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

              [ ] 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: 1-14190

                        INTELLIGENT MEDICAL IMAGING, INC.

             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

          DELAWARE                                        65-0136178
    (STATE OR OTHER JURISDICTION              (IRS EMPLOYER IDENTIFICATION  NO.)
 OF INCORPORATION OR ORGANIZATION)

     4360 NORTHLAKE BOULEVARD, SUITE 214, PALM BEACH GARDENS, FLORIDA 33410
              (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE)

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (561) 627-0344

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 NOVEMBER  12, 1998,  THERE WERE  OUTSTANDING  11,583,333  SHARES OF COMMON
STOCK, PAR VALUE $.01, OF THE REGISTRANT.



<PAGE>
                        INTELLIGENT MEDICAL IMAGING, INC.

                        QUARTER ENDED SEPTEMBER 30, 1998

                                      INDEX

                                                                            PAGE

PART I - FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS (Unaudited)

           CONDENSED BALANCE SHEETS AS OF
           SEPTEMBER 30, 1998 AND DECEMBER 31, 1997                          3

           CONDENSED STATEMENTS OF OPERATIONS FOR THE THREE
           AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997                 4

           CONDENSED STATEMENTS OF CASH FLOWS FOR
           THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997                 5

           NOTES TO CONDENSED FINANCIAL STATEMENTS                           6

ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL                 9
                      CONDITION AND RESULTS OF OPERATIONS

PART II - OTHER INFORMATION                                                 15

           ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K                      15

SIGNATURES                                                                  16

<PAGE>


<TABLE>
<CAPTION>
                         PART I - FINANCIAL INFORMATION

ITEM 1.  CONDENSED FINANCIAL STATEMENTS

                        INTELLIGENT MEDICAL IMAGING, INC.
                            CONDENSED BALANCE SHEETS

                                                                          September 30,            December 31,
                                                                               1998                    1997
                                                                         -----------------       -----------------
                                                                           (Unaudited)

Assets
Current assets:                                                           
<S>                                                                              <C>                     <C>     
     Cash and cash equivalents                                                   $437,726                $853,164
     Investments available for sale                                                     0               6,230,009
     Accounts receivable, net                                                     209,207                 671,905
     Notes receivable related party                                               223,232                       0
     Accrued interest receivable                                                        0                  13,151
     Inventory                                                                  5,092,010               5,933,815
     Prepaid expenses                                                             113,033                  61,799
     Current portion of investment in sales-type leases                           113,808                 222,213
                                                                         -----------------       -----------------
Total current assets                                                            6,189,016              13,986,056

Revenue equipment, net                                                            306,096                 263,632
Property and equipment, net                                                     2,865,559               2,789,693

Long-term portion of investment in sales-type leases                              435,326                 240,145
Deferred financing costs                                                          106,700                       0
Other assets                                                                      178,033                 126,883
                                                                         -----------------       -----------------
                                                                              $10,080,730             $17,406,409
                                                                         =================       =================


Liabilities and stockholders' equity Current liabilities:
     Accounts payable                                                          $1,230,904              $1,298,811
     Accrued salaries and benefits                                                313,635                 394,190
     Other accrued liabilities                                                    217,600                 101,816
     Current portion of deferred revenue                                          105,210                  74,673
                                                                         -----------------       -----------------
Total current liabilities                                                       1,867,349               1,869,490

Deferred revenue                                                                  434,542                 219,574
Convertible debentures, net of unamoritized discount of $662,036                2,337,964                       0


Stockholders' equity
Preferred stock, $.01 par value-authorized 2,000,000 shares;
     no shares issued or outstanding                                                    0                       0
Common stock, $.01 par value-authorized 30,000,000 shares;
     issued and outstanding, 11,583,333 shares at September 30, 1998
     and 11,023,938 shares at December 31, 1997                                   115,834                 110,239
Additional paid-in capital                                                     43,671,440              42,537,633
Deferred compensation                                                           (158,313)               (228,252)
Accumulated deficit                                                          (38,188,086)            (27,102,275)
                                                                         -----------------       -----------------
Total stockholders' equity                                                      5,440,875              15,317,345
                                                                         -----------------       -----------------
                                                                              $10,080,730             $17,406,409
                                                                         =================       =================

See accompanying notes

</TABLE>

<PAGE>



<TABLE>
<CAPTION>


                        INTELLIGENT MEDICAL IMAGING, INC.
                       CONDENSED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)



                                                Three months        Three months       Nine months         Nine months
                                                    ended              ended              ended               ended
                                                September 30,      September 30,      September 30,       September 30,
                                                    1998                1997               1998               1997
                                             ------------------------------------------------------------------------------

<S>                                                     <C>                <C>              <C>                 <C>       
Sales                                                   $633,808           $431,516         $2,113,403          $2,843,559

Cost of sales                                            661,331            352,578          1,765,563           1,647,799
                                             ------------------------------------------------------------------------------
                                                        (27,523)             78,938            347,840           1,195,760

Operating expenses:
     Selling, general and administrative               2,058,338          2,469,323          7,009,123           6,042,244
     Research and development                          1,275,259            931,423          4,047,256           2,733,469
                                             ------------------------------------------------------------------------------
Total operating expenses                               3,333,597          3,400,746         11,056,379           8,775,713
                                             ------------------------------------------------------------------------------
Loss from operations                                 (3,361,120)        (3,321,808)       (10,708,539)         (7,579,953)

Other (expense) income:
     Investment and interest income                       37,480            207,240            132,047             872,202
     Interest expense                                  (478,314)                  0          (478,314)                   0
                                             ------------------------------------------------------------------------------
Other (expense) income                                 (440,834)            207,240          (346,267)             872,202
                                             ------------------------------------------------------------------------------

Net loss                                            $(3,801,954)       $(3,114,568)      $(11,054,806)        $(6,707,751)
                                             ==============================================================================

Loss per common share-basic and diluted                  $(0.33)            $(0.28)            $(0.97)             $(0.61)
                                             ==============================================================================
Weighted average common
     shares outstanding                               11,583,334         10,975,109         11,359,499          10,930,096
                                             ==============================================================================

