<PAGE>
 
              UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                          WASHINGTON,  D.C.  20549

                                  FORM 10-Q
                                        

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED September 30, 1998.


                                       OR


[_]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________ TO
     ______________.


                        COMMISSION FILE NO.  0-21371


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


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

                         2380 WALSH AVENUE, BUILDING B
                         SANTA CLARA, CALIFORNIA 95051
          (Address of principal executive offices, including zip code)

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



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

As of October 31, 1998, 11,520,735 shares of the Registrant's Common Stock were
outstanding.
<PAGE>
 
                             APPLIED IMAGING CORP.

                                     INDEX
<TABLE>
<CAPTION>

                                                                                   Page
                                                                                   ----

                         PART I.  FINANCIAL INFORMATION
                         ------------------------------
Item 1.  Financial Statements
<S>                                                                     <C>   
 
                Condensed Consolidated Balance Sheets
                September 30, 1998 and December 31, 1997.    .    .    .    .    .    3
 
                Condensed Consolidated Statements of Operations
                Three and Nine months ended September  30, 1998 and 1997    .    .    4
 
                Condensed Consolidated Statements of Cash Flows
                Nine months ended September 30, 1998 and 1997.    .    .    .    .    5
 
                Notes to Condensed Consolidated Financial Statements   .    .    .  6-8
 
Item 2.  Management's Discussion and Analysis of
         Financial Condition and Results of Operations .    .     .    .    .    . 9-11
 
                          PART II.  OTHER INFORMATION
                          ---------------------------

Item 6.  Exhibits and Reports on Form 8-K    .    .    .    .    .    .    .    .    12

         Signatures .    .    .    .    .    .    .    .    .    .    .    .    .    13
</TABLE> 

                                       2
<PAGE>
 
PART I.  FINANCIAL INFORMATION
------------------------------

ITEM 1.  FINANCIAL STATEMENTS

                             APPLIED IMAGING CORP. AND SUBSIDIARIES
                             CONDENSED CONSOLIDATED BALANCE SHEETS
                                         (In thousands)
                                           (Unaudited)
<TABLE> 
<CAPTION> 
                                                                            September 30,         December 31,           
                                                                                1998                  1997                
                                                                         ------------------    ------------------
ASSETS
<S>                                                                             <C>                     <C> 
Current assets:
          Cash and cash equivalents                                       $          5,608      $          2,918        
          Short term investments                                                     7,432                 5,460        
          Trade accounts receivable, net                                             3,184                 3,358        
          Inventories                                                                1,334                   849        
          Prepaid expenses and other assets                                            424                   268        
                                                                         ------------------    ------------------
                   Total current assets                                             17,982                12,853     
Property and equipment, net                                                          1,663                 1,793         
Other assets, net                                                                       81                    68         
                                                                         ------------------    ------------------
                   TOTAL ASSETS                                           $         19,726      $         14,714         
                                                                         ==================    ==================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
          Current portion of bank debt                                               $ 518                 $ 333     
          Accounts payable                                                           1,476                 1,754     
          Accrued expenses                                                           2,711                 2,434     
          Deferred revenue                                                             959                 1,161     
                                                                         ------------------    ------------------
                   Total current liabilities                                         5,664                 5,682     
          Other long-term obligations                                                   71                    89     
                                                                         ------------------    ------------------
                   Total liabilities                                                 5,735                 5,771     

Stockholders' equity:

          Common stock                                                                  12                     8     
          Additional paid-in capital                                                41,099                29,636     
          Deferred compensation                                                       (514)                 (801)    
          Other comprehensive loss                                                    (367)                 (367)    
          Accumulated deficit                                                      (26,239)              (19,533)    
                                                                         ------------------    ------------------
                   Total stockholders' equity                                       13,991                 8,943     
                                                                         ------------------    ------------------
                   TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY             $         19,726      $       $ 14,714 
                                                                         ==================    ==================
</TABLE> 
    See accompanying notes to condensed consolidated financial statements.

