SELECTED FIVE-YEAR
        FINANCIAL DATA

         (IN THOUSANDS,
 EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
<TABLE>
<CAPTION>

                                      1998       1997      1996       1995         1994
                                 ______________________________________________________
<S>                            <C>          <C>        <C>       <C>          <C>

Statement of Operations Data
Revenues                          $ 12,079   $ 10,824   $ 3,062   $     --     $     --
Gross margin                         5,368      6,049     1,157         --           --
Operating expenses:
  Research and development          11,269     14,249    11,202      9,384        9,183
  Selling, general 
    and administrative              17,950     17,746    11,295      6,626        3,320
  Write-off of intangible 
    assets (1)                       3,084         --        --         --           --
Net loss                           (26,181)   (23,597)  (17,655)   (14,365)     (12,324)
Basic and diluted net 
  loss per share (2)                 (1.81)     (1.66)    (1.36)     (1.59)          --
Pro forma (excluding write-off 
  of intangible assets)
  Loss                             (23,097)   (23,597)  (17,655)   (14,365)     (12,324)
  Basic and diluted loss per share   (1.60)     (1.66)    (1.36)     (1.59)          --
                     
Balance Sheet Data
Cash, cash equivalents, and
  securities available-for-sale   $  8,954   $ 28,719  $ 58,488   $ 23,430      $ 2,295
Working capital                     10,438     34,673    60,821     22,876        2,316
Total assets                        38,150     58,941    76,132     28,016        5,193
Long-term obligations,
  less current portion               1,257        102       183        258          176
Total shareholders' equity          28,228     53,228    71,602     25,133        3,602

</TABLE>
                     
The comparability of the above data is affected by the Company's initial 
public offering completed in February 1995 and follow on public offering
completed in January 1996.  See Note 7 of Notes to Financial Statements.
                     
(1)  See Note 4 of Notes to Financial Statements.
(2)  The basis for determining the number of shares used in computing basic 
     and diluted net loss per share is described in Note 1 of Notes to
     Financial Statements.  Basic and diluted net loss per share for 1994 
     is not considered meaningful due to changes in the Company's capital 
     structure.

10
<PAGE>

MANAGEMENT'S DISCUSSION
        AND ANALYSIS OF
FINANCIAL CONDITION AND
  RESULTS OF OPERATIONS

            OVERVIEW
                         NeoPath, Inc. ("NeoPath" or the "Company")
                     develops and markets visual intelligence technology
                     to increase accuracy in medical testing.  NeoPath's
                     initial products include two automated screening
                     systems that integrate proprietary high-speed
                     morphology computers, video imaging technology, and
                     sophisticated image interpretation software to
                     capture and analyze thousands of microscopic images
                     from a Papanicolaou ("Pap") smear slide for the early
                     detection of cervical cancer.
                         The United States Food and Drug Administration
                     (the "FDA") approved NeoPath's AutoPap(R)
                     300 QC Automatic Pap Screener System (the "AutoPap
                     QC") in 1995.  The AutoPap QC is a rescreening device
                     used for quality control and rescreening of Pap smear
                     slides previously screened by cytotechnologists.
                     Clinical studies have shown that the AutoPap QC
                     detects a significantly higher proportion of
                     undetected abnormal slides than procedures typically
                     employed by clinical laboratories to meet federal
                     rescreening requirements.
                         The FDA approved NeoPath's AutoPap(R) Primary
                     Screening System (the "AutoPap Screener")
                     in May 1998.  The AutoPap Screener uses the same
                     hardware components as the AutoPap QC, but uses
                     enhanced software to perform the initial screening of
                     Pap smear slides and to classify up to 25% of such
                     slides as requiring no further review.  Clinical
                     studies have shown that the AutoPap Screener provides
                     statistically significantly better sensitivity and
                     specificity when compared to existing laboratory
                     practice.  Currently, it is the only instrument
                     approved by the FDA that allows Pap smear slides to
                     bypass human review.  This feature of the AutoPap
                     Screener provides customers with an economic
                     incentive to adopt the technology.
                         The "AutoPap System" refers to the AutoPap
                     Screener and the AutoPap QC together.

RESULTS OF OPERATIONS

                             CHANGE FROM                CHANGE FROM
(IN THOUSANDS)       1998     PRIOR YEAR        1997     PRIOR YEAR      1996
_____________________________________________________________________________ 

Revenues         $ 12,079        $ 1,255    $ 10,824        $ 7,762   $ 3,062
                                     12%                       254%
                     
                         NeoPath began recognizing product revenues in
                     1996.  The Company recognizes revenue on either a
                     product sale or fee-per-use basis (subject to
                     service and license agreements, rental contracts,
                     and minimum payments on certain fee-per-use
                     contracts).  Under its fee-per-use program, NeoPath
                     retains ownership of AutoPap Systems placed at
                     customer sites and assesses customers a charge for
                     each Pap smear slide processed.  The cost of each
                     AutoPap System is reclassified from inventories to
                     depreciable equipment upon shipment to a fee-per-use
                     customer site.  Such equipment, reflected on the
                     balance sheet under "fee-per-use systems, net," is
                     depreciated on a straight-line basis over a four-
                     year period, commencing upon commercial operation.
                         Because the AutoPap Screener is the only FDA-
                     approved system for automated primary screening of
                     Pap smears, NeoPath has implemented a strategy in
                     the United States to take advantage of this
                     competitive opportunity by offering AutoPap
                     Screeners to customers with initial fee-per-use
                     pricing in line with existing laboratory economics.
                     Per-slide pricing is designed to increase during
                     contract periods to reflect expected increases in
                     third-party reimbursement levels.  NeoPath also
                     continues to offer traditional, fixed-price fee-per-
                     use contracts.
                     
11
<PAGE>
                     
                         In October 1998, NeoPath announced an agreement
                     with SmithKline Beecham Clinical Laboratories
                     ("SmithKline") pursuant to which SmithKline agreed
                     to adopt the AutoPap Screener throughout its
                     domestic laboratory organization.  This four-year
                     contract is intended to enable SmithKline to process
                     100% of its Pap smear volume on AutoPap Screeners.
                     At current AutoPap processing rates, NeoPath
                     estimates that SmithKline may require up to 125
                     AutoPap Screeners to process its nationwide volume
                     of Pap smears.  During the fourth quarter of 1998,
                     NeoPath shipped more than 40 additional AutoPap
                     Screeners to SmithKline.  These shipments, combined
                     with existing AutoPap QCs at SmithKline sites that
                     were previously upgraded to AutoPap Screeners, total
                     approximately 70 AutoPap Screeners at SmithKline as
                     of December 31, 1998.
                         In February 1999, SmithKline and Quest
                     Diagnostics Incorporated ("Quest") announced that
                     Quest had agreed to purchase SmithKline.  The
                     combined entity would be the largest clinical
                     laboratory company in the world.  NeoPath's national
                     agreement with SmithKline is binding on successor
                     organizations, and NeoPath management believes that
                     the AutoPap Screeners installed under the SmithKline
                     agreement will continue to generate revenues in
                     accordance with the underlying agreement.
                         In October 1998, NeoPath announced a national
                     agreement with Kaiser Permanente ("Kaiser"), which
                     is the largest non-profit group health plan in the
                     United States.  This national agreement allows
                     Kaiser and affiliated entities to purchase AutoPap
                     Screeners during the two-year term of the agreement,
                     with additional annual service and licensing fees
                     due over four years.  At current AutoPap processing
                     rates, NeoPath estimates that Kaiser may require up
                     to 35 AutoPap Screeners to process its nationwide
                     volume of Pap smears.  The timing of specific
                     purchase orders -- and related AutoPap Screener
                     shipments -- is subject to the adoption plans of
                     Kaiser laboratories and affiliates.  No product
                     revenues were recognized under this agreement in
                     1998.
                         NeoPath's AutoPap System placements have
                     consisted primarily of fee-per-use contracts in the
                     United States and sale contracts internationally.
                     Because sale contracts result in immediate revenue
                     recognition, whereas fee-per-use contracts provide a
                     recurring revenue stream over several years,
                     NeoPath's total revenues have included a significant
                     sale component.  In the past three years, sale
                     revenues (including upgrades) have accounted for 61%
                     to 65% of total revenues.  Remaining revenues
                     consisted primarily of fee-per-use contract
                     billings.
                         Fee-per-use revenues in 1998 increased 31%
                     from the prior year, with much of the increase
                     occurring in the fourth quarter of 1998.  The
                     increase in NeoPath's fee-per-use business was the
                     result of higher overall per-slide pricing and
                     increased System placements during the fourth
                     quarter of 1998, primarily at SmithKline sites.
                         Approximately 19% of NeoPath's revenues in
                     1998 were from customers outside of the United
                     States, compared to 51% in 1997 and 45%
                     in 1996.  International revenues in prior
                     years included initial system orders under a
                     distribution agreement in Japan.  NeoPath's AutoPap
                     technology is now available internationally at
                     commercial laboratories in Taiwan, Japan, China
                     (Hong Kong), Korea, Australia, and in Europe.  Total
                     1998 revenues included additional AutoPap System
                     placements in Taiwan, Hong Kong and Japan.  The
                     Company's international product placements have
                     primarily been denominated in U.S. dollars; however,
                     future product revenues may be subject to foreign
                     exchange rate fluctuations.
                         
