain the billings for certain customers

for a period of time subsequent to the transaction. These receivables represent

sales made by the Company.



(3)  Inventories



     A summary of inventories follows (in thousands):







                                                     December 31,

                                             ---------------------------

                                                 1999           1998

                                             ------------   ------------

                                                      

          Raw materials...................   $      1,300   $        999

          Work in process.................             13             96

          Finished goods..................             56             74

                                             ------------   ------------

                                             $      1,369   $      1,169

                                             ============   ============





                                       33





                    APPLIED IMAGING CORP. AND SUBSIDIARIES



            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)



(4)  Property and Equipment



     A summary of property and equipment follows (in thousands):







                                                      December 31,

                                                ------------------------

                                                   1999          1998

                                                ----------    ----------

                                                        

          Equipment........................     $   2,708     $   2,726

          Demonstration equipment..........         1,323         1,173

          Furnitures and fixtures..........           621           626

                                                ----------    ----------

                                                    4,652         4,525

          Less accumulated depreciation             3,638         2,956

                                                ----------    ----------

                                                $   1,014     $   1,569

                                                ==========    ==========





     In 1998, the Company reduced the carrying amount of property and equipment

and the related accumulated depreciation by $569,000 related to fully

depreciated property and equipment that is no longer in use. As of December 31,

1999 and 1998, $85,000 and $117,000, respectively, of equipment is under capital

lease with an accumulated amortization $70,000 and $43,000, respectively.

Depreciation expense was $968,000, $192,000 and $590,000 for 1999, 1998 and 1997

respectively.



(5)  Accrued Expenses



          A summary of accrued expenses follows (in thousands):







                                                                            December 31,

                                                                      ----------------------

                                                                        1999         1998

                                                                      ---------    ---------

                                                                             

               Compensation and related costs.....................    $     766    $     523

               Warranty related costs.............................          347          197

               Royalties..........................................          306          367

               Restructuring costs................................          261          226

               Product discontinuance costs.......................          240          -

               Audit, tax, legal and external reporting costs.....          234          279

               Consulting related expenses........................          192           35

               Other..............................................          820          892

                                                                      ---------    ---------

                                                                      $   3,166    $   2,519

                                                                      =========    =========





(6)  Debt Obligations



     Applied Imaging International, Limited has a (Pounds)750,000 gross and

(Pounds)500,000 net unsecured revolving line of credit with an international

bank which is guaranteed by the Company. Under the line of credit the Company

also has the ability to borrow additional amounts based on cash deposits held by

the bank up to a maximum additional amount of (Pounds)250,000. The line of

credit is available until March 31, 2000 and, while the Company expects an

extension, any outstanding balance is due on demand after that date if no

extension is granted. The line of credit bears interest at 3% above the bank's

base rate, for borrowings up to (Pounds)500,000 and 6% for borrowings over

(Pounds)500,000. The base rate was 5.5% as of December 31, 1999. As of December

31, 1999 amounts outstanding under this facility amounted to $1,042,000. The

weighted average interest rate on short-term borrowings by the Company as of

December 31, 1999 was 8.49%.



                                       34





                    APPLIED IMAGING CORP. AND SUBSIDIARIES



            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)



     On September 9, 1999, the Company entered into a $2.0 million loan and

Security Agreement with Silicon Valley Bank. The term of the loan is three years

and calls for monthly principal payments of $55,556 plus interest. The loan

bears interest at prime plus 1.25% (9.75% at December 31, 1999) and carries

certain covenants pertaining to minimum liquidity, minimum and maximum total

liabilities and tangible net worth ratio and maximum loss. At December 31, 1999,

the Company is in compliance with all these covenants. In conjunction with the

loan, the Company paid a facility fee of $10,000.



     As part of the payment terms to Vysis Inc., for the acquisition by the

Company of the intellectual and software property related to the former's

cytogenetic imaging instrumentation business, the Company agreed to a note

obligation of $750,000 payable in two installments each at 7% interest rate: the

first for $500,000 payable one year from the anniversary date of the acquisition

agreement and is included in current liabilities as a current portion of note

payable, related party and the second for $250,000 payable eighteen months from

the anniversary date and is included in long term liabilities as long term

portion of note payable, related party.



