<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

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

                                    FORM 10-Q

                   QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934



    For the quarter ended                                       Commission File
    September 30, 1998                                              No. 1-11181

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


                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
             (Exact name of registrant as specified in its charter)


    Delaware                                                      94-2579751
    (State or other jurisdiction of                           (I.R.S. Employer
    incorporation or organization)                           Identification No.)



                9162 Eton Avenue, Chatsworth CA.            91311
             (Address of principal executive offices)    (Zip Code)

                         Telephone Number: 818-709-1244


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      [ ]


The number of shares of Common Stock of the registrant outstanding as of October
31, 1998 was 6,362,745.

<PAGE>   2

                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.


                               INDEX TO FORM 10-Q

             Three and Nine Months Ended September 30, 1998 and 1997




<TABLE>
<CAPTION>
                                                                                 PAGE
<S>                                                                              <C>
      PART 1 -   FINANCIAL INFORMATION

                 ITEM 1 - Consolidated Financial Statements

                 Consolidated Balance Sheets........................................2


                 Consolidated Statements of Operations..............................3


                 Consolidated Statements of Cash Flows..............................5


                 Consolidated Statements of Comprehensive Income....................6


                 Notes to Consolidated Financial Statements.........................7


                 ITEM 2 - Management's Discussion and Analysis of
                          Financial Condition and Results of Operations............14



      PART 2 -   OTHER INFORMATION

                 ITEM 1 - Legal Proceedings........................................19

                 ITEM 5 - Other Information........................................19

                 ITEM 6 - Exhibits and Reports on Form 8-K

                 (a) Exhibits......................................................19
                 (b) Reports on Form 8-K...........................................20

      SIGNATURE....................................................................20
</TABLE>


<PAGE>   3

PART 1 - FINANCIAL INFORMATION

ITEM 1 - CONSOLIDATED FINANCIAL STATEMENTS


                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
                           CONSOLIDATED BALANCE SHEETS


                                     ASSETS

<TABLE>
<CAPTION>
                                                                        At December 31,     At September 30,
                                                                             1997                1998
                                                                        ------------------------------------
                                                                                              (unaudited)
<S>                                                                     <C>                 <C>         
Current assets:
Cash and cash equivalents                                                $  1,470,861        $    514,079
Short-term investments                                                         25,000              25,000
Accounts receivable, net of allowance for doubtful
  accounts of $267,579 in 1997 and $271,544 in 1998                         5,319,539           5,674,005
Inventories                                                                 3,739,483           4,666,727
Prepaid expenses and other current assets                                     259,822             306,110
Deferred tax asset                                                            993,950             993,950
                                                                         ------------        ------------
    Total current assets                                                   11,808,655          12,179,871

Property and equipment, at cost, net of accumulated depreciation
  of $4,272,973 in 1997 and $4,918,075 in 1998                              1,847,746           1,814,594
Purchased intangibles, net of accumulated amortization                      8,597,601           7,741,528
Software development costs, net of accumulated amortization of
  $1,223,601 in 1997 and $1,484,272 in 1998                                 1,080,106           1,134,880
Deferred tax asset                                                          7,621,800           7,829,079
Other assets                                                                1,778,669           2,027,460
                                                                         ------------        ------------
    Total assets                                                         $ 32,734,577        $ 32,727,412
                                                                         ============        ============

                      LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
  Short-term borrowings                                                  $    850,000        $    600,000
  Current portion of long-term debt                                         3,400,000           1,200,000
  Accounts payable                                                          2,613,297           2,700,026
  Accrued expenses                                                          2,383,946           2,639,183
  Deferred income - service contracts and other                               911,459           1,015,894
                                                                         ------------        ------------
    Total current liabilities                                              10,158,702           8,155,103

Subordinated note payable                                                   7,000,000           7,000,000
Deferred income - service contracts and other                                 241,507             307,685
Notes payable, long-term portion                                              542,027           2,142,027
                                                                         ------------        ------------
    Total liabilities                                                      17,942,236          17,604,815

Commitments and contingencies

Shareholders' equity:
  Preferred stock, $.01 par value
    Authorized:  3,000,000 shares
    Convertible Series A,
    Shares issued and outstanding :  1997 and 1998 - 3,000
    ($3,000,000 liquidation preference)                                            30                  30
  Common stock, $.01 par value
    Authorized:  15,600,000 shares
    Shares issued and outstanding:
    1997 - 6,259,728, 1998 - 6,348,345                                         62,597              63,482
  Additional paid-in capital                                               37,788,536          38,021,456
  Treasury stock, at cost (26,240 shares in 1997 and none in 1998)           (103,500)                 --
  Unearned compensation                                                      (333,495)           (240,733)
  Foreign currency translation adjustment                                      35,877              49,302
  Accumulated deficit                                                     (22,657,704)        (22,770,940)
                                                                         ------------        ------------
          Total shareholders' equity                                       14,792,341          15,122,597
                                                                         ------------        ------------
          Total liabilities and shareholders' equity                     $ 32,734,577        $ 32,727,412
                                                                         ============        ============
</TABLE>

----------

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



                                       2
<PAGE>   4

                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (unaudited)


<TABLE>
<CAPTION>
                                                                  For the three months ended 
                                                                          September 30,
                                                                 ------------------------------
                                                                        1997               1998
                                                                 -----------        -----------
<S>                                                              <C>                <C>        
Sales of IVD imaging systems                                     $ 3,025,079        $ 2,505,429
Sales of IVD imaging supplies and services                         2,664,516          3,189,095
Sales of small instruments and supplies                            1,143,862          1,099,339
Royalties and licensing revenues                                     363,256            343,740
                                                                 -----------        -----------

Net revenues                                                       7,196,713          7,137,603
                                                                 -----------        -----------

Cost of goods - IVD imaging systems                                1,574,168          1,374,907
Cost of goods - IVD imaging supplies and services                  1,343,553          1,489,849
Cost of goods - small instruments and supplies                       666,676            600,331
                                                                 -----------        -----------

Cost of goods sold                                                 3,584,397          3,465,087
                                                                 -----------        -----------

Gross margin                                                       3,612,316          3,672,516

Marketing and selling                                              1,308,216          1,479,292
General and administrative                                           930,352            926,520
Research and development, net                                        439,513            565,970
Intangibles amortization                                             324,019            290,497
Unusual legal expenses                                                31,641             38,254
                                                                 -----------        -----------

Total operating expenses                                           3,033,741          3,300,533

Operating income                                                     578,575            371,983

Other income (expense):
   Interest income                                                     8,182              7,557
   Interest expense                                                 (307,670)          (311,975)
   Other income                                                       64,822             79,802
                                                                 -----------        -----------

Income before provision for income taxes                             343,909            147,367

Provision for income taxes                                           129,528             53,319
                                                                 -----------        -----------

Net income                                                       $   214,381        $    94,048
                                                                 ===========        ===========

Net income per common share - basic                              $       .04        $       .01
                                                                 ===========        ===========

Net income per common share - diluted                            $       .03        $       .01
                                                                 ===========        ===========

Weighted average number of common shares - basic                   6,027,151          6,316,706
                                                                 ===========        ===========

Weighted average number of common shares and common
    share equivalents outstanding for the period - diluted         7,179,223          7,794,539
                                                                 ===========        ===========
</TABLE>

----------

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



                                       3
<PAGE>   5

                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (unaudited)

<TABLE>
<CAPTION>
                                                                    For the nine months ended 
                                                                          September 30,
                                                                --------------------------------
                                                                        1997                1998
                                                                ------------        ------------
<S>                                                             <C>                 <C>         
Sales of IVD imaging systems                                    $  8,344,746        $  7,691,193
Sales of IVD imaging supplies and services                         7,883,636           9,114,971
Sales of small instruments and supplies                            3,296,899           3,196,620
Royalty and license revenue                                          565,751             434,490
                                                                ------------        ------------

Net revenues                                                      20,091,032          20,437,274
                                                                ------------        ------------

Cost of goods - IVD imaging systems                                4,290,092           4,439,617
Cost of goods - IVD imaging supplies and services                  4,012,072           4,356,474
Cost of goods - sales of small instruments and supplies            1,832,738           1,765,149
                                                                ------------        ------------

Cost of goods sold                                                10,134,902          10,561,240
                                                                ------------        ------------

Gross margin                                                       9,956,130           9,876,034

Marketing and selling                                              3,795,167           3,965,782
General and administrative                                         2,671,689           2,686,630
Research and development, net                                      1,575,309           1,638,873
Intangibles amortization                                             948,979             869,989
Unusual legal charges                                                129,662             124,842
                                                                ------------        ------------

Total operating expenses                                           9,120,806           9,286,116

Operating income                                                     835,324             589,918