12
<PAGE>
                     
                         NeoPath believes that increased third-party
                     reimbursement of Pap smears in general, and
                     increased reimbursement for screening utilizing the
                     AutoPap System in particular, would increase market
                     acceptance of the Company's products.  In early
                     1998, NeoPath established a reimbursement team to
                     work with third-party insurers and managed care
                     organizations to establish and/or improve third-
                     party reimbursement levels for the AutoPap System.
                     These reimbursement specialists also work closely
                     with NeoPath's field sales personnel throughout the
                     United States.  On January 1, 1999, revised
                     Physicians' Current Procedural Terminology ("CPT")
                     codes (established by the American Medical
                     Association) became effective for the AutoPap
                     Screener.  CPT codes are a standardized system used
                     by physicians and clinical laboratories to identify
                     specific procedures when billing insurers for their
                     services.  New CPT codes that address utilization of
                     the AutoPap QC became available on January 1, 1998.

<TABLE>
<CAPTION>
                                      
                              PERCENTAGE OF                 PERCENTAGE OF                 PERCENTAGE OF
(IN THOUSANDS)         1998        REVENUES        1997          REVENUES        1996          REVENUES
_______________________________________________________________________________________________________                     
<S>                <C>       <C>               <C>         <C>               <C>        <C>  

Cost of revenues    $ 6,711             56%     $ 4,775               44%     $ 1,905               62%
                     
Gross margin          5,368             44%       6,049               56%       1,157               38%

</TABLE>

                         The primary components of fee-per-use cost of
                     revenues include depreciation and allocated service
                     and support costs.  For AutoPap Systems sold, cost
                     of revenues include the related manufacturing cost
                     and estimated one-year warranty expense.
                         NeoPath's 1998 gross margin reflects discounts
                     and incentives included in AutoPap QC sale pricing
                     in the first half of the year as customers
                     anticipated the FDA's approval of the AutoPap
                     Screener, as well as pricing incentives offered in
                     the second half of the year as initial primary
                     screening placements were made.  The higher
                     comparative gross margin in 1997 was attributable to
                     international sales under a distribution agreement
                     with higher initial AutoPap System pricing.  Primary
                     screening systems are expected to process a greater
                     number of slides, on average, than the prior
                     installed base of AutoPap QCs, which is expected to
                     improve the fee-per-use gross margin percentage.
                     Fee-per-use revenues in the periods included lower-
                     margin initial AutoPap QC placements.

<TABLE>
<CAPTION>     
                    
                                       CHANGE FROM                CHANGE FROM
(IN THOUSANDS)                1998      PRIOR YEAR        1997     PRIOR YEAR         1996
__________________________________________________________________________________________
<S>                      <C>          <C>            <C>         <C>             <C>                                

Research and
  development expenses    $ 11,269       $ (2,980)    $ 14,249        $ 3,047     $ 11,202
                                             (21%)                        27%
  
</TABLE>
                   
                         NeoPath's research and development expenses
                     include salaries and benefits of scientific,
                     engineering, and regulatory personnel; costs
                     relating to clinical studies and submission of
                     applications to the FDA; testing equipment;
                     components used in prototypes; relevant consulting
                     services; and the costs of preparing and filing
                     applications for patent protection of NeoPath's
                     technologies.
                         The Company incurred higher research and
                     development costs in 1997 due primarily to NeoPath's
                     AutoPap Screener clinical study, which was completed
                     in 1997.  NeoPath continues to focus research and
                     development efforts primarily on AutoPap
                     enhancements, as well as on other applications of
                     AutoPap technology.
                     
13
<PAGE>
                     
<TABLE>
<CAPTION>
                     
                                  CHANGE FROM                 CHANGE FROM
(IN THOUSANDS)            1998     PRIOR YEAR        1997      PRIOR YEAR         1996
______________________________________________________________________________________
<S>                 <C>          <C>           <C>          <C>              <C>     

Selling, general and 
  administrative
  expenses            $ 17,950          $ 204    $ 17,746         $ 6,451     $ 11,295
                                           1%                         57%

</TABLE>
                     
                         Selling, general and administrative expenses
                     include salaries and benefits of sales, marketing,
                     administrative, and financial personnel; non-patent
                     application legal expenses; amortization of
                     intangible assets; and certain facility-related
                     costs.
                         Overall expenses in 1998 remained flat in
                     comparison to the prior year, despite significant
                     increased expenses in the first half of 1998 to
                     launch the AutoPap Screener.  NeoPath reduced
                     overall spending in the second half of 1998 as the
                     Company carefully focused corporate spending.
                         The increased spending in 1997 was due primarily
                     to significant new sales and marketing initiatives,
                     costs related to the purchase and integration of the
                     Pathfinder System product line (including
                     amortization of intangible assets), increased
                     personnel-related expenses, and increased legal
                     expenses relating primarily to the Neuromedical
                     Systems, Inc. lawsuits (see Note 9 of Notes to
                     Financial Statements).
                     
                                   CHANGE FROM             CHANGE FROM
(IN THOUSANDS)              1998    PRIOR YEAR     1997     PRIOR YEAR      1996
________________________________________________________________________________
                     
Write-off of 
  intangible assets      $ 3,084       $ 3,084    $  --          $  --     $  --
                     
                        In the quarter ended December 31, 1998, NeoPath
                     wrote off intangible assets related to the
                     Pathfinder System product line.  The write-off did
                     not involve any cash expenditure.  NeoPath acquired
                     the Pathfinder System product line in June 1997 for
                     a total purchase price of $4.6 million, including
                     transaction-related expenses.  As a result of the
                     purchase, the Company recorded $4.3 million in
                     intangible assets that were to be amortized over
                     five years.  As a result of continuing low sales
                     levels of Pathfinder Systems, and related losses
                     attributable directly to the Pathfinder product
                     line, the Company identified indications of
                     impairment in the fourth quarter of 1998 and later
                     decided to discontinue immediate continued
                     development and commercialization of this product
                     line.  The Company then compared the carrying value
                     of these intangible assets to expected future cash
                     flows applicable to the Pathfinder product and, as a
                     result, wrote off the remaining balance of
                     intangible assets.  Pathfinder product sales
                     accounted for 3% of total revenues in each of the
                     two years ended December 31, 1998 and 1997.
                     
                               CHANGE FROM                CHANGE FROM
(IN THOUSANDS)        1998      PRIOR YEAR        1997     PRIOR YEAR       1996
________________________________________________________________________________

Interest income    $ 1,009       $ (1,390)     $ 2,399      $ (1,343)    $ 3,742
                                     (58%)                      (36%)
                     
                         The decrease in interest income over the past two
                     years is due to NeoPath's negative operating cash
                     flow during the periods and the resulting decreased
                     cash available for investment purposes.
                     
14
<PAGE>
                     
LIMITATION ON USE OF
NET OPERATING LOSS AND
TAX CREDIT CARRYFORWARDS

                         As of December 31, 1998, the Company had net
                     operating loss carryforwards of approximately $111.5
                     million and research and development credit
                     carryforwards of approximately $3.4 million for
                     federal income tax purposes, which expire between
                     2004 and 2013.  Due to the issuance and sale of
                     shares of preferred stock prior to 1995 and the
                     Company's initial public offering completed in 1995,
                     the Company incurred "ownership changes" pursuant to
                     applicable regulations in effect under the Internal
                     Revenue Code of 1986, as amended.  Therefore, the
                     Company's use of losses incurred through the date of
                     these ownership changes will be limited during the
                     carryforward period.  The Company estimates that the
                     use of approximately $28.0 million of losses
                     incurred prior to one or more of the ownership
                     changes would be limited in the carryforward
                     periods.  To the extent that any single-year loss is
                     not utilized to the full amount of the limitation,
                     such unused loss is carried over to subsequent years
                     until the earlier of its utilization or the
                     expiration of the relevant carryforward period.  See
                     Note 6 of Notes to Financial Statements.

        MARKET RISKS

                         The Company is exposed to market risk related to
                     changes in interest rates, which could adversely
                     affect the value of the Company's investments in
                     securities available-for-sale or increase the
                     interest expense on outstanding debt.  The Company
                     does not use derivative financial instruments.
                         NeoPath maintains a short-term investment
                     portfolio consisting of interest-bearing securities
                     with an average maturity of less than two years.
                     These securities are classified as "available-for-
                     sale" securities.  The interest-bearing securities
                     are subject to interest rate risk and will fall in
                     value if market interest rates increase.  If market
                     interest rates were to increase immediately and
                     uniformly by 10% from levels at December 31, 1998,
                     the fair value of the portfolio would decline by an
                     immaterial amount.
                         In like manner, a 10% increase in market
                     interest rates would have an immaterial effect on
                     the Company's long-term obligations.  The Company
                     does not expect its operating results or cash flows
                     to be affected to any significant degree by a sudden
                     change in market interest rates.
                     