     Below is the future maturities of the Company's debt obligations (in

thousands):







                                                      Maturities

                                           --------------------------------

                                             2000        2001        2002

                                           --------    --------    --------

                                                          

          International bank in UK.....    $  1,042    $    -      $    -

          Silicon Valley Bank..........         667         667         500

          Vysis Inc....................         500         250         -

                                           --------    --------    --------

                                           $  2,209    $    917    $    500

                                           ========    ========    ========





(7)  Acquisition of Assets



     On July On July 16, 1999, (the "anniversary date") the Company acquired the

intellectual and software property related to the cytogenetic imaging

instrumentation business of Vysis Inc. The acquisition was accounted for as a

purchase. The consideration paid was $2,350,000 consisting of a cash payment of

$1.0 million, $500,000 in cash to be paid one year from the anniversary date,

$250,000 in cash to be paid eighteen months from the anniversary date and

497,368 shares of the Company's common stock issued at $1.206 per share. The

installment payments bear interest at the annual rate of seven percent. The

interest is due and payable at the time the installment is due. In addition, the

Company has recorded a liability of approximately $100,000 for the estimated

costs associated with certain warranties and service contracts that the Company

has taken responsibility for. In addition, the Company incurred approximately

$32,000 in legal expenses directly related to this acquisition. The Company has

recorded goodwill of $2,482,000 and will amortize such goodwill over ten years.



(8)  Stockholders' Equity



     Common Stock



     The Company is authorized to issue 20,000,000 shares of common stock. As of

December 31, 1999, there were warrants outstanding to purchase 173,010 shares of

common stock at $5.78 per share and 140,000 shares at $4.25 per share. These

warrants both expire in 2000.



     As of December 31, 1999, 950,000 shares of common stock were reserved for

issuance under the Company's 1998 Stock Plan which is the maximum aggregate

number of shares which may be optioned and sold under the Plan. Under the 1998

Stock Plan, stock options may be granted to Board members, officers, key

employees, and consultants at the fair market value of the common stock at the

date of the grant, as determined by the Board. Options are exercisable over 10

years from the date of grant, and typically vest ratably over 4 years. In

October 1998, the Company's 1988



                                       35





                    APPLIED IMAGING CORP. AND SUBSIDIARIES



            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)



Amended and Restated Incentive Stock Option Plan expired. In 1994, the Company

enacted a Directors Option Plan designed to encourage participation on the

Company's Board. Under this plan, 5,000 shares per year are automatically

granted to non-employee directors. The terms of the plan allow the granting of

stock options upon initial election to the Board and for each subsequent term on

the Board. As of December 31, 1999 there were 25,000 shares reserved for

issuance under this plan and a total of 95,000 options have been granted.



     On June 19, 1996, the Board adopted, effective upon the closing of the IPO,

the Company's Employee Stock Purchase Plan (the Plan) which has a term of 10

years whereby eligible employees may purchase common stock through payroll

deductions of up to 10% of compensation, at a per share price of 85% of the fair

market value of the Company's common stock on the enrollment date or the

exercise date six months later, whichever is lower. As of December 31, 1999

there were 144,395 shares reserved for issuance under the Plan.



Accounting for Stock-Based Compensation



     As of December 31, 1999, there were 61,500 options available for grant

under the 1998 Stock Plan. In 1996, the Company recorded a deferred charge of

$1,473,000, representing the difference between the exercise price and the

deemed fair value of the Company's common stock for 246,750 shares subject to

common stock options granted in the 12-month period preceding the IPO. The

deferred stock compensation is being amortized to compensation expense over the

period during which the options become exercisable, generally four years.



     The Company has adopted the pro forma disclosure provisions of SFAS No. 123

for the 1998 Stock Plan and Employee Stock Purchase Plan. Had compensation cost

for the Company's stock-based compensation plans been determined in a manner

consistent with the fair value approach described in SFAS No. 123 'Accounting

for Stock-Based Compensation', the Company's net loss and pro forma net loss per

share as reported would have been increased to the pro forma amounts indicated

below (in thousands, except per share data):







                                                                          December 31,

                                                            ----------------------------------------

                                                                1999          1998          1997

                                                            -----------   -----------    -----------

                                                                                

          Net loss:

               As reported:...........................      $   (6,009)   $   (8,472)    $   (7,512)

               Pro forma..............................          (6,886)   $   (9,206)    $   (8,218)

          Net loss per share:

               As reported:

                       Basic and diluted .............           (0.50)   $    (0.86)    $    (1.03)

               Pro forma

                       Basic and diluted..............           (0.58)   $    (0.93)    $    (1.12)