See accompanying notes


</TABLE>

<PAGE>



<TABLE>
<CAPTION>


                        INTELLIGENT MEDICAL IMAGING, INC.
                       CONDENSED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)


                                                                Nine months             Nine months
                                                                   ended                   ended
                                                               September 30,           September 30,
                                                                   1998                    1997
 Operating activities
<S>                                                              <C>                      <C>         
 Net loss                                                        $(11,054,806)            $(6,707,752)
 Adjustments to reconcile net loss
      to net cash used in operating activities:
           Depreciation                                                970,134                 509,531
           Recognition of deferred revenue                            (78,041)                       0
           Amortization of discount on convertible                                    
            debentures and deferred financing costs                    478,314                       0
           Services exchanged for common stock                          69,939                  69,939
           Changes in operating assets and liabilities
                Accounts receivable                                    462,698             (1,251,420)
                Inventory                                              288,930             (3,432,376)
                Prepaid expenses and accrued interest         
                     receivable                                       (38,083)                (35,100)
                Investment in sales-type leases                       (86,776)                       0
                Other assets                                          (51,150)                (99,312)
                Revenue equipment                                     (42,464)                       0
                Accounts payable                                      (67,907)                 (7,449)
                Accrued salaries and benefits                         (80,555)                 183,207
                Accrued interest payable                                     0               (421,132)
                Other accrued liabilities                              115,784                  58,156
                Deferred revenue                                       323,546                       0
                Contingent settlement liability                              0             (1,210,891)
                                                             ------------------      ------------------
 Net cash used in operating activities                             (8,790,437)            (12,344,599)

 Investing activities
 Purchases of property and equipment                                 (493,125)             (1,184,454)
 Sales of investments available for sale                             6,199,004              13,295,326
 Advances to related parties                                         (622,267)                       0
 Repayments on advances to related parties                             399,035                       0
                                                             ------------------      ------------------
 Net cash provided by investing activities                           5,482,647              12,110,872

 Financing activities
 Proceeds from issuance of common stock                                 92,352                 110,544
 Proceeds from issuance of convertible debentures, net
      of financing costs                                             2,800,000                       0
                                                             ------------------      ------------------
 Net cash provided by financing activities                           2,892,352                 110,544


 Net decrease in cash and cash equivalents                           (415,438)               (123,183)
 Cash and cash equivalents at beginning of period                      853,164                 288,001
                                                             ------------------      ------------------

 Cash and cash equivalents at end of period                           $437,726                $164,818
                                                             ==================      ==================

 Supplemental information

 Stock purchase warrants issued for financing costs                   $116,400                      $0
                                                             ==================      ==================

 Inventory transferred to property and equipment                      $552,875                $974,715
                                                             ==================      ==================

 See accompanying notes

</TABLE>


                        INTELLIGENT MEDICAL IMAGING, INC.
                     NOTES TO CONDENSED FINANCIAL STATEMENTS
                                   (UNAUDITED)


1.   BASIS OF PRESENTATION

The accompanying  unaudited condensed financial statements have been prepared in
accordance with generally accepted  accounting  principles for interim financial
information and with the  instructions to Form 10-Q and Article 10 of Regulation
S-X.  Accordingly,  they do not include  all of the  information  and  footnotes
required by generally  accepted  accounting  principles  for complete  financial
statements. In the opinion of management,  all adjustments (consisting of normal
recurring  accruals)  considered  necessary  for a fair  presentation  have been
included.  These financial statements,  footnotes and discussions should be read
in conjunction with audited financial  statements and related footnotes included
in Intelligent Medical Imaging, Inc.'s ("IMI" or "the Company") annual report on
Form 10-K for the year ended December 31, 1997. Operating results for the three-
and nine-month  periods ended September 30, 1998 are not necessarily  indicative
of the results that may be expected for the year ending December 31, 1998.

2.   REVENUE RECOGNITION

In October 1997, the American Institute of Certified Public Accountants  (AICPA)
issued Statement of Position (SOP) 97-2,  "Software Revenue  Recognition"  which
the Company has adopted for transactions  entered into during the year beginning
January 1, 1998. SOP 97-2 provides guidance for recognizing  revenue on software
transactions and supersedes SOP 91-1, "Software Revenue  Recognition".  In March
1998, the AICPA issued SOP 98-4,  "Deferral of the Effective Date of a Provision
of SOP 97-2, Software Revenue  Recognition".  SOP 98-4 defers, for one year, the
application  of  certain  passages  in SOP 97-2 which  limit what is  considered
vendor-specific  objective  evidence necessary to recognize revenue for software
licenses in  multiple-element  arrangements  when  undelivered  elements  exist.
Additional guidance is expected to be provided prior to adoption of the deferred
provision  of SOP 97-2.  The Company  will  determine  the impact,  if any,  the
additional guidance will have on the current revenue recognition  practices when
issued. Adoption of the remaining provisions of SOP 97-2 did not have a material
impact on revenue recognition during 1998.

3.   INVESTMENTS AVAILABLE-FOR-SALE

At September 30, 1998 all  investments  held for sale had been sold and realized
gains and losses of the investments are included in the statements of operation.
Investments  available-for-sale  at December 31, 1997  consisted of asset backed
securities,  corporate  bonds  and  U.S.  Government  agency  bonds.  Management
determines the proper  classifications  of investments in obligations with fixed
maturities  and  marketable  equity  securities  at the  time  of  purchase  and
re-evaluates  such  designations  as of each balance sheet date. At December 31,
1997, all securities were designated as available-for-sale.  Accordingly,  these
securities  are stated at fair market value,  with  unrealized  gains and losses
reported as a separate  component of  stockholders'  equity.  Realized gains and
losses on sales of  investments,  as  determined  on a  specific  identification
basis, are included in the statements of operations.

