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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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|x | Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
|- | ----------------------------------------------------------------------------------------



For the Quarterly Period ended June 30, 2005



OR



| ̈ | Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
|- | -----------------------------------------------------------------------------------------



For the Transition Period From  To
.



Commission File Number: 0-21371



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APPLIED IMAGING CORP.

(Exact name of registrant as specified in its charter)



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



120 Baytech Drive,

San Jose, California 95134

(Address of principal executive offices including zip code)



(408) 719-6400

(Registrants telephone number, including area code)



---



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



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



As of July 27, 2005 there were 4,784,012 shares of the Registrants Common Stock outstanding.



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##### Table of Contents

APPLIED IMAGING CORP.



|        |  |                                                                                                                                  |  |      
|------- |  | -------------------------------------------------------------------------------------------------------------------------------- |  | -----
|        |  |                                                                                                                                  |  | Page 
|        |  | PART I. FINANCIAL INFORMATION                                                                                                    |  |      
|        |  |                                                                                                                                 
|Item 1. |  | Financial Statements (Unaudited)                                                                                                 |  | 2    
|        |  |                                                                                                                                 
|        |  | Condensed Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004                                                  |  | 3    
|        |  |                                                                                                                                 
|        |  | Condensed Consolidated Statements of Operations and Comprehensive Loss for the three and six months ended June 30, 2005 and 2004 |  | 4    
|        |  |                                                                                                                                 
|        |  | Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2005 and 2004                                  |  | 5    
|        |  |                                                                                                                                 
|        |  | Notes to Condensed Consolidated Financial Statements                                                                             |  | 6-10 
|        |  |                                                                                                                                 
|Item 2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                            |  | 10-13
|        |  |                                                                                                                                 
|Item 3. |  | Quantitative and Qualitative Disclosures about Market Risk Derivatives and Financial Instruments                                 |  | 13   
|        |  |                                                                                                                                 
|Item 4. |  | Disclosure Controls and Procedures                                                                                               |  | 14   
|        |  |                                                                                                                                 
|        |  | PART II. OTHER INFORMATION                                                                                                       |  |      
|        |  |                                                                                                                                 
|Item 1. |  | Legal Proceedings                                                                                                                |  | 15   
|        |  |                                                                                                                                 
|Item 4. |  | Submission of Matters to a Vote of Security Holders                                                                              |  | 15   
|        |  |                                                                                                                                 
|Item 6. |  | Exhibits                                                                                                                         |  | 16   
|        |  |                                                                                                                                 
|        |  | Signatures                                                                                                                       |  | 16   



INDEX



PART I - FINANCIAL INFORMATION



Item 1. Financial Statements



Unless the context otherwise indicates, all share and per share common stock information in this Quarterly Report reflects a 1-for-4 reverse stock split of the common stock effected May 20, 2005.



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##### Table of Contents

APPLIED IMAGING CORP. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(in thousands)

(Unaudited)



|                                           |  |              |         |   |                  |   |         |  
|------------------------------------------ |  | ------------ | ------- | - | ---------------- | - | ------- | -
|                                           |  | June 30,2005 |         |   | December 31,2004 |  
|ASSETS                                     |  |              |         |   |                  |   |         |  
|                                           |  |             
|Current assets:                            |  |              |         |   |                  |   |         |  
|Cash and cash equivalents                  |  | $            | 2,955   |   |                  | $ | 3,927   |  
|Restricted cash                            |  |              | 180     |   |                  |   | 193     |  
|Trade accounts receivable, net             |  |              | 3,928   |   |                  |   | 4,083   |  
|Inventories                                |  |              | 908     |   |                  |   | 1,428   |  
|Prepaid expenses and other current assets  |  |              | 770     |   |                  |   | 483     |  
|                                           |  |              |         |   |                  |   |         |  
|Total current assets                       |  |              | 8,741   |   |                  |   | 10,114  |  
|                                           |  |             
|Property and equipment, net                |  |              | 1,247   |   |                  |   | 1,503   |  
|                                           |  |             
|Goodwill                                   |  |              | 2,364   |   |                  |   | 2,364   |  
|Other assets                               |  |              | 52      |   |                  |   | 51      |  
|                                           |  |              |         |   |                  |   |         |  
|Total assets                               |  | $            | 12,404  |   |                  | $ | 14,032  |  
|                                           |  |              |         |   |                  |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY       |  |              |         |   |                  |   |         |  
|                                           |  |             
|Current liabilities:                       |  |              |         |   |                  |   |         |  
|Accounts payable                           |  | $            | 1,465   |   |                  | $ | 1,453   |  
|Accrued expenses and other                 |  |              | 2,417   |   |                  |   | 2,860   |  
|Bank debt                                  |  |              | 1,461   |   |                  |   | 1,531   |  
|Deferred rent, current                     |  |              | 160     |   |                  |   | 160     |  
|Deferred revenue, current                  |  |              | 3,531   |   |                  |   | 3,507   |  
|                                           |  |              |         |   |                  |   |         |  
|Total current liabilities                  |  |              | 9,034   |   |                  |   | 9,511   |  
|                                           |  |             
|Deferred rent, non-current                 |  |              | 438     |   |                  |   | 513     |  
|                                           |  |             
|Deferred revenue, non-current              |  |              | 429     |   |                  |   | 572     |  
|                                           |  |              |         |   |                  |   |         |  
|Total liabilities                          |  |              | 9,901   |   |                  |   | 10,596  |  
|                                           |  |              |         |   |                  |   |         |  
|Stockholders equity:                      |  |              |         |   |                  |   |         |  
|Common stock                               |  |              | 19      |   |                  |   | 19      |  
|Additional paid-in capital                 |  |              | 53,091  |   |                  |   | 53,077  |  
|Accumulated deficit                        |  |              | (50,240 | ) |                  |   | (49,293 | )
|Accumulated other comprehensive loss       |  |              | (367    | ) |                  |   | (367    | )
|                                           |  |              |         |   |                  |   |         |  
|Total stockholders equity                 |  |              | 2,503   |   |                  |   | 3,436   |  
|                                           |  |              |         |   |                  |   |         |  
|Total liabilities and stockholders equity |  | $            | 12,404  |   |                  | $ | 14,032  |  
|                                           |  |              |         |   |                  |   |         |  