     On February 2, 1998, the Company's board of directors approved an amendment

to reprice options outstanding under the Company's 1988 Stock Option Plan with

exercise prices over $3.00 per share. On February 2, 1998, holders of such

options were offered the choice of retaining their existing options without

amendment or accepting the amendment of their stock options. The exercise price

of the amended options is $2.44 per share, which equals the fair market value of

the Company's common stock on February 2, 1998. Vesting of the amended options

occurs over four years and begins on February 2, 1998. Holders of the options

had until March 30, 1998 to make an irrevocable decision to either retain their

existing options without amendment or accept the amendment to their options. The



                                       36





                    APPLIED IMAGING CORP. AND SUBSIDIARIES



            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)



amendment of the options is treated for accounting purposes as if the Company

cancelled the existing options and issued new options with the lower exercise

price and new vesting schedule. The compensation expense measured for the

difference between the fair value of the Company's common stock on the date

employees elected to accept new repriced options and the exercise price of the

repriced options ($2.44 per share) was not significant.



     The fair value of each option is estimated on the date of grant using the

fair value method with the following weighted-average assumptions: volatility of

60%, no dividends, an expected life of three years, and risk-free interest rates

of 6%, 4.66 %, and 6.16% for the years ended December 31, 1999, 1998 and 1997

respectively. All of the above assumptions were used for the Employee Stock

Purchase Plan except the expected life is six months. A summary of the status of

the Company's stock option activity for the years ended December 31, 1999, 1998

and 1997, is as follows:







                                                                                       Weighted-        Weighted-

                                                                                        average       average fair

                                                                        Shares       exercise price       value

                                                                      ------------   --------------   ------------

                                                                                             

     Outstanding at December 31, 1996..............................        481,250   $         2.48

     Granted--Exercise price equals market value...................        443,750             5.67   $       2.93

     Granted--Exercise price greater than market value.............        269,400             3.87           1.88

     Granted--Exercise price less than market value................         60,250             4.05           2.15

     Cancelled.....................................................        (21,375)            3.90

     Exercised.....................................................        (34,003)            2.15

                                                                      ------------



     Outstanding at December 31, 1997..............................      1,199,272   $         4.04

     Granted--Exercise price equals market value...................        714,750             2.43   $       1.05

     Granted--Exercise price greater than market value.............        520,250             1.91           0.83

     Granted--Exercise price less than market value................         16,000             3.19           1.44

     Cancelled.....................................................       (654,016)            5.30

     Exercised.....................................................         (8,851)            1.82

                                                                      ------------



     Outstanding at December 31, 1998..............................      1,787,405   $         2.32

     Granted--Exercise price equals market value...................        377,500             0.99   $       0.48

     Cancelled.....................................................       (170,837)            2.34

     Exercised.....................................................         (5,500)            1.80

                                                                      ------------

     Outstanding at December 31, 1999..............................      1,988,568





Approximately 604 shares that were exercised in 1998 were issued in 1999.



                                       37





                    APPLIED IMAGING CORP. AND SUBSIDIARIES



            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)



The following table summarizes information about stock options outstanding

as of December 31, 1999







                                                Options Outstanding                Options Exercisable

                                ------------------------------------------------   ----------------------

                                                   Weighted                                      Weighted

                                                   average           Weighted                    average

                                  Number           remaining         average                     exercise

Range of exercise prices        outstanding     contractual life  exercise price   Number          price

- ------------------------        -----------     ----------------  --------------   -------       --------

                                                                                  

From $0.72 to $1.19                 247,500         9.69 years            $ 1.07    19,737         $ 0.97

From $1.25 to $1.44                 130,000         9.65 years              1.35       -               -

From $1.80 to $1.88                 817,000         7.72 years              1.85   489,750           1.84

From $2.06 to $2.38                  25,541         8.23 years              1.90     9,436           2.25

From $2.44 to $3.00                 684,819         7.86 years              2.55   337,763           2.56

From $3.13 to $5.00                  38,708         8.08 years              3.58    19,515           3.58

From $5.13 to $6.30                  45,000         6.94 years              6.17    42,500           6.23

                                -----------                                        -------

                                  1,988,568                                        918,701

                                ===========                                        =======





(9)  Income Taxes



     The Company has not recorded an income tax benefit in 1999, 1998, and 1997

due to the recording of a valuation allowance as an offset to net deferred tax

assets. A valuation allowance is provided due to uncertainties surrounding the

realization of deferred tax assets due to the history of operating losses

incurred by the Company. The tax effects of temporary differences that give rise

to significant portions of deferred tax assets are presented below.