Other income (expense):
   Interest income                                                    41,833              34,116
   Interest expense                                                 (899,908)           (871,422)
   Other income (expense)                                            100,739              65,733
                                                                ------------        ------------

Income (loss) before provision (benefit) for income taxes             77,988            (181,655)

Provision (benefit) for income taxes                                  48,352             (68,419)
                                                                ------------        ------------

Net income (loss)                                                     29,636            (113,236)

Less imputed preferred stock dividend                               (450,000)                 --
                                                                ------------        ------------

Net loss available to common shareholders                       $   (420,364)       $   (113,236)
                                                                ============        ============

Net loss per common share - basic                               $       (.07)       $       (.02)
                                                                ============        ============

Net loss per common share - diluted                             $       (.07)       $       (.02)
                                                                ============        ============

Weighted average number of common share - basic                    5,988,562           6,289,045
                                                                ============        ============

Weighted average number of common shares and common
share equivalents outstanding for the period                       5,988,562           6,289,045
                                                                ============        ============
</TABLE>



----------

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



                                       4
<PAGE>   6

                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (unaudited)

<TABLE>
<CAPTION>
                                                                              For the nine months ended 
                                                                                     September 30,
                                                                            ------------------------------
                                                                                   1997               1998
                                                                            -----------        -----------
<S>                                                                         <C>                <C>         
Cash flow from operating activities:
    Net income (loss)                                                       $    29,636        $  (113,236)
    Adjustments to reconcile net income (loss) to cash provided by
    operations:
     Deferred tax benefit                                                       (35,444)          (207,279)
     Depreciation and amortization                                            2,002,387          1,882,232
     Common stock and stock option compensation amortization                    199,981            195,897
    Changes in assets and liabilities:
     Accounts receivable - trade and other                                      158,165           (416,442)
     Service contracts, net                                                     343,821             70,530
     Inventories                                                                427,595           (926,428)
     Prepaid expenses and other current assets                                  (22,964)           (68,579)
     Other assets                                                               (32,497)          (312,297)
     Accounts payable                                                        (1,299,206)            84,694
     Accrued expenses                                                          (236,406)           328,260
     Deferred income - other                                                    (52,495)           114,905
                                                                            -----------        -----------
Net cash provided by operating activities                                     1,482,573            632,257
                                                                            -----------        -----------

Cash flow from investing activities:
    Acquisition of property and equipment                                      (426,613)          (612,219)
    Software development costs                                                 (388,438)          (315,445)
    Adjustment to cost of acquired business                                          --            167,790
    Acquisition of other assets                                                 (30,000)                --
    Decrease in short-term investments                                          642,589                 --
                                                                            -----------        -----------
Net cash used by investing activities                                          (202,462)          (759,874)
                                                                            -----------        -----------

Cash flow from financing activities:
    Borrowings under credit facility                                          3,235,000          4,360,000
    Repayments of credit facility                                            (3,519,755)        (4,110,000)
    Repayment of notes payable                                               (2,300,000)        (1,107,350)
    Installment payment on repurchase of common stock                          (545,057)                --
    Issuance of common stock and warrant for cash                               139,039            202,835
    Deferred stock or debt issuance costs                                      (411,893)          (175,298)
                                                                            -----------        -----------
Net cash used by financing activities                                        (3,402,666)          (829,813)
                                                                            -----------        -----------

Effect of foreign currency fluctuation on cash and cash equivalents             (10,757)               648
                                                                            -----------        -----------
Net decrease in cash and cash equivalents                                    (2,133,312)          (956,782)
Cash and cash equivalents at beginning of period                              3,602,535          1,470,861
                                                                            -----------        -----------
Cash and cash equivalents at end of period                                  $ 1,469,223        $   514,079
                                                                            ===========        ===========

Supplemental schedule of non-cash investing and financing activities:
    Issuance of common stock in exchange for services                       $   116,079        $   103,135
    Capital lease obligation incurred                                                --             70,000
    Issuance of common stock in satisfaction of liabilities                     283,699             31,336
    Issuance of warrants to purchase common stock                               216,180                 --
    Issuance of note payable for accrued liabilities                          1,042,027                 --

Supplemental disclosure of cash flow information:
    Cash paid for interest                                                      839,261            813,547
    Cash paid for income taxes                                                   50,075            176,180
</TABLE>


----------

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



                                       5
<PAGE>   7

                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
                 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
                                   (unaudited)



<TABLE>
<CAPTION>
                                                              For the three months ended 
                                                                     September 30,
                                                              --------------------------
                                                                   1997             1998
                                                              ---------        ---------
<S>                                                           <C>              <C>      
            Net income                                        $ 214,381        $  94,048

                Other comprehensive income (loss),
                foreign currency translation adjustment          (3,884)           5,632
                                                              ---------        ---------

            Comprehensive income                              $ 210,497        $  99,680
                                                              =========        =========
</TABLE>


<TABLE>
<CAPTION>
                                                              For the nine months ended 
                                                                     September 30,
                                                              ---------        ---------
                                                                   1997             1998
                                                              ---------        ---------
<S>                                                           <C>              <C>       
            Net income (loss)                                 $  29,636        $(113,236)

                Other comprehensive income (loss),
                foreign currency translation adjustment         (39,001)          13,425
                                                              ---------        ---------

            Comprehensive loss                                $  (9,365)       $ (99,811)
                                                              =========        =========
</TABLE>


----------

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



                                       6
<PAGE>   8

                   INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  FORMATION AND BUSINESS OF THE COMPANY.

    International Remote Imaging Systems, Inc. was incorporated in California in
1979 and reincorporated during 1987 in Delaware. International Remote Imaging
Systems, Inc. and its subsidiaries (collectively "IRIS" or the "Company")
operate in three segments. (See Note 13-"Segment and Geographic Information".)
The Company designs, develops, manufactures and markets in vitro diagnostic
("IVD") equipment, including imaging systems based on patented and proprietary
automated intelligent microscopy ("AIM") technology, and special purpose
centrifuges and other small instruments for specimen preparation in microscopic
and other procedures performed in clinical laboratories. The Company also
provides ongoing service and supplies to support the equipment sold.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.

Basis of Presentation of Unaudited Interim Financial Statements:

    In the opinion of management, the accompanying unaudited consolidated
financial statements contain all normal recurring adjustments necessary to
present fairly the financial position of the Company as of September 30, 1998
and 1997 and the results of its operations for the three and nine month periods
then ended. These financial statements should be read in conjunction with the
financial statements and notes included in the Company's latest annual report on
Form 10-K/A. Interim results are not necessarily indicative of results for a
full year.

Segment Reporting:

    In the second quarter of 1998, the Company adopted Statement of Financial
Accounting Standards (FAS) 131, "Disclosures about Segments of an Enterprise and
Related Information". FAS 131 supersedes FAS 14, "Financial Reporting for
Segments of a Business Enterprise", replacing the "industry segment" approach
with the "management" approach. The management approach designates the internal
organization that is used by management for making operating decisions and
assessing performance as the source of the Company's reportable segments. FAS
131 also requires disclosures about products and services, geographic areas, and
major customers. The adoption of FAS 131 did not affect results of operations or
financial position but did affect the disclosure of segment information. See
Note 13-"Segment and Geographic Information".

Use of Estimates:

    The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting
periods. Actual results could differ from those estimates.

Principles of Consolidation:

    The consolidated financial statements include the accounts of International
Remote Imaging Systems, Inc. and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in the consolidated
financial statements.

Reclassifications:

    Certain reclassifications have been made to the 1997 financial statements to
conform with the 1998 presentation.

3.  COMPREHENSIVE INCOME.

    In January 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS
130"). FAS 130 establishes standards for reporting and displaying comprehensive
income and its components (revenues, expenses, gains and losses) in financial
statements. FAS 130 requires that all items that are required to be recognized
under accounting standards as components of comprehensive income be reported in
a financial statement that is displayed with the same prominence as other
financial statements.

    No tax effect has been allocated to the foreign currency translation
adjustment for the periods presented.