                                       3
<PAGE>
 
                     APPLIED IMAGING CORP. AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                     ( in thousands, except per share data)
                                 (Unaudited)
<TABLE> 
<CAPTION> 
                                                      Three months ended                Nine months ended 
                                                         September 30,                     September 30,
                                               --------------------------------  --------------------------------
                                                     1998             1997             1998             1997
                                               ---------------  ---------------  ---------------   --------------
<S>                                             <C>              <C>              <C>                    <C> 
Revenues                                        $       2,639    $       2,750    $       8,608     $      9,641
Cost of revenues                                        1,340            1,315            4,216            4,466
                                               ---------------  ---------------  ---------------   --------------
          Gross profit                                  1,299            1,435            4,392            5,175
                                               ---------------  ---------------  ---------------   --------------

Operating expenses:
          Research and development                      1,707            2,267            5,158            5,519
          Sales and marketing                           1,171            1,061            3,767            2,767
          General and administrative                      736              622            2,191            2,408
          Restructuring costs                               -                -              353                -
                                               ---------------  ---------------  ---------------   --------------
                   Total operating expenses             3,614            3,950           11,469           10,694
                                               ---------------  ---------------  ---------------   --------------
                   Operating loss                      (2,315)          (2,515)          (7,077)          (5,519)

Other income (expense), net                               213               90              371              258
                                               ---------------  ---------------  ---------------   --------------

          Net loss                              $      (2,102)   $      (2,425)   $      (6,706)    $     (5,261)
                                               ===============  ===============  ===============   ==============
Net loss per share - basic and diluted          $       (0.18)   $       (0.32)   $       (0.72)    $      (0.73)
                                               ===============  ===============  ===============   ==============
Shares used in computing basic and
   diluted net loss per share                          11,448            7,634            9,277            7,209
                                               ===============  ===============  ===============   ==============
</TABLE> 
    See accompanying notes to condensed  consolidated financial statements.

                                       4
<PAGE>
 
                    APPLIED IMAGING CORP. AND SUBSIDIARIES
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                (In thousands)
                                  (Unaudited)
<TABLE> 
<CAPTION> 
                                                                                Nine months ended September 30,
                                                                                  1998                   1997
                                                                           ----------------       ----------------
<S>                                                                            <C>                      <C> 
CASH FLOWS FROM OPERATING ACTIVITIES:
       Net Loss                                                             $       (6,706)        $       (5,261)
       Adjustments to reconcile net loss to
       net cash used by operating activities:
           Depreciation and Amortization                                               644                    500
           Compensation expense on stock options                                       287                    287
           Loss on sale of fixed assets                                                  5                     29
           Unrealized gain                                                               -                      4
           Changes in operating assets and liabilities:
               Accounts receivable, net                                                174                   (896)
               Inventories                                                            (485)                  (323)
               Prepaid expenses and other assets                                      (156)                    84
               Accounts payable                                                       (278)                  (215)
               Accrued expenses                                                        177                    470
               Deferred revenue                                                       (202)                   (27)
                                                                           ----------------       ----------------
           Net cash (used) by operating activities:                                 (6,540)                (5,348)
                                                                           ----------------       ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
       Purchases of property and equipment                                            (543)                  (916)
       Purchase of marketable securities                                            (6,181)                (3,815)
       Sales of marketable securities                                                4,209                      -
       Proceeds from sale of fixed assets                                               24                      -
       Other assets                                                                    (13)                    (1)
                                                                           ----------------       ----------------
           Net cash provided (used) by investing activities:                        (2,504)                (4,732)
                                                                           ----------------       ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
       Bank loan proceeds (payments), net                                              167                    (43)
       Proceeds from Issuance of Common Stock                                       11,567                  4,043
                                                                           ----------------       ----------------
           Net cash provided by financing activities:                               11,734                  4,000
                                                                           ----------------       ----------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                 2,690                 (6,080)
Cash and cash equivalents at beginning of period                                     2,918                 12,318
                                                                           ----------------       ----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD                                  $        5,608         $        6,238
                                                                           ================       ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
           Interest paid during period                                      $           72         $           32
                                                                           ================       ================
</TABLE> 
DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:

Proceeds from Issuance of Common Stock include an accrual of $100 for estimated
private placement costs.

