SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

OR

Commission file number 0-22885

TRIPATH IMAGING, INC.

(336) 222-9707

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 (   )

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

TriPath Imaging, Inc.

Table of Contents

Note Regarding Trademarks

We have registered trademarks in the United States for AutoCyte^®, AutoCyte Quic^®, AutoPap^®, CytoRich^®, ImageTiter^®, PrepMate^®, SlideWizard^®, and TriPath Imaging^®. We have pending U.S. trademark applications for i³ Series^TM, FocalPoint^TM, PrepStain^TM, SurePath^TM, TriPath Care Technologies^TM, and TriPath Oncology^TM. Foreign registrations are maintained for several of our trademarks in Australia, Canada, Chile, China, the European Union, Finland, Hong Kong, Indonesia, Israel, Japan, Malaysia, Norway, the Russian Federation, Singapore, South Africa, Sweden, Switzerland, Taiwan, Thailand and the United Kingdom. We have pending foreign trademark applications FocalPoint^TM, i³ Series^TM, PrepStain^TM, SurePath^TM, and TriPath Care Technologies^TM. In addition to trademark activity, we issue a copyright notice on all of our documentation and operating software. There can be no assurance that any trademarks or copyrights that we own will provide competitive advantages for our products or will not be challenged or circumvented by our competitors.

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Part I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

TriPath Imaging, Inc.

See accompanying notes to condensed consolidated financial statements

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TriPath Imaging, Inc.

     See accompanying notes to condensed consolidated financial statements.

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TriPath Imaging, Inc.

See accompanying notes to condensed consolidated financial statements

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TriPath Imaging, Inc.

1.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by TriPath Imaging, Inc. in accordance with generally accepted accounting principles and applicable Securities and Exchange Commission regulations for interim financial information. These financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The balance sheet at December 31, 2003 has been derived from the audited financial statements at that date, but does not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. The accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting of normal, recurring accruals) that, in our opinion, are necessary for a fair presentation of the results for the interim periods presented. The results of operations for such periods are not necessarily indicative of the results expected for the full year or for any future periods. The accompanying condensed consolidated financial statements and related notes should be read in conjunction with our audited consolidated financial statements and notes included in our Annual Report on Form 10-K (File No. 0-22885) for the year ended December 31, 2003.

2.

Inventory

Inventory consists of the following:

For the three months ended March 31, 2004 and 2003, reclassifications of $1,113 and $1,445, respectively, occurred between customer-use assets, property and equipment, and inventory.

3.

Net Loss Per Share of Common Stock

Per share information is based upon the weighted-average number of shares of common stock outstanding during the period. We incurred losses during all periods presented. As a result, 4,037,853 options and warrants were not used to compute diluted loss per share since the effect would be anti-dilutive. Accordingly, there is no difference between basic and diluted loss per share in the periods presented.

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TriPath Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(In thousands, except share and per share amounts)

4.

Long-Term Debt

In connection with a term loan which was fully repaid in 2003, we issued to the lenders warrants to purchase 223,253 shares of our common stock. Using a Black-Scholes pricing model, the warrants were valued upon issuance at $675, which represented non-cash debt issuance costs. These warrants, which expire in 2007, were recorded as additional paid-in capital and the resulting debt issuance costs were amortized on a straight-line basis to interest expense over the three-year term of the loan. That amortization has been completed. These warrants have a weighted average exercise price of $4.70 and were exercisable upon issuance. In January 2004 122,670 of these warrants were exercised using the net issuance feature contained in such warrants resulting in the issuance of 41,677 shares of common stock.

5.

Lines of Credit

In January 2004, we renewed our working capital facility with Silicon Valley Bank and increased the amount of the line to $7,500. The outstanding balance is limited to an amount equal to 80% of eligible accounts receivable if certain financial covenants are not met, all of which have been met. The current line commitment expires on January 28, 2005. The line bears interest at the bank’s prime rate plus 1/2% and is collateralized by substantially all of our assets. The line of credit carries customary covenants, including the maintenance of a minimum modified quick ratio and other requirements. We had no outstanding borrowings under this agreement at March 31, 2004.