     Deferred tax assets (liabilities) consist of the following (in thousands):







                                                   1999               1998                1997

                                                -----------        -----------        -----------

                                                                             

     Bad debt reserve                           $       51         $       31         $       43

     Inventory reserve                                 182                162                146

     Depreciation & amortization                       115                100                -

     Deferred compensation                            (227)               122                122

     Accrued expenses                                  241                237                415

     Net operating loss carryforwards               10,467              8,740              6,109

     Business credit carryforwards                   1,301              1,186                540

                                                -----------        -----------        -----------



     Total Gross Deferred Assets                    12,130             10,578              7,375

     Less: Valuation Allowance                     (12,130)           (10,578)            (7,368)

                                                -----------        -----------        -----------

     Net Deferred Tax Assets                    $        -         $        -         $        7

                                                ===========        ===========        ===========





     As of December 31, 1999, the Company had net operating loss carryforwards

for U.S. federal, U.K., and California state tax return purposes of

approximately $26,645,000, $8,342,000 and $2,803,000 respectively. The federal

and California net operating loss carryforwards expire in the years between 2005

and 2019 and between 1999 and 2005, respectively.



(10) Commitments



     The Company has various noncancelable operating leases for equipment,

vehicles, and facilities expiring through 2008. The facility leases generally

contain renewal options for periods ranging from two to five years and require

the Company to pay all executory costs such as maintenance, property taxes, and

insurance. Rent expense under operating



                                       38





                    APPLIED IMAGING CORP. AND SUBSIDIARIES



            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)



leases aggregated $455,183, $481,000 and $351,000 during 1999, 1998 and 1997,

respectively. The Company's primary lease commitments are for its facilities in

the United Kingdom, which aggregate approximately (Pounds)119,000 per year

through 2003, with a five-year renewal option held by the Company, and for its

facilities in the United States, which aggregate approximately $303,000 for

2000. The lease on US facilities expires in November 2000 and converts to a

month-to-month lease thereafter. The Company intends to negotiate an extension

of the present lease on the US facilities.



     The Company has a capital lease commitment of $85,000, including interest

of $9,000 at 10%, which calls for annual payments of $34,000 through the year

2001 and a payment of $15,000 in 2002.



     In March 1998, the Company entered into a non-exclusive world-wide

agreement with Amersham Pharmacia Biotech Inc. for the right to use certain

technologies in conjunction with its DNA probe technology. The agreement

requires minimum annual royalty payments of $10,000. The agreement will remain

in full force and effect until the expiration of all patents or eight years,

whichever is later.



(11) Employee Benefit Plans



     In January 1994, the Company implemented a retirement savings and

investment plan that is intended to qualify under Section 401(k) of the Internal

Revenue Code (the 401(k) Plan) covering all of the Company's United States-based

employees. An employee may elect to defer, in the form of contributions to the

401(k) Plan on his or her behalf, up to 15% of the total compensation that would

otherwise be paid to the employee, not to exceed the amount allowed by

applicable Internal Revenue Service guidelines. The Company matches 100% of the

amounts deferred by the employee participants up to 3% of such employee's total

compensation and such matching amounts vest over a three-year period from the

initial participation date. The Company contributed $72,000, $90,000 and $85,000

in 1999, 1998 and 1997, respectively.



     The Company's United Kingdom-based employees are covered by retirement

savings plans (the International Retirement Plans). Under such plans, an

employee may elect to make contributions of 3.5% of such employee's earnings.

Amounts contributed by the Company range from 5.5% to 10.5% of such employee's

earnings. During 1999, 1998 and 1997, respectively, the Company made

contributions to the Internal Retirement Plans totaling $63,000, $66,000,

$60,000, respectively.