    The following is a reconciliation of accumulated other comprehensive income
balance for the nine months ended September 30, 1998:

<TABLE>
<S>                                                                      <C>    
            Beginning balance                                            $35,877
            Current period change                                         13,425
                                                                         -------
            Ending balance                                               $49,302
                                                                         =======
</TABLE>



                                       7
<PAGE>   9

4.  INVENTORIES.

    Inventories are carried at the lower of cost or market on a first-in
first-out basis and consist of the following:

<TABLE>
<CAPTION>
                                                   At December 31,     At September 30,
                                                       1997                 1998
                                                    -----------         -----------
<S>                                                <C>                 <C>        
     Finished goods                                 $   766,525         $   717,677
     Work-in-process                                    788,374             214,404
     Raw materials, parts and sub-assemblies          2,184,584           3,734,646
                                                    -----------         -----------
                                                    $ 3,739,483         $ 4,666,727
                                                    ===========         ===========
</TABLE>

5.  PURCHASED INTANGIBLES.

    Purchased intangibles, at cost, consist of the following:


<TABLE>
<CAPTION>
                                                   At December 31,     At September 30,
                                                       1997                 1998
                                                    -----------         -----------
<S>                                                <C>                 <C>        
     Goodwill                                       $   383,108         $   383,108
     International distribution channel               5,571,728           5,403,938
     Acquired technology and know-how                 3,960,904           3,960,904
                                                    -----------         -----------
                                                      9,915,740           9,747,950
     Less accumulated amortization                   (1,318,139)         (2,006,422)
                                                    -----------         -----------

     Total                                          $ 8,597,601         $ 7,741,528
                                                    ===========         ===========
</TABLE>




                                       8
<PAGE>   10

    In 1996 the Company acquired the genetic analysis segment. A portion of the
purchase price was allocated to the international distribution channel and
acquired technology and know how. During the quarter ended September 30, 1998,
the Company received a contractual adjustment to the purchase price of $167,790.
Consistent with the original allocation methodology, these monies were offset
against the value assigned to the international distribution channel intangible.

6.  SHORT TERM BORROWINGS AND NOTES PAYABLE.

    As of September 30, 1998, the Company's liabilities included $3.2 million
outstanding under a credit agreement. On May 8, 1998, the Company refinanced its
bank loan with the proceeds of a new credit facility from Foothill Capital
Corporation, a division of Norwest Bank. The new credit facility consists of a
$3.6 million term loan and a $4.0 million revolving line of credit. Borrowings
under the line of credit are limited to a percentage of eligible accounts
receivable and are subject to a combined limit of $7.0 million for the total
credit facility. The Company had approximately $1.4 million available under the
line of credit at September 30, 1998. The term loan bears interest at the
lender's prime rate (8.25% on September 30, 1998) plus 3.0% and is payable in 36
equal monthly installments. The revolving credit line bears interest at the
lender's prime rate plus 1.0%. The new credit facility is subject to minimum
interest charges, prepayment penalties and customary fees, is collateralized by
a first priority lien on all assets of the Company and matures in 2001. It also
contains financial covenants based primarily on tangible net worth and cash flow
and imposes restrictions on acquisitions, capital expenditures and cash
dividends.

    On September 30, 1998, the Company had outstanding notes payable in the
aggregate amount of $742,027 from the repurchase of common stock and warrants
from an affiliate of Boehringer Mannheim GmbH, a former strategic partner in
1996. The notes bear interest at the rate of 8%, and principal is due in
bi-monthly installments of $100,000.

7.  CAPITAL STOCK.

Stock Issuances:

    During the nine months ended September 30, 1998, the Company (i) issued
72,645 shares of common stock in exchange for $84,226 in cash and services under
the Key Employee Stock Purchase Plan, (ii) issued options to purchase 214,800
shares of common stock under the Company's stock option plans and (iii)
cancelled options to purchase 80,867 shares of common stock. Options for 37,732
shares of common stock were exercised during the period. At September 30, 1998,
options to purchase 1,362,501 shares of common stock were issued and outstanding
under the Company's stock options plans. The outstanding options expire by the
end of 2008. The exercise price for these options ranges from $1.19 to $4.50 per
share. On November 6, 1998, the Board of Directors acted to reprice all
outstanding stock options to a maximum of $1.31 per share, the current market
price as of that date. Also, any common stock acquired upon exercise of the
repriced options cannot be resold without the Board of Directors approval for a
period of one year following the repricing. Accordingly, following this action,
the aggregate exercise price of the options issued and outstanding at September
30, 1998 was approximately $1.8 million. At September 30, 1998, there were
548,667 shares of common stock available for the granting of future options.

    During the nine months ended September 30, 1998, warrants were exercised to
purchase 12,778 shares of common stock for $49,487. Also, warrants to purchase
an additional 75,000 shares of common stock were issued for cash proceeds of
$35,000, and 70,098 options outstanding to purchase common stock relating to the
StatSpin acquisition expired unexercised. Also, during this period warrants to
purchase 367,900 shares of common stock expired unexercised.

    In June 1998, the Company's shareholders adopted a new stock option plan
under which it may grant non-qualified stock options and incentive stock
options. Under the 1998 Plan, the Company is authorized to issue options up to
an aggregate of 600,000 shares of common stock at 100% of the fair market value
of a share of common stock at the date of grant with a duration of up to ten
years. The Plan expires on March 22, 2008.



                                       9
<PAGE>   11

Warrants:

    At September 30, 1998, the following warrants to purchase shares of common
stock were outstanding and exercisable:

<TABLE>
<CAPTION>
                  Number of Shares                Price           Expiration Date
                  ----------------                -----           ---------------
<S>                                               <C>             <C>
                            50,000                 3.875          January 15, 2000
                           298,633                 4.00           March 29, 2000
                            25,000                 4.375          June 1, 2000
                            25,000                 4.0625         July 1, 2000
                           123,000                 7.80           September 28, 2000
                           875,000                 8.00           July 31, 2001
                            84,270                 3.56           December 31, 2001
                            10,000                 4.31           May 15, 2002
</TABLE>

8.  COMMITMENTS AND CONTINGENCIES .

    In July 1996, the Company acquired Perceptive Scientific Instruments, Inc.
("PSI") from Digital Imaging Technologies, Inc. ("DITI"). As part of the
purchase price, the Company issued to DITI a five-year warrant to purchase
875,000 shares of common stock at $8.00 per share. In August 1997, the Company
filed a demand for arbitration against DITI with the American Arbitration
Association. The Company's demand for arbitration alleges material breaches of
the representations, warranties and covenants in the purchase agreement
governing the PSI acquisition. DITI subsequently filed a counterclaim in the
arbitration proceeding alleging that the Company misrepresented or omitted to
disclose material facts in connection with the PSI acquisition. DITI had
previously requested a reduction in the exercise price of the warrant but
elected to seek unspecified monetary damages in the counterclaim. The parties
are currently engaged in discovery. Although the Company does not presently
anticipate any material adverse effect as a result of this arbitration
proceeding, there can be no assurance that it will not have such an effect on
the Company or result in additional dilution to holders of the common stock.

9.  RESEARCH AND DEVELOPMENT GRANTS AND CONTRACTS.

    The Company has in the past partially funded its research and development
programs through (i) grants from NASA and the National Institutes of Health,
(ii) joint development programs with strategic partners and (iii) Company
sponsored research and development entities.

    Reimbursements and direct costs connected with research and development
grants and agreements were as follows:

<TABLE>
<CAPTION>
                                            Three Months Ended                 Nine Months Ended 
                                               September 30,                     September 30,
                                       ---------------------------         --------------------------
                                            1997              1998              1997             1998
                                       ---------         ---------         ---------        ---------
<S>                                    <C>               <C>               <C>              <C>      
     Reimbursements                    $ 253,316         $ 216,514         $ 903,625        $ 792,264
     Costs                               210,737           209,971           976,441          846,356
                                       ---------         ---------         ---------        ---------
     Net costs (reimbursements)        $ (42,579)        $  (6,543)        $  72,816        $  54,092
                                       =========         =========         =========        =========
</TABLE>

    Net costs incurred under research and development grants and contracts have
been included in research and development expense in the statements of
operations.

10. UNUSUAL CHARGES.

    The results of operations for the nine month period ended September 30,
1998, include unusual charges totaling $124,842 and are primarily legal expenses
relating to the pending arbitration matter with DITI. The unusual charges in the
comparable period last year totaled $129,662 and are primarily legal expenses
related to a completed arbitration matter.

11. INCOME TAXES.

    The income tax provision (benefit) for the three and nine month period ended
September 30, 1998 was $53,319 and $(68,419), respectively, as compared to an
income tax provision of $129,528 and $48,352, respectively, for the comparable
periods last year. The income tax provision and benefit differs from the federal
statutory rate due to state, local and foreign income taxes and permanent
differences between income reported for financial statement and income tax
purposes.

12. EARNINGS PER SHARE (EPS).

    The computation of per share amounts for the nine months ended September 30,
1998 and 1997 is based on the average number of common shares outstanding for
the period. Options and warrants to purchase 2,853,404 and 2,970,470 shares of
common stock outstanding during the nine months ended September 30, 1998 and
nine months ended September 30, 1997, respectively, were not considered in the
computation of diluted EPS because their inclusion would have been antidilutive.
Preferred stock convertible into 842,679 and 1,477,833 common shares at
September 30, 1997 and 1998, respectively, was also not considered in the
computation of diluted EPS for the nine month periods then ended because their
inclusion would have been antidilutive.