During August 2002, we obtained a $1,500 lease line of credit from Bank of America. Amounts used under this lease line are secured by a letter of credit against our line of credit with Silicon Valley Bank discussed above. Assets leased under this lease line carry three-year lease terms for items acquired under it and financing charges based on three-year constant Treasury Maturities. The lease line was used as an alternative source of capital to secure operating leases for assets, primarily equipment. As of March 31, 2004, assets with an original cost of $1,286 were leased under this lease line. As the lease line has expired, no further assets will be leased under this line of credit.

During April 2003, we obtained a $2,500 lease line of credit from General Electric Capital Corporation. This lease line carries three-year lease terms for items acquired under it and financing charges based on the fixed basic term lease rate factor. The lease line will be used as an alternative source of capital to secure operating leases for assets, primarily equipment. As of March 31, 2004, assets with an original cost of $820 were leased under this lease line. In March 2004, this line was renewed for $2,000 (in addition to amounts for assets already leased under the line). Terms of the new line are substantially the same as the expiring line. The primary difference is that lease terms under the new line range from 30 to 36 months.

6.

Other Liabilities and Commitments

On July 31, 2001, we entered into a series of agreements with Becton, Dickinson and Company (“BD”) to develop and commercialize tests for malignant melanoma and cancers of the cervix, breast, ovary and prostate using genomic and proteomic markers identified at Millennium Pharmaceuticals, Inc. (“Millennium”). We have accounted for the transaction in accordance with the provisions of SFAS No. 68, “Research and Development Arrangements.” In connection with the transaction, we recorded $6,198 in deferred

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TriPath Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(In thousands, except share and per share amounts)

research and development (“R&D”) funding, which was amortized against such expenses over thirty months on a straight line basis. During the three months ended March 31, 2004 and 2003, respectively, we recorded $207 and $620 of amortization against R&D expense. This deferred R&D funding was fully amortized as of March 31, 2004.

During 2001, we entered into a contract with a vendor in Switzerland to purchase a minimum of 300 and up to 525 base units for our PrepStain instrument. We committed to purchase at least 300 complete units by December 31, 2004, and to the extent that we purchase less than 525 complete units, we will be obligated to purchase component parts for the balance. At March 31, 2004 we had taken delivery of 265 complete base units. Our remaining commitment under this contract approximates $2,764 based on the exchange rate in effect at March 31, 2004.

7.

Stock Based Compensation

We account for stock options issued to employees in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). Under APB 25, no compensation expense is recognized for stock or stock options issued with an exercise price equivalent to the fair value of our Common Stock. For stock options granted at exercise prices below the deemed fair value, we record deferred compensation expense for the difference between the exercise price of the shares and the deemed fair value. Any resulting deferred compensation expense is amortized ratably over the vesting period of the individual options.

In October 1995, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123, “Accounting for Stock Based Compensation” (“SFAS 123”). For companies that continue to account for stock based compensation arrangements under APB 25, SFAS 123 requires disclosure of the pro forma effect on net income (loss) and earnings (loss) per share as if the fair value based method prescribed by SFAS 123 had been applied.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123” (“SFAS 148”), which amends the disclosure requirements of FASB Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock based employee compensation and the effect of the method used on reported results (see below).

Had compensation cost for our stock options been determined based on the fair value at the date of grant consistent with the provisions of SFAS 123 and 148, with respect to our Equity Incentive Plan and our Employee Stock Purchase Plan, our pro forma net loss and net loss per share would have been as follows:

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TriPath Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(In thousands, except share and per share amounts)

8.

Operations by Industry Segment

Description of Products and Services by Segment and Geographic Area

We create solutions that redefine the early detection and clinical management of cancer. Specifically, we develop, manufacture, market, and sell proprietary products for cancer detection, diagnosis, staging, and treatment selection. We are using our proprietary technologies and know-how to create an array of products designed to improve the clinical management of cancer. We have developed and marketed an integrated solution for cervical cancer screening and other products that deliver image management, data handling, and prognostic tools for cell diagnosis, cytopathology and histopathology. We have created new opportunities and applications for our proprietary technology by applying recent advances in genomics, biology, and informatics to develop new molecular diagnostic and pharmacogenomic products and services for malignant melanoma and cancers of the cervix, breast, ovary and prostate.