(12) Other Income, Net



     The components of other income, net are as follows (in thousands of

dollars):







                                                                                    December 31,

                                                                      ------------------------------------

                                                                          1999         1998         1997

                                                                      ----------   ----------    ---------

                                                                                        

          Interest income..........................................   $      472   $      579    $     595

          Interest expense.........................................         (128)         (92)         (49)

          Gain (loss) on foreign exchange..........................         (154)          58         (163)

          Provision for income taxes...............................          (31)           -            -

          Miscellaneous income (expense)...........................           (1)          (4)          15

                                                                      ----------   ----------    ---------

                                                                      $      158   $      541    $     398

                                                                      ==========   ==========    =========





                                       39





                    APPLIED IMAGING CORP. AND SUBSIDIARIES



            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)



(13) Segment and Foreign Operations



     The Company has adopted the provision of SFAS No. 131, Disclosure About

Segments of an Enterprise and Related Information. SFAS No 131 establishes

standards for the reporting by public business enterprises of information about

operating segments, products and services, geographic areas, and major

customers. The method for determining what information to report is based on the

way management organizes the operating segments within the Company for making

operating decision and assessing financial performance. The following table

represents revenues by geographic area (in thousands):







                                   United States     United Kingdom    Israel     Consolidated

                                   -------------     --------------    ------     ------------

                                                                      

          Revenues

              1999..............   $     5,701       $     8,429            -     $    14,130

              1998..............         4,304             7,380            -          11,684

              1997..............         5,328             7,806            -          13,134

          Identifiable Assets

              1999..............   $    10,736       $     8,978       $    30    $    19,744

              1998..............        11,779             6,981            48         18,808





  The Company's chief operating decision maker is considered to be the Company's

Chief Executive Officer ('CEO"). The CEO reviews financial information presented

on a consolidated basis for purposes of making operating decisions and assessing

financial performance. The consolidated financial information is identical to

the information presented in the accompanying consolidated statements of

operations. The Company has one segment.



No single customer accounted for greater than 10% of revenues in any period

reported.



(14) Restructuring



     To focus the Company on the execution of its sales and marketing strategy

and to transition from working in fetal cell research to work in cancer

metastasis, and to reduce operating costs, the Company eliminated 15 positions

in 1999 at both its United States and United Kingdom facilities. The Company

recorded a net restructuring charge for the year of $818,000. The charge is

largely related to the severance costs of the terminated employees and certain

costs associated with discontinued products. As of December 31, 1999, $255,000

has been paid against the liability related to the termination benefits for the

terminated employees, and the balance is expected to be paid sometime in 2000.



     In 1998, to reduce operating costs the Company recorded a restructuring

charge of $353,000 related to the elimination of thirteen positions at the

Company's facilities in the United States and United Kingdom. Substantially all

of the restructuring charge in 1998 were paid by the end of that year.



                                       40





                    APPLIED IMAGING CORP. AND SUBSIDIARIES



            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)



The following table summarizes the amounts that were charged and where they are

reflected in the accompanying statement of operations (in thousands):







                  Description                          Year Ended December 31,      Classification on Statement of Operations

     ----------------------------------------          -----------------------      ---------------------------------------------

                                                          1999         1998

                                                       ----------   ----------

                                                                           



     Employee separation costs..................       $      516   $      353      All restructuring charges have been reflected

                                                                                    in the Statement of Operations as a separate

     Costs associated with product close-down...              302          -        line item under operating expenses.

                                                       ----------   ----------

     Total......................................       $      818   $      353

                                                       ==========   ==========





The following table summarizes the Company's restructuring reserve balances

through December 31, 1999 (in thousands):







                                                           Restructuring

                                                               Costs

                                                           -------------

                                                        

          Restructuring charge taken in 1998               $         353

          Cash charges                                              (353)

                                                           -------------

          Restructuring reserve balances at

          December 31, 1998                                          -

          Restructuring charge                                       818

          Cash charges                                              (255)

          Non cash charges                                          (302)

                                                           -------------

          Restructuring reserve balances at

          December 31, 1999                                $         261

                                                           =============





                                       41





                    APPLIED IMAGING CORP. AND SUBSIDIARIES



            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)





(15) Private Placement Transactions



     On November 3, 1999, the Company consummated a private sale of one million

shares of its Common Stock to certain accredited investors at a purchase price

of $2.00 per share. The investors also entered into a distribution agreement for

the Company's products. The price exceeded the closing price of the Company's

Common Stock as reported on the Nasdaq National Market System. As part of the

private placement, the Company recognized deferred revenue of $720,000 to be

amortized over 50 months. The total recognized to date is $29,000.



     On June 3, 1998, the Company consummated a private sale of 3,333,331 shares

of its common stock to certain accredited investors at $3.00 per share. The

price exceeded the closing price of the Company's common stock as reported on

the NASDAQ National Market System. Included in the sale was 1,000,000 shares

sold to New Enterprise Associates, a principal owner of the Company. Thomas C.