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





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##### Table of Contents

APPLIED IMAGING CORP. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

and Comprehensive Loss

(in
thousands, except per share data)

(Unaudited)



|                                                        |  |                            |       |   |                           |   |        |      |  |   |       |   |  |   |        |  
|------------------------------------------------------- |  | -------------------------- | ----- | - | ------------------------- | - | ------ | ---- |  | - | ----- | - |  | - | ------ | -
|                                                        |  | Three months endedJune 30, |       |   | Six months ended June 30, |  
|                                                        |  | 2005                       |       |   | 2004                      |   |        | 2005 |  |   | 2004  |  
|Revenues                                                |  | $                          | 4,912 |   |                           | $ | 4,271  |      |  | $ | 9,802 |   |  | $ | 9,186  |  
|Cost of revenues                                        |  |                            | 2,015 |   |                           |   | 1,690  |      |  |   | 4,039 |   |  |   | 3,568  |  
|                                                        |  |                            |       |   |                           |   |        |      |  |   |       |   |  |   |        |  
|Gross profit                                            |  |                            | 2,897 |   |                           |   | 2,581  |      |  |   | 5,763 |   |  |   | 5,618  |  
|Operating expenses                                      |  |                            |       |   |                           |   |        |      |  |   |       |   |  |   |        |  
|Research and development                                |  |                            | 870   |   |                           |   | 844    |      |  |   | 1,755 |   |  |   | 1,735  |  
|Sales and marketing                                     |  |                            | 1,323 |   |                           |   | 1,630  |      |  |   | 2,721 |   |  |   | 3,337  |  
|General and administrative                              |  |                            | 1,013 |   |                           |   | 1,093  |      |  |   | 2,066 |   |  |   | 2,130  |  
|                                                        |  |                            |       |   |                           |   |        |      |  |   |       |   |  |   |        |  
|Total operating expenses                                |  |                            | 3,206 |   |                           |   | 3,567  |      |  |   | 6,542 |   |  |   | 7,202  |  
|                                                        |  |                            |       |   |                           |   |        |      |  |   |       |   |  |   |        |  
|Operating loss                                          |  |                            | (309  | ) |                           |   | (986   | )    |  |   | (779  | ) |  |   | (1,584 | )
|                                                        |  |                            |       |  
|Other income (expense), net                             |  |                            | (127  | ) |                           |   | (45    | )    |  |   | (168  | ) |  |   | (90    | )
|                                                        |  |                            |       |  
|Net loss                                                |  | $                          | (436  | ) |                           | $ | (1,031 | )    |  | $ | (947  | ) |  | $ | (1,674 | )
|                                                        |  |                            |       |   |                           |   |        |      |  |   |       |   |  |   |        |  
|Net loss per share - basic and diluted                  |  | $                          | (0.09 | ) |                           | $ | (0.22  | )    |  | $ | (0.20 | ) |  | $ | (0.39  | )
|                                                        |  |                            |       |   |                           |   |        |      |  |   |       |   |  |   |        |  
|Weighted average shares outstanding - basic and diluted |  |                            | 4,776 |   |                           |   | 4,655  |      |  |   | 4,780 |   |  |   | 4,323  |  
|                                                        |  |                            |       |   |                           |   |        |      |  |   |       |   |  |   |        |  



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





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APPLIED IMAGING CORP. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)



|                                                                            |  |                          |        |   |      |   |        |  
|--------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | -
|                                                                            |  | Six months endedJune 30, |       
|                                                                            |  | 2005                     |        |   | 2004 |  
|Cash flows from operating activities:                                       |  |                          |        |   |      |   |        |  
|Net loss                                                                    |  | $                        | (947   | ) |      | $ | (1,674 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                          |        |   |      |   |        |  
|Depreciation and amortization                                               |  |                          | 369    |   |      |   | 293    |  
|Provision for doubtful accounts                                             |  |                          | 27     |   |      |   |       |  
|Provision for excess and obsolete inventory                                 |  |                          | 6      |   |      |   |       |  
|Changes in operating assets and liabilities:                                |  |                          |        |   |      |   |        |  
|Trade accounts receivable, net                                              |  |                          | 128    |   |      |   | 1,606  |  
|Inventories                                                                 |  |                          | 514    |   |      |   | (163   | )
|Prepaid expenses and other current assets                                   |  |                          | (287   | ) |      |   | (862   | )
|Other assets                                                                |  |                          | (1     | ) |      |   | 99     |  
|Accounts payable                                                            |  |                          | 12     |   |      |   | 431    |  
|Accrued expenses and other                                                  |  |                          | (443   | ) |      |   | (216   | )
|Deferred revenue                                                            |  |                          | (119   | ) |      |   | 504    |  
|Deferred rent                                                               |  |                          | (75    | ) |      |   | 723    |  
|                                                                            |  |                          |        |   |      |   |        |  
|Net cash (used) provided by operating activities                            |  |                          | (816   | ) |      |   | 741    |  
|                                                                            |  |                          |        |   |      |   |        |  
|Cash flows from investing activities:                                       |  |                          |        |   |      |   |        |  
|Purchases of property and equipment                                         |  |                          | (113   | ) |      |   | (685   | )
|                                                                            |  |                          |        |   |      |   |        |  
|Net cash used by investing activities                                       |  |                          | (113   | ) |      |   | (685   | )
|                                                                            |  |                          |        |   |      |   |        |  
|Cash flows from financing activities:                                       |  |                          |        |   |      |   |        |  
|Net proceeds from issuance of common stock                                  |  |                          | 14     |   |      |   | 3,870  |  
|Bank and other loan proceeds                                                |  |                          | 5,933  |   |      |   | 5,675  |  
|Bank and other loan payments                                                |  |                          | (6,003 | ) |      |   | (6,763 | )
|Restricted cash                                                             |  |                          | 13     |   |      |   | (3     | )
|                                                                            |  |                          |        |   |      |   |        |  
|Net cash (used) provided by financing activities                            |  |                          | (43    | ) |      |   | 2,779  |  
|                                                                            |  |                          |        |   |      |   |        |  
|Net (decrease) increase in cash and cash equivalents                        |  |                          | (972   | ) |      |   | 2,835  |  
|                                                                            |  |                         
|Cash and cash equivalents at beginning of year                              |  |                          | 3,927  |   |      |   | 2,047  |  
|                                                                            |  |                          |        |   |      |   |        |  
|Cash and cash equivalents at end of quarter                                 |  | $                        | 2,955  |   |      | $ | 4,882  |  
|                                                                            |  |                          |        |   |      |   |        |  