Investment securities available for sale at December 31, 1997, are summarized as
follows:

                                                      Unrealized    Market
                                          Cost           Gains      Value
                                        --------------------------------------

Cash and cash equivalents                 $164,708         $-        $164,708

U.S. Government agency bonds
  and mortgages                         $3,677,946       $5,466    $3,683,412

U.S. Corporate bonds and
  asset backed securities               $2,356,350      $25,539    $2,381,889

                                        ======================================
Total investments available-for-sale    $6,199,004      $31,005    $6,230,009
                                        ======================================


4.   PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

                                        September 30,           December 31,
                                            1998                    1997
                                       ----------------        ----------------
Furniture, fixtures and office          
     equipment                              $2,564,179              $1,403,234
Computer and development                
     equipment                               2,847,205               2,962,150
                                       ----------------        ----------------
                                             5,411,384               4,365,384
Accumulated depreciation                   (2,545,825)             (1,575,691)
                                       ----------------        ----------------
                                            $2,865,559              $2,789,693
                                       ================        ================

5.   NOTE RECEIVABLE RELATED PARTIES

In January 1998,  $196,000 was advanced to the Company's  President and $424,000
was  advanced  to an  individual  who was at that  time a member of the Board of
Directors. The advance of $196,000 to the Company's President,  plus all accrued
interest  thereon,  was repaid in full on August 14, 1998. The original due date
for the  advance  in the amount of  $424,000,  which is secured by shares of the
Company's  common  stock and  bears  interest  at the rate of prime  plus 1% per
annum,  was April 8, 1998.  During the  quarter  ended  September  30,  1998 and
through November 13, 1998 payments in the amount of $250,000,  including accrued
interest,  plus a $75,000 credit offset in consulting fees due the former member
of the Board of  Directors  have been made  leaving a balance of  $125,053.  The
balance of $125,053 has been extended to January 28, 1999.

6.   CONVERTIBLE DEBENTURES

On June 30,  1998  ("Original  Issue  Date") the  Company  issued,  in a private
placement  transaction,  $3,000,000 of 6% convertible  debentures,  due June 30,
2001 (the  "Debentures").  Subject to adjustment in certain events,  twenty-five
percent (25%) of the aggregate principal amount of the Debentures is convertible
into the common stock of the Company  beginning on September 28, 1998  ("Initial
Conversion Date") and on the first,  second and third month anniversaries of the
Initial Conversion Date up to 50%, 75% and 100%, respectively,  of the aggregate
principal amount of the Debentures  originally issued on the Original Issue Date
is  convertible.   The  Debentures  are   convertible  at  a  conversion   price
("Conversion  Price")  equal to the  lesser  of (a) 120% of the  average  of the
closing  bid price for the common  stock of the Company for the five (5) trading
days immediately  preceding the Original Issue Date or (b) 86% multiplied by the
average of the five (5)  lowest  closing  bid prices of the common  stock of the
Company during the twenty-five (25) trading days immediately  preceding the date
of the applicable  conversion  notice.  The Company  recorded a debt discount of
$906,250  representing the intrinsic value of the beneficial  conversion feature
of the  Debentures.  Interest is payable  quarterly  and may,  at the  Company's
option and subject to certain  restrictions,  be paid in shares of the Company's
common  stock based on the  Conversion  Price.  Subject to certain  notification
requirements  and the  payment  of a  prepayment  premium  which  is tied to the
applicable Conversion Price and the closing bid price of the common stock on the
date of  prepayment,  the  Company has the right to prepay all or any portion of
the outstanding principal amount of the Debentures which has not previously been
repaid or converted. The principal amount of the Debentures for which conversion
notices have not previously  been received or for which  prepayment has not been
made will be automatically converted on June 30, 2001 at the Conversion Price on
such date.  The Debentures may be converted in whole or in part at the option of
the holder if the average of the closing  sales  prices of the common  stock for
any twenty (20) consecutive trading days is equal to or greater than 175% of the
average of the per share market values for the five (5) trading days immediately
preceding the original issue date. The principal  amount of Debentures for which
conversion notices have not previously been received or for which prepayment has
not  been  made or  required  shall  be  automatically  converted  on the  third
anniversary  of the Original  Issue Date at the  Conversion  Price on such date.
This automatic  conversion  shall not occur if (a) (1) an Underlying  Securities
Registration  Statement is not then effective that names the holder as a selling
stockholder  thereunder or (2) the holder is not permitted to resell  underlying
shares  pursuant to Rule 144(k)  promulgated  under the  Securities Act of 1993,
without volume restrictions; (b) there are not sufficient shares of common stock
authorized and reserved for issuance upon such  conversion;  and (c) the Company
shall not have defaulted on its covenants and obligations hereunder or under the
Purchase  Agreement  or  Registration  Rights  Agreement.  The Company  incurred
financing  costs of $200,000 in connection  with the issuance of the Debentures,
which will be amortized over the life of the  Debentures.  On July 30, 1998, the
Company  filed a  registration  statement  on Form S-3 with the  Securities  and
Exchange  Commission  ("SEC")  to  register  the  common  stock  underlying  the
convertible   debentures  issued  in  connection  with  the  transaction.   This
registration  statement  was declared  effective by the SEC on October 20, 1998.
Additional capital  commitments of up to $7,000,000 are available to IMI subject
to the parties mutually agreeing on the terms.

In connection with the issuance of the  Debentures,  the Company issued warrants
to the holders of the  Debentures  to purchase  120,000  shares of the Company's
common  stock at $3.93 per share.  The  warrants  are  exerciseable  immediately
through June 30, 2003. The fair value of the warrants based on the Black-Scholes
valuation  method is $1.87.  The  Company  recorded a debt  discount of $224,400
representing the fair value of the warrants.