McConnell, a director of the company, is an affiliate of New Enterprise

Associates.



     On July 7, 1998 and July 15, 1998, the Company consummated private sales of

collectively 499,999 shares of its common stock to certain accredited investors

at $3.00 per share. The price exceeded the closing price of the Company's common

stock as reported on the NASDAQ National Market System.



     On May 22, 1997, the Company consummated a private sale of 796,020 shares

of its common stock to certain partnerships affiliated with New Enterprise

Associates, at $5.025 per share. The price per share was calculated as the

average of the closing prices of the Company's common stock as reported on the

NASDAQ National Market System for the previous five trading days prior to the

day of the transaction closing date. In connection with this transaction, the

Company also issued warrants, which may be exercised within a three-year period

ending May 21, 2000 to acquire an aggregate of 173,010 shares of the Company's

common stock at a purchase price of $5.78 per share. The Company allocated a

portion of the proceeds to the warrants based on the fair value using the Black-

Scholes pricing model and such amount is included within common stock.





Item 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND

          FINANCIAL DISCLOSURE



     None.



                                       42





                                   PART III



     Certain information required by Part III is omitted from this Report on

Form 10-K in that the Registrant will file a definitive proxy statement within

120 days after the end of its fiscal year pursuant to Regulation 14A with

respect to the 2000 Annual Meeting of Stockholders (the "Proxy Statement") and

certain information included therein is incorporated herein by reference.



Item 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT



     Certain of the information required by this item relating to directors is

incorporated by reference to the information under the caption "Proposal No. 1--

Election of Directors" in the Proxy Statement.



     The executive officers of the Registrant, who are elected by the board of

directors, are as follows:



Name                             Age   Position

- ----                             ---   --------



Jack Goldstein, Ph.D..........    52   Chief Executive Officer and Chairman

Carl Hull.....................    41   President and Chief Operating Officer



     Jack Goldstein, Ph.D. joined the Company as Chief Executive Officer and

President in April 1997. Dr. Goldstein has 26 years of management experience at

leading healthcare companies. From 1986 to 1997, Dr. Goldstein worked for

Johnson & Johnson in various executive management positions including President

of Ortho Diagnostic Systems and Executive Vice President of Professional

Diagnostics at Johnson & Johnson World Headquarters. Prior to his tenure at

Johnson & Johnson, Dr. Goldstein served in management positions at Baxter

Healthcare Corporation and American Home Products Corporation. Dr. Goldstein

holds a B.A. degree in Biology from Rider University, an M.S. in Immunology and

a Ph.D. in Microbiology from St. John's University.



     Carl Hull joined the Company as Vice President of Worldwide Marketing in

August 1997. In January 1999 he also became Vice President of Sales. In

September 1999, Mr. Hull was appointed President and Chief Operating Officer.

Prior to joining the Company, Mr. Hull served as Vice President of Marketing and

Business Development for Ventana Medical Systems. From 1982 to 1996, he served

in various marketing and sales management positions at Abbott Laboratories,

including Vice President and General Manager of Abbott Laboratories, Puerto

Rico. He also served as Marketing Manager Far-East, Marketing manager for

Hematology Products, District Sales Manager as well as Product Manager for

several diagnostic product lines. Mr. Hull received his MBA from University of

Chicago and a B.A. in Political Science and International Relations at Johns

Hopkins University.



Item 11.  EXECUTIVE COMPENSATION



     The information required by this item is incorporated by reference to the

information under the caption "Executive Compensation" in the Proxy Statement.



Item 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT



     The information required by this item is incorporated by reference to the

information under the caption "Record Date and Stock Ownership" in the Proxy

Statement.



Item 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS



     The information required by this item is incorporated by reference to the

information under the caption "Certain Transactions" in the Proxy Statement.