We are organized into two operating units: (1) Commercial Operations, through which we manage the market introduction, sales, service, manufacturing and ongoing development of our products; and (2) TriPath Oncology, our wholly-owned subsidiary through which we manage the development of molecular diagnostic and pharmacogenomic products and services for cancer.

Results by Segment

The results, by segment, for the three months ended March 31, 2004 and 2003, are as follows:

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TriPath Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(In thousands, except share and per share amounts)

All sales were generated from external customers. There were no inter-segment revenues. Sales to external customers in the TriPath Oncology segment were $10 and $133 during the three months ended March 31, 2004 and 2003, respectively, and were attributable to services sold. Sales to external customers in the Commercial Operations segment for the three months ended March 31, 2004 and 2003, include the following:

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TriPath Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(In thousands, except share and per share amounts)

At December 31, 2003, we had accounts and notes receivable of $2,036 from a company which disclosed to us its intention to exit the cervical cytology business. The contract we had with this customer was a multi-year agreement that included commitments for reagents and disposables. As we were unable to reach a mutually acceptable settlement through negotiations, we filed suit against that company in February 2003 in state court in North Carolina to enforce our rights under the agreement. In February 2004, we settled the dispute pursuant to a confidential settlement agreement. As a result of the payments that we have received and are entitled to receive under the settlement and the reserve that we established when the dispute arose, we are not required to record a charge against revenues. To date, both parties have complied with the settlement agreement.

Depreciation and amortization expense for the three months ended March 31, 2004 and 2003 amounted to $1,141 and $1,012, respectively, for the Commercial Operations segment and $57 and $55, respectively, for the TriPath Oncology segment. The TriPath Oncology segment also amortized $207 and $620, respectively, of deferred R&D funding against R&D expenses for each of the three-month periods ended March 31, 2004 and 2003.

As of March 31, 2004, the TriPath Oncology segment had total assets of $1,292 and the Commercial Operations segment had total assets of $63,758.

Geographic Area Data

Our Commercial Operation’s domestic revenues are generated primarily by direct sales activities. International revenues continue to be derived primarily through distributors. For the three months ended March 31, 2004 and 2003, international revenues accounted for 29% and 26%, respectively, of total revenues.

9.

Contingencies

We and Cytyc Corporation (“Cytyc”) compete in our sale of our FocalPoint and Cytyc’s sale of its ThinPrep Imaging System. We believe Cytyc’s ThinPrep Imaging System infringes our patents and, on June 16, 2003, we filed a lawsuit in the United States District Court for the Middle District of North Carolina seeking damages and injunctive relief to stop such infringement. On July 24, 2003, Cytyc filed its answer in the North Carolina court, which included counterclaims seeking a declaration that our patents are invalid and that its ThinPrep Imaging System does not infringe our patents. On October 30, 2003, the Court in this action issued an order transferring this case to the United States District Court for the District of Massachusetts.

On June 16, 2003, Cytyc filed an action in the United States District Court for the District of Massachusetts seeking a declaration that our patents are invalid and that its ThinPrep Imaging System does not infringe our patents. Cytyc is not claiming in either of its actions that our FocalPoint or any of our other products infringe any of its patents. On November 10, 2003, we filed our answer, which included a counterclaim for infringement of our patents by Cytyc’s ThinPrep Imaging System.

On January 5, 2004, the district court in Massachusetts entered an order consolidating the two lawsuits into a single action. On April 30, 2004, the district court granted us leave to amend our complaint and

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TriPath Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(In thousands, except share and per share amounts)

answer in the consolidated action to assert infringement against Cytyc’s ThinPrep Imaging System under two additional patents. The consolidated case is currently in the discovery phase and no trial date has been set. We anticipate that a trial will be scheduled sometime in 2005 based on the current case schedule. At this time, because of the early stage of the consolidated proceedings, we are unable to predict the ultimate outcome. Similarly, we are unable to predict the potential effect on our business and results of operations that any outcome may ultimately have.

The case number for the action transferred from North Carolina to Massachusetts is 1:03-CV- 12630-DPW and the case number for the consolidated Massachusetts action is 1:03-CV-11142-DPW. The case numbers are for reference only and the corresponding pleadings are expressly not incorporated into this document by reference.

Furthermore, in the ordinary course of business, we are the subject of, or party to, various pending or threatened claims and litigation. In the opinion of management, settlement of such claims and litigation will not have a material effect on our operations or financial position.