LIQUIDITY AND CAPITAL RESOURCES

                         As of December 31, 1998, the Company had $9.0
                     million in cash, cash equivalents, and securities
                     available-for-sale, compared to $28.7 million as of
                     December 31, 1997.  The decrease was a result of
                     cash used in the Company's operations during the
                     year, offset by $5 million in cash obtained from a
                     bank debt facility (of which $3.7 million remained
                     outstanding as of December 31, 1998).  As of
                     December 31, 1998, the bank facility was secured by
                     $2.0 million in restricted cash in an interest-
                     bearing account with the bank.  The restricted cash
                     is included in cash and cash equivalents on the
                     balance sheet.  The Company's cash used in operating
                     activities was $22.6 million in 1998, $28.7 million
                     in 1997, and $25.0 million in 1996.  Total operating
                     cash usage included amounts for inventories and
                     manufacturing of AutoPap fee-per-use systems as
                     follows:  $7.0 million in 1998, $8.2 million in
                     1997, and $11.1 million in 1996.  The Company
                     expended cash for property and equipment, excluding
                     AutoPap Systems reclassified to either fee-per-use
                     systems or reclassified to property and equipment,
                     of $0.6 million in 1998, $1.0 million in 1997, and
                     $3.3 million in 1996.
                         On February 9, 1999, NeoPath completed a $14.5
                     million private equity transaction in which the
                     Company issued 2.9 million shares of common stock to
                     investors at a price of $5.00 per share.  On
                     February 12, 1999, NeoPath filed a shelf
                     registration statement on Form S-3 that will, when
                     declared effective by the Securities and Exchange
                     Commission, allow resale of the newly issued shares.
                     NeoPath must use its best efforts to keep this
                     registration statement effective for two years.
                     
15
<PAGE>
                     
                         NeoPath's fee-per-use business strategy requires
                     a significant investment in the production of
                     AutoPap Systems, as well as sufficient resources to
                     meet operating expenses while this recurring revenue
                     stream grows.  The Company expects negative cash
                     flow from operations to continue at least through
                     1999.  The Company may require additional funds to
                     produce AutoPap Systems for its fee-per-use program
                     and cover continuing losses.  NeoPath's future
                     capital requirements will depend on numerous
                     factors, including the following:
                     
                        -  sales of AutoPap Systems;
                        -  fee-per-use revenues;
                        -  research and development programs
                           for the development of enhanced products;
                        -  additional clinical trials;
                        -  relationships with existing and
                           future corporate collaborators, if any;
                        -  competing technological and market developments;
                        -  the time and costs involved in
                           obtaining regulatory approvals;
                        -  the costs involved in filing,
                           prosecuting, defending and enforcing patent 
                           claims; and
                        -  the time and costs of manufacturing scale-up and 
                           commercialization activities.
                     
                         The Company estimates that existing cash and
                     cash equivalents will meet capital requirements
                     through 1999.  The Company cannot guarantee that the
                     assumptions underlying its estimates will prove to
                     be accurate.  The Company intends to seek additional
                     funding through private debt financing to provide
                     additional resources to support AutoPap System
                     production.  Adequate funds, whether obtained
                     through financial markets or from collaborative or
                     other arrangements with corporate partners or other
                     sources, may not be available when needed or may not
                     be available on favorable terms, if at all.  If the
                     Company raises additional funds by issuing equity
                     securities, existing shareholders will suffer
                     dilution of their interest in NeoPath.  In addition, 
                     if the Company obtains additional funds through
                     arrangements with collaborative partners, NeoPath
                     may have to relinquish rights to certain
                     technologies or potential products that the Company
                     would otherwise seek to develop or commercialize
                     itself.  Insufficient funds may require the Company
                     to delay, scale back or eliminate some of its
                     manufacturing, sales and marketing, research and
                     development or clinical programs.
                     
16
<PAGE>

 IMPACT OF YEAR 2000

                         The Year 2000 issue is the result of computer
                     programs being written using two digits rather than
                     four to define the applicable year.  Any of the
                     Company's internal or product computer programs or
                     hardware that have date-sensitive software or
                     embedded chips may recognize a date using "00" as
                     the year 1900 rather than the year 2000.  This could
                     result in system errors or failures, and could
                     significantly disrupt normal business activities.
                         Based on assessments made in 1998, the Company
                     determined that it would be required to modify or
                     replace certain portions of its internal systems and
                     product software and certain hardware so that those
                     systems will properly recognize dates beyond
                     December 31, 1999.  To date, the Company has
                     completed its assessment of all internal and product
                     systems that could be significantly affected by the
                     Year 2000 issue.  The assessment indicated that
                     certain of the Company's internal and product
                     systems could be affected.  However, no significant
                     Year 2000 issues have been identified that cannot be
                     resolved through software or hardware upgrades that
                     are currently available or expected to be available
                     soon.  The Company presently believes that with
                     modifications or replacements of existing software
                     and certain hardware, the Year 2000 issue as it
                     relates to the Company's internal systems and
                     products can be effectively mitigated.  However, if
                     such modifications and replacements are not made, or
                     are not completed in a timely manner, the Year 2000
                     issue could have a material impact on NeoPath's and
                     its customers' operations.  In addition, the Company
                     has gathered information about the Year 2000
                     compliance status of its significant suppliers and
                     subcontractors and continues to monitor their
                     compliance.
                         The Company utilizes existing internal resources
                     to reprogram or replace, test, and implement the
                     internal systems and product software and certain
                     hardware modifications necessary for Year 2000
                     compliance.  The total cost of the Year 2000 project
                     has been borne primarily by operating departments
                     with existing personnel and infrastructure;
                     therefore, incremental costs have not been material
                     and remaining incremental costs are estimated at
                     less than $100,000. The project is estimated to be
                     completed by mid-1999.
                         The Company has queried its significant
                     suppliers and subcontractors as to their Year 2000
                     compliance status.  To date, the Company is not
                     aware of any external agent with Year 2000 problems
                     that would materially impact the Company's results
                     of operations, liquidity, or capital resources.
                     However, the Company has no means of ensuring that
                     external agents will be Year 2000 ready.  The
                     inability of external agents to complete their Year
                     2000 resolution process in a timely fashion could
                     materially impact the Company.  The Company cannot
                     determine the effect of non-compliance by external
                     agents.
                         The Company currently has no contingency plans
                     in place in the event it does not complete all
                     phases of the Year 2000 program, including the possibility 
                     that its external agents are not Year 2000 ready.  The
                     Company plans to evaluate the status of its own Year
                     2000 program, in the first half of 1999 and
                     determine whether such a plan is necessary.  NeoPath
                     management believes it has an effective program in
                     place to resolve the Year 2000 issues within its
                     control in a timely manner.  The Company believes
                     that with modifications to NeoPath's products,
                     existing internal software and conversions to new
                     software, the Year 2000 issue will not pose
                     significant operational problems for its computer
                     systems.  However, in the worst case scenario, if
                     the Company or external agents do not make necessary
                     modifications and conversions, or do not complete
                     them on time, the Year 2000 issue could disrupt
                     NeoPath's operations and materially affect its
                     business, financial condition, and results of
                     operations.
                     
17
<PAGE>

FORWARD-LOOKING STATEMENTS

                         The preceding Management's Discussion and
                     Analysis of Financial Condition and Results of
                     Operations contains "forward-looking statements"
                     that reflect the Company's current views with
                     respect to future events and financial performance.
                     These forward-looking statements are subject to
                     certain risks and uncertainties that could cause
                     actual results to differ materially from historical
                     results or those anticipated.  The words "plan,"
                     "expect," "anticipate," "believe," and similar
                     expressions identify forward-looking statements.
                     Readers are cautioned not to place undue reliance on
                     these forward-looking statements, which speak only
                     as of their dates.  The Company undertakes no
                     obligation to publicly update or revise any forward-
                     looking statements, whether as a result of new
                     information, future events, or otherwise.
                         Factors that could cause actual results to
                     differ materially from historical results or those
                     anticipated include, without limitation, the
                     following:
                     
                        -  history of losses and uncertainty
                           of profitable operations;
                        -  potential need for additional capital;
                        -  uncertainty of market acceptance
                           of NeoPath's products;
                        -  market consolidation and
                           concentration among a few large customers;
                        -  uncertainty of product regulatory clearance;
                        -  sole or limited source of supply
                           for key components;
                        -  governmental regulation of NeoPath's manufacturing;
                        -  competition in the industry;
                        -  dependence on third-party reimbursement;
                        -  dependence on a single product line;
                        -  product liability and availability of adequate 
                           insurance;
                        -  dependence on patents and proprietary rights;
                        -  risk of third-party claims ofinfringement;
                        -  dependence on key personnel;
                        -  highly volatile stock price;
                        -  potential fluctuations in future
                           quarterly results; and
                        -  Year 2000 issue.
                     