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





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NOTE 1  Restatement



The
Company restated its condensed consolidated financial statements for the three and six month periods ending June 30, 2004. All applicable financial information contained in this Form 10-Q gives effect to the restatement.



NOTE 2 - Basis of Presentation



The accompanying condensed consolidated financial statements include the
accounts of Applied Imaging Corp. and subsidiaries (the Company, we, us, our) for the three and six months ended June 30, 2005 and 2004. These condensed consolidated financial statements are unaudited
and reflect all adjustments, consisting only of normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of our financial position, operating results and cash flows for those interim periods presented.



Unless the context otherwise indicates, all share and per
share common stock information in this Quarterly Report reflects a 1-for-4 reverse stock split of the common stock effected May 20, 2005.



The results of operations for the three and six months ended June 30, 2005 are not necessarily indicative of results to be expected for the fiscal year
ending December 31, 2005. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, for the year ended December 31, 2004, contained in our Form 10-K filed with the
Securities and Exchange Commission on April 27, 2005.



Going
Concern



The accompanying condensed consolidated financial
statements of the Company were prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The realization of assets and the satisfaction of liabilities in the
normal course of business are dependent on, among other things, the Companys ability to operate profitably, to generate cash flows from operations, collections of receivables to fund its obligations, as well as the Companys ability to
maintain credit facilities adequate to conduct its business. In the course of its operations, the Company has sustained operating losses and negative cash flows from operations and expects such losses to continue in the foreseeable future. As of
June 30, 2005, the Company had cash and cash equivalents on hand of $3.0 million, working capital deficit of $293,000, and an accumulated deficit of $50.2 million. The Company intends to finance its operations primarily through its cash and cash
equivalents, future financing and future revenues.



Expenditures required to achieve the Companys growth or the cash flow used in operations may be greater than projected. As a result, the Companys capital needs may require the Company to seek to obtain additional funds through
equity or debt financing, collaborative or other arrangements with other companies, bank financing and other sources. There can be no assurance that the Company will be able to obtain additional debt or equity financing on terms acceptable to the
Company, or at all. 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 internally, or to reduce the marketing, customer support, or other resources devoted to product development. Accordingly, the failure of the Company to obtain sufficient funds on acceptable terms when
needed could have a material adverse effect on the Companys ability to achieve its longer term business objectives.



In 2004, we incurred $1.3 million in legal and accounting expenses in conjunction with patent litigation and the restatement of our prior financial
statements. Additionally, we had increased the size of our workforce in anticipation of revenue growth that did not materialize. In the first quarter of 2005 we settled our patent litigation, completed the restatement of our prior financial results
and reduced the size of our workforce. We believe these actions will reduce losses and cash used in operations in 2005 as compared to 2004. In addition to the actions we have taken to reduce expenses and cash outlay, we are seeking equity financing
to improve both our cash and working capital position as well as to provide funds for additional investment in our circulating tumor cell initiative. However, there are no assurances that adequate financing will be available on terms acceptable to
us.



The Companys inability to operate profitably and to
consistently generate cash flows from operations, its reliance therefore on external funding either from loans or equity raises substantial doubt about the Companys ability to continue as a going concern.



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The Company has a loan agreement with Silicon Valley Bank, SVB, which provides for borrowing of up to
$3.5 million based on the level of certain of its North American accounts receivable. In February 2005, the loan agreement was amended to extend the term of the loan for two years through March 2007. In April 2005, the loan agreement was amended to
revise the minimum net worth covenant commencing April 2005 to $1,000 at the end of each month plus 70% of all consideration received from and after March 2005 for equity securities and subordinated debt and 50% of any quarterly profits in the
current quarter. As part of the April 2005 amendment to the loan agreement, the minimum tangible net worth requirement for March 2005 was waived by SVB. The Company was in compliance with its loan covenants for each of the three months in the second
quarter.



At June 30, 2005, the Company had used $1.5 million
of the SVB facility with $24,000 available for borrowing. The interest rate on the facility was 8.0% at June 30, 2005, computed as the SVB prime rate plus 2 percent. The loan is collateralized by substantially all of the assets of the U.S.
Corporation and requires maintenance of a minimum level of tangible net worth. Other loan covenants include the need to maintain insurance on its property, monthly reporting to SVB, the need to obtain SVB approval for any extraordinary action and a
limitation on the U.S. Corporations ability to transfer more than $600,000 to a subsidiary.



The Company collateralizes various credit card and bank guarantees (used for customs clearance purposes) with cash deposits at an international bank in
the United Kingdom. This amounted to £100,000 ($180,000) at June 30, 2005.