                                       43





                                    PART IV



Item 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K



(a)  1.   Financial Statements



          The following Financial Statements of Applied Imaging Corp. and Report

          of PricewaterhouseCoopers, LLP, have been provided as Item 8, above:



          Report of PricewaterhouseCoopers, LLP



          Consolidated Balance Sheet, 1999



          Consolidated Statement of Operations, Year Ended December 31, 1999



          Consolidated Statement of Stockholders' Equity, Year Ended December

          31, 1999



          Consolidated Statement of Cash Flows, Year Ended December 31, 1999



          Notes to Consolidated Financial Statements



          The following Financial Statements of Applied Imaging Corp. and Report

          of KPMG LLP, have been provided as Item 8, above:



          Report of KPMG LLP



          Consolidated Balance Sheets, 1998 and 1997



          Consolidated Statements of Operations, Years Ended December 31, 1998

          and 1997



          Consolidated Statements of Stockholders' Equity, Years Ended December

          31, 1998 and 1997



          Consolidated Statements of Cash Flows, Years Ended December 31, 1998

          and 1997



          Notes to Consolidated Financial Statements



     2.   Financial Statement Schedules



          The financial statement schedule entitled "Valuation and Qualifying

          Accounts" is included at page 48 of this Form 10-K.



          All other schedules are omitted because they are not applicable or the

          required information is shown in the Financial Statements or the notes

          thereto.



     3.   Exhibits



          Refer to (c) below.



(b)  Reports on Form 8-K



     The Company was not required to and did not file any reports on Form 8-K

     during the three months ended December 31, 1999.



10   Exhibits



Exhibit No.                                  Description

- -----------                                  -----------

 3.1(1)        Restated Certificate of Incorporation of the Registrant.

 3.2(2)        Bylaws of the Registrant as amended.

 4.1(1)        Specimen Common Stock Certificate.

 4.3(3)        Preferred Shares Rights Agreement dated as of May 29, 1998,

               between the Registrant and Norwest Bank Minnesota, N.A. including

               the form of Rights Certificate, the Certificate of Designation

               and the summary of Rights attached thereto as Exhibits A, B, and

               C, respectively.

10.1(1)        Form of Indemnification Agreement for directors and officers.

10.2(b)(4)     1998 Incentive Stock Option Plan and form of Stock Option

               Agreement thereunder.

10.4(1)        Employee Stock Purchase Plan.

10.5(1)        Amended and Restated Registration Rights Agreements.

10.6(1)        License Agreement dated December 1, 1993 between the Registrant

               and Chronomed, Inc.

10.7(1)        Assignment dated December 1, 1993 by and between the Registrant

               and Alex Saunders, M.D.

10.8(a)(1)     Lease dated February 15, 1994 for the Registrant's headquarters

               in Santa Clara, CA.

10.8(b)(2)     Lease renewal dated December 8, 1998 for the Registrants

               headquarters in Santa Clara, CA.

10.9(2)        Lease dated July 1998 between Bio Science Center and Applied

               Imaging International Ltd.

10.12(1)       Know-How License Agreement dated November 1989 between Medical

               Research Council and Shandon Scientific Limited (assigned to the

               Registrant in November 1989), as amended, July 5, 1994.



                                       44





Exhibit No.                                  Description

- -----------                                  -----------

10.13(1)       Cooperative Research and Development Agreement, dated June 10,

               1995 between Registrant and the National Institute of Health.

10.14(1)       Supply & Distribution Agreement dated March 3, 1994 between

               Cytocell Ltd. and Registrant.

10.15(1)       Research Purchase Agreement dated March 26, 1996 between

               Pharmacia Biotech AB and Registrant.

10.16(1)       Development Agreement dated February 5, 1996 between EM

               Industries and Registrant.

10.17(1)       Security and Loan Agreement dated September 5, 1995 between

               Registrant and Imperial Bank.

10.18(1)       Extension to Security and Loan Agreement dated September 16, 1996

               between Registrant and Imperial Bank.

10.19(2)       License Agreement dated October 24, 1997 between Cambridge

               University and the Registrant.

10.20(2)       Employment Letter Agreement dated July 21, 1997 between the

               Company and Carl Hull.

10.21(2)       Employment Letter Agreement dated April 2, 1997 between the

               Company and Jack Goldstein, Ph.D. and amendment dated April 4,

               1997.

10.23(7)       Stock and Warrant Purchase Agreement dated May 22, 1997 between

               the registrant and certain investors

10.24(8)       Form of Stock Purchase Agreement between the Registrant and

               certain investors used in connection with sales of Common Stock

               on July 7 and July 15, 1998.

10.25(9)       Asset Purchase, License and Distribution Agreement between the

               Company and Vysis, Inc. dated July 16, 1999

21.1(1)        List of Subsidiaries of the Registrant.