<PAGE>   12

    In early 1997 the staff of the Securities and Exchange Commission ("SEC
staff") announced a new position on accounting for convertible preferred stock
which is potentially convertible at a discount to the market price of the common
stock, even if the potential for a discount is only a possibility. The SEC staff
has taken the position, that solely for purposes of calculating earnings per
share the potential discount is an imputed dividend to the preferred
stockholders, which reduces the amount of earnings available to common
stockholders. Accordingly, the issuance of the Series A Preferred Stock resulted
in a one-time reduction in earnings available to common shareholders of $450,000
or $0.08 per share in the three-month period ended March 31, 1997.

    The following is a reconciliation of net income and shares used in computing
basic and diluted earnings per share amounts for the three months ended
September 30, 1998:

<TABLE>
<CAPTION>
                                                                              Number of        Per Share 
                                                              Income           Shares           Amount
                                                             ---------        ---------        ---------
<S>                                                          <C>              <C>              <C>      
            Basic EPS
              income available to Common Shareholders        $  94,048        6,316,706        $     .01

            Effects of Dilutive Securities
                Warrants                                            --               --               --
                Options                                             --               --               --
                Convertible Preferred Stock                         --        1,477,833               --

            Diluted EPS
              income available to Common Shareholders
                                                             ---------        ---------        ---------
                 plus assumed conversions                    $  94,048        7,794,539        $     .01
                                                             =========        =========        =========
</TABLE>

    Options and warrants to purchase 2,853,404 shares of common stock at $1.19
to $8.00 per share outstanding during the three months ended September 30, 1998,
were not included in the computation of diluted EPS because the exercise price
was greater than the average market price of common shares during the period.

    The following is a reconciliation of net income and shares used in computing
basic and diluted earnings per share amounts for the three months ended
September 30, 1997.

<TABLE>
<CAPTION>
                                                                              Number of        Per Share 
                                                              Income           Shares           Amount
                                                             ---------        ---------        ---------
<S>                                                          <C>              <C>              <C>      
            Basic EPS
              income available to Common Shareholders        $ 214,381        6,027,151        $     .04

            Effects of Dilutive Securities
                Warrants                                            --           17,819               --
                Options                                             --          291,556               --
                Convertible Preferred Stock                         --          842,697             (.01)

            Diluted EPS
                                                             ---------        ---------        ---------
              income available to Common Shareholders
                plus assumed conversions                     $ 214,381        7,179,223        $     .03
                                                             =========        =========        =========
</TABLE>

    Options and warrants to purchase 1,723,533 shares of common stock at $4.25
to $8.125 per share outstanding during the three months ended September 30,
1997, were not included in the computation of diluted EPS because the exercise
price was greater than the average market price of the common shares during the
period.

13. SEGMENT AND GEOGRAPHIC INFORMATION.

    In the quarter ended June 30, 1998, the Company adopted FAS 131, replacing
FAS 14. (See Note 2-"Segment Reporting".) Under FAS 14 the Company operated in
one industry segment. The Company is organized on the basis of products and
related services and under FAS 131 operates in three segments; (1) urinalysis,
(2) genetic analysis and (3) small laboratory devices.



                                       11
<PAGE>   13
    The urinalysis segment designs, develops, manufactures and markets IVD
imaging systems based on patented and proprietary AIM technology for automating
microscopic procedures for urinalysis. In December 1997, this segment also began
distributing the UF-100 urine cell analyzer in the United States under an
existing agreement with its manufacturer. The segment also provides ongoing
sales of supplies and service necessary for the operation of installed
urinalysis workstations. In the United States, these products are sold through a
direct sales force. Internationally, these products are sold through
distributors. This segment has also had a major program over a number of years
to develop The White IRIS leukocyte differential analyzer. The Company has
elected not to launch The White IRIS at this time due to limited resources and
the potential impact of product launch costs on profitability. The Company is
exploring strategic alternatives for The White IRIS program and therefore cannot
reasonably estimate any impact on the recoverability of the capitalized costs
associated with the product line, principally capitalized software and
inventory. If the Company is unable to develop a viable strategic alternative
for the program and as a result abandons the product line, it would incur a 
charge against future earnings of up to $1.2 million for the related amounts 
capitalized.

    The genetic analysis segment designs, develops, manufactures and markets IVD
imaging systems for karyotyping, DNA probe analysis and comparative genomic
hybridization. These products are sold in the United States through a direct
sales force and internationally through its United Kingdom subsidiary directly
as well as through distributors and agents.

    The small laboratory devices segment designs, develops, manufactures and
markets a variety of benchtop centrifuges, small instruments and supplies. These
products are used primarily for manual specimen preparation and dedicated
applications in coagulation, cytology, hematology and urinalysis. These products
are sold worldwide through distributors.

    The accounting policies of the segments are the same as those described in
the "Summary of Significant Accounting Policies" included in this report on Form
10-Q and in the Company's report on Form 10-K/A for the year ended December 31,
1997. The Company evaluates the performance of its segments and allocates
resources to them based on earnings before income taxes, excluding corporate
charges ("Segment Profit").

    The tables below presents information about reported segments for the three
and nine month periods ended September 30, 1998 and 1997:

    Three Months Ended September 30, 1998:

<TABLE>
<CAPTION>
                                                                              Small          Unallocated
                                                           Genetic          Laboratory        Corporate
                                       Urinalysis         Analysis           Devices           Expenses            Total
                                      ------------      ------------       ------------      ------------       ------------
<S>                                   <C>               <C>                <C>               <C>                <C>         
  Revenues                            $  4,322,023      $  1,481,241       $  1,334,339                --       $  7,137,603

  Interest income                     $      5,061      $        740       $      1,756                --       $      7,557

  Interest expense                    $      1,443      $    310,532                 --                --       $    311,975

  Depreciation and amortization       $    275,296      $    356,793       $     43,278      $     14,194       $    689,561

  Segment profit (loss)               $    789,306      $   (669,501)      $    431,986      $   (404,424)      $    147,367

  Segment assets                      $ 11,801,339      $ 10,254,467       $  1,843,911      $  8,827,695       $ 32,727,412

  Investment in long term assets      $    276,931      $    127,323                 --                --       $    404,254
</TABLE>



    Three Months Ended September 30, 1997:

<TABLE>
<CAPTION>
                                                                              Small          Unallocated
                                                          Genetic           Laboratory        Corporate
                                       Urinalysis         Analysis           Devices           Expenses             Total
                                      ------------      ------------       ------------      ------------       ------------
<S>                                   <C>               <C>                <C>               <C>                <C>         
  Revenues                            $  4,111,092      $  1,941,759       $  1,143,862                --       $  7,196,713

  Interest income                     $      5,113      $         10       $      3,059                --       $      8,182

  Interest expense                              --      $    307,670                 --                --       $    307,670
</TABLE>



                                       12
<PAGE>   14

<TABLE>
<S>                                   <C>               <C>                <C>               <C>                <C>         
  Depreciation and amortization       $    276,862      $    374,096       $     84,072      $     16,309       $    751,339

  Segment profit (loss)               $    852,033      $   (296,432)      $    157,897      $   (369,589)      $    343,909

  Segment assets                      $ 10,810,661      $ 11,667,762       $  2,932,633      $  8,248,629       $ 33,659,685

  Investment in long term assets      $    147,864      $    209,366       $      7,330                --       $    364,560
</TABLE>



    Nine Months Ended September 30, 1998:

<TABLE>
<CAPTION>
                                                                              Small          Unallocated
                                                          Genetic           Laboratory        Corporate
                                       Urinalysis         Analysis           Devices           Expenses             Total
                                      ------------      ------------       ------------      ------------       ------------
<S>                                   <C>               <C>                <C>               <C>                <C>         
  Revenues                            $ 12,698,660      $  4,306,994       $  3,431,620                --       $ 20,437,274

  Interest income                     $     16,878      $      4,211       $     13,027                --       $     34,116

  Interest expense                    $      3,682      $    867,740                 --                --       $    871,422

  Depreciation and amortization       $    778,753      $  1,121,112       $    129,036      $     49,228       $  2,078,129

  Segment profit (loss)               $  2,223,007      $ (2,067,926)      $    849,533      $ (1,186,269)      $   (181,655)

  Investment in long term assets      $    587,001      $    299,172       $     41,491                --       $    927,664
</TABLE>


    Nine Months Ended September 30, 1997:

<TABLE>
<CAPTION>
                                                                              Small          Unallocated
                                                          Genetic           Laboratory        Corporate
                                       Urinalysis         Analysis           Devices           Expenses             Total
                                      ------------      ------------       ------------      ------------       ------------
<S>                                   <C>               <C>                <C>               <C>                <C>         
  Revenues                            $ 11,790,054      $  4,936,922       $  3,364,056                --       $ 20,091,032

  Interest income                     $     29,719      $      2,220       $      9,894                --       $     41,833