    See accompanying notes to condensed consolidated financial statements.

                                       5
<PAGE>
 
                     APPLIED IMAGING CORP. AND SUBSIDIARIES

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (UNAUDITED)
                                        

NOTE I - BASIS OF PRESENTATION
------------------------------

     The accompanying condensed consolidated financial statements include the
accounts of Applied Imaging Corp. and subsidiaries (the "Company") for the three
and nine months ended September 30, 1998 and 1997.  These financial statements
are unaudited and reflect all adjustments, consisting only of normal recurring
adjustments, which are, in the opinion of management, necessary for a fair
presentation of the Company's financial position, operating results and cash
flows for those interim periods presented.  The results of operations for the
three and nine months ended September 30, 1998 are not necessarily indicative of
results to be expected for the fiscal year ending December 31, 1998.  These
condensed consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto, for the year ended
December 31, 1997, contained in the Company's 1997 annual report on Form 10K.


NOTE 2 - INVENTORIES (IN THOUSANDS)
----------------------------------

Balances as of          September 30, 1998      December 31, 1997
                       --------------------    --------------------    

Raw Materials                      $ 1,182                   $ 721   
Work in process                        104                      85      
Finished goods                          48                      43
                       --------------------    --------------------    
Total                              $ 1,334                   $ 849
                       ====================    ====================    

NOTE 3 - LOSS PER SHARE
-----------------------

     The company has reported losses per share in accordance with the Financial
Accounting Standards Board (FASB) Statement of Financial Accounting Standards,
(SFAS) No. 128 "Earnings Per Share."  SFAS No. 128 requires the presentation
of basic earnings per share ("EPS") and, for companies with complex capital
structures (or potentially dilutive securities, such as convertible debt,
options and warrants), diluted EPS.

     There were no reconciling items of the numerators and denominators of the
basic and diluted EPS computation.  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:

Balances as of          September 30, 1998      December 31, 1997
                       --------------------    --------------------    
Options                          1,198,190               1,036,998
Warrants                           577,909                 681,744     
                       --------------------    --------------------    
Total                            1,776,099               1,718,742       
                       --------------------    --------------------    

     As of September 30, 1998 the options and warrants excluded from the
computation of EPS had  weighed average exercise prices of $2.51 and $5.17,
respectively.

                                       6
<PAGE>
 
NOTE 4 - RECENT ACCOUNTING PRONOUNCEMENTS
-----------------------------------------

     In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information".  The Statement requires that a public
business enterprise report financial and descriptive information about its
reportable operating segments on the basis that is used internally for
evaluating segment performance and deciding how to allocate resources to
segments.

     SFAS No. 131 is effective for annual financial statements for periods
beginning after December 15, 1997 and for interim periods after the first year
of adoption.  The Company has yet to determine the impact of adopting its
disclosure requirement.

     Effective January 1, 1998 the Company adopted the provisions of SFAS No.
130, "Reporting of Comprehensive Income". SFAS No. 130 establishes standards for
the display of comprehensive income and its components in a full set of
financial statements. Comprehensive income includes all changes in equity during
a period except those resulting from the issuance of stock and distributions to
stockholders. There were no material differences between net loss and
comprehensive loss during the quarter and nine months ended September 30, 1998
and 1997.


NOTE 5 - PRIVATE PLACEMENT TRANSACTIONS
---------------------------------------

     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.

NOTE 6 - RESTRUCTURING COSTS
----------------------------

     During the quarter ended June 30, 1998, plans were developed to reduce
costs by eliminating thirteen positions in the Company. The reductions were made
at both the United States and United Kingdom facilities. The consolidated
statement of operations includes $353,000 of pretax charges relating to the
severance costs of these employees. During the quarter ended September 30, 1998
the Company paid approximately $325,000 of these restructuring costs.