10.

Recently Issued Accounting Standards

In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN 46”), which requires a new approach in determining if a reporting entity should consolidate certain legal entities, including partnerships, limited liability companies, or trusts, among others, collectively defined as variable interest entities, or “VIE’s.” A legal entity is considered a VIE if it does not have sufficient equity at risk to finance its own activities without relying on financial support from other parties. If the legal entity is a VIE, then the reporting entity that is the primary beneficiary must consolidate it. Even if a reporting entity is not obligated to consolidate a VIE, then certain disclosures must be made about the VIE if the reporting entity has a significant variable interest. Certain transition disclosures are required for all financial statements issued after January 31, 2003. The adoption of FIN 46 had no impact on our results of operations or financial position for the three months ending, nor as of, March 31, 2004.

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

The following discussion of our financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in Item 1 of this Quarterly Report on Form 10-Q.

This report on Form 10-Q contains forward-looking statements based on our current plans and expectations of our management. Important information about the basis for these plans and expectations and certain factors that may cause our actual results to differ materially from these statements are contained below and in “Certain Factors Which May Affect Future Operations and Results,” beginning on page 20.

Overview

     We create solutions that redefine the early detection and clinical management of cancer. Specifically, we develop, manufacture, market, and sell proprietary products for cancer detection, diagnosis, staging, and treatment selection. We are using our proprietary technologies and expertise to create an array of products designed to improve the clinical management of cancer. We have developed and marketed an integrated solution for cervical cancer screening and other products that deliver image management, data handling, and prognostic tools for cell diagnosis, cytopathology and histopathology. We have created new opportunities and applications for our proprietary technology by applying recent advances in genomics, biology, and informatics to our efforts to develop new molecular diagnostic and pharmacogenomic products and services for malignant melanoma and cancers of the cervix, breast, ovary, and prostate.

     We are organized into two operating units: (1) Commercial Operations, through which we manage the market introduction, sales, service, manufacturing and ongoing development of our products; and (2) TriPath Oncology, our wholly-owned subsidiary through which we manage the development of molecular diagnostic and pharmacogenomic products and services for cancer.

     Our Commercial Operations is a commercial engine organized to grow sales, drive margin and generate cash. TriPath Oncology is the development engine of a broad based gene discovery program created to develop new molecular diagnostic and pharmacogenomic products for the early detection and clinical management of cancer. Our revenues are, by-and-large, generated today through our Commercial Operations from the sale of our cervical cytology screening products. Although we do not expect that the products and services that we are developing in TriPath Oncology will materially impact revenues in 2004 and 2005, we do believe that beginning in 2006 sales related to products developed by TriPath Oncology may significantly impact our growth going forward.

Commercial Operations

     We generate revenue from the sale, rental and lease of PrepStain systems and from the sale of the related SurePath and PrepStain test kits, comprised of proprietary reagents and other disposables. We also generate revenue from the direct sale of FocalPoint systems and from the placement of FocalPoint systems under fee-per-use contracts. Additionally, we generate revenue from service contracts on PrepStain and FocalPoint systems. Finally, we generate revenue from the sale and rental of our SlideWizard line of products and from service contracts on these products.

     Our marketing strategy is focused on providing solutions that address the unmet needs of our three broad market stakeholders: clinical laboratories, clinicians and third-party payors. We direct our marketing resources toward various initiatives designed to promote brand identification and awareness, increase market acceptance of our products and services and enhance product management. We have expanded our presence in the marketplace through increased advertising and promotion,

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company-sponsored seminars and trade shows, and peer selling activities. An important element of our marketing strategy is to achieve broad market acceptance of our integrated product consisting of our PrepStain thin-layer slides for cervical cancer screening by the FocalPoint system.

TriPath Oncology

     Our TriPath Oncology business focuses on developing molecular diagnostic and pharmacogenomic products for malignant melanoma and cancers of the cervix, breast, ovary, and prostate.

     The goal of our molecular oncology program is to use new discoveries in genomics and proteomics research to develop and commercialize diagnostic and pharmacogenomic products and services to improve the early detection and clinical management of certain types of cancer. We have active programs in development seeking to create tests to identify individuals with certain types of cancer at the earliest possible stage of the disease, provide individualized predictive and prognostic information, guide treatment selection for patients with cancer, and predict disease recurrence. The core products and services we are developing will be based upon genomic and proteomic markers that were identified through discovery research conducted at Millennium under its research and development agreement with BD as well as other markers that have been or may be identified independently of that agreement.