24.1           Power of Attorney (included at page 46 below).

24.2           Michael Braden left the Company on February 23, 2000.

27.1           Financial Data Schedule.



_____________

(1)  Filed as an Exhibit to the Company's Registration Statement on Form S-1

     (File No. 333-06703) and incorporated herein by reference.



(2)  Filed as an exhibit to the Company's Form 10-K for the year ending December

     31, 1998 and 1997 and incorporated herein by reference.



(3)  Filed as exhibit 3 to the Registrant's Report on Form 8-A with the

     Commission on June 5, 1998 and incorporated herein by reference.



(4)  Filed as exhibit 4.1 to the Registrant's Report on Form S-8 filed with the

     Commission on June 26,1998 and incorporated herein by reference.



(5)  Filed as exhibit 10.1 to the Registrant's Report on form 8-K filed with the

     Commission on June 4, 1997 and incorporated herein by reference.



(6)  Filed as exhibit 10.1 to the Registrant's Report on form 8-K filed with the

     Commission on June 16, 1998 and incorporated herein by reference.



(7)  Files as exhibit 10.1 to the Registrant's Report on Form 8-K filed with the

     Commission on July 28, 1998 and incorporated herein by reference.



(8)  Filed as exhibit 2.1 to the Registrant's Report on Form 8-K filed with the

     Commission on July 30, 1999 and incorporated herein by reference.



                                       45





                                  SIGNATURES



     Pursuant to the requirements of the Securities Act, the Registrant has duly

caused this report to be signed on its behalf by the undersigned, thereunto duly

authorized.



                                        Applied Imaging Corp.







                                        By: /s/ Jack Goldstein

                                           -------------------------------

                                                    Jack Goldstein

                                                Chief Executive Officer



Date:  March 29, 2000



                               POWER OF ATTORNEY



     KNOW ALL MEN AND WOMEN BY THESE PRESENTS, that each person whose signature

appears below constitutes and appoints Jack Goldstein and Carl Hull his or her

attorney-in-fact, with the power of substitution, for him or her in any and all

capacities, to sign any amendments to this Report on Form 10-K, and to file the

same, with exhibits thereto and other documents in connection therewith, with

the Securities and Exchange Commission, hereby ratifying and confirming all that

said attorneys-in-fact, or his or her substitute or substitutes, may do or cause

to be done by virtue thereof.



     Pursuant to the requirements of the Securities Exchange Act of 1934, this

report has been signed below by the following persons on behalf of the

Registrant and in the capacities and on the date indicated.



         Signatures                       Title                   Date

         ----------                       -----                   ----



     /s/ Jack Goldstein

- -----------------------------  Chief Executive Officer and   March 29, 2000

        (Jack Goldstein)         Director (Principal

                                 Executive Officer)



    /s/ Michael J. Braden

- -----------------------------   Corporate Controller          March 29, 2000

       (Michael J. Braden)       (Principal

                                 Accounting Officer)



  /s/ John F. Blakemore, Jr.

- -----------------------------

    (John F. Blakemore, Jr.)   Director                      March 29, 2000





   /s/ Gilbert J.R. McCabe

- -----------------------------  Director                      March 29, 2000

     (Gilbert J.R. McCabe)



   /s/ Thomas C. McConnell

- -----------------------------

     (Thomas C. McConnell)     Director                      March 29, 2000



   /s/ Andre F. Marion

- -----------------------------

       (Andre F. Marion)       Director                      March 29, 2000



   /s/ Robert C. Miller

- -----------------------------

       (Robert C. Miller)      Director                      March 29, 2000



      /s/ G. Kirk Raab

- -----------------------------

         (G. Kirk Raab)        Director                      March 29, 2000



    /s/ Pablo Valenzuela

- -----------------------------

    Pablo Valenzuela           Director                      March 29, 2000

                                       46





                             APPLIED IMAGING CORP.



- --------------------------------------------------------------------------------



                 SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS

                                 (In thousands)







                                              Balance of    Charged to     Deductions/    Balance at

                                             Beginning of   Costs and      Recoveries       End of

          Allowance for doubtful accounts        Year       Expenses       Other             Year

                                                                              

          Year ended December 31, 1999       $        162   $       89     $       -      $      251

                                             =======================================================

          Year ended December 31, 1998       $        191   $      -       $       (29)   $      162

                                             =======================================================

          Year ended December 31, 1997       $        228   $       10     $       (47)   $      191

                                             =======================================================





                                       47