                         For a more detailed discussion of these factors,
                     see "Factors Affecting Future Results and Forward-
                     Looking Statements" in the Company's Form 10-K for
                     the fiscal year ended December 31, 1998.
                     
18
<PAGE>
                     
                     
BALANCE SHEETS

DECEMBER 31                                                1998            1997
_______________________________________________________________________________
                     
Assets
Current assets:
  Cash and cash equivalents                       $   5,579,867   $   3,308,970
  Securities available-for-sale                       3,374,549      25,409,633
  Accounts receivable, net                            3,011,078       3,863,818
  Inventories                                         6,744,417       7,514,001
  Other current assets                                  392,415         187,147
                                                  _____________________________
Total current assets                                 19,102,326      40,283,569

Fee-per-use systems, net                             14,602,963       8,564,189
Property and equipment, net                           3,530,694       5,979,849
Intangible assets, net                                       --       3,383,925
Deposits and other assets                               913,850         729,280
                                                  _____________________________
Total assets                                      $  38,149,833   $  58,940,812
                                                  =============================
                     
Liabilities and Shareholders' Equity
Current liabilities:
  Accounts payable                                $   2,944,252   $   2,173,179
  Salaries and wages payable                          1,681,710       2,357,045
  Customer deposits                                     332,485         431,877
  Other accrued liabilities                           1,157,077         567,759
  Current portion of long-term obligations            2,549,151          80,966
                                                  _____________________________
Total current liabilities                             8,664,675       5,610,826
                     
Long-term obligations, less current portion           1,257,027         101,872
                     
Commitments and contingencies
                     
Shareholders' equity:
  Preferred stock, $.01 par value; 
    10,000,000 shares authorized; none 
    issued and outstanding                                   --              --
  Common stock, $.01 par value; 40,000,000 shares
    authorized; 14,504,623 and 14,389,378 shares
    issued and outstanding at December 31, 1998 
    and 1997, respectively                          142,057,561     141,057,881
  Accumulated deficit                              (113,813,699)    (87,633,118)
  Accumulated other comprehensive loss                  (15,731)       (196,649)
                                                  _____________________________
Total shareholders' equity                           28,228,131      53,228,114
                                                  _____________________________
Total liabilities and shareholders' equity        $  38,149,833   $  58,940,812
                                                  =============================
                     
See accompanying notes.

19
<PAGE>

STATEMENTS OF OPERATIONS

YEAR ENDED DECEMBER 31,              1998              1997              1996
_____________________________________________________________________________

Revenues                   $   12,078,936    $   10,824,380     $   3,061,849
Cost of revenues                6,711,314         4,774,920         1,904,559
                           __________________________________________________
Gross margin                    5,367,622         6,049,460         1,157,290
                     
Operating expenses:
  Research and development     11,269,363        14,248,669        11,202,375
  Selling, general and 
    administrative             17,950,151        17,745,936        11,295,228
  Write-off of 
    intangible assets           3,084,289                --                --
                           __________________________________________________
                               32,303,803        31,994,605        22,497,603
                           __________________________________________________

Loss from operations          (26,936,181)      (25,945,145)      (21,340,313)
                     
Interest income                 1,008,638         2,399,117         3,741,843
Interest expense                 (253,038)          (50,884)          (56,813)
                           __________________________________________________
Net loss                   $  (26,180,581)   $  (23,596,912)   $  (17,655,283)
                           ==================================================

Basic and diluted net 
  loss per share           $        (1.81)   $        (1.66)   $        (1.36)
                           ==================================================
                     
Weighted average common 
  shares outstanding           14,467,902        14,197,307        13,029,314
                           ================================================== 

See accompanying notes.

20
<PAGE>

STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>   

                                             COMMON STOCK                                          ACCUMULATED
                              ___________________________                                                OTHER
                                NUMBER OF                          DEFERRED       ACCUMULATED    COMPREHENSIVE
                                   SHARES          AMOUNT      COMPENSATION           DEFICIT    INCOME (LOSS)          TOTAL
                              _______________________________________________________________________________________________
                              <C>         <C>               <C>               <C>              <C>             <C>     

Balance at January 1, 1996      9,819,487   $  71,649,971       $  (175,782)   $  (46,380,923)     $    39,945  $  25,133,211
  Follow on public 
    offering -- common 
    stock, net of
    issuance costs of 
    $4,384,649                  2,875,000      61,740,351                --                --               --     61,740,351
  Exercise of options 
    and warrants                  957,669       2,889,169                --                --               --      2,889,169
  Amortization of deferred
    compensation                       --         (23,745)          101,536                --               --         77,791
   
  Unrealized loss on securities
    available-for-sale                 --              --                --                --         (583,103)      (583,103)
  Net loss                             --              --                --       (17,655,283)              --    (17,655,283)
                                                                                                                 ____________
     Comprehensive loss                                                                                           (18,238,386)
                              _______________________________________________________________________________________________
Balance at December 31, 1996   13,652,156     136,255,746           (74,246)      (64,036,206)        (543,158)    71,602,136
    Exercise of options 
      and warrants                688,658       3,952,135                --                --               --      3,952,135
    Amortization of deferred
      compensation                     --              --            74,246                --               --         74,246
    Common stock issued on 
      purchase of Pathfinder 
      System product line          48,564         850,000                --                --               --        850,000
   
    Unrealized appreciation 
      on securities
      available-for-sale               --              --                --                --          346,509        346,509
    Net loss                           --              --                --       (23,596,912)              --    (23,596,912)
                                                                                                                 ____________    
      Comprehensive loss                                                                                          (23,250,403)
                             ________________________________________________________________________________________________
Balance at December 31, 1997   14,389,378     141,057,881                --       (87,633,118)        (196,649)    53,228,114
  Exercise of options 
    and warrants                   56,520         119,752                --                --               --        119,752
  Release of common stock
    held in escrow                 42,050         549,278                --                --               --        549,278
  Issuance of common stock 
    under employee stock 
    purchase plan                  16,675         130,650                --                --               --        130,650
  Stock-based compensation to
    consultants                        --         200,000                --                --               --        200,000
   
  Unrealized appreciation on
    securities available-for-sale      --              --                --                --          180,918        180,918
  Net loss                             --              --                --       (26,180,581)              --    (26,180,581)
                                                                                                                 ____________    
    Comprehensive loss                                                                                            (25,999,663)
                              _______________________________________________________________________________________________
Balance at December 31, 1998   14,504,623   $ 142,057,561        $       --    $ (113,813,699)      $  (15,731)  $ 28,228,131
                              ===============================================================================================


</TABLE>
   
See accompanying notes.
   
21
<PAGE>
   
STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>


YEAR ENDED DECEMBER 31,                           1998                 1997                  1996
_________________________________________________________________________________________________                     
<S>                                  <C>                   <C>                    <C>           

Operating activities
Net loss                                $  (26,180,581)      $  (23,596,912)       $  (17,655,283)
  Adjustments to reconcile 
    net loss to net cash
    used in operating activities:
      Write-off of intangible assets         3,084,289                   --                    --
      Depreciation and amortization          5,699,537            4,326,157             1,994,064
      Stock-based compensation                 200,000               74,246                77,791
      Accrued interest on 
        securities available-for-sale          562,267            1,152,187               660,623            
      Net change in operating accounts:
      Accounts receivable                      852,740           (3,023,562)             (840,256)                           
      Inventories and
        fee-per-use systems                 (7,048,460)          (8,243,774)          (11,093,253)       
      Accounts payable and accrued 
        liabilities                            585,664            1,208,837             1,839,915           
  Other                                       (364,591)            (594,194)               40,888 
                                         ________________________________________________________  
Net cash used in operating activities      (22,609,135)         (28,697,015)          (24,975,511)

Investing activities
Purchases of securities 
  available-for-sale                        (1,743,949)          (5,349,511)          (75,750,434)
Maturities of securities 
  available-for-sale                        23,397,684           29,750,677            43,169,070
Purchase of Pathfinder 
  System product line                               --           (2,696,114)                   --
Additions to property and equipment           (640,689)            (950,424)           (3,325,122)
Other                                           (6,756)               3,379               166,396
                                         ________________________________________________________
Net cash provided by (used in) 
  investing activities                      21,006,290           20,758,007           (35,740,090)

Financing activities
Proceeds from note payable to bank           4,950,000                   --                    --
Payments on note payable to bank            (1,236,369)                  --                    --
Principal payments on obligations 
  under capital leases                         (90,291)             (75,558)             (193,441)
Payment on short-term 
  note payable issued in purchase
  of Pathfinder System product line                 --             (500,000)                   --
Exercise of options and warrants               119,752            3,952,135             2,889,169
Issuance of common stock under 
  employee stock purchase plan                 130,650                   --                    --
Issuance of common stock, net                       --                   --            61,740,351
                                         ________________________________________________________
Net cash provided by 
  financing activities                       3,873,742            3,376,577            64,436,079
                                         ________________________________________________________
Net increase (decrease) in 
  cash and cash equivalents                  2,270,897           (4,562,431)            3,720,478
Cash and cash equivalents:
     Beginning of year                       3,308,970            7,871,401             4,150,923         
                                         ________________________________________________________
     End of year                         $   5,579,867        $   3,308,970         $   7,871,401
                                         ========================================================                    
 
Noncash transactions
AutoPap Systems reclassified 
  to fee-per-use systems, net            $   8,745,621        $   4,152,386         $   6,563,537
AutoPap Systems reclassified 
  to (from) property and
  equipment, net                              (663,839)           2,457,367               729,362

</TABLE>
                     
See accompanying notes.
                     