In addition,  the Company issued a warrant to a financial consultant to purchase
60,000 shares of the Company's  common stock at $3.63 per share.  The warrant is
exercisable  immediately  through June 30, 2003. The Company  recorded  deferred
financing costs of $116,400 in connection with the issuance of the warrant. Such
costs will be amortized over the term of the Debentures. The assumptions used to
compute the value of the warrants were as follows:

         Risk-free interest rate                     5.48%
         Volatility factors of the
         expected market price of the
         Company's common stock                      .598
         Expected life                               5 Years
         Dividend yield                              0%

7.   COMMITMENTS AND CONTINGENCIES

In November 1996, IMI and DiaSys Corporation  ("DiaSys") (Nasdaq,  DIYS) entered
into a Product Integration  Agreement (the "DiaSys Agreement").  DiaSys designs,
develops,  manufactures and distributes workstation products which prepare fluid
samples.   Under  the  DiaSys   Agreement,   IMI  was  granted  a  nonexclusive,
nontransferable   license  to  integrate  the  patented  DiaSys  wet-preparation
specimen  handling  system  together  with  the  MICRO21  in  order  to  produce
integrated  systems for resale to MICRO21 end users.  The DiaSys  Agreement  was
terminated  in July 1997,  when IMI  rejected  products  delivered by DiaSys and
returned  them.  The  DiaSys  Agreement   provides  for  mandatory  and  binding
arbitration of disputes between the parties. On January 12, 1998, DiaSys filed a
demand for  arbitration of the dispute.  In its demand for  arbitration,  DiaSys
seeks  damages in excess of $1,000,000  for IMI's  alleged  breach of the DiaSys
Agreement and IMI's alleged defamation of DiaSys and its products. IMI filed its
response on February 9, 1998. In its  response,  IMI denies that it breached the
DiaSys  Agreement  or defamed  DiaSys,  and  states  that it  properly  rejected
products supplied by DiaSys due to  non-conformance.  IMI also seeks damages for
libelous  statements  made by DiaSys in a July 2, 1997 press  release  issued by
DiaSys, and for delays in IMI's product  development  efforts caused by DiaSys's
breach of the DiaSys Agreement. On October 7, 1998 the arbitration hearings were
completed  and on November  6, 1998  written  arguments  were  presented  to the
arbitration  panel.  Management  is unable to make a meaningful  estimate of the
likelihood  or amount or range of loss that  could  result  from an  unfavorable
outcome of the pending  arbitration.  As of September 30, 1998,  the Company has
not accrued any loss  contingencies  or related expenses in connection with this
arbitration.  The Company  believes that DiaSys's claims are without merit,  and
that the  Company  will  prevail in the  arbitration.  However,  there can be no
assurance  that  the  Company  will  prevail  in  the   arbitration  or  in  its
counterclaim  asserted  against  DiaSys,  or that any resolution of the dispute,
which is expected  to occur  within one year,  will not have a material  adverse
effect  on  the  Company's   liquidity,   financial  condition  and  results  of
operations.

On  March  7,  1997,  the  Company  entered  into a  settlement  agreement  with
International  Remote Imaging Systems,  Inc.  ("IRIS")  effective March 1, 1997.
Under  the  settlement  agreement,   IRIS  granted  the  Company  a  fully-paid,
royalty-free  license for  worldwide  direct sales of the MICRO21  system by the
Company.  The Company  agreed to pay a 4 percent  royalty on future sales of the
MICRO21  system  through  third-party  distributors  in the United  States.  The
Company  does  not  believe  the  4  percent   royalty  on  U.S.  sales  through
distributors  will  significantly  adversely  impact  the  Company's  results of
operations during the term of the license.  This license and royalty  obligation
expire in  September  2000,  when the IRIS  patents  that are the subject of the
license expire. The Company has the right, but not the obligation,  to request a
license  from IRIS for sales  through  third-party  distributors  outside of the
United  States;  however,  the Company does not believe that the MICRO21  system
infringes any foreign  patents held by IRIS and the Company has no current plans
to request such a license.

8.   MANAGEMENT'S PLANS

The Company reported a net loss of approximately $10,899,000 for the nine-months
ended September 30, 1998, incurred cumulative losses from inception to September
30, 1998,  aggregating  approximately  $38,032,000,  and reported  negative cash
flows  from  operations  for  the  nine-months  ended  September  30,  1998,  of
approximately $8,790,000. At September 30, 1998, the Company had working capital
of   approximately   $4,272,000  and   shareholders'   equity  of  approximately
$5,597,000.  Costs and delays associated with the Company's efforts to build its
internal sales and service force in the wake of the termination of its exclusive
distribution  and  marketing  agreement  with  Coulter   Corporation   Agreement
adversely affected the Company's  business,  results of operations and financial
condition  in 1997  and  1998.  The  Company's  1998 and  1999  operating  plans
contemplate  focusing  activities on expanding sales revenue through the efforts
of its internal  sales,  marketing and service  force.  In addition,  during the
fourth  quarter of 1997 the Company began to offer a short-term  rental  program
which it believes will augment its sales and long-term  lease programs by giving
potential customers the ability to fund a MICRO21 with operating funds,  thereby
overcoming  potential  cost  barriers  associated  with limited or  non-existent
capital  expenditure  funds.  Expansion  of this  program may  require  that the
Company secure additional financing. During 1998, the Company has introduced two
new products, a Hematology Slide Maker and Urine Slide Maker, and two additional
procedures which management  believes will offer  significant  opportunities for
expanding the Company's  potential  customer  base. In addition,  the Company is
currently  negotiating with a company for distribution and licensing  agreements
associated  with  sales of the  Company's  products.  The  Company's  plans also
contemplate  cost control  measures  implemented  in 1998 and cost and personnel
reductions which reduce monthly  expenditures from approximately $1.1 million to
$850,000;  the cost  reductions  also include  closing the  Company's  office in
Europe in July, 1998. The Company's plans also contemplate  seeking  alternative
sources of financing and exploring strategic alternatives.