NOTE 3  Inventories



Inventories
are stated at the lower of cost (determined on a first in, first out) or market. The company records provisions to write down its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory
and its estimate market value based upon assumptions about future market demand and market conditions. If future demand or market conditions are less favorable than currently expected, additional inventory provision may be required. Inventories
consisted of the following (in thousands):



|                     |  |               |     |                   |   |      
|-------------------- |  | ------------- | --- | ----------------- | - | -----
|                     |  | June 30, 2005 |     | December 31, 2004
|Raw materials        |  | $             | 607 |                   | $ | 966  
|Work in process      |  |               | 105 |                   |   | 162  
|Finished goods       |  |               | 196 |                   |   | 300  
|                     |  |               |     |                   |   |      
|Total inventory, net |  | $             | 908 |                   | $ | 1,428
|                     |  |               |     |                   |   |      



NOTE 4  Net Loss Per
Share



The computation of basic and diluted net loss
per share (EPS) for the three and six months ended June 30, 2005 and June 30, 2004 is determined by dividing net loss as reported as the numerator by the number of shares included in the denominator as shown in the following table (in
thousands):



|                                               |  |                            |  |                          |  |       |  |      
|---------------------------------------------- |  | -------------------------- |  | ------------------------ |  | ----- |  | -----
|                                               |  | Three months endedJune 30, |  | Six months endedJune 30,
|                                               |  | 2005                       |  | 2004                     |  | 2005  |  | 2004 
|Weighted average shares outstanding - basic    |  | 4,776                      |  | 4,655                    |  | 4,780 |  | 4,323
|                                               |  |                            |  |                         
|Dilutive shares - stock options                |  |                           |  |                         |  |      |  |     
|Dilutive shares - warrants                     |  |                           |  |                         |  |      |  |     
|                                               |  |                            |  |                          |  |       |  |      
|Weighted average shares outstanding - dilutive |  | 4,776                      |  | 4,655                    |  | 4,780 |  | 4,323
|                                               |  |                            |  |                          |  |       |  |      



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



|         |  |               |  |              
|-------- |  | ------------- |  | -------------
|         |  | June 30, 2005 |  | June 30, 2004
|Options  |  | 860,556       |  | 824,108      
|Warrants |  | 393,644       |  | 393,644      
|         |  |               |  |              
|Total    |  | 1,254,200     |  | 1,217,752    
|         |  |               |  |              



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NOTE 5  Stock Based Compensation



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



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



|                                                                                   |  |                            |       |   |                          |   |        |      |  |   |        |   |  |   |        |  
|---------------------------------------------------------------------------------- |  | -------------------------- | ----- | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                   |  | Three months endedJune 30, |       |   | Six months endedJune 30, |  
|                                                                                   |  | 2005                       |       |   | 2004                     |   |        | 2005 |  |   | 2004   |  
|Net loss as reported                                                               |  | $                          | (436  | ) |                          | $ | (1,031 | )    |  | $ | (947   | ) |  | $ | (1,674 | )
|Less: Stock-based employee compensation expense determined under fair-value method |  |                            | (85   | ) |                          |   | (179   | )    |  |   | (157   | ) |  |   | (368   | )
|                                                                                   |  |                            |       |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Pro forma net loss                                                                 |  | $                          | (521  | ) |                          | $ | (1,210 | )    |  | $ | (1,104 | ) |  | $ | (2,042 | )
|                                                                                   |  |                            |       |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net loss per share:                                                                |  |                            |       |   |                          |   |        |      |  |   |        |   |  |   |        |  
|As reported basic and diluted per share                                            |  | $                          | (0.09 | ) |                          | $ | (0.22  | )    |  | $ | (0.20  | ) |  | $ | (0.39  | )
|                                                                                   |  |                            |       |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Pro forma basic and diluted per share                                              |  | $                          | (0.11 | ) |                          | $ | (0.26  | )    |  | $ | (0.23  | ) |  | $ | (0.47  | )
|                                                                                   |  |                            |       |   |                          |   |        |      |  |   |        |   |  |   |        |  



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



|                         |  |                            |   |  |                          |   |  |      |   |  |      |  
|------------------------ |  | -------------------------- | - |  | ------------------------ | - |  | ---- | - |  | ---- | -
|                         |  | Three months endedJune 30, |   |  | Six months endedJune 30, |  
|                         |  | 2005                       |   |  | 2004                     |   |  | 2005 |   |  | 2004 |  
|Risk-free interest rate  |  | 3.53                       | % |  | 3.00                     | % |  | 3.53 | % |  | 2.51 | %
|Expected life (in years) |  | 5                          |   |  | 5                        |   |  | 5    |   |  | 5    |  
|Dividend yield           |  |                           | % |  |                         | % |  |     | % |  |     | %
|Expected volatility      |  | 84                         | % |  | 74                       | % |  | 84   | % |  | 75   | %



The above assumptions
for the Employee Stock Purchase Plan were the expected life is six months, volatility of 86% and interest rate of 3.88%.



8



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##### Table of Contents

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



NOTE 6  Product Warranty



The Company generally offers warranties on its products
against defects for a period of one year and records a liability for such product warranty obligations at the time of sale based upon our historical experience of warrantee claims made. The Company sells separately priced service contracts to
provide additional service coverage on its systems when the warranty period expires. The related revenue on the service contracts is recognized on a straight-line basis over the life of the service contract, which is generally one year. Costs
associated with services performed under the service contract obligation are expensed as incurred.



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



|                                             |  |               |     |   |               |   |     |  
|-------------------------------------------- |  | ------------- | --- | - | ------------- | - | --- | -
|                                             |  | June 30, 2005 |     |   | June 30, 2004 |  
|Balances as of the beginning of the year     |  | $             | 101 |   |               | $ | 102 |  
|Add: accruals for warranties issued          |  |               | 110 |   |               |   | 33  |  
|Less: costs incurred under warranties issued |  |               | (78 | ) |               |   | (42 | )
|                                             |  |               |     |   |               |   |     |  
|Balances as of the end of the quarter        |  | $             | 133 |   |               | $ | 93  |  
|                                             |  |               |     |   |               |   |     |  



NOTE 7  Commitments and
Contingencies



On July 8, 2004, the Company renewed
its exclusive supply agreement with StemCell Technologies Inc. for the use of StemCells RosetteSep® reagent technology for the isolation of circulating tumor cells in the blood of cancer patients. The Companys minimum purchase commitment for 2005 is $108,000. This amount was
charged to expense in the first quarter of fiscal year 2005.