                                       7
<PAGE>
 
NOTE 7 - PREFERRED SHARES  RIGHTS AGREEMENT
-------------------------------------------

     On June 8, 1998, the Board of Directors adopted a Shareholders Rights
Agreement ("Rights Agreement"). Under the Rights Agreement, the Company declared
a dividend distribution of one Preferred Share Purchase Right ("Right") on each
outstanding share of the Company's Common Stock held by stockholders of record
at the close of business on June 15, 1998.  The dividend was distributed on June
24, 1998 and the Rights expire on March 27, 2008.  Each Right  will entitle
stockholders to buy one share of the Company's Series A Participation Preferred
Stock at an exercise price of $50.00.  The Rights will become exercisable
following the tenth day after a person or group announces an acquisition of 20%
or more of the Company's Common Stock or announces commencement of a tender
offer the consummation of which would result in ownership by the person or group
of 20% or more of the Common Stock. The Company will be entitled to redeem the
Rights at $.01 per Right at any time on or before the tenth day following the
acquisition by a person or group of 20% or more of the Company's Common Stock.

NOTE 8 - WARRANTS
-----------------

     During the quarter ended September 30, 1998, the Company offered to extend
the term of 368,734 warrants to purchase shares of Common Stock at $5.25 per
share for one year. The warrants were scheduled to expire on July 28, 1998. In
exchange for $.09 per share, the fair market value per warrant as of July 28,
1998, the Company extended the expiration date to July 28, 1999. The Company
received $23,841 to extend 264,899 warrants. The balance of the
warrants,103,835, expired on July 28, 1998.

                                       8
<PAGE>
 
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

     The following discussion should be read in conjunction with the attached
condensed consolidated financial statements and notes thereto, and with the
Company's audited financial statements and notes thereto for the fiscal year
ended December 31, 1997.

     The information set forth 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  under "Item one" in the Company's  annual report on form
10-K for the fiscal year ended December 31, 1997.


RESULTS OF OPERATIONS

Revenues.  The Company's revenues are derived primarily from the sale of
products and software maintenance and instrument service contracts. Revenues for
the three and nine months ended September 30, 1998 were $2.6 million and $8.6
million, respectively, compared to $2.8 million and $9.6 million for the
corresponding periods in the prior year. The decreases over the prior year
periods are primarily attributable to the economic crisis in Asia as well as
lower sales in North America.

Cost of revenues.  Cost of revenues includes direct material and labor costs,
manufacturing overhead, installation costs, warranty related expenses and post-
warranty service and application support expenses. Costs of revenues, as a
percentage of total revenues, for the three and nine months ended September 30,
1998 were 51% and 49%, respectively, compared to 48% and 46% for the
corresponding periods of the prior year. The increases are primarily due to
lower selling prices, as a result of increased price competition for the
cytogenetic instrumentation products, and lower service revenues.

Research and development expenses.  Research and development expenses consist of
research and development relating to new products as well as software
development costs to upgrade existing products. Research and development
expenses for the three and nine months ended September 30, 1998 were $1.7
million and $5.2 million, respectively, compared to $2.3 million and $5.5
million over the corresponding prior year periods. Such expenses were 65% and
60% of total revenues for the three and nine months ended September 30, 1998
respectively, compared to 82% and 57% in the corresponding prior year periods.
The decreases for the quarter and year to date are primarily due to costs
savings programs.

Sales and marketing expenses.  Sales and marketing expenses consist primarily of
salaries, commissions and related travel expenses of the Company's direct sales
force, as well as commissions paid to independent international sales agents.
Sales and marketing expenses for the three and nine months ended September 30,
1998 were $1.2 million and $3.8 million respectively, increasing $110,000 and
$1.0 million over the corresponding prior year periods. These increases are
principally attributable to higher staffing levels. As a percentage of revenues,
sales and marketing expenses were 44% of total revenues for the three and nine
months ended September 30, 1998 compared to 39% and 29% in the corresponding
prior year periods.

General and administrative expenses.  General and administrative expenses
consist primarily of payroll costs associated with the Company's management and
administrative personnel, travel 

                                       9
<PAGE>
 
expenses, and legal, accounting and compliance costs. General and administrative
expenses were $736,000 and $2.2 million for the three and nine months ended
September 30, 1998, compared to $622,000 and $2.4 million over the prior year
periods. The decrease for the three and nine months is primarily due to lower
staffing levels and lower costs for recruiting and relocation.