In June  1998,  the  Company  issued $3 million of  convertible  debentures.  An
additional  $7  million  of  financing  is  available  to the  Company,  but the
availability  of  such  financing  is at  the  discretion  of the  lender  after
consideration of the trading  characteristics  of the common stock, the lender's
exposure to the Company at that time, the absence of any material adverse change
in the Company's  financial  condition or operations and the Company's continued
compliance with the terms of the financing. The debentures include a requirement
that the  Company's  common  stock be listed for trading by Nasdaq.  The closing
price of the Company's  common stock has closed below the Nasdaq National Market
minimum  requirement on a consistent  basis,  resulting in the potential for the
stock to be delisted  from Nasdaq  which  would  constitute  an event of default
under the  convertible  debenture  agreement,  in which event the full principal
amount of the  debentures,  together with all accrued  interest  thereon,  would
become immediately due and payable in cash and the availability of the remaining
borrowing  capacity under the convertible  debenture  agreement could be further
limited.  The  Company is  considering  a reverse  stock  split to rectify  this
situation,  however, there can be no assurance that such action will achieve the
intended  result  or that  it will  satisfy  the  event  of  default  under  the
convertible debenture agreement.

The Company  continues to explore a variety of  alternatives  for increasing its
sales and  distribution  capacity  and  raising  sufficient  capital to fund its
operations.   Implementation   of  the  Company's   business  strategy  requires
significant expenditures of capital. The Company is currently seeking additional
funds through debt or equity.  There can be no assurance  that such funds can be
obtained on favorable terms, if at all.

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
         RESULTS OF OPERATIONS

OVERVIEW

The  Company  has  developed  and  is  marketing  the  MICRO21(TM)   system,  an
intelligent,  automated  microscope  system,  for  diagnostic  use in  hospital,
commercial  reference and physician  group  laboratories.  The MICRO21 system is
designed to automate a broad range of manual microscopic procedures, potentially
enabling the clinical  laboratory  to reduce costs and exposure to  liabilities,
enhance  analytical  accuracy  and  consistency,  increase the  productivity  of
medical technologists and improve patient care.

On April 20, 1998, the Company signed a customer financing  agreement with Prime
Capital Corp  ("Prime") to provide up to $36 million of financing  for customers
acquiring the MICRO21 System Workstation.  Under the terms of the agreement, the
Company and Prime will establish a wholesale customer finance relationship under
which Prime will provide a "Private Label Fee Per Slide"  financing  facility to
customers  of the  Company for an ongoing  vendor  leasing  program.  Prime will
provide up to $12  million of  customer  financing  per year over 3 years.  This
agreement  should help IMI to continue to meet its near-term cash flow needs and
provides a financing alternative for IMI's customers.

On June 30, 1998 the Company  completed the sale of $3,000,000 of 6% convertible
debentures,  due June 30, 2001.  See Footnote 6 of Notes to Condensed  Financial
Statements  in Part I, Item 1 of this  Form  10-Q.  The sale of the  convertible
debentures will help IMI to continue to meet its near-term cash flow needs.

On August 14, 1998 the Company  received full  repayment of all amounts due with
respect to an advance  which the  Company  made to the  Company's  President  in
January  1998 in the  amount of  $196,000.  With  respect  to  repayment  of the
Company's advance to a former director,  R. Wayne Fritzsche,  as of November 13,
1998  payments  in the  amount of  $250,000,  plus a $75,000  credit  offset for
consulting fees past due or payable to Mr.  Fritzsche by the Company,  have been
applied against the amount due,  leaving a balance due of $125,053.  The Company
and Mr.  Fritzsche  have agreed that the balance of $125,053 will be paid by Mr.
Fritzsche in installments with full payment due on January 28, 1999.

On October 30, 1998 Nasdaq  notified  the Company of its concern  regarding  the
continued  listing of the  Company's  shares of common  stock for trading on the
Nasdaq National Market as a result of the failure of the Company's  common stock
to  maintain a closing  bid price of  greater  than or equal to $1.00 for thirty
(30) consecutive  trade dates.  Pursuant to Nasdaq rules, the Company has ninety
(90) calendar days in which to regain  compliance with Nasdaq continued  listing
requirements.  If within this 90-day  period the common stock  complies with the
minimum  closing  bid  price  requirement  of $1.00  for a  minimum  of ten (10)
consecutive  days,  and is in compliance  with all other  listing  requirements,
continued listing will occur.  However,  if the Company is unable to demonstrate
compliance with the $1.00 minimum bid price requirement on or before January 28,
1999,  the Company's  securities  will be delisted at the opening of business on
February 1, 1999. Such delisting would  constitute an event of default under the
Debentures, in which event the full principal amount of the Debentures, together
with all accrued interest thereon,  would become  immediately due and payable in
cash and the availability of the remaining  borrowing capacity under the related
convertible debenture agreement could be further limited.

On November 16, 1998 the Company  entered  into three  related  agreements  with
Bayer  Corporation  ("Bayer")  involving  the Company's  blood slide maker,  the
Hematology  Slide  Master(TM)  (HSM(TM)).  The  three  agreements,  a  Licensing
Agreement,  Instrument  Supply  Agreement and an After Market Supply  Agreement,
provide Bayer with certain non-exclusive rights to manufacture and sell products
based on the HSM. Pursuant to the Licensing  Agreement,  Bayer will pay to IMI a
one-time  licensing fee of $1,100,000 in  installments  with the last payment of
$500,000  subject to Bayer's  acceptance  of the  Company's  first  commercially
manufactured  HSM,  as well as a royalty  payment of $2,000 on each of the first
400 HSM-based units it manufactures and sells in exchange for the  non-exclusive
right to manufacture and sell HMS-based  products and the right to negotiate for
the manufacture and  distribution of the Company's  MICRO21 System,  Urine Slide
Maker  ("USM")  and any  other  new  Company  products.  The  Instrument  Supply
Agreement  provides that Bayer will  manufacture  the HSM for the Company for at
least two years in the event the Company  chooses not to manufacture  the HSM or
chooses  to  have  Bayer   manufacture  the  HSM  to  supplement  the  Company's
manufacture  of this  product.  Finally,  pursuant  to the After  Market  Supply
Agreement, with limited exceptions Bayer is required to recommend the Company as
a sole source of consumables  used on all HSM-based  products  manufactured  and
sold by Bayer until the earlier to occur of (a) three  years  following  Bayer's
sale of 200 HSM's or (b) five years after Bayer's initial sale of an HSM.