In September 2004, the Inland Revenue, the UK taxing authority, notified the Company that it disputed the valuation the Company applied to its Cytogenetics technology that the Company transferred from its UK subsidiary to its US parent
entity a transaction which occurred in 2000, claiming that such valuation understated the fair value of the transferred assets. The Company originally valued the assets at £1.8 million ($3.5 million). The Inland Revenue has indicated that it
believes the value of the assets should have been £4.0 million ($7.7 million), which would result in the Company owing tax of approximately £585,000 ($1.1 million). The Company plans to have further discussions with the Inland Revenue to
support its original valuation of the transferred assets. The Company intends to vigorously defend its position and management believes that an estimate of an accrual is not probable or estimable at this time and therefore it has not accrued for any
amount in respect of this matter.



NOTE 8  Segment and Foreign
Operations



The Company operates in one segment. 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.



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The following table presents net revenues by geographic region (in thousands):



|                                 |  |                            |       |                          |   |       |  |      |       |  |   |      
|-------------------------------- |  | -------------------------- | ----- | ------------------------ | - | ----- |  | ---- | ----- |  | - | -----
|                                 |  | Three months endedJune 30, |       | Six months endedJune 30,
|                                 |  | 2005                       |       | 2004                     |   | 2005  |  | 2004
|Revenues                         |  |                            |       |                          |   |       |  |      |       |  |   |      
|North America                    |  | $                          | 3,116 |                          | $ | 2,780 |  | $    | 6,302 |  | $ | 4,842
|International-Principally Europe |  |                            | 1,796 |                          |   | 1,491 |  |      | 3,500 |  |   | 4,344
|                                 |  |                            |       |                          |   |       |  |      |       |  |   |      
|Total Revenues                   |  | $                          | 4,912 |                          | $ | 4,271 |  | $    | 9,802 |  | $ | 9,186
|                                 |  |                            |       |                          |   |       |  |      |       |  |   |      



Recently Issued Accounting
Pronouncements



In December 2004, the FASB issued SFAS No.
123R,Share-Based Payment, which replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123R requires
compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on fair value on the grant date of the equity or liability
instruments issued. Compensation cost will be recognized over the period that an employee provides service for that award. This new standard will be effective for us beginning January 1, 2006.



In May 2005, SFAS No. 154, Accounting Changes and Error
Corrections, was issued. This statement applies to all voluntary changes in accounting principle and requires retrospective application to prior periods financial statements of changes in accounting principle, unless this would be
impracticable. This statement also makes a distinction between retrospective application of an accounting principle and the restatement of financial statements to reflect the correction of an error. This statement is
effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company is evaluating the effect the adoption of this interpretation will have on its financial position, cash flows and results
of operations.



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



The following discussion should be read in conjunction with the attached unaudited condensed consolidated financial statements and notes, and with our
audited financial statements and notes for the fiscal year ended December 31, 2004.



This quarterly report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Our actual results could differ materially from those predicted in the
forward-looking statements as a result of risks and uncertainties including, but not limited to, those discussed in this quarterly report and those discussed under Item 1  Business, Additional Factors That Might Affect Future
Results, and under Item 7  Managements Discussion And Analysis of Financial Condition And Results of Operations commencing on pages 11 and 24 in our Annual Report on Form 10-K for the fiscal year ended December 31,
2004. You should not rely on these forward-looking statements, which reflect our position as of the date of this report. We are under no obligation to revise or update any forward-looking statements.



Results of Operations



Revenues. Our revenues are derived primarily from the sale of systems, service contracts, software maintenance and grant revenues.
Revenues for the three and six months ended June 30, 2005 were $4.9 million and $9.8 million, respectively, compared to $4.3 million and $9.2 million for the corresponding periods in 2004.



Sales of systems were $3.5 million and $7.0 million for the three and six
months ended June 30, 2005, respectively, compared to $2.9 million and $6.5 for the corresponding periods in 2004. North American sales of Ariol systems accounted for the increased revenues.



Service contract, software maintenance and grant revenues were $1.4 million
and $2.8 million for the three and six months ended June 30, 2005, respectively, compared to $1.4 million and $2.7 for the corresponding periods in 2004.



Cost of revenues. Cost of revenues includes direct material and labor costs, manufacturing overhead, installation costs, warranty-related expenses and service and
application support expenses. Costs of revenues for the three and six months ended June 30, 2005 were $2.0 million and $4.0 million, respectively, compared to $1.7 million and $3.6 million for the corresponding periods in 2004. Cost of revenues, as
a percentage of total revenues, for the three months and six months ended June 30, 2005 were 41% and 41%, respectively, compared to 2004 were 40% and 39% for the corresponding periods in 2004. The increased cost of revenues was attributed to
increased Ariol sales relative to other products.



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Research and development expenses.Research and development expenses for the three and six months ended June 30,
2005 were $870,000 and $1.8 million, respectively, compared to $844,000 and $1.7 million for the corresponding periods in 2004. Research and development expenses in the first quarter and second quarter of 2005 included increased costs for our
circulating tumor development initiative and lower costs for our developed Ariol system.



Sales and marketing expenses. Sales and marketing expenses for the three and six months ended June 30, 2005 were $1.3 million and $2.7 million, respectively, compared to $1.6 million and $3.3 million for the
corresponding periods in 2004. Sales and marketing expenses were lower in the first quarter and second quarter of 2005 as compared to 2004 due to reduced headcount in sales and marketing and lower overall marketing costs as a result of management
actions taken in January 2005 to streamline Company operations.