     We are also leveraging our proprietary imaging technology in an effort to develop new collaborations to expand our commercial opportunities.

     TriPath Oncology is not expected to generate any significant revenue until 2006, and, consequently, will continue to incur expenses in excess of revenues generated.

Challenges

     In 2004, the challenges and risks we face are familiar on some fronts and new on others. Some historical challenges and risks that still face us in 2004 include the competitive pressure from Cytyc Corporation. We have made measurable strides in the cervical cytology marketplace, but we have more ground to gain. Balancing existing cash reserves against effective marketing and selling programs continues to be one of our prime areas of focus. Additionally, successful movement of three product offerings through the clinical trial and FDA approval processes is a challenge we face in 2004. If we are able to obtain FDA approval for (i) use of our SurePath product with alternate collection devices, (ii) our FocalPoint GS system and (iii) use of our preservative solution to collect specimens for use in Digene’s Hybrid Capture HPV test, we will have additional opportunities to address the cervical cytology market competitively. There can be no assurance that we will obtain FDA approval for these product offerings.

     The new challenges and risks that we face in 2004 primarily reflect the progress we have made in our molecular diagnostics development programs to date and the fact that some of these programs will now move into the next stages of development and commercialization. In 2003, we completed the marker discovery for all of our cancer development programs, including cancer of the breast, cervix, ovary, and prostate and completed the transfer of breast staging, cervical staging, ovarian screening and breast screening markers. We made significant progress in translating the cervical, breast, and ovarian markers into assay reagents, and developed functional prototype assays to evaluate each marker’s clinical performance. In 2004, we face the challenge of optimizing our cervical and breast staging assays, release of the resultant assays for external research, and initiation of the process to gain regulatory approval for the sale of these assays. We also face the challenges and risks associated with selection of the final marker panel for screening for ovarian cancer, for continuing clinical studies related to our melanoma staging product, and for preparation of our facilities and operations for manufacture of the molecular diagnostic products that we are developing. We also intend to seek and develop additional markers as opportunities arise.

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Developments

In the first quarter of 2003, we entered into an agreement with Quest Diagnostics Incorporated (“Quest Diagnostics”) to introduce our cervical cancer screening products in select locations. Quest Diagnostics completed an evaluation process of these products in late 2003. Early in the second quarter of 2004, on the strength of the outcome of this evaluation, we entered into a new multi-year agreement with Quest Diagnostics. Under this agreement, Quest Diagnostics uses our i3 Series integrated solution, including the SurePath product and the PrepStain system, and is finalizing its evaluation of the FocalPoint system for use in its operations. During the term of the agreement, we will work together with Quest Diagnostics to expand the use of our products by educating physicians about the benefits of our technology.

In connection with the new agreement, we issued Quest Diagnostics incentive warrants with respect to an aggregate of 4,000,000 shares of our common stock as follows: a three-year warrant exercisable immediately for 800,000 shares at an exercise price of $9.25 per share; a three-year warrant exercisable upon achievement of a certain milestone for 200,000 shares at an exercise price of $10.18 per share; a three-year warrant exercisable upon achievement of a certain milestone for 500,000 shares at an exercise price of $10.64 per share; a four-year warrant exercisable upon achievement of a certain milestone for 1,000,000 shares at an exercise price of $11.56 per share; and a four-year warrant exercisable upon achievement of a certain milestone for 1,500,000 shares at an exercise price of $12.03 per share. The milestones all are based on the volume of SurePath tests purchased by Quest Diagnostics within specified time periods. In addition, the warrants permit exercise on a net issuance basis and are subject to a lock-up provision, which prohibits sales and other transfers of the underlying shares for a period of two years and subjects sales for an additional one year thereafter to certain limitations.

During the first quarter of 2003, we initiated clinical trials in the U.S., under a binding agreement protocol with the FDA to collect data in support of an application for U.S. approval for our FocalPoint GS system. We continue to collect specimens and analyze both new and existing data as required by our binding agreement protocol with the FDA. We anticipate completing this trial in the first half of 2004. There can be no assurance that our FocalPoint GS system will demonstrate clinical efficacy or receive the required regulatory approvals, when anticipated, if at all.

