SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

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™, FocalPoint™, PrepStain™, SurePath™, TriPath Care Technologies™, and TriPath Oncology™. 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™, i³ Series™, PrepStain™, SurePath™, and TriPath Care Technologies™. 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.

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 June 30, 2004 and 2003, reclassifications of $1,113 and $409, respectively, occurred between customer-use assets, property and equipment, and inventory. For the six months ended June 30, 2004 and 2003, reclassifications of $2,226 and $1,854, respectively, occurred between customer-use assets, property and equipment, and inventory.

3. Net Income/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 except during the second quarter of 2004. Consequently, except for the three months ended June 30, 2004, there is no difference in the method of calculating basic and diluted earnings per share. Basic earnings /(loss) per share is computed by dividing net earnings /(loss) by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing net earnings by the weighted average number of common shares outstanding plus potentially dilutive shares, as if they had been issued at the beginning of the period

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

presented. Potentially dilutive common shares result from our outstanding stock options and warrants. Certain shares, attributable to certain stock options and warrants, were excluded from diluted earnings per share because their impact was antidilutive.

The following represents a reconciliation of the weighted average shares used in the calculation of basic and diluted earnings per share:

The following table summarizes the potential common shares not included in the computation of diluted earnings per share because their impact would have been antidilutive:

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. The warrants 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. The remaining warrants outstanding, 100,583 in total, have a weighted average exercise price of $6.69.

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 June 30, 2004.

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

During April 2003, we obtained a $2,500 lease line of credit from General Electric Capital Corporation (“GE Capital”). Individual lease schedules under this lease line carry three-year terms. Financing charges are based on the fixed basic term lease rate factor. The lease line is being used as an alternative source of capital to secure operating leases for assets, primarily equipment. 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. As of June 30, 2004, assets with an original cost of $1,074 were leased under our lease lines with GE Capital. Future minimum lease payments under this lease line are $903.

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. Financing charges are 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 June 30, 2004, assets with an original cost of $1,286 were leased under this lease line. Future minimum lease payments under this lease line are $638. As the lease line has expired, no further assets will be leased under this line of credit.

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 research and development (“R&D”) funding, which was amortized against such expenses over thirty months on a straight-line basis. During the six months ended June 30, 2004 and 2003, respectively, we recorded $207 and $1,240 of amortization against R&D expense. This deferred R&D funding was fully amortized as of January 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 by the end of 2005. At June 30, 2004 we had taken delivery of 343 complete base units. Our remaining commitment under this contract approximates $1,582 based on the exchange rate in effect at June 30, 2004.

7. Stock Based Transactions

As allowed by the provisions of SFAS No. 123 “Accounting for Stock-Based Compensation”(“SFAS 123 ”), we continue to 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. The Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 in October 1995. For companies that continue to account for stock based compensation arrangements under APB 25, SFAS 123 requires disclosure of the pro forma

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

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:

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

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

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.

When and if it becomes apparent that any of the four tranches of currently unexercisable warrants held by Quest may vest upon the achievement of the applicable sales-based milestone, we will amortize the resulting deferred sales discounts over the related number of tests in the sixth-month period for which the warrants were earned. Since the deferred sales discount relating to these tranches of warrants will be amortized over only six months, if and when such warrants vest, the quarterly impact upon the future quarters in which they are recorded will be disproportionately large compared to the ongoing quarterly non-cash sales discount of $195 recorded in connection with the initial currently exercisable warrants.

In connection with this agreement, the initial 800,000 warrants were valued using a Black-Scholes pricing model upon issuance at $3,896, which represented a deferred sales discount. These warrants, which expire in 2007, were recorded as additional paid-in capital and the resulting deferred sales discount will be amortized on a straight-line basis against revenues over the five-year term of the agreement. Amortization of $130 was recorded as a reduction of revenue in the three months ended June 30, 2004.

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 current products; and (2) TriPath Oncology, our wholly-owned subsidiary through which we manage the development and market introduction of molecular diagnostic and pharmacogenomic products and services for cancer.

Results by Segment

The results, by segment, for the three and six months ended June 30, 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)