General and
administrative expenses. General and administrative expenses for the three and six months ended June 30, 2005 were $1.0 million and $2.1 million, respectively, compared to $1.1 million and $2.1 million for the corresponding periods in 2004.
General and administration expenses in the second quarter of 2004 included costs associated with the patent infringement lawsuit with Clarient that was initiated in March 2004 and settled in March 2005.



Other income (expense), net.Other expense of $127,000 in the second quarter of 2005
was due primarily to foreign exchange losses of $121,000 incurred in the translation of various balance sheet items from foreign currencies into the U.S. dollar and interest expense of $19,000 payable on our bank borrowings. Other expenses of
$45,000 in the second quarter of 2004 was primarily comprised of $30,000 in foreign exchange losses incurred in the translation of various balance sheet items from foreign currencies into the U.S. dollar and $20,000 of interest expense related to
our bank borrowings. For the 6 month periods ending June 30, 2005 and 2004, foreign currency exchange losses and interest expense primarily caused the net other expense. The foreign exchange loss for the period ending June 30, 2005 relates to the
weakening of the U.S. dollar against the British Pound Sterling.



|                        |  |                            |      |   |                          |   |     |      |  |   |      |   |  |   |     |  
|----------------------- |  | -------------------------- | ---- | - | ------------------------ | - | --- | ---- |  | - | ---- | - |  | - | --- | -
|                        |  | Three months endedJune 30, |      |   | Six months endedJune 30, |  
|                        |  | 2005                       |      |   | 2004                     |   |     | 2005 |  |   | 2004 |  
|Interest income         |  | $                          | 14   |   |                          | $ | 7   |      |  | $ | 28   |   |  | $ | 11  |  
|Interest expense        |  |                            | (19  | ) |                          |   | (20 | )    |  |   | (63  | ) |  |   | (42 | )
|Foreign exchange losses |  |                            | (121 | ) |                          |   | (30 | )    |  |   | (134 | ) |  |   | (56 | )
|Miscellaneous           |  |                            | (1   | ) |                          |   | (2  | )    |  |   | 1    |   |  |   | (3  | )
|                        |  |                            |      |   |                          |   |     |      |  |   |      |   |  |   |     |  
|Total                   |  | $                          | (127 | ) |                          | $ | (45 | )    |  | $ | (168 | ) |  | $ | (90 | )
|                        |  |                            |      |   |                          |   |     |      |  |   |      |   |  |   |     |  



Liquidity and Capital Resources



At June 30, 2005, we had cash and cash equivalents of
$3.0 million and a working capital deficit of $293,000, compared to $3.9 million in cash and cash equivalents and a $603,000 working capital surplus at December 31, 2004. Restricted cash, which collateralizes various credit card and bank guarantees
in the United Kingdom, amounted to $180,000 at June 30, 2005 and $193,000 at December 31, 2004.



Cash used by operations for the first six months ended June 30, 2005 was $816,000, compared to $741,000 provided for the first six months in 2004.



Cash used by operations in the first six months of 2005 of
$816,000 included a net loss of $947,000. Reduced inventories through improved supply chain management provided cash of $514,000. Payments on accrued expenses related to accounting and legal fees related to the restatement of our prior financial
statements, as well as expenses related to settled patent litigation with Clarient used cash of $443,000.



Cash provided by operations in the first six months of 2004 was $741,000. Cash provided by operations included a loss of $1.7 million, a reduction of
accounts receivable which provided $1.6 million and an increase in deferred revenue which provided $504,000. There was an increase in deferred rent incentive of $723,000 due to the rent incentive received for our new office facilities in 2004 while
prepaid and other assets used $862,000 in cash.



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Accounts receivable as a percent of second quarter revenues were 80% at June 30, 2005, compared to 106%
at June 30, 2004 and 71% for the quarter ending December 31, 2004. This strong relationship between quarter-end receivables and that quarters sales is primarily due to the fact that most of our sales occur late in the quarter as is typical of
a capital equipment business. Although our payment terms are net 30 days, certain customers, specifically government, university, Asian and European customers, tend to take longer to pay their receivable balances.



Cash used in investing activities for the first six months ended June 30,
2005 and 2004 was $113,000, and $685,000, respectively. In the period ending June 30, 2004, approximately $685,000 was spent on capital equipment and leasehold improvements for our San Jose headquarters which we moved into in 2004.



Cash used in financing activities for the first six months ended June 30,
2005 was $43,000 compared to cash provided of $2.8 million for the period ending June 30, 2004. In the first half of fiscal 2004, we received $3.9 million net from the issuance of common stock in a private placement transaction while net borrowings
were reduced by $1.0 million.



The Company has a loan agreement
with Silicon Valley Bank, SVB, which provides for borrowing of up to $3.5 million based on the level of certain of its North American accounts receivable. In February 2005, the loan agreement was amended to extend the term of the loan for two years
through March 2007. In April 2005, the loan agreement was amended to revise the minimum net worth covenant commencing April 2005 to $1,000 at the end of each month plus 70% of all consideration received from and after March 2005 for equity
securities and subordinated debt and 50% of any quarterly profits in the current quarter. As part of the April 2005 amendment to the loan agreement, the minimum tangible net worth requirement for March 2005 was waived by SVB. The Company was in
compliance with its loan covenants for each of the months in the second quarter.



At June 30, 2005, we had used $1.5 million of the facility with $24,000 available but not used. The interest rate on the facility was 8.0% at June 30, 2005, computed as the SVB prime rate plus 2 percent. The loan is
collateralized by substantially all of the assets of the U.S. Corporation and requires maintenance of a minimum level of tangible net worth. Other loan covenants include the need to maintain insurance on our property, monthly reporting to SVB, the
need to obtain SVB approval for any extraordinary action and a limitation on the U.S. corporations ability to transfer more than $600,000 to a subsidiary.