During the second quarter of 2003, we initiated data collection to support a submission to the FDA for approval for humanpapilloma virus (HPV) testing using the Digene Hybrid Capture® HPV Test on cells collected using our SurePath Test Pack. We expect to make a submission to the FDA containing the results from this clinical trial in the first half of 2004. There can be no assurance that our submission will be made within this timeframe or will receive the required regulatory approvals, when anticipated, if at all.

Litigation with Cytyc Corporation

We and Cytyc Corporation (“Cytyc”) compete in our sale of our FocalPoint and Cytyc’s sale of its ThinPrep Imaging System. We believe Cytyc’s ThinPrep Imaging System infringes our patents and, on June 16, 2003, we filed a lawsuit in the United States District Court for the Middle District of North Carolina seeking damages and injunctive relief to stop such infringement. On July 24, 2003, Cytyc filed its answer in the North Carolina court, which included counterclaims seeking a declaration that our patents are invalid and that its ThinPrep Imaging System does not infringe our patents. On October 30, 2003, the Court in this action issued an order transferring this case to the United States District Court for the District of Massachusetts.

On June 16, 2003, Cytyc filed an action in the United States District Court for the District of Massachusetts seeking a declaration that our patents are invalid and that its ThinPrep Imaging System does not infringe our patents. Cytyc is not claiming in either of its actions that our FocalPoint or any of our other products infringe any of its patents. On November 10, 2003, we filed our answer, which included a counterclaim for infringement of our patents by Cytyc’s ThinPrep Imaging System.

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On January 5, 2004, the district court in Massachusetts entered an order consolidating the two lawsuits into a single action. On April 30, 2004, the district court granted us leave to amend our complaint and answer in the consolidated action to assert infringement against Cytyc’s ThinPrep Imaging System under two additional patents. The consolidated case is currently in the discovery phase and no trial date has been set. We anticipate that a trial will be scheduled sometime in 2005 based on the current case schedule. At this time, because of the early stage of the consolidated proceedings, we are unable to predict the ultimate outcome. Similarly, we are unable to predict the potential effect on our business and results of operations that any outcome may ultimately have.

The case number for the action transferred from North Carolina to Massachusetts is 1:03-CV- 12630-DPW and the case number for the consolidated Massachusetts action is 1:03-CV-11142-DPW. The case numbers are for reference only and the corresponding pleadings are expressly not incorporated into this document by reference.

Critical Accounting Estimates

In our Annual Report on Form 10-K for the fiscal year ended December 31, 2003, we identified our judgments and assumptions with respect to revenue recognition, allowance for doubtful accounts receivable, inventory and valuation of long-lived and other intangible assets as most critical to the accounting estimates used in the preparation of our financial statements. We reviewed our policies and estimates and determined that those policies require the most critical judgments and assumptions for the three months ended March 31, 2004. We did not make any changes in those policies during the quarter.

Results of Operations
(In thousands, except share and per share amounts)

Three Months Ended March 31, 2004 and March 31, 2003

Revenues – Total revenues for the first quarter of 2004 were $15,510, representing an increase of 39.1%, compared to revenues of $11,147 in the first quarter of 2003.

Revenues for the first quarter of 2004 in our Commercial Operations segment were $15,500, representing an increase of 40.7%, compared to revenues of $11,014 in the first quarter of 2003. TriPath Oncology had $10 of revenues in the first quarter of 2004, compared with $133 in the same period of 2003. The net increase in Commercial Operations revenues was primarily due to an increase in reagent sales of $3,130, or 37.4%, and an increase in sales of instruments of $670, or 62.1%, during the first quarter of 2004 compared to the first quarter of 2003. Other revenues, consisting primarily of fee-per-use sales, service on system placements, sales of non-instrument related SlideWizard products, various consumable products, freight and royalties, increased approximately $686 during the first quarter of 2004 compared to the first quarter of 2003, largely attributable to service, FocalPoint fee-per-use, various consumable product and freight revenues.