  Interest expense                              --      $    899,908                 --                --       $    899,908

  Depreciation and amortization       $    859,143      $  1,084,266       $    210,807      $     48,152       $  2,202,368

  Segment profit (loss)               $  1,918,139      $ (1,411,410)      $    677,484      $ (1,106,225)      $     77,988

  Investment in long term assets      $    515,554      $    315,465       $     14,032                --       $    845,051
</TABLE>


    The Company ships products from three locations in the United States and
from its subsidiary in the United Kingdom. The following is sales by its United
States and United Kingdom locations for the three and nine-month periods ended
September 30, 1998 and 1997:

<TABLE>
<CAPTION>
                                    Three Months Ended              Nine Months Ended 
                                       September 30,                   September 30,
                              ----------------------------      ----------------------------
                                     1997             1998             1997             1998
                              -----------      -----------      -----------      -----------
<S>                           <C>              <C>              <C>              <C>        
     Sales

          United States       $ 6,432,921      $ 6,393,260      $18,138,545      $17,850,804

          United Kingdom          763,792          744,343        1,952,487        2,586,470
                              -----------      -----------      -----------      -----------

                              $ 7,196,713      $ 7,137,603      $20,091,032      $20,437,274
                              ===========      ===========      ===========      ===========
</TABLE>



                                       13
<PAGE>   15

    The following is long-lived assets information by geographic area as of
September 30, 1998 and 1997:

<TABLE>
<CAPTION>
                                           At September 30,
                                     ----------------------------
                                            1997             1998
                                     -----------      -----------
<S>                                  <C>              <C>        
            Long-lived assets

                 United States       $ 9,018,510      $ 7,650,445
                 United Kingdom        5,451,353        5,068,017
                                     -----------      -----------
                                     $14,469,863      $12,718,462
                                     ===========      ===========
</TABLE>

14. RECENTLY ISSUED ACCOUNTING STANDARDS.

    In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in the
fair value of derivatives will be recorded each period in current earnings or
other comprehensive income, depending on whether a derivative is designated as
part of a hedge transaction and, if it is, the type of hedge transaction. The
new rules will be effective the first quarter of 2000. The Company does not
believe that the new standard will have a material impact on the Company's
financial statements.


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

OVERVIEW

    The Company generates revenues from sales of in vitro diagnostic ("IVD")
imaging systems based on its patented and proprietary AIM technology. Following
their initial sale, these systems become part of the "installed base" and
generate follow-on sales of supplies and service necessary for their operation.
The Company also generates revenues from sales of ancillary lines of small
laboratory instruments and supplies.

    Until 1996, the Company generated most of its revenues from sales of two
models of The Yellow IRIS urinalysis workstation and related supplies and
service. These two models differ mainly by their speed and price. In 1996, the
Company introduced a third model of The Yellow IRIS, the Model 900UDx urine
pathology system, which is a higher capacity automated urinalysis workstation
designed especially for the high-volume testing requirements of large hospitals
and reference laboratories. The Company also began selling the PowerGene family
of genetic analyzers in August 1996 after completing the acquisition (the "PSI
acquisition") of the digital imaging business of Perceptive Scientific
Instruments, Inc. ("PSI"). The Company is currently seeking to enhance PSI's
revenue stream by adding DNA probe kits for chromosome analysis to the PowerGene
product line and may pursue this goal through internal research and development
efforts or a strategic transaction with another company. Finally, in December
1997, the Company began distributing the UF-100 urine cell analyzer in the
United States under an existing agreement with its manufacturer, TOA Medical
Electronics, Inc. ("TOA"). TOA has initiated contractual procedures for
terminating the exclusive nature of the IRIS distribution rights to the UF-100
based on allegations of inadequate performance. The Company has disputed these
allegations and the parties have entered into discussions about the pricing and
marketing of the UF-100. If those discussions are not mutually agreeable, TOA
may attempt to appoint other distributors for the UF-100 in North America. The
outcome and impact of any such attempt cannot be ascertained at this time.

    The Company invests significant amounts in research and development for new
products and enhancements to existing products. The following table summarizes
total product technology expenditures for the periods indicated:

<TABLE>
<CAPTION>
                                                       Three Months Ended             Nine Months Ended 
                                                          September 30,                 September 30,
                                                  --------------------------      --------------------------
                                                        1997            1998            1997            1998
                                                  ----------      ----------      ----------      ----------
<S>                                               <C>             <C>             <C>             <C>       
Research and development expense, net             $  440,000      $  566,000      $1,575,000      $1,639,000
Capitalized software development costs               145,000         100,000         388,000         315,000
Reimbursed costs for research and
  development grants and contracts                   253,000         216,000         904,000         792,000
                                                  ----------      ----------      ----------      ----------
       Total product technology expenditures      $  838,000      $  882,000      $2,867,000      $2,746,000
                                                  ==========      ==========      ==========      ==========
</TABLE>


    The Company partially funds its research and development programs through
(i) grants from NASA and the National Institutes of Health, (ii) joint
development programs with strategic partners and (iii) Company-sponsored
research and development entities.

    In the quarter ended June 30, 1998, the Company adopted FAS 131, replacing
FAS 14. (See Note 2-Segment Reporting.) Under FAS 14, the Company operated in
one industry segment. The Company is organized on the basis of products and
related services and under FAS 131 operates in three segments: (1) urinalysis,
(2) genetic analysis and (3) small laboratory devices. (See Note 13-"Segment and
Geographic Information".)

RESULTS OF OPERATIONS



                                       14
<PAGE>   16

    COMPARISON OF QUARTER ENDED SEPTEMBER 30, 1998 TO QUARTER ENDED 
SEPTEMBER 30, 1997

    Net revenues for the quarter ended September 30, 1998 decreased to $7.1
million from $7.2 million, a decrease of $59,000 or 1% from the comparable
period last year. Sales of IVD imaging systems decreased to $2.5 million from
$3.0 million, a decrease of $520,000 or 17% from the comparable period last
year. Revenues from sales of The Yellow IRIS family of urinalysis workstations
decreased $42,000 due to decreased average unit selling prices to domestic
customers. Revenues from sales of the PowerGene line of genetic analyzers
decreased $478,000. The decrease relates primarily to the non-recurrence of a
record $1.25 million multi-system sale of genetic analyzers during the second
($611,000), third ($393,000) and fourth ($250,000) quarters of last year, lower
average selling prices in response to increased competition, partially offset by
increased unit volumes. Sales of IVD imaging system supplies and services
increased to $3.2 million from $2.7 million, an increase of $525,000 or 20% over
the comparable period last year, primarily due to the larger installed base of
The Yellow IRIS IVD imaging systems. Sales of small instruments and supplies
totaled $1.1 million, which is comparable last year.

    Revenues from the urinalysis segment totaled $4.3 million in the current
quarter as compared to $4.1 million in the same quarter of last year, an
increase of $211,000, partially offset by decreased licensing revenue. This
growth is due to increased sales of related system supplies and services to the
growing installed base. Revenues from the genetic analysis segment decreased to
$1.5 million in the current quarter as compared to $1.9 million in the same
quarter last year, for the reasons described above. Revenues from small
laboratory devices increased to $1.3 million in the current quarter, as compared
to $1.1 million in the same quarter of last year, an increase of $190,000. This
increase is due to higher licensing revenues partially offset by reduced
purchases by one distributor.

    Royalty and license revenue decreased to $344,000 in the three months ended
September 30, 1998 as compared to $363,000 in the comparable period last year.
The decrease is mainly due to differences in non-recurring licensing fees
received in the two periods.

    Cost of goods for IVD imaging systems increased as a percentage of sales of
IVD imaging systems to 55% for the quarter ended September 30, 1998 from 52% for
the comparable period last year. The increase is primarily due to lower average
selling prices of The Yellow IRIS urinalysis workstations and the PowerGene
genetic analyzers. Cost of goods for IVD imaging system supplies and services as
a percentage of sales of such products decreased to 47% for the current period
as compared to 50% for the same period last year. The decrease is primarily due
to improved pricing, partially offset by increased service-related costs. Cost
of goods for small instruments and supplies as a percentage of sales of small
instruments and supplies totaled 55% for the current quarter compared to 58% for
the comparable period last year. The decrease is primarily due to a change in
the sales mix. The net result of these changes was an increase in aggregate
gross margin to 51% for the quarter ended September 30, 1998, as compared to 50%
in the comparable period last year.

    Cost of goods sold as a percentage of revenues from the urinalysis segment
totaled 49% this quarter, as compared to 48% in the same quarter of last year.
This increase is attributable to lower licensing fees received by this segment.
Cost of goods sold as a percentage of revenues from the genetic analysis segment
totaled 49% this quarter, as compared to 48% in the same quarter of last year.
This increase is primarily the result of lower average selling prices due to the
non-recurrence of the multi-system order discussed above, price pressures from
increased competition and a change in product mix towards systems having a
higher proportion of OEM components. Cost of goods for small laboratory devices
as a percentage of revenues totaled 45% in the current period, as compared to
58% in the same quarter of last year. This decrease is due to increased
licensing revenues and a change in sales mix.