22
<PAGE>
                     
            NOTES TO
FINANCIAL STATEMENTS

   DECEMBER 31, 1998

             NOTE 1  DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT 
                     ACCOUNTING POLICIES

                     BUSINESS        NeoPath, Inc. ("NeoPath" or the
                     "Company") develops and markets visual intelligence
                     technology to increase accuracy in medical testing.
                     NeoPath's initial products include two automated
                     screening systems that integrate proprietary high-
                     speed morphology computers, video imaging
                     technology, and sophisticated image interpretation
                     software to capture and analyze thousands of
                     microscopic images from a Papanicolaou ("Pap") smear
                     slide for the early detection of cervical cancer.
                         The AutoPap(R) 300 QC Automatic Pap Screener
                     System (the "AutoPap QC") is a rescreening device
                     used for quality control and rescreening of
                     previously screened Pap smear slides.  The
                     AutoPap(R) Primary Screening System (the "AutoPap 
                     Screener") is an enhanced system that classifies up
                     to 25% of a clinical laboratory's volume of Pap smear
                     slides as requiring no further review.
                         The "AutoPap System" refers to the AutoPap
                     Screener and the AutoPap QC together.
                     
                     REVENUES AND MARKETS        NeoPath's primary market
                     includes domestic and foreign clinical laboratories.
                     Domestic revenues are generated primarily through
                     NeoPath's direct sales activities; international
                     revenues are derived primarily through distributors.
                     Approximately 19% of NeoPath's revenues in 1998 were
                     from customers outside of the United States,
                     compared to 51% in 1997 and 45% in 1996.  The
                     Company's four largest customers accounted for 41%
                     of total revenues in 1998, compared to 65% in 1997
                     and 86% in 1996.  The Company recognizes revenue on
                     either a product sale or fee-per-use basis (subject
                     to service and license agreements, rental contracts,
                     and minimum payments on certain fee-per-use
                     contracts).  Fee-per-use revenues commence in the
                     month an AutoPap System is initially placed in
                     commercial use at the customer site.  Sales of
                     AutoPap Systems are generally recognized at date of
                     shipment. In the past three years, sale revenues
                     (including upgrades) have accounted for 61% to 65% of
                     total revenues. Remaining revenues consisted
                     primarily of fee-per-use contract billings.
                     
                     CASH EQUIVALENTS        Short-term investments with
                     an original maturity of three months or less are
                     considered to be cash equivalents.  Cash equivalents
                     are carried at cost, which approximates market
                     value.
                     
                     SECURITIES AVAILABLE-FOR-SALE        NeoPath's
                     investment portfolio is classified as available-for-
                     sale, and such securities are stated at fair value,
                     with the unrealized gains and losses included in
                     other comprehensive income or loss.  Interest earned
                     on securities available-for-sale is included in
                     interest income.  The amortized cost of investments
                     in this category is adjusted for amortization of
                     premiums and accretion of discounts to maturity.
                     Such amortization and accretion are included in
                     interest income.  The cost of securities sold is
                     calculated using the specific identification method.
                     
                     INVENTORIES        Inventories are valued at the
                     lower of cost or market (first in, first out basis).
                     
                     FEE-PER-USE SYSTEMS        AutoPap Systems
                     manufactured for fee-per-use placements are carried
                     in inventories until the AutoPap Systems are
                     shipped, at which time they are reclassified to fee-
                     per-use systems (non-current assets).  Fee-per-use
                     systems are depreciated on a straight-line basis
                     over an estimated useful life of four years.
                         NeoPath purchases all components for the AutoPap
                     System from outside vendors, including certain
                     components from sole-source or single vendors.  The
                     establishment of additional or replacement sources
                     of supply for the AutoPap System could require
                     regulatory approval.  In addition, a vendor's
                     inability to supply acceptable components in a
                     timely manner and in the quantity required could
                     delay or halt the Company's manufacture of its
                     products.
                     
23
<PAGE>
                     
                     PROPERTY AND EQUIPMENT        Property and equipment
                     are recorded at cost, less accumulated depreciation
                     and amortization.  Depreciation is calculated on a
                     straight-line basis over the estimated useful lives
                     of the related assets, ranging from three to seven
                     years.  Leasehold improvements are amortized over
                     the lesser of their estimated useful lives or the
                     term of the lease.
                     
                     ASSET IMPAIRMENT        In accordance with Statement
                     of Financial Accounting Standards ("SFAS") No. 121,
                     "Accounting for the Impairment of Long-Lived Assets
                     and for Long-Lived Assets to be Disposed Of," the
                     Company recognizes impairment losses on long-lived
                     assets used in operations when indicators of
                     impairment are present and the discounted cash flows
                     estimated to be generated by those assets are less
                     than the assets' carrying amounts.  During 1998, the
                     Company recognized such a loss for the write down of
                     intangible assets related to the Pathfinder System
                     product line (see Note 4).  There were no such
                     losses recognized in 1997 or 1996.
                     
                     STOCK-BASED COMPENSATION        NeoPath has elected
                     to follow the intrinsic value method prescribed by
                     Accounting Principles Board Opinion No. 25,
                     "Accounting for Stock Issued to Employees," and
                     related Interpretations in accounting for its stock
                     options.  Because the exercise price of the
                     Company's stock options generally equals the market
                     price of the underlying stock on the date of grant,
                     no corresponding compensation expense has been
                     recognized since NeoPath's initial public stock
                     offering.  (See Note 7 for SFAS No. 123, "Accounting
                     for Stock-Based Compensation," pro forma
                     disclosures.)
                        In accordance with applicable accounting
                     standards, NeoPath recognizes compensation expense
                     for options and warrants granted to consultants in
                     lieu of cash payment.
                     
                     ADVERTISING EXPENSES        Advertising expenses are
                     expensed as incurred.  Total advertising expenses
                     incurred during 1998, 1997, and 1996 were $1.1
                     million, $0.7 million, and $0.3 million,
                     respectively.

                     BASIC AND DILUTED NET LOSS PER SHARE        Basic
                     and diluted net loss per share is computed based on
                     the weighted average number of shares of common
                     stock outstanding.  Because NeoPath's stock options
                     and warrants are not dilutive (due to net losses)
                     there is no difference between basic net loss per
                     share and diluted net loss per share.
                     
                     COMPREHENSIVE INCOME        As of January 1, 1998,
                     NeoPath adopted SFAS No. 130, "Reporting
                     Comprehensive Income."  Statement 130 established
                     new rules for the reporting and display of
                     comprehensive income or loss and its components;
                     however, the adoption of this Statement had no
                     impact on the Company's operating results or
                     shareholders' equity.  Statement 130 requires
                     unrealized gains or losses on the Company's
                     securities available-for-sale, which prior to
                     adoption were reported within shareholders' equity,
                     to be included in other comprehensive income or
                     loss.  Statement 130 also requires presentation of
                     accumulated other comprehensive income or loss
                     separately in shareholders' equity.  Accordingly,
                     prior year financial statements have been
                     reclassified to conform to these requirements.
                     
                     BUSINESS SEGMENTS        NeoPath currently operates
                     in a single business segment -- clinical laboratories --
                     and management evaluates its operating performance
                     based on this single segment.
                     
                     CONCENTRATIONS OF CREDIT RISK        The Company
                     invests its excess cash in accordance with
                     guidelines that limit the credit exposure to any one
                     financial institution and to any one type of
                     investment.  The guidelines also specify that the
                     financial instruments are issued by institutions
                     with strong credit ratings.  The securities are
                     generally not collateralized and mature within two
                     years.
                     
                     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 amounts
                     reported in the financial statements and
                     accompanying notes.  Actual results could differ
                     from those estimates.
                     