We collateralize various credit card and bank guarantees (used for customs clearance purposes) with cash deposits at an international bank in the
United Kingdom. This amounted to $180,000 at June 30, 2005.



We
believe that our current cash balances may not be sufficient to fund planned expenditures. This raises substantial doubt about our ability to continue as a going concern. During 2005, we intend to raise additional funds through the issuance of
equity or debt securities, or a combination thereof, in the public or private markets in order to continue operations, or sell the Company. Additional financing and merger opportunities may not be available, or if available, may not be on favorable
terms. The availability of financing or merger opportunities will depend, in part, on market conditions, and the outlook for our Company. Any future equity financing would result in substantial dilution to our stockholders. If we raise additional
funds by issuing debt, we may be subject to limitations on our operations, through debt covenants or other restrictions. If adequate and acceptable financing is not available, we may have to delay development or commercialization of certain of our
products or license to third parties the rights to commercialize certain of our products or technologies that we would otherwise seek to commercialize. We may also reduce our marketing, customer support or other resources devoted to our products.
Any of these options could reduce our sales growth and result in continued net losses.



In 2004, we incurred $1.3 million in legal and accounting expenses in conjunction with patent litigation and the restatement of our prior financial statements. Additionally, we had increased the size of our workforce
in anticipation of revenue growth that did not materialize. In the first quarter of 2005 we settled our patent litigation, completed the restatement of our prior financial results and reduced the size of our workforce. We believe these actions will
reduce losses and cash used in operations in 2005 as compared to 2004. In addition to the actions we have taken to reduce expenses and cash outlay, we are seeking equity financing to improve both our cash and working capital position as well as to
provide funds for additional investment in our circulating tumor cell initiative. However, there are no assurances that adequate financing will be available on terms acceptable to us.



Nasdaq has conditioned our continued listing on our ability to timely file all our periodic reports for all reporting
periods through December 31, 2005. While it is our intent to make timely filings of all periodic reports for all reporting periods ending on or before December 31, 2005, we may not complete our filings on a timely basis. If we are not able to comply
with the conditions specified by the Nasdaq, our shares could be delisted from the Nasdaq SmallCap Market. If



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delisted, our stock may be quoted using the Pink Sheets, LLC or other similar market. A delisting from the Nasdaq
SmallCap Market may adversely impact our stock price, as well as our liquidity and the ability of our stockholders to purchase and sell their shares in an orderly manner, or at all. Furthermore, a delisting of our shares from the Nasdaq SmallCap
Market could damage our general business reputation and impair our ability to raise additional funds. Any of the foregoing events could have a material adverse effect on our business, financial condition and operating results.



We prepare our financial statements in conformity with accounting principles
generally accepted in the United States of America. These principles are subject to interpretation by the Securities and Exchange Commission (the SEC) and various bodies formed to interpret and create appropriate accounting policies. A
change in these policies can have a significant effect on our reported results and may even retroactively affect previously reported transactions. In particular, changes to FASB guidelines relating to accounting for stock-based compensation will
likely increase our compensation expense, could make our net income less predictable in any given reporting period and could change the way we compensate our employees or cause other changes in the way we conduct our business.



Critical Accounting Policies



There have been no material changes to the critical accounting policies
discussed in our Annual Report on Form 10-K for the year ended December 31-, 2004. For a discussion of our critical accounting policies refer to Item 7. Managements Discussion and Analysis of Financial Condition and Results of
Operations Critical Accounting in our Annual Report on Form 10-K for the year ended December 31, 2004. Below is an update description for clarification purposes:



Revenue Recognition



The Company recognizes revenue on sales contracts upon the transfer of title of the product from the Company to the customer. In the vast majority of the
Companys sales contracts, the transfer of title occurs upon shipment of the product from the Companys facility however, in certain sales contracts, transfer of title may occur upon receipt or upon acceptance by the customer.
Additionally, should there be a third party financing company involved in a sales contract and there is incremental risk in the sales contract (lease agreement) as compared to a sales contract where there is no third party leasing company involved
in the transaction, the Company recognizes revenue over the life of the lease.



Property and Equipment



The Company records depreciation expense on its demonstration equipment to sales and marketing expense as the Company uses demonstration equipment as a marketing tool and does not hold demonstration equipment for resale.



Reclassifications



Certain reclassifications have been made to prior period amounts to be
consistent with current period presentation.



Recently Issued Accounting
Pronouncements



In December 2004, the FASB issued SFAS No.
123R,Share-Based Payment, which replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123R requires
compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on fair value on the grant date of the equity or liability
instruments issued. Compensation cost will be recognized over the period that an employee provides service for that award. This new standard will be effective for us beginning January 1, 2006.



In May 2005, SFAS No. 154, Accounting Changes and Error
Corrections, was issued. This statement applies to all voluntary changes in accounting principle and requires retrospective application to prior periods financial statements of changes in accounting principle, unless this would be
impracticable. This statement also makes a distinction between retrospective application of an accounting principle and the restatement of financial statements to reflect the correction of an error. This statement is
effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company is evaluating the effect the adoption of this interpretation will have on its financial position, cash flows and results
of operations.



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



For the six months ended June 30, 2005, there were no material changes from the disclosures made in our Form 10-K for the year ended December 31, 2004. We
maintain our funds as cash or cash equivalents, primarily in money market investments with a maturity of less than 90 days. We invested these funds at an average interest rate of 2.8% for the second quarter of 2005. These investments are not subject
to interest rate risk.



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Item 4. Disclosure Controls and Procedures.



(a)Evaluation of disclosure controls and procedures. Based on an evaluation as of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer have concluded that our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act) were effective to ensure that information required to be disclosed by us in reports that we file
or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in Securities and Exchange Commission rules and forms.



In March 2005, we restated our financial results for the years ended December 31, 2003 and 2002 and for the quarters ended
June 30, 2004 and June 30, 2004 to reflect adjustments to our previously reported financial results. The restatements arose out of an investigation by the Audit Committee.