    Marketing and selling expenses totaled $1.5 million for the quarter ended
September 30, 1998 as compared to $1.3 million in the same period last year.
This increase is primarily due to increased promotion of the PowerGene genetic
analyzer. As a percentage of net revenues these expenses totaled 21% in the
current quarter as compared to 18% last year.

    General and administrative expenses remained constant at $927,000 for the
quarter ended September 30, 1998 as compared to $930,000 for the comparable
period last year. General and administrative expenses as a percentage of net
revenues remained constant at 13%.

    Net research and development expenses increased to $566,000 for the quarter
ended September 30, 1998 from $440,000, an increase of $126,000 or 29% from the
comparable period last year. Net research and development expenses increased as
a percentage of revenues from 6% to 8%. Reimbursements under joint development
programs decreased to $216,000 from $253,000. Total product technology
expenditures, including capitalized software development costs and reimbursed
costs under research and development grants and contracts, increased to $882,000
from $838,000, an increase of $44,000 or 5% as compared to the comparable period
last year. The increase in total product technology expenditures is due to
increased spending on The Yellow IRIS and PowerGene families of products
partially offset by decreased expenditures on products under joint development
with Poly U/A Systems, Inc.



                                       15
<PAGE>   17

    Amortization of intangible assets for the quarter ended September 30, 1998
decreased to $290,000 from $324,000, a decrease of $34,000 or 10% from the
comparable period last year. The decline is primarily the result of the
write-off in the fourth quarter of 1997 of goodwill from the digital
refractometer product line acquired in 1995.

    The results of operations for the quarter ended September 30, 1998 include
unusual legal expenses of $38,000 as compared to $31,000 in the prior year and
relates to a pending arbitration matter.

    Interest expense increased to $312,000 for the quarter ended September 30,
1998 from $308,000 for the comparable period last year due to increased interest
rates on the new credit facility.

    For the quarter ended September 30, 1998, urinalysis segment profits
decreased to $789,000 as compared to $852,000 in the same period last year, a
decrease of $63,000, or 7%. This decrease is largely due to lower licensing
revenues. Losses for the genetic analysis segment totaled $670,000 in the
current quarter as compared to losses of $296,000 in the same period last year,
an increased loss of $374,000. The increased loss is due to the decrease in
sales and gross margins described above and increased marketing and selling
expenses. Segment profits from the small laboratory devices segment totaled
$432,000 in the current quarter as compared to $158,000 in the same period last
year. The improvement was primarily caused by the increase in this segment's
licensing revenues as described above. Unallocated corporate expenses totaled
$404,000 in the current period as compared to $370,000 in the comparable period
last year, an increase of $34,000. This increase is due to increased legal
expenses and decreased expense reimbursements received from providing services
to Poly U/A Systems.

    The income tax provision for the quarter ended September 30, 1998 was
$53,000, as compared to an income tax provision of $130,000 for the comparable
period in 1997.

    The above factors contributed to a net income of $94,000 or $.01 per diluted
share for the quarter ended September 30, 1998 as compared to $214,000 or $0.03
per diluted share for the quarter ended September 30, 1997.

    COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 1998 TO NINE MONTHS ENDED 
SEPTEMBER 30, 1997

    Net revenues for the nine months ended September 30, 1998 increased to $20.4
million from $20.1 million, an increase of $346,000 or 2% over the comparable
period last year. Sales of IVD imaging systems decreased to $7.7 million from
$8.3 million, a decrease of $654,000 or 8% from the comparable period last year.
Revenues from sales of The Yellow IRIS family of urinalysis workstations
remained constant at $3.8 million due to increased sales to an international
distributor offset by decreased domestic sales. Revenues from sales of the
PowerGene line of genetic analyzers decreased $652,000. The decrease relates
primarily to the non-recurrence of a record $1.25 million multi-system sale of
genetic analyzers during the second, third and fourth quarters of last year,
lower average selling prices in response to increased competition, partially
offset by increased unit volumes. Sales of IVD imaging system supplies and
services increased to $9.1 million from $7.9 million, an increase of $1.2
million or 16% over the comparable period last year, primarily due to the larger
installed base of The Yellow IRIS IVD imaging systems. Sales of small
instruments and supplies decreased to $3.2 million from $3.3 million, a decrease
of $100,000.

    Revenues from the urinalysis segment totaled $12.7 million in the current
nine-month period as compared to $11.8 million in the same period of last year,
an increase of $909,000. This growth is due to the reasons discussed above
regarding The Yellow IRIS system and related supplies and service sales,
partially offset by decreased licensing revenues. Revenues from the genetic
analysis segment declined to $4.3 million in the current period as compared to
$4.9 million in the same period last year for the reasons described above.
Revenues from small laboratory devices improved due to increased licensing
revenues partially offset by reduced purchases by one distributor.

    Royalty and license revenue decreased to $434,000 in the nine months ended
September 30, 1998 as compared to $566,000 in the comparable period last year.
The decrease is primarily due to differences in non-recurring licensing fees
received in the two periods.

    Cost of goods for IVD imaging systems increased as a percentage of sales of
IVD imaging systems to 58% for the nine months ended September 30, 1998 from 51%
for the comparable period last year. The increase is primarily due to lower
average selling prices of The Yellow IRIS urinalysis workstations under an
international distribution agreement and lower average sales prices relating to
the PowerGene genetic analyzer. Cost of goods for IVD imaging system supplies
and services as a percentage of sales of such products decreased to 48% for the
current period as compared to 51% for the same period last year. The decrease is
primarily due to decreased costs and increased selling prices. Cost of goods for
small instruments and supplies as a percentage of sales of small instruments and
supplies totaled 55% for the current quarter compared to 56% for the comparable
period last year. The decrease is primarily due to a change in the sales mix.
The net result of these changes was a decrease in aggregate gross margin to 48%
for the nine months ended September 30, 1998, as compared to 50% in the
comparable period last year.



                                       16
<PAGE>   18

    Cost of goods sold as a percentage of revenues from the urinalysis segment
totaled 52% this period, as compared to 51% in the same period last year. Lower
average selling prices for The Yellow IRIS workstation under an international
distribution agreement were offset by improved pricing and decreased costs of
supplies and service. Cost of goods sold as a percentage of revenues from the
genetic analysis segment totaled 52% this quarter, as compared to 46% in the
same period of last year. This increase is primarily the result of lower average
selling prices due to the non-recurrence of the multi-system order discussed
above, price pressures from increased competition and a change in product mix
towards systems having a higher proportion of OEM components. Cost of goods for
small instrument devices as a percentage of revenues totaled 51% in the current
period, as compared to 54% in the same period last year due to a change in sales
mix and increased licensing revenues.

    Marketing and selling expenses totaled $4.0 million for the nine months
ended September 30, 1998, as compared to $3.8 million last year, an increase of
$171,000 or 4%. The increase is primarily due to increased promotion of the
PowerGene genetic analyzers. Marketing and selling expenses as a percentage of
net revenues amounted to 19% in both periods.

    General and administrative expenses totaled $2.7 million for the nine months
ended September 30, 1998, which is comparable to last year. General and
administrative expenses as a percentage of net revenues totaled 13% in both
periods.

    Net research and development expenses totaled $1.6 million for the nine
months ended September 30, 1998, which is comparable to the same period last
year. Net research and development expenses remained constant as a percentage of
revenues at 8%. Reimbursements under joint development programs decreased to
$792,000 from $904,000. Total product technology expenditures, including
capitalized software development costs and reimbursed costs under research and
development grants and contracts, decreased to $2.7 million from $2.9 million, a
decrease of $121,000 or 4% as compared to the comparable period last year. The
decrease is due to reduced spending on products under joint development with
Poly U/A Systems, Inc., partially offset by increased expenditures relating to
the Yellow IRIS and PowerGene genetic analyzer product families.

    Amortization of intangible assets for the nine months ended September 30,
1998 decreased to $870,000 from $949,000, a decrease of $79,000 or 8% from the
comparable period last. The decline is primarily the result of the write-off in
the fourth quarter of 1997 of goodwill from the digital refractometer product
line acquired in 1995.

    The results of operations for the nine months ended September 30, 1998
include unusual legal expenses of $125,000 relating to a pending arbitration
matter. The unusual legal expenses in the comparable period last year totaled
$130,000, and relate primarily to a separate, completed arbitration matter and
partially to the pending arbitration matter with DITI.