24
<PAGE>
                     
NOTE 2   SECURITIES AVAILABLE-FOR-SALE

Securities available-for-sale consist of the following:

<TABLE>
<CAPTION>

                                             GROSS            GROSS
                           AMORTIZED    UNREALIZED       UNREALIZED
DECEMBER 31, 1998               COST         GAINS           LOSSES         FAIR VALUE
______________________________________________________________________________________
<S>                <C>                 <C>           <C>             <C>         
                     
Corporate bonds       $    3,390,280       $ 5,608     $    (21,339)    $    3,374,549
                      ================================================================
                     
                                             GROSS            GROSS
                           AMORTIZED    UNREALIZED       UNREALIZED
DECEMBER 31, 1997               COST         GAINS           LOSSES         FAIR VALUE
______________________________________________________________________________________                      

Corporate bonds       $   17,888,047       $   835     $   (112,479)    $   17,776,403
Government bonds           7,718,235            --          (85,005)         7,633,230
                      ________________________________________________________________
                     
                      $   25,606,282       $   835     $   (197,484)     $  25,409,633
                      ================================================================                     

</TABLE>

                         There were realized gains of $5,092 and realized
                     losses of $43,472 on sales of securities available-
                     for-sale for the year ended December 31, 1998.
                     There were no realized gains or losses on sales of
                     securities available-for-sale for the years ended
                     December 31, 1997 and 1996.  The net adjustment for
                     unrealized holding gains and losses on securities
                     available-for-sale, included in other comprehensive
                     income or loss, was a gain of $180,918 in 1998, a
                     gain of $346,509 in 1997, and a loss of $583,103 in
                     1996.  The fair value of securities available-for-
                     sale maturing within one year totals $1,282,882.
                     The fair value of securities available-for-sale
                     maturing between one and two years totals
                     $2,091,667.  The Company considers all securities
                     available-for-sale as available for use in current
                     operations.
                     
25
<PAGE>

NOTE 3   BALANCE SHEET INFORMATION

Detailed balance sheet data is as follows:

DECEMBER 31,                                   1998                 1997
________________________________________________________________________

Accounts receivable
  Receivables                          $  3,477,196         $  4,363,818 
  Allowance for doubtful accounts          (466,118)            (500,000)
                                       _________________________________
                                       $  3,011,078         $  3,863,818
                                       =================================
Inventories
  Raw materials                        $  2,093,748         $  3,819,830 
  Work-in-process                         2,365,472            1,061,900        
  Finished goods                          2,285,197            2,632,271
                                       _________________________________
                                       $  6,744,417         $  7,514,001
                                       =================================
                     
                         Finished goods consist of AutoPap Systems that
                     will be reclassified to fee-per-use systems (non-
                     current assets) when placed in commercial use,
                     AutoPap Systems to be sold, and AutoPap Systems used
                     internally on a temporary basis.
                     
Fee-per-use systems
  Systems                              $ 18,249,245        $  10,628,468
  Accumulated depreciation               (3,646,282)          (2,064,279)
                                       _________________________________
                                       $ 14,602,963        $   8,564,189
                                       =================================

Property and equipment
  Laboratory and other equipment       $  7,987,377        $   8,206,222     
  Furniture and fixtures                  1,156,863            1,108,168 
  Leasehold improvements                  1,222,093            1,210,930
                                       _________________________________
    Total property and equipment         10,366,333           10,525,320 
  Accumulated  depreciation 
    and amortization                     (6,835,639)          (4,545,471)
                                       _________________________________
                                       $  3,530,694        $   5,979,849
                                       =================================        
    
                         At December 31, 1998 and 1997, the Company held
                     equipment under capitalized leases with an original
                     cost of $317,594 and $373,432, and a net book value
                     of $73,172 and $147,219, respectively.
                     
Intangible assets
  Intangible assets                    $        --         $   3,759,917       
  Accumulated amortization                      --              (375,992)
                                       _________________________________
                                       $        --         $   3,383,925
                                       =================================

26
<PAGE>
                     
            NOTE  4  PATHFINDER SYSTEM PRODUCT LINE

                        In the quarter ended December 31, 1998, NeoPath
                     wrote off $3.1 million of intangible assets related
                     to the Pathfinder System product line.  The write-
                     off did not involve any cash expenditure. NeoPath
                     acquired the Pathfinder System product line in June
                     1997 for an initial purchase price of $4.1 million.
                     The initial purchase price included cash of $2.7
                     million (including transaction-related expenses), a
                     $500,000 short-term note paid in October 1997, and
                     48,564 shares of NeoPath common stock.  In addition,
                     certain shares of NeoPath common stock were issued
                     and were held in escrow until  April 1998, when the
                     Company released the remaining 42,050 shares, which
                     added approximately $550,000 to Pathfinder
                     intangible assets.  As a result of the purchase,
                     NeoPath recognized $4.3 million in intangible assets
                     that were to be amortized over five years.  As a
                     result of continuing low sales levels of Pathfinder
                     Systems, and related losses attributable directly to
                     the Pathfinder product line, the Company identified
                     indications of impairment in the fourth quarter of
                     1998 and later decided to discontinue immediate
                     continued development and commercialization of this
                     product line.  The Company then compared the
                     carrying value of these intangible assets to
                     expected future cash flows applicable to the
                     Pathfinder product and, as a result, wrote off the
                     remaining balance of intangible assets.  Pathfinder
                     product sales accounted for 3% of total revenues in
                     each of the two years ended December 31, 1998 and
                     1997.
                     
              NOTE 5 LONG-TERM OBLIGATIONS AND COMMITMENTS
                     
                     NOTE PAYABLE TO BANK        In April 1998, NeoPath
                     entered into a loan agreement with a bank pursuant
                     to which the Company could borrow amounts based on
                     the manufacturing cost of AutoPap Systems placed on
                     fee-per-use contracts.  Accordingly, in June 1998,
                     NeoPath borrowed $5.0 million under the loan
                     agreement.  The bank debt is secured by
                     substantially all of NeoPath's assets, excluding
                     intellectual property, and amounts are repaid over
                     24 months from the date of each drawdown.  In
                     addition, NeoPath must comply with certain financial
                     covenants.  As of December 31, 1998, the bank
                     facility was secured by $2.0 million in restricted
                     cash in an interest-bearing account with the bank.
                     The restricted cash is included in cash and cash
                     equivalents on the balance sheet. Borrowings under
                     this agreement bear interest at the bank's prime
                     rate plus 1 percent per annum (8.75% at December 31,
                     1998).
                     
                     LEASE AGREEMENTS        NeoPath leases certain
                     property and equipment under capital leases pursuant
                     to master equipment lease agreements.  Under such
                     agreements, the Company entered into multiple
                     capital leases for property and equipment.  The
                     agreements included lease terms ranging from 36 to
                     60 months and purchase options at the end of each
                     lease.  Interest rates on capitalized leases
                     approximate 10%.
                         The Company leases office and operating
                     facilities under operating leases expiring in
                     January 1999 through August 2007, with various
                     renewal options, and other leased items through
                     2002.  Operating lease expense was $833,590 in 1998,
                     compared to $831,983 in 1997, and $620,895 in 1996.
                         Minimum future payments as of December 31, 1998
                     are as follows:
                                                                          LEASES
                             NOTE PAYABLE          _____________________________
                                  TO BANK            CAPITAL           OPERATING
________________________________________________________________________________
              
1999                         $  2,475,000          $  80,168          $  806,807
2000                            1,238,631             19,050              31,328
2001                                   --                 --              31,328
2002                                   --                 --              31,328
2003                                   --                 --              31,328
Thereafter                             --                 --              44,926
                             ____________          _____________________________
Total minimum payments                                99,218          $  977,045
                                                                      ==========
Less amount representing 
  interest                                             6,671
                                                   _________
Present value of 
  minimum payments              3,713,631             92,547
Current portion                 2,475,000             74,151
                             ____________          _________
Long-term obligations, 
  less current portion       $  1,238,631          $  18,396
                             ============          =========
                   
27
<PAGE>

             NOTE 6  INCOME TAXES

                         As of December 31, 1998, the Company had net
                     operating loss carryforwards of approximately $111.5
                     million and research and development credit
                     carryforwards of approximately $3.4 million for
                     federal income tax purposes, which expire between
                     2004 and 2013.  Due to the issuance and sale of
                     shares of preferred stock prior to 1995 and the
                     Company's initial public offering completed in 1995,
                     the Company incurred "ownership changes" pursuant to
                     applicable regulations in effect under the Internal
                     Revenue Code of 1986, as amended.  Therefore, the
                     Company's use of losses incurred through the date of
                     these ownership changes will be limited during the
                     carryforward period.  The Company estimates that the
                     use of approximately $28.0 million of losses
                     incurred prior to one or more of the ownership
                     changes would be limited in the carryforward
                     periods.  To the extent that any single-year loss is
                     not utilized to the full amount of the limitation,
                     such unused loss is carried over to subsequent years
                     until the earlier of its utilization or the
                     expiration of the relevant carryforward period.
                     Approximately $5.1 million of the net operating loss
                     carryforward is attributed to the deduction for
                     stock options, the tax effect of which will be
                     credited to common stock when recognized.
                         Deferred income taxes reflect the net tax
                     effects of temporary differences between the tax
                     basis of assets and liabilities and the
                     corresponding financial statement amounts.
                     Significant components of the Company's deferred
                     income tax assets (liabilities) at December 31, 1998
                     and 1997 are as follows:
                     
DECEMBER 31,                                     1998                     1997
______________________________________________________________________________
                      
Net operating loss carryforwards        $  37,904,000            $  29,416,000
Research and development credits            3,377,000                2,374,000
Amortization and write-off of 
  intangible assets                         1,331,000                   85,000
Research and development costs                335,000                  548,000
Allowance for doubtful accounts               243,000                  238,000
Deferred compensation                         192,000                  168,000
Accrued vacation                              155,000                  219,000
Charitable contribution 
  carryforwards                               126,000                  125,000
Other                                         475,000                  387,000
Property and equipment                       (501,000)                  97,000
Valuation allowance                       (43,637,000)             (33,657,000)
                                        ______________________________________
                                        $          --           $           --
                                        ======================================
                     
                         Due to the uncertainty of the Company's ability
                     to generate taxable income to realize its deferred
                     tax assets, a valuation allowance has been
                     established for financial reporting purposes equal
                     to the amount of the net deferred tax assets.  The
                     Company's valuation allowance increased $10.0
                     million and $9.5 million for the years ended
                     December 31, 1998 and 1997, respectively.