As a result of the investigation, the Audit Committee determined that we had incorrectly recorded revenue on sales contracts
that included commitments for as yet undeveloped software upgrade applications for which vendor specific objective evidence (VSOE) for the fair value had not yet been established. The Audit Committee further determined that the we had
incorrectly recorded revenue on certain sales contracts upon shipment rather than recording revenue when customer acceptance criteria had been met; and on certain other transactions where the we had recorded revenue upon shipment of sales with
participation by a third party financing company, but had not met all the revenue recognition criteria necessary to recognize revenue. In addition, the Audit Committee determined that we had incorrectly recorded revenue on certain transactions where
additional revenue on extended warranty/post customer support (software maintenance and service) arrangements were inappropriately recognized resulting in incorrect revenue being recognized and/or deferred at the time of product shipment.



As a result, the Audit Committee concluded that we had
material weaknesses in our system of internal controls as follows:



| |  |  | We did not have a policy for mandatory disclosures in sales contracts including disclosures for commitments for as not yet developed software applications and had not properly
trained sales personnel and management on sales contract disclosure or on SOP 97-2 (Statement of Position 97-2, Software Revenue Recognition);
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Personnel reviewing sales contracts were not qualified or properly trained to review sales contracts particularly as they related to SOP 97-2 and customer acceptance criteria.
Furthermore, the review was not a formalized process.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Audit Committee therefore directed management to implement a number of additional measures designed to further ensure that our financial results are reported accurately. These measures included:



| |  |  | The adoption of a disclosure policy to insure that all commitments to customers in a sales contract are fully disclosed so we could correctly account for the sales contract;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The hiring of a sales contracts administrator who will review all sales contracts and identify all commitments to customers to insure that sales contracts are properly accounted
for;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The adoption of a future software commitment policy so our sales personnel have guidelines regarding future software application commitments to customers;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The adoption of an updated revenue recognition policy which specifically addresses SOP 97-2 as it relates to our business;
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | The prioritization of hiring a new Chief Financial Officer;
| | - |  | -----------------------------------------------------------



| |  |  | The planned realignment of the international sales order processing and finance function to move these functions from our UK affiliate to our US head quarters;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The education of our management and sales force on these new policies and procedures.
| | - |  | -------------------------------------------------------------------------------------



The status of the implementation of these measures is as follows:



In Q4 2004, we



| |  |  | incorporated sales contract disclosure requirements in our newly adopted revenue recognition policy;
| | - |  | ----------------------------------------------------------------------------------------------------



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| |  |  | engaged the services of a lawyer to serve as our contracts administrator. The contracts administrator reviews all sales contracts and identifies all commitments to customers in the
contract to insure that sales contracts are properly accounted for;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | adopted a new revenue recognition policy which specifically addresses SOP 97-2 as it relates to our business.
| | - |  | -------------------------------------------------------------------------------------------------------------



In Q1 2005, we



| |  |  | hired a Chief Financial Officer;
| | - |  | --------------------------------



| |  |  | moved our international sales contract and order processing function to our US headquarters;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | conducted extensive training of our management and sales force on all new policies and procedures regarding sales contract disclosure and our new revenue policy;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | adopted disclosure checklists to be completed by the sales representative on each sales contract.
| | - |  | -------------------------------------------------------------------------------------------------



In Q2 2005, we



| |  |  | relocated our international finance function to our US headquarters.
| | - |  | --------------------------------------------------------------------



We believe that with these implemented changes to our system of internal controls, our disclosure controls and procedures are adequate to provide
reasonable assurance that the information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported, within the time periods specified in the SECs rules and forms, and that such information is
accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of disclosure
controls and procedures in Rule 13-a-14(c). However, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within our Company have been detected.
These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake.



(b) Changes in internal control over financial reporting. During the last fiscal quarter of 2004 and the first and
second quarters of 2005, as described in section (a) we initiated a number of actions to improve our system of internal controls over revenue recognition. Other than the actions to improve our internal controls over revenue recognition, there were
no changes in our internal control over financial reporting or in other factors during the second fiscal quarter of 2005 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.



PART II - OTHER INFORMATION



Item 1. Legal Proceedings



We are not a party to
any material legal proceedings.



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



We held our Annual Meeting of Stockholders on May 19, 2005.



At our Annual Meeting, the stockholders elected the following individuals as Class III directors to serve for terms of three years on our Board of Directors until our 2008 Annual Meeting of Stockholders or until their
successors are duly qualified and elected:



|                        |  |            |  |         
|----------------------- |  | ---------- |  | --------
|Name                    |  | Votes For  |  | Withheld
|Andre F. Marion         |  | 12,929,463 |  | 92,966  
|                        |  |           
|Pablo Valenzuela, Ph.D. |  | 12,901,112 |  | 121,317 



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Our stockholders also authorized our Board of Directors to effect up to a 1-for-4 reverse stock split.
The number of shares for, against, and abstaining were 12,825,779, 176,404, and 20,246, respectively.



Item 6. Exhibits.



(a) Exhibits.



|            |  |                                                                                                                                                
|----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                    
|31.1        |  | Chief Executive Officers Certification Pursuant to 15 U.S.C. Section 7241                                                                     
|            | 
|31.2        |  | Chief Financial Officers Certification Pursuant to 15 U.S.C. Section 7241                                                                     
|            | 
|32.1        |  | Certificate of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|            | 
|32.2        |  | Certificate of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



APPLIED IMAGING
CORP.



SIGNATURES



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



|                     |  |                                    |  |                        
|-------------------- |  | ---------------------------------- |  | -----------------------
|                     |  | APPLIED IMAGING CORP. (Registrant)
|                     |  |                                   
|Date: August 8, 2005 |  | By:                                |  | /S/ ROBIN STRACEY      
|                     |  |                                    |  | Robin Stracey          
|                     |  |                                    |  | Chief Executive Officer





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