    Interest expense decreased to $871,000 for the nine months ended September
30, 1998 from $900,000 for the comparable period last year primarily due to
reduced indebtedness, partially offset by the effect of increased interest rates
on the new credit facility.

    For the nine months ended September 30, 1998, urinalysis segment profits
increased to $2.2 million as compared to $1.9 million in the same period last
year, an increase of $305,000 or 16%. This increase is largely attributable to
increased sales of related supplies and service described above, partially
offset by a small increase in operating expenses. Losses for the genetic
analysis segment totaled $2.1 million in the current period as compared to
losses of $1.4 million in the same period last year, an increase of $657,000.
The increased loss is due to the decrease in sales and gross margins for this
segment and increased expenses described above. Segment profits from the small
laboratory devices segment totaled $850,000 in the current period as compared to
$678,000 last year. The improvement is due to the increase in this segment's
licensing revenues described above. Unallocated corporate expenses totaled $1.2
million in the current period as compared to $1.1 million last year, an increase
of $80,000. This is due to increased legal fees related to a pending arbitration
matter.

    The income tax benefit for the nine months ended September 30, 1998 totaled
$68,000, as compared to an income tax provision of $48,000 for the comparable
period in 1997.

    The above factors contributed to a net loss of $113,000 or $.02 per diluted
share for the nine months ended September 30, 1998 as compared to a net income
of $30,000 or $0.07 per diluted share for the nine months ended September 30,
1997. In early 1997 the staff of the Securities and Exchange Commission ("SEC
staff") announced a new position on accounting for convertible preferred stock
which is potentially convertible at a discount to the market price of the common
stock, even if the potential for a discount is only a possibility. The SEC staff
has taken the position, that solely for purposes of calculating earnings per
share the potential discount is an imputed dividend to the preferred
stockholders, which reduces the amount of earnings available to common
stockholders. Accordingly, the issuance of the Series A Preferred Stock resulted
in a one-time reduction in earnings available to common shareholders of $450,000
or $0.08 per share in the nine-month period ended September 30, 1997.

LIQUIDITY AND CAPITAL RESOURCES

    Cash and cash equivalents decreased to $514,000 at September 30, 1998 from
$1.5 million at December 31, 1997. The decrease is due to a decline in cash
provided by operations and increased cash used by investing activities. Cash
provided by operations for the nine months ended September 30, 1998 decreased to
$632,000 from $1.5 million for the comparable 



                                       17
<PAGE>   19

period last year. This decline is primarily due to increases in accounts
receivable caused by a shift in the timing of system sales, a build up in
inventories to prevent shortages and an increase in long-term sales type leases
not sold to a third party. These increases were partially offset by increases in
accounts payable and other liabilities.

    Cash used by investing activities totaled $760,000 for the nine months ended
September 30, 1998, as compared to $202,000 in the prior year. The increase is
primarily due to the lack of short term investments available for conversion
into cash. Expenditures for property and equipment, including the cost of
equipment leased under short term rental agreements, and capitalized software
development totaled $612,000 and $315,000, respectively, in the current
nine-month period as compared to $427,000 and $388,000, respectively, in the
same period last year.

    On May 8, 1998, the Company refinanced its bank loans with the proceeds of a
new credit facility from Foothill Capital Corporation, a division of Norwest
Bank. The new credit facility consists of a $3.6 million term loan and a $4.0
million revolving line of credit. Borrowings under the line of credit are
limited to a percentage of eligible accounts receivable and are subject to a
combined limit of $7.0 million for the total credit facility. The term loan
bears interest at the lender's prime rate (8.25% on September 30, 1998) plus
3.0% and is payable in 36 equal monthly installments. The revolving line of
credit bears interest at the lender's prime rate plus 1.0%. The new credit
facility is subject to minimum interest charges, prepayment penalties and
customary fees, is collateralized by a first priority lien on all the assets of
the Company and matures in 2001. It also contains financial covenants based
primarily on tangible net worth and cash flow and imposes restrictions on
acquisitions, capital expenditures and cash dividends.

    Net cash used by financing activities totaled $830,000 and consisted
primarily of principal payments made in connection with the refinanced bank
loan, partially offset by proceeds from the new credit facility and proceeds
from the issuance of common stock. As of September 30, 1998, the Company had
$3.2 million outstanding under the term loan and had $1.4 million available
under the revolving credit line.

    As of September 30, 1998, the Company also had outstanding notes payable in
the aggregate amount of $742,000 from the repurchase of common stock and
warrants from a former strategic partner in 1996. The notes bear interest at the
rate of 8.0%, and principal is due in bi-monthly installments of $100,000.

    The Company has scheduled principal payments on outstanding debt totaling
$1.8 million during the next twelve months.

    The Company believes that its current cash on hand, together with cash
generated from operations, and cash available under the credit facility will be
sufficient to fund normal operations and pay principal and interest on
outstanding debt obligations for the next twelve months. The Company would like
to pursue equity financing to reduce indebtedness and to fund its long-term
business strategy. However, the Company has postponed these efforts due to the
decline in the Company's stock price.

     The FDA cleared The White IRIS leukocyte differential analyzer in May 1996,
but its commercial release was subsequently delayed by other priorities such as
the introductions of the Model 900 UDx urine pathology system and the UF-100
urine cell analyzer. The Company has elected not to launch The White IRIS at
this time due to limited resources and the potential impact of product launch
costs on profitability. The Company is exploring strategic alternatives for The
White IRIS program and therefore cannot reasonably estimate any impact on the
recoverability of the capitalized costs associated with the product line,
principally capitalized software and inventory. If the Company is unable to
develop a viable strategic alternative for the program and as a result abandons
the product line, it would incur a charge against future earnings of up to $1.2
million for the related amounts capitalized.

     In September 1995, the Company and Poly U/A Systems Inc. ("Poly") entered
into a research and development agreement to develop several new urinalysis
automation products using the Company's technology. The Company was funding the
first $15,000 per month of the cost of the project and has contributed its
maximum obligation of $500,000. Poly has reimbursed the Company for the excess.
The Company has an option until November 29, 1998 to acquire all of the common
stock of Poly for an aggregate price of $5.1 million, payable in cash or shares
of common stock of the Company. The Company has decided not to exercise its
option at the contractual amount and, instead, has entered into discussions to
acquire Poly at a price below the option price. The Company cannot predict
whether these discussions will lead to mutually acceptable terms for an
acquisition. If the Company acquires Poly, the portion of the purchase price
allocated to completed products and other assets would be capitalized and its
subsequent amortization would impact future earnings. For the portion of the
purchase price allocated to in-process research and development, if any, the
Company would record a nonrecurring, non-cash (if purchased with Common Stock)
charge against then current earnings.

YEAR 2000 PROBLEM

         The Year 2000 ("Y2K") problem arose because many existing computer
programs use only the last two digits to recognize a year. Therefore, when the
year 2000 arrives, these programs may not properly recognize a year beginning
with "2000" instead of the familiar "1900". The Y2K problem may result in the
improper processing of dates and date-sensitive calculations by computers and
other microprocessor-controlled equipment as the year 2000 is approached and
reached.

         STATE OF READINESS

         The Company has divided its review of Y2K problems into three major
areas: (1) internal systems, (2) Company products, including components supplied
by outside vendors, and (3) potential Y2K problems associated with outside
vendors.

     The Company has focused most of its Y2K efforts on internal systems because
it believes this area could be its primary source of Y2K problems. The Company's
internal computer systems are the foundation for its business operations and
include such critical functions as order entry, shipping, purchasing, inventory
control, manufacturing, accounts receivable, accounts payable and the general
ledger. The Company has completed a review of these critical systems and has
determined that they are not Y2K compliant. These systems are supported by third
parties who currently have software updates available at reasonable prices. The
Company plans to install and implement these updates by December 31, 1998. The
Company is also in the process of reviewing other equipment that contains
date-sensitive information. The Company expects to complete its review of all
other internal systems by June 30, 1999 and does not expect this review to
uncover a risk of a material adverse effect on its operations from Y2K problems
in this area.

         The Company has reviewed its products and has determined that the IVD
imaging systems produced by the urinalysis and genetics segments have date
sensitive fields or components that have date sensitive fields. Based on
completed verification and validation testing and, if applicable, certificates
received from third party vendors, the Company has concluded that all the
genetic segment IVD imaging systems, the unattended urinalysis IVD imaging
system (the Model 900 UDx urinalysis workstation) and the UF-100 urine cell
analyzer are Y2K compliant. The Company has also determined that there are no
date sensitive fields contained in the products of the small instruments
segment. The Company has determined that the unattended IVD imaging systems
produced by the urinalysis segment (Models Bravo, 250, 300, 450 and 500
urinalysis workstations) have date sensitive fields. The Company has completed
work on the software updates to make these products Y2K compliant and is
currently in the process of performing verification and validation of these
software updates. The Company expects to be distributing these software updates
by June 30, 1999.