28
<PAGE>
                     
              NOTE 7 SHAREHOLDERS' EQUITY

                     COMMON STOCK        On February 9, 1999, NeoPath
                     completed a $14.5 million private equity transaction
                     in which the Company issued 2.9 million shares of
                     common stock to investors at a price of $5.00 per
                     share.  In connection with the financing, NeoPath
                     issued to Invemed Associates, Inc., a related party,
                     five-year warrants to purchase 100,000 shares of
                     common stock at an exercise price of $5.89 per
                     share.
                     
                     STOCK OPTION PLANS          The Company has two
                     stock option plans that provide for option grants to
                     employees, directors, and others.  The options
                     generally vest over four years or as otherwise
                     determined by the plan administrator.  Options to
                     purchase shares expire no later than ten years after
                     the date of grant.
                         In May 1998, Neopath's Board of Directors
                     approved a plan to allow all Company personnel the
                     opportunity to surrender previously granted stock
                     options in exchange for a new option at the current
                     market price. In total, 1,357,836 options were
                     surrendered and canceled; a corresponding number of
                     new options were issued with an exercise price of
                     $13.00 per share.
                         A summary of the Company's stock option activity
                     and related information follows:
                     
                                         OUTSTANDING               EXERCISABLE
                               _____________________        __________________
                                            WEIGHTED                  WEIGHTED
                                             AVERAGE                   AVERAGE
                                            EXERCISE                  EXERCISE
                                  SHARES       PRICE         SHARES      PRICE
____________________________________________________        __________________

Balance, January 1, 1996       1,027,242     $  6.59        483,974    $  1.66
  Granted                        838,218       22.91        ==================
  Exercised                     (195,429)       2.60
  Canceled                       (65,811)      10.66
                               _____________________
Balance, December 31, 1996     1,604,220       15.39        524,318    $  5.12
  Granted                        845,025       16.46        ==================
  Exercised                     (225,165)       2.07
  Canceled                      (285,532)      20.18
                               _____________________
Balance, December 31, 1997     1,938,548       16.68        655,156    $ 13.56
  Granted                      1,785,083       12.35        ==================
  Exercised                      (51,904)       1.73
  Canceled                    (1,808,561)      18.01
                               =====================
Balance, December 31, 1998     1,863,166     $ 11.64        839,279    $ 11.16
                               =====================        ==================

Available for grant at 
  December 31, 1998            1,065,020
                               =========

29
<PAGE>
                     
                     Outstanding and exercisable stock options by price
range as of December 31, 1998 are as follows:

<TABLE>
<CAPTION>

                                                       OUTSTANDING                     EXERCISABLE
                       ___________________________________________     ___________________________
                                           WEIGHTED       WEIGHTED                        WEIGHTED
          RANGE OF            SHARES        AVERAGE        AVERAGE            SHARES       AVERAGE
    EXERCISE PRICE             AS OF      REMAINING       EXERCISE             AS OF      EXERCISE
         PER SHARE     DEC. 31, 1998   TERM (YEARS)          PRICE     DEC. 31, 1998         PRICE
__________________________________________________________________     ___________________________
<S>                 <C>               <C>            <C>             <C>              <C>   

$ 0.60  -  $  1.20            35,463           4.24        $  1.15            34,713       $  1.15
  1.80  -     2.40           136,939           5.53           2.38           136,939          2.38
  4.00  -     6.00           103,128           9.68           4.64            13,178          4.28
  6.50  -     9.00            57,676           9.58           6.88             1,979          8.77
 11.25  -    12.69            51,500           8.36          11.86            16,000         11.25
 13.00  -    13.00         1,385,129           9.41          13.00           558,775         13.00
 13.75  -    23.63            93,331           7.70          19.61            77,695         19.09
__________________________________________________________________     ___________________________
$ 0.60  -  $ 23.63         1,863,166           8.93       $  11.64           839,279       $ 11.16
==================================================================     ===========================

</TABLE>

                         Pro forma information regarding net loss and net
                     loss per share is required by SFAS 123 and has been
                     determined as if the Company had accounted for its
                     employee stock options under the fair value method
                     of SFAS 123.  The fair value for these options was
                     estimated at the date of grant using a Black-Scholes
                     multiple option pricing model with the following
                     weighted-average assumptions for 1998, 1997, and
                     1996, respectively:  risk-free interest rates of
                     5.18%, 6.08%, and 6.01%; dividend yields of 0%;
                     volatility factors of the expected market price of
                     the Company's common stock of 0.8992, 0.6589, and
                     0.5512; and a weighted-average expected life of the
                     option of 1.47, 1.47, and 1.46 years after vest
                     date.
                         The Black-Scholes option value model was
                     developed for use in estimating the fair value of
                     traded options that have no vesting restrictions and
                     are fully transferable.  In addition, option
                     valuation models require the input of highly
                     subjective assumptions, including the expected stock
                     price volatility.  Because the Company's stock
                     options have characteristics significantly different
                     from those of traded options, and because changes in
                     the subjective input assumptions can materially
                     affect the fair value estimate, in management's
                     opinion, the existing models do not necessarily
                     provide a reliable single measure of the fair value
                     of its stock options.
                         For purposes of pro forma disclosures, the
                     estimated fair value of the options is amortized to
                     expense over the options' vesting period.  The
                     Company's pro forma information follows:
                     
YEAR ENDED DECEMBER 31,                1998              1997             1996
______________________________________________________________________________

Pro forma net loss            $ (32,951,440)    $ (27,930,575)   $ (20,717,024)
Pro forma basic and diluted 
  net loss per share                  (2.28)            (1.97)           (1.59)
                     
                         SFAS No. 123 pro forma disclosures above are not
                     necessarily indicative of future pro forma
                     disclosures because of the manner in which SFAS 123
                     calculations are phased in over time.
                         The weighted average fair value for options granted 
                     during 1998, 1997, and 1996 using the Black-Scholes 
                     multiple option pricing model is $6.99, $8.81, and $10.86, 
                     respectively.
                     
                     WARRANTS       In 1998, NeoPath issued a warrant to
                     a consultant to purchase 60,000 shares of NeoPath
                     common stock at $4.31 per share, which was the
                     closing price of the Company's common stock on the
                     date of the initial agreement.  The Company also
                     issued a comparable stock option grant to the same
                     consultant.  As a result, in 1998, the Company
                     recognized $200,000 in non-cash expenses related to
                     the consulting agreement and will continue to
                     recognize non-cash expenses during the one-year
                     agreement.
                         Common stock warrants outstanding at December 31,
                     1998 totaled 278,910 at a weighted average exercise
                     price per share of $6.86.  These warrants expire at
                     various dates through 2004.
                     
30
<PAGE>
                     
                         During 1998, warrants were exercised to purchase
                     4,616 shares of NeoPath's common stock.  During
                     1997, warrants were exercised to purchase 463,493
                     shares of the Company's common stock, of which
                     13,273 shares were issued through "net exercise"
                     rights, for which the Company received no proceeds.
                     Such rights allow the warrant holder to exercise the
                     warrant and "pay" the warrant price through the
                     intrinsic value of the warrants; therefore, fewer
                     shares of common stock are issued as a result.
                     During 1996, warrants were exercised to purchase
                     762,240 shares of the Company's common stock, of
                     which 346,468 shares were issued through net
                     exercise rights.  The remaining warrants outstanding
                     as of December 31, 1998 have net exercise rights.
                     
                     COMMON STOCK RESERVED        At December 31, 1998,
                     common stock was reserved for the following
                     purposes:

                     Stock options                     2,928,186
                     Common stock warrants               278,910
                     Employee stock purchase plan        133,325
                                                       _________
                                                       3,340,421
                                                       =========

             NOTE 8  EMPLOYEE BENEFITS

                         The Company has a retirement plan covering
                     substantially all employees that provides for
                     voluntary salary deferral contributions on a pre-tax
                     basis in accordance with Section 401(k) of the
                     Internal Revenue Code of 1986, as amended.  To date,
                     the Company has made no contributions to the plan.
                         In May 1997, NeoPath's shareholders approved the
                     1997 Employee Stock Purchase Plan (the "ESPP") and
                     authorized the issuance of up to 150,000 shares of
                     the Company's common stock under the ESPP.  The ESPP
                     permits eligible employees of the Company to
                     purchase common stock at not less than 85% of fair
                     market value as defined in the ESPP through payroll
                     deductions of up to 15% of their compensation,
                     provided that no employee may purchase common stock
                     worth more than $25,000 in any calendar year.
                     Participants are required to hold ESPP stock for a
                     minimum of six months following the purchase date.
                     The ESPP will expire in 2007.
                     