The Company is implementing  strategic steps so as to allow IMI to remain viable
until sufficient market penetration for the Company's products is achieved. This
plan, which includes  personnel  reductions,  reduces monthly  expenditures from
approximately  $1,100,000  to  $850,000  with  the  reduction  in  extraordinary
development  expenditures  coinciding  with  the  completion  of the HSM and USM
instruments  and  across  the board  reductions  in IMI's  operating  costs.  In
connection  with these cost  reductions,  the Company decided to discontinue its
operations  in Europe and,  instead,  rely on  qualified  distributors.  The IMI
Europe office was officially closed on July 31, 1998.

The Company is moving  forward to identify  and  implement  reductions  in sales
expenditures,  while emphasizing a sales process that better targets prospective
customers who are closest to making a purchase decision.  The reduction of sales
expenditures is in furtherance of the strategy of focusing on specific  customer
groups and markets and the de-emphasis on providing total market coverage to all
types of  prospects.  The Company is  implementing  a plan that will segment the
market according to product fit and geographic location.

During  the fourth  quarter of 1997,  the  Company  began to offer a  short-term
rental  program  which  provides  for  monthly or annual  rentals of the MICRO21
system.  The  Company  believes  that this  program  will  augment its sales and
long-term  lease  programs by giving  potential  customers the ability to fund a
MICRO21  with  operating  funds,  thereby  overcoming  potential  cost  barriers
associated with limited or non-existent capital expenditure funds.  Expansion of
the short-term  rental  program may require that the Company  secure  additional
financing.

The Company  continues to explore a variety of  alternatives  for increasing its
sales and  distribution  capacity  and  raising  sufficient  capital to fund its
operations.   Implementation   of  the  Company's   business  strategy  requires
significant expenditures of capital. The Company is currently seeking additional
funds through debt or equity.  There can be no assurance  that such funds can be
obtained on favorable terms, if at all.

RESULTS OF OPERATIONS

Product sales were $633,808 for the third quarter of 1998 compared with $431,516
for the third quarter of 1997 an increase of $202,292. The increase in sales for
the  quarter  was  primarily  due to an  increase  in the number of  closings of
MICRO21s.  Product sales were $2,113,403 for the nine months ended September 30,
1998 compared with  $2,843,599  for the nine months ended  September 30, 1997, a
decrease of  $730,156.  The overall  decease in sales for the nine months  ended
September  30,  1998  compared to  September  30,  1997 was  primarily  due to a
decrease in closings of MICRO21s in the international market.

Cost of sales was $661,331 for the third  quarter of 1998 compared with $352,578
for the third  quarter  of 1997,  an  increase  of  $308,753.  Cost of sales was
$1,765,563 for the nine months ended September 30, 1998 compared with $1,647,799
for the nine months  ended  September  30, 1997,  an increase of  $117,764.  The
increase  in cost of sales for the  quarter was  primarily  due to  depreciation
recorded on the revenue  equipment,  the write down of obsolete  inventory,  and
costs associated with idle capacity.

Gross  margin was  negative  for the third  quarter of 1998 at ($27,523) or (4%)
compared  with $78,938 or 18% for the third  quarter of 1997 and $347,840 or 16%
for the nine months ended September 30, 1998 compared with $1,195,760 or 42% for
the nine months ended  September 30, 1997.  This decline is primarily the result
of sales not meeting the Company's expectations and, therefore,  the Company has
incurred  manufacturing  inefficiencies and idle plant costs. As a result of the
lower than expected sales, the Company  continues to examine the adequacy of its
obsolescence  reserves,  particularly for materials  associated with the Micro21
and through  September  30, 1998 has recorded  additional  reserves or inventory
writedowns.  In addition,  during the fourth  quarter of 1997 the company  began
offering  the Micro21 on  operating  lease  arrangements  which  result in lower
margins than those achieved on sales or sales-type lease transactions.

Selling,  general and  administrative  expenses  were  $2,058,338  for the third
quarter of 1998  compared  with  $2,469,323  for the third  quarter  of 1997,  a
decrease of $410,985.  Selling,  general and  administrative  expenses decreased
because  of the  staff and  expense  reductions  implemented  early in the third
quarter.  Selling,  general and administrative  expenses were $7,009,123 for the
nine months ended  September  30, 1998  compared  with  $6,042,245  for the nine
months ended September 30, 1997, an increase of $966,878.  The overall  increase
in selling,  general and administrative  expenses was primarily due to increases
in staffing during the second half of 1997, expenses  associated  therewith were
incurred  throughout most of 1998. In addition,  the Company  incurred  business
development expenses during 1998 and increases in legal and accounting fees.

Research and development  expenses were $1,275,259 for the third quarter of 1998
compared  with  $931,423 for the third quarter of 1997, an increase of $343,836.
Research and  development  expenses  were  $4,047,256  for the nine months ended
September 30, 1998 compared with  $2,733,469 for the nine months ended September
30, 1997,  an increase of  $1,313,787.  Research and  development  expenses have
increased due to resources  being utilized in the development of new procedures,
technologies  and  products.  The  majority of the  expenses  are related to the
designing,  manufacturing and testing of the HSM system,  which was completed in
October, 1998. In October 1998, the Company began manufacturing the HSM system.

Interest income was $37,480 for the third quarter of 1998 compared with $207,240
for the third  quarter of 1997,  a decrease  of  $169,760.  Interest  income was
$132,047 for the nine months ended September 30, 1998 compared with $872,202 for
the nine months ended  September 30, 1997, a decrease of $740,155.  The decrease
was primarily due to the sale of investment securities to fund operations.

Interest expense was $478,314 for the third quarter of 1998 compared with $0 for
the third  quarter of 1997.  Interest  expense was  $478,314 for the nine months
ended  September 30, 1998  compared with $0 for the nine months ended  September
30, 1997.  Interest  expense  represents the  amortization  of the discounts and
deferred  financing costs related to the issuance of the convertible  debentures
that were issued on June 30, 1998.

LIQUIDITY AND CAPITAL RESOURCES

For the nine  months  ended  September  30,  1998,  net cash  used in  operating
activities of $8,790,437 was primarily due to the Company's operating loss.