In the first quarter of 2004, reagent revenues increased by $3,130, or 37.4%, versus the first quarter of 2003. Domestic sales of our SurePath and PrepStain reagents increased $2,526, or 40.1%, and international sales increased $604, or 29.1%, over the same period in 2003. Worldwide, we shipped 37 PrepStain instruments, including 12 sales and 25 reagent rentals in the first quarter of 2004. In the U.S., we placed 24 PrepStain instruments with new and existing customers, 23 of which were reagent rentals. During the first quarter of 2004, we gained 12 new laboratory customers in the U.S. Revenues from domestic sales of reagents and disposables increased by 0.5% from the fourth quarter of 2003. Domestic sales of reagents were particularly low in January but rebounded strongly by March. Domestic sales in units increased by 0.3% from the fourth quarter of 2003 and by 39.6% from the first quarter of 2003. Our SurePath Test Pack share of the domestic Pap smear testing market in the U.S. was approximately 11.5% as of the end of the first quarter of 2004 versus 8.3% as of the end of the first quarter of 2003.

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We continue to believe that there is an ongoing U.S. market shift toward liquid-based Pap smear testing. As we have pointed out in the past, FocalPoint was not FDA approved to screen SurePath thin-layer slides until the fourth quarter of 2001 and, therefore, could only initially be used for the screening of conventional Pap smears in the U.S. Since receiving FDA approval in October 2001 to screen SurePath thin-layer slides on FocalPoint, we have leveraged our combined product to drive sales of reagents and disposables. We continue to expect to realize the results from our combined product throughout 2004 and beyond.

Instrument revenues increased $670, or 62.1%, for the first quarter of 2004 over the first quarter of 2003. Sales of PrepStain instruments worldwide were essentially flat, increasing by only $7, or 1.3% for the first quarter of 2004 over the first quarter of 2003, including a domestic decrease of $67 offset by an increase of $74 internationally. Worldwide sales of FocalPoint systems increased approximately $645, or 118.5%, during the first quarter of 2004 over the first quarter of 2003, with a domestic decrease of $108 offset by an international increase of $753, or 440.1%. Overall, FocalPoint slide profilers were placed with two new customers in the U.S. during the quarter. This brings the total of FocalPoint slide profiler customers in the U.S. to 55, representing 88 instruments. Approximately 67% of FocalPoint customers in the U.S. utilize our integrating software to process both conventional Pap smears and SurePath slides. Sales related to our Extended SlideWizard instruments increased $18 between the two comparable quarters.

Other revenues increased $686, or 43.8%, from the first quarter of 2003 to the first quarter of 2004. The major components of this overall increase were service revenue increases of $238, or 74.1% compared with the first quarter of 2003; fee-per-use revenue increases of $126, or 27.9% compared with the first quarter of 2003; and increases of $274, or 50.8%, in sales of miscellaneous PrepStain and reagent related accessories. Other net increases amounted to $48 and were mainly freight related.

Gross Margin - Gross margin for the first quarter of 2004 was 68.3%, an increase from 65.2% in the comparable period of 2003. This resulted in increased gross profit of $3,329, or 45.8%, between the comparable quarters. Gross margin increased as the result of continued growth in higher margin reagent and disposable sales, higher product prices to new accounts, and lean-based efficiencies in our manufacturing operations.

Research and Development - Research and development expenses include salaries and benefits of scientific and engineering personnel, testing equipment, relevant consulting and professional services, components for prototypes and certain facility costs. Total research and development expenses for the first quarter of 2004 were $2,334, a 19.3% increase from $1,957 in the first quarter of 2003.

These expenses at TriPath Oncology increased by $373, or 25.9%, from $1,440 in the first quarter of 2003 to $1,813 in the first quarter of 2004 and reflect the imaging research and development activities around our instrument platforms for our molecular diagnostic programs and the incremental expenses related to the development of our molecular diagnostic markers, reagents and assays. The increase largely reflects the loss of the amortization of a deferred credit that we have been recording as a credit to expense over the 30 months ended January 2004, when this credit expired. Whereas the first quarter of 2003 contained a credit of $620 against research and development expenses, the first quarter of 2004 reflected only $207 of such expense credit, resulting in an increase to expenses of $413. An increase in research and development expenses of $4, or 0.8% over the comparable quarter in 2003, was also recorded in the Commercial Operations segment.