Restructuring costs.  A restructuring charge of $353,000 was accrued in the
quarter ended June 30,1998. The charge reflects the severance costs for thirteen
employees.

FACTORS THAT MAY AFFECT FUTURE RESULTS

     The Company's operating results may vary significantly depending on certain
factors, including the effect of delays in its research and development program,
adverse results in its clinical studies, delays 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, and the factors set forth in the Company's annual report on form
10-K for the fiscal year ended December 31, 1997.

     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

     The Company strengthened it financial position during the quarter ended
September 30,  raising $1.5 million of additional equity via a private placement
of its Common Stock.  At September 30, 1998, the Company had cash, cash
equivalents and securities available for sale of  $13.0 million and  working
capital of $12.3 million. Cash used by operations for the nine months ended
September 30, 1998 was $6.5 million compared to $5.3 million for the
corresponding prior year period. The increase in cash used in operations is
primarily due to increased losses as explained above. In addition, the Company
consumed $543,000 for purchases of capital equipment compared to $916,000 for
the prior year period.

     The Company expects negative cash flow from operations to continue into at
least 2000, as it continues the development of its fetal cell technology,
conducts clinical trials required for FDA clearance of the DNA probe portion of
that technology, expands its marketing, sales and customer support capabilities,
and adds administrative infrastructure.* The Company currently estimates that
its capital resources will enable it to sustain operations through 1999*. 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 investigation, 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 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.*

                                       10
<PAGE>
 
No assurance can be given 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 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.*

     The Company accrued a $353,000 restructuring charge in the quarter ended
June 30, 1998. During the three months ended September 30, 1998, the Company
paid $325,000 of these costs.

  YEAR 2000 COMPLIANCE
 
  The Company is aware of the issues associated with the programming code in
existing computer systems as the year 2000 approaches. The "year 2000 problem"
is pervasive and complex as virtually every computer operation will be affected
in some way by the rollover of the two-digit year value to 00. The issue is
whether computer systems will properly recognize date sensitive information when
the year changes to 2000. Systems that do not properly recognize such
information could generate erroneous data or cause a system to fail. Management
is in the process of working with its software vendors to assure that the
Company is prepared for the year 2000.* Management does not anticipate that the
Company will incur significant operating expenses or be required to invest
heavily in computer systems improvements to be year 2000 compliant.* However,
significant uncertainty exists concerning the potential costs and effects
associated with any year 2000 compliance. The Company is in the process of
implementing an upgrade to its management information system that the Company
believes is year 2000 compliant.* Any year 2000 compliance problem of either the
company or its suppliers or partners or customers, could materially adversely
affect the Company's business, results of operation, financial condition and
prospects*.

                                       11
<PAGE>
 
PART II  -  OTHER INFORMATION
-----------------------------

ITEM 6:  EXHIBITS AND REPORTS ON FORM 8-K

     (a) Exhibit
         -------

         Exhibit 27.1-Financial Data Schedule

     The following report on Form 8-K was filed during the period for  which
this report is filed:

     (b) Reports on Form 8-K
         -------------------
 
     The Company filed a Form 8-K on July 28, 1998, announcing that on July 7,
1998 and July 15, 1998 , it consummated private sales of, collectively, 499,999
shares of its Common Stock to certain accredited investors at a purchase price
of $3.00 per share, which exceeded each such day's closing price of the
Company's Common Stock as reported on the Nasdaq National Market System.

                                       12
<PAGE>
 
                             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 its behalf by the
undersigned thereunto duly authorized.



                                                 APPLIED IMAGING CORP.
                                                     (Registrant)



 
Date: November 12, 1998             By:  /S/ JACK GOLDSTEIN
                                         -------------------------    
                                         Jack Goldstein
                                         President and
                                         Chief Executive Officer
 
                                    By:  /S/ MICHAEL J. BRADEN
                                         -------------------------    
                                         Michael J. Braden
                                         Chief Accounting Officer
 

                                       13