For the nine months ended  September  30, 1998,  net cash  provided by investing
activities  of  $5,482,647  was  primarily  the  result of sales of  investments
available-for-sale,  partially  offset by purchases of computer  equipment to be
used in research and  development  and advances  made to a former  member of the
Board of Directors.

For the nine months ended  September  30, 1998,  net cash  provided by financing
activities of  $2,892,352  was the result of the cash received from the issuance
of the convertible debentures offset by the financing costs.

     During  1998 the  Company  has  experienced  a  reduction  in  revenue  and
increased  costs that have adversely  affected the Company's  current results of
operations  and its  liquidity.  The  Company's  1998 and 1999  operating  plans
contemplate  focusing  activities on expanding sales revenue through the efforts
of its internal  sales,  marketing and service  force.  In addition,  during the
fourth  quarter of 1997 the Company began to offer a short-term  rental  program
which it believes will augment its sales and long-term  lease programs by giving
potential customers the ability to fund a MICRO21 with operating funds,  thereby
overcoming  potential  cost  barriers  associated  with limited or  non-existent
capital  expenditure  funds.  Expansion  of this  program may  require  that the
Company  secure  additional  financing.  The  Company's  plans also  contemplate
continuing the cost control measures  implemented in 1998 and cost and personnel
reductions,  which reduce monthly expenditures from approximately  $1,100,000 to
$850,000;  the cost  reductions  also include  closing the  Company's  office in
Europe in July 1998. The Company's plans also  contemplate  seeking  alternative
sources of financing  and exploring  strategic  alternatives.  During 1998,  the
Company has  introduced  two new  products,  a Hematology  Slide Maker and Urine
Slide Maker, and two additional  procedures which management believes will offer
significant  opportunities for expanding the Company's  potential customer base.
In  addition,   the  Company  is  currently   negotiating  with  a  company  for
distribution  and licensing  agreements  associated  with sales of the Company's
products.  Also, during the third quarter of 1998, the Company  implemented cost
controls and personnel  reductions.  In June 1998, the Company issued $3 million
of convertible debentures;  an additional $7,000,000 million of financing may be
available to the Company  subject to the mutual  agreement  of the  parties.  At
September  30, 1998 the  Company's  remaining  cash balance  totalled  $437,726.
Although management  believes that its plan will be successful,  there can be no
assurance that the Company will be successful in its attempt to expand  revenue,
secure  additional  financing  or  consummate  the  distribution  and  licensing
agreements.

As described  above,  in June 1998, the Company issued $3 million of convertible
debentures.  An additional  $7,000,000  million of financing may be available to
the Company,  but the availability of such financing is at the discretion of the
lender after  consideration of the trading  characteristics of the common stock,
the lender's  exposure to the Company at that time,  the absence of any material
adverse  change in the  Company's  financial  condition  or  operations  and the
Company's continued  compliance with the terms of the financing.  The debentures
include a requirement  that the Company's  common stock be listed for trading by
Nasdaq.  On October 30, 1998 Nasdaq  notified the Company that it's common stock
has failed to maintain a closing bid price of greater than or equal to $1.00 for
thirty  consecutive dates. The Company has 90 calendar days to regain compliance
with Nasdaq rules. If the Company is unable to comply with the minimum bid price
requirement on or before  January 28, 1999,  the Company's  common stock will be
delisted at the opening of business on February 1, 1999.  Such  delisting  which
would constitute an event of default under the convertible  debenture agreement,
in which event the full principal  amount of the  debentures,  together with all
accrued interest thereon,  would become  immediately due and payable in cash and
the  availability  of the remaining  borrowing  capacity  under the  convertible
debenture  agreement  could be further  limited.  The Company is  considering  a
reverse  stock  split  to  rectify  this  situation,  however,  there  can be no
assurance  that such action will  achieve  the  intended  result or that it will
satisfy the event of default under the convertible debenture agreement.

Implementation  of  the  Company's   business   strategy  requires   significant
expenditures  of capital.  The Company is  currently  seeking  additional  funds
through  equity  or debt.  There  can be no  assurance  that  such  funds can be
obtained on favorable terms, if at all.

YEAR 2000 ISSUE

The  Company  has  implemented  a  process  for  identifying,  prioritizing  and
modifying or replacing  certain computer and other systems and programs that may
be affected by the Year 2000 issue.  The Company is also monitoring the adequacy
of the manner in which  certain third parties and third party vendors of systems
are  attempting  to address the Year 2000 issue.  The Company has  substantially
completed an assessment of its computer and embedded systems and determined that
it needed to modify or replace  portions of its  software  so that its  computer
systems  will  function  properly  with  respect  to dates in the year  2000 and
thereafter. While the Company believes its process is designed to be successful,
because of the  complexity of the Year 2000 issue,  and the  interdependence  of
organizations using computer systems, it is possible that the Company's efforts,
or  those  of  third  parties  with  whom  the  Company  interacts,  will not be
successful or satisfactorily completed in a timely fashion.

The Company  estimates that the total cost that it will incur in connection with
attempting to address the Year 2000 issue, including assessment development of a
modification  or  replacement  plan,  purchase of new  hardware and software and
implementation  of the  modification  or replacement  plan or software,  will be
approximately  $50,000. To date, the Company has incurred  approximately $35,000
(of which $-0- has been  capitalized and $35,000  expensed).  The Company funded
the costs incurred to date through cash flow from operations and expects to fund
future costs through cash flow from operations.

The project is estimated to be  completed by September  1999,  which is prior to
any anticipated impact on the Company's operating systems.  The Company believes
that with  modifications to existing  software,  conversions to new software and
replacement or modification  of certain  embedded  systems,  the Year 2000 issue
will not pose significant  operational problems.  However, if such modifications
and conversions  are not made, or are not completed on a timely basis,  the Year
2000 issue  would  have a material  adverse  impact on the  Company's  business,
financial condition and results of operations.