         The Company has completed a review of outside vendors products that
interface with the Company's for any potential Y2K problems and has determined
that the Company's products need no further modification to interface with the
products of these vendors. The Company is also in the process of identifying any
potential Y2K problems from other outside vendors whose systems interface with
the Company's internal systems. The Company expects to complete this review by
June 30, 1999.

         Based on a preliminary review of the Y2K problem associated with
outside vendors, the Company does not expect this issue to have a material
adverse effect on its operations. However, since third-party Y2K compliance is
not within the Company's control, the Company cannot assure stockholders that
Y2K problems affecting the systems of other companies on which the Company's
systems rely will not have a material adverse effect on the Company's
operations.

         COSTS TO ADDRESS THE Y2K ISSUE

         Costs to address the Y2K problem include hardware, software, and
implementation costs paid to outside consultants. These costs incurred to date
have totaled less than $50,000, the majority of which has been expensed. The
Company expects to incur costs totaling less than $50,000 to upgrade its
internal systems. Estimated costs to be incurred with the verification and
validation of the urinalysis segment unattended IVD imaging systems are expected
to total less than $75,000.

         RISKS PRESENTED BY THE YEAR 2000 ISSUE

         To date, the Company has not identified any Y2K problem that it
believes could materially adversely affect the Company or for which a suitable
solution cannot be timely implemented. However, as the review of its interfaces
with other outside vendors progresses and the verification and validation of
changes made to the urinalysis segment's unattended IVD imaging systems is
completed, it is possible that Y2K problems may be identified that could result
in a material adverse effect on its operations. Also, the Company's credit
facility with Foothill Capital Corporation requires that it be Y2K compliant by
October 1, 1999. If the Company is unable to complete this work by that time,
the Company would have to seek a waiver or extension of this requirement.

         CONTINGENCY PLANS

         Although the Company has not formulated a contingency plan to date, the
Company intends to continue to assess its Y2K risks to determine whether it
needs to do so. The Company will develop a contingency plan if its
implementation of internal systems, ongoing review of other outside vendors or
verification and validation of the urinalysis segment unattended IVD imaging
systems identify a Y2K problem that poses a significant risk to its business 
operations.



                                       18
<PAGE>   20

INFLATION

    The Company does not foresee any material impact on its operations from
inflation.

HEALTHCARE REFORM POLICIES 

    In recent years, an increasing number of legislative proposals have been
introduced or proposed in Congress and in some state legislatures that would
effect major changes in the healthcare system, nationally, at the state level or
both. Future legislation, regulation or payment policies of Medicare, Medicaid,
private health insurance plans, health maintenance organizations and other
third-party payors could adversely affect the demand for the Company's current
or future products and its ability to sell its products on a profitable basis.
Moreover, healthcare legislation is an area of extensive and dynamic change, and
the Company cannot predict future legislative changes in the healthcare field or
their impact on its business.


RECENTLY-ISSUED ACCOUNTING STANDARDS

    Recently issued accounting standards are described in Note 14 to the
financial statements.

FORWARD-LOOKING STATEMENTS

    The foregoing discussion contains various forward-looking statements which
reflect the Company's current views with respect to future events and financial
results and are subject to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements include, but are
not limited to, the Company's views with respect to future financial results,
capital requirements, market growth, new product introductions and the like, and
are generally identified by phrases such as "anticipates," "believes,"
"estimates," "expects," "intends," "plans" and words of similar import. The
Company reminds stockholders that forward-looking statements are merely
predictions and therefore inherently subject to uncertainties and other factors
which could cause the actual results to differ materially from the
forward-looking statement. The Company has attempted to identify some of these
uncertainties and other factors in its 1997 Annual Report on Form 10-K/A.


PART 2 - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS.

    In July 1996, the Company acquired PSI from Digital Imaging Technologies,
Inc. ("DITI"). As part of the purchase price, the Company issued to DITI a
five-year warrant to purchase 875,000 shares of common stock at $8.00 per share.
In August 1997, the Company filed a demand for arbitration against DITI with the
American Arbitration Association. The Company's demand for arbitration alleges
material breaches of the representations, warranties and covenants in the
purchase agreement governing the PSI acquisition. DITI subsequently filed a
counterclaim in the arbitration proceeding alleging that the Company
misrepresented or omitted to disclose material facts in connection with the PSI
acquisition. DITI had previously requested a reduction in the exercise price of
the warrant but elected to seek unspecified monetary damages in the
counterclaim. The parties are currently conducting discovery. Although the
Company does not presently anticipate any material adverse effect as a result of
this arbitration proceeding, there can be no assurance that it will not have
such an effect on the Company or result in additional dilution to holders of the
common stock.

    The Company is involved in routine litigation arising in the ordinary course
of its business, and, while the results of the proceedings cannot be predicted
with certainty, the Company believes that the final outcome of such matters will
not have a material adverse effect on the Company.

ITEM 5.  OTHER INFORMATION

         The Company recently enlarged the Office of the Chief Executive to
three members. Dr. John A. O'Malley and Mr. Roland Jang, both long time advisers
to the Company, have joined Dr. Fred H. Deindoerfer in the Office of the Chief
Executive on a part time basis. Members of the office will share equally in its
key operational and strategic decisions.

         Earlier this year at the Company's Annual Meeting, Dr. Deindoerfer had
announced his desire to begin making succession plans. The enlarged office
structure will ensure continued focus on the Company's operational and strategic
challenges during the succession process.

         Dr. O'Malley, who has served on the Company's Board since 1988, is
President of Second Opinion, a consulting firm serving the healthcare diagnostic
and biotechnology industry. He is also a member of the Office of the President
of Litmus Concepts, Inc., a developer of point-of-care diagnostic tests for the
women's healthcare market and a member of the Board of Directors of Cytometrix,
Inc., a developer of point-of-care photonics-based medical devices which perform
non-invasive blood tests. Dr. O'Malley earned his Ph.D. in Physical Chemistry at
the University of Pennsylvania.

         Mr. Jang is a private investor/consultant who has worked in top level
positions for a number of healthcare diagnostic and high technology electronics
companies, including several successful startup companies he helped found. Mr.
Jang is Chairman of the Board of Directors of FlowScan Inc., a company with a
proprietary high sensitivity stethoscope in its early stage of marketing and a
member of the Board of Directors of Digital Medical Systems, Inc., a company
supplying a unique computer system to consolidate and analyze input/output data
in hospitals. Mr. Jang previously served as a member of the Company's Board of
Directors for twelve years following its inception and has frequently served as
an advisor to Dr. Deindoerfer on Company matters since then. He received his
M.S. in Chemical Engineering from the University of California at Berkeley.

         A founder of the Company, Dr. Deindoerfer has been Chairman, President
and Chief Executive Officer of the Company since 1980. He has guided the Company
through its formative years, and since 1990 has spearheaded its growth from a $4
million to $28 million Company. He plans to continue in his role as Chairman of
the Board of Directors.



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

    (a)    Exhibits

<TABLE>
<CAPTION>
    No.        Description
    ---        -----------
<S>            <C>
    3.1(a) --  Certificate of Incorporation, as amended (1)
    3.1(b) --  Certificate of Designations of Series A Convertible Preferred Stock (2)
    3.2    --  Restated Bylaws (3)
    4.1    --  Specimen of Common Stock Certificate (4)
    4.2    --  Certificate of Designations of Series A Convertible Preferred Stock (2)
    27.1   --  Financial Data Schedule-1997
    27.2       Financial Data Schedule-1998
</TABLE>

----------

    Exhibits followed by a number in parenthesis are incorporated by reference
to the similarly numbered Company document cited below:

(1) Current Report on Form 8-K dated August 13, 1987 and its Quarterly Report on
    Form 10-Q for the quarter ended September 30, 1993.



                                       19
<PAGE>   21

(2) Current Report on Form 8-K dated January 15, 1997.

(3) Quarterly Report on Form 10-Q for the quarter ended September 30, 1994.

(4) Registration Statement on Form S-3, as filed with the Securities and
    Exchange Commission on March 27, 1996 (File No. 333-002001).

    (b)    Reports on Form 8-K

    During the quarter ended September 30, 1998, the Company filed no reports on
Form 8-K. However, on October 9, 1998 the Company filed a report on Form 8-K to
voluntarily report segment information in accordance with FAS 131 for the three
completed fiscal years ended December 31, 1997.

    SIGNATURE

    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, in Chatsworth, California, on November
16, 1998.


                                    INTERNATIONAL REMOTE IMAGING SYSTEMS, INC.



                                    By: /s/ MARTIN S. MCDERMUT   
                                        ----------------------------------------
                                        Martin S. McDermut, Vice President, 
                                        Finance & Administration and Chief 
                                        Financial Officer



                                       20