The  estimated  costs of the project and the date on which the Company  believes
necessary  modifications and replacements to address the Year 2000 issue will be
completed  are based on  management's  estimates,  which were derived  utilizing
numerous assumptions of future events,  including the continued  availability of
certain resources and other factors. As the Company progresses in addressing the
Year 2000 issue,  estimates of costs could change, and there can be no assurance
that the Company will not experience  cost overruns or delays in connection with
its plan for modifying or replacing  systems and programs.  In addition,  it may
not be possible to adequately  assess the impact of the failure of third parties
to adequately address the Year 2000 issue. As a result, actual operating results
could differ  materially  from those  anticipated.  Specific  factors that might
cause  such  material   differences   include,  but  are  not  limited  to,  the
availability  and cost of personnel  trained to address the Year 2000 issue, the
ability  to  locate  and  correct  all  relevant   computer  codes  and  similar
uncertainties.

Due to the fact that the Company believes it has secured sufficient resources to
address  the  Year  2000  issue  as it  relates  to its  computer  systems,  the
assessment of embedded systems is complete and the Company does not believe that
contingency  planning is warranted at this time. The assessment of third parties
external to the Company is underway,  and the results of this  assessment,  when
completed,  may reveal the need for  contingency  planning at a later date.  The
Company will regularly  evaluate the need for contingency  planning based on the
progress and findings of the Year 2000 project.

FORWARD LOOKING STATEMENTS

Statements  contained  in this  Form  10-Q  that are not  historical  facts  are
forward-looking  statements that are made pursuant to the safe harbor provisions
of the Private  Securities  Litigation  Reform Act of 1995. The Company cautions
that a number of important  factors could cause the Company's actual results for
1998 and beyond to differ materially from those expressed in any forward-looking
statements made by, or on behalf of, the Company.

Forward-looking   statements   involve  a  number  of  risks  and  uncertainties
including,  but not  limited  to, the  Company's  history of  operating  losses;
uncertainty of profitability and uncertainty of widespread market acceptance for
the  MICRO21  system;  the need for the Company to raise  additional  capital to
finance operations in the immediate  near-term,  through debt or equity, and the
inability to provide assurances that such capital will be available or available
on terms  favorable  to the  Company;  the delays and  impediments  to  customer
acceptance  associated  with industry and market  perception  of the  historical
dispute  between  the  Company  and  Coulter  Corporation;  the  uncertainty  of
availability  of debt or equity  capital  for future  long-term  capital  needs,
especially  in the event of  further  delays in  anticipated  widespread  market
acceptance and market  penetration of MICRO21  systems;  the  uncertainty of the
commercial  viability and potential market acceptance of other IMI products such
as the newly developed HSM and USM, which have not yet been manufactured or sold
in commercial  volumes;  uncertainty as to the ability of the Company to achieve
sales  and  marketing  goals  following  implementation  of the  Company's  cost
reduction program,  including reduction in sales and marketing personnel, due to
the decrease in personnel and the possible adverse impact on potential  customer
perception of the Company;  the risk that expansion of sales in foreign  markets
may be possible only through distributors,  such as Beckman Coulter, at transfer
prices too low for  favorable  profitability;  the  inability  of the Company to
enter into an  alternative  exclusive  distribution  arrangement  due to certain
rights granted to Coulter  Corporation under the Coulter  Settlement  Agreement;
uncertainty  as to whether the Company  and  Beckman  Coulter  will enter into a
definitive agreement based on the signed nonbinding letter of intent relating to
the HSM; the potential for an adverse judgment against the Company in connection
with the  ongoing  arbitration  of the  dispute  between  the Company and DiaSys
Corporation;  the potential termination of listing of the Company's common stock
on Nasdaq;  potential  delays and  technical  problems  in the  development  and
commercial  release of new products and procedures such as the proposed  MICRO21
Microscopic  Workstation  System,  the HSM and the USM; the expense,  delays and
potential  setbacks in  development of competent and capable sales and marketing
teams and  service  teams for  penetration  and  support  of the  market for the
MICRO21 system,  including but not limited to the  pharmaceutical and veterinary
lab market;  delays in closing  sales of systems  placed for  evaluation  due to
length of the  closing  cycle,  uncertainty  due to industry  consolidation  and
customer budget processes and restrictions;  the expense of product  development
and the  related  delay and  uncertainty  as to  receipt  of any  requisite  FDA
clearance or other  governmental  clearance or approval for new products and new
procedures for use on the MICRO21 system;  the uncertainty of profitability  and
sustainability  of revenues and  profitability;  the possibility that agreements
with a potential strategic partner candidate will not be consummated or will not
result  in  significant   improvements   in  results;   the  Company's   limited
manufacturing  experience;  fluctuations  in operating  results;  the  Company's
ability to its protect trade secrets and proprietary technology; competition and
technological  change in the  industry in which the Company is engaged;  product
liability  and the  ability of the  Company  to obtain  adequate  insurance  for
product  liability;  uncertainty  of third party  reimbursement  and health care
reform policies;  and government  regulation.  The Company cannot assure that it
will be able to anticipate or respond  timely to any of the factors,  or changes
in any of the factors,  listed above, which could adversely affect the operating
results in one or more fiscal quarters. Results of operations in any past period
should not be  considered  indicative  of the results to be expected  for future
periods.  Fluctuations  in operating  results may also result in fluctuations in
the price of the Company's common stock.


<PAGE>


                           PART II - OTHER INFORMATION


ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

       (a) Exhibits:

           LIST OF EXHIBITS               DESCRIPTION

                27                        Financial Data Schedule

       (b) Reports on Form 8-K:

           None.




<PAGE>




                                   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.


                                               INTELLIGENT MEDICAL IMAGING, INC.


Date:      November 16, 1998                   By: /S/ TYCE M. FITZMORRIS
                                                  ------------------------------
                                                       Tyce M. Fitzmorris,
                                                       President and Chief
                                                         Executive Officer


Date:      November 16, 1998                   By: /S/ GENE M. COCHRAN
                                                  ------------------------------
                                                       Gene M. Cochran,
                                                       Chief Financial Officer