              NOTE 9 LITIGATION

                        On July 15, 1996, Neuromedical Systems, Inc.
                     ("Neuromedical") filed a lawsuit against NeoPath
                     in the United States District Court for the Southern
                     District of New York.  The complaint alleges patent
                     infringement, unfair competition, false advertising,
                     and related claims.  On September 5, 1996, NeoPath
                     filed its answer and counter claims.  In May 1998, a
                     judge in the United States District Court for the
                     Southern District of New York denied Neuromedical's
                     motion for a preliminary injunction against the
                     Company.  The parties have agreed to dismiss their
                     claims and counter claims on all but the patent
                     issues, and Neuromedical accordingly served an
                     amended complaint on July 27, 1998 asserting only
                     patent infringement claims.  This lawsuit is still
                     in the discovery stage, and a trial date has not
                     been set.  The Company believes it has a strong
                     position in this action and continues to defend
                     itself vigorously.
                         On March 31, 1997, the Company filed a patent
                     infringement lawsuit against Neuromedical in the
                     United States District Court for the Western
                     District of Washington.  The complaint alleges
                     patent infringement and seeks permanent injunctions
                     against Neuromedical.  In March and April 1998 this
                     lawsuit was amended, and NeoPath filed an additional
                     related patent lawsuit against Neuromedical.
                     Neuromedical filed a motion for summary judgment,
                     which the court denied in April 1998.  In October
                     1998, Neuromedical filed another motion for summary
                     judgment that the court denied.  The Company expects
                     trial on the first Washington lawsuit to begin in
                     1999.  The second Washington lawsuit is currently in
                     the discovery stage.
                     
31
<PAGE>
                     
        MANAGEMENT'S
           STATEMENT
        OF FINANCIAL
      RESPONSIBILITY
                     
                         The management of NeoPath, Inc. is responsible
                     for the fair and accurate presentation of the
                     financial information in this annual report.  We
                     have prepared the financial statements and related
                     notes in accordance with generally accepted
                     accounting principles based on Company records and
                     other sources.  Certain financial information is, of
                     necessity, based on judgment and estimation.
                         We believe that adequate accounting systems and
                     financial controls are maintained to ensure that
                     NeoPath's records are free from material
                     misstatement and to protect the Company's assets
                     from loss or unauthorized use.  In addition, the
                     Audit Committee of the Board of Directors
                     periodically meets with NeoPath management and with
                     Ernst & Young LLP, the Company's independent
                     auditors.
                     
                     
                     
                     /s/  ALAN C. NELSON
                     ___________________ 
                     Alan C. Nelson, Ph.D.
                     Chairman of the Board
                     
                     
                     
                     /s/  RONALD R. BROMFIELD
                     ________________________
                     Ronald R. Bromfield
                     President and
                     Chief Executive Officer
                     
                     
                     
                     /s/  ROBERT C. BATEMAN
                     ______________________
                     Robert C. Bateman
                     Vice President and
                     Chief Financial Officer
                     
32
<PAGE>
                     
           REPORT OF
  ERNST & YOUNG LLP,
INDEPENDENT AUDITORS

                     The Board of Directors and Shareholders
                     NeoPath, Inc.
                     
                         We have audited the accompanying balance sheets
                     of NeoPath, Inc. as of December 31, 1998 and 1997,
                     and the related statements of operations,
                     shareholders' equity, and cash flows for each of the
                     three years in the period ended December 31, 1998.
                     These financial statements are the responsibility of
                     the Company's management.  Our responsibility is to
                     express an opinion on these financial statements
                     based on our audits.
                         We conducted our audits in accordance with
                     generally accepted auditing standards.  Those
                     standards require that we plan and perform the audit
                     to obtain reasonable assurance about whether the
                     financial statements are free of material
                     misstatement.  An audit includes examining, on a
                     test basis, evidence supporting the amounts and
                     disclosures in the financial statements.  An audit
                     also includes assessing the accounting principles
                     used and significant estimates made by management,
                     as well as evaluating the overall financial
                     statement presentation.  We believe that our audits
                     provide a reasonable basis for our opinion.
                         In our opinion, the financial statements referred
                     to above present fairly, in all material respects,
                     the financial position of NeoPath, Inc. as of
                     December 31, 1998 and 1997, and the results of its
                     operations and its cash flows for each of the three
                     years in the period ended December 31, 1998,
                     in conformity with generally accepted accounting
                     principles.
                     

                                                   /s/ ERNST & YOUNG LLP

                     Seattle, Washington
                     February 9, 1999
                     
33
<PAGE>
                     
        COMMON STOCK
         INFORMATION
                     
                          Neopath's common stock trades on The Nasdaq
                     Stock Market(R) (or "Nasdaq") under the symbol
                     "NPTH." Nasdaq uses computers and telecommunications
                     to unite its participants in a screen-based market.
                     It enables market participants to compete with each
                     other for investor orders in each Nasdaq security,
                     and it facilitates the trading and surveillance of
                     thousands of securities. As of February 25, 1999,
                     there were 291 holders of record of the common stock
                     of the Company and 17,412,504 shares outstanding.
                     Since shares of NeoPath's common stock are also held
                     in street name, there are additional beneficial
                     holders of the Company's common stock.
                          The following table sets forth, for the periods
                     indicated, the high and the low trade prices for
                     NeoPath's common stock as reported by Nasdaq:
                     
                                                     1998                  1997
                                      ___________________    __________________
                                         HIGH         LOW       HIGH        LOW
                                      ___________________    __________________ 

                     First Quarter    $ 18.19     $ 11.25    $ 19.75    $ 13.50
                     Second Quarter     16.00        5.63      23.00      11.50
                     Third Quarter       8.63        3.88      20.00      15.00
                     Fourth Quarter      8.75        3.06      20.38      12.63

                          The Company has not declared or paid cash
                     dividends on its common stock.  The Company
                     currently intends to retain all earnings for use in
                     its business and does not anticipate paying cash
                     dividends in the foreseeable future.

34
<PAGE>
                     
           CORPORATE
         INFORMATION

                     DIRECTORS
                     
                     Alan C. Nelson, Ph.D.
                     Chairman of the Board
                     
                     Thomas A. Bonfiglio, M.D.
                     Senior Attending Pathologist and Director of Cytology,
                     The Genesee Hospital
                     
                     William L. Scott
                     Retired General Manager, Boston Scientific
                     Corporation -- Northwest Technology Center
                     
                     Cristina H. Kepner
                     Director and Executive Vice President,
                     Invemed Associates, Inc.
                     
                     Walter L. Robb, Ph.D.
                     President, Vantage Management, Inc.
                     
                     David A. Thompson
                     Retired Senior Vice President,
                     Abbott Laboratories
                     
                     Gail R. Wilensky, Ph.D.
                     John M. Olin Senior Fellow, Project HOPE
                     
                     
                     OFFICERS
                     
                     Alan C. Nelson, Ph.D.
                     Chairman of the Board
                     
                     Ronald R. Bromfield
                     President and Chief Executive Officer
                     
                     Robert C. Bateman
                     Vice President and Chief Financial Officer
                     
                     Shih-Jong James Lee, Ph.D.
                     Vice President and Chief Technical Officer
                     
                     Larry A. Nelson
                     Vice President, Intellectual Property and New
                     Business Development
                     
                     Mary K. Norton
                     Vice President, Regulatory/Government Affairs and
                     Quality Assurance
                     
                     David H. Robison
                     Vice President, Operations
                     
35
<PAGE>
                     
           CORPORATE
         INFORMATION

                     CORPORATE HEADQUARTERS

                     NeoPath, Inc.
                     8271 - 154th Avenue NE
                     Redmond, WA  98052
                     Phone:  (425) 869-7284
                     Fax:  (425) 869-5325


                     LEGAL COUNSEL

                     Perkins Coie LLP
                     1201 Third Avenue
                     Seattle, WA  98101


                     TRANSFER AGENT

                     American Stock Transfer & Trust Company
                     40 Wall Street
                     New York, NY  10005


                     INDEPENDENT AUDITORS

                     Ernst & Young LLP
                     999 Third Avenue, Suite 3500
                     Seattle, WA 98104


                     ANNUAL MEETING

                     The Annual Meeting of Shareholders will be held at
                     8:30 a.m. (Pacific Daylight Time) on Thursday, May
                     20, 1999 at NeoPath, Inc. Corporate Headquarters,
                     8271 - 154th Avenue NE, Redmond, Washington  98052


                     SHAREHOLDER INQUIRIES

                     Copies of the Company's Form 10-K, as filed with the
                     Securities and Exchange Commission, may be obtained
                     without charge by writing:

                     Attn:  Investor Relations
                     NeoPath, Inc.
                     8271 - 154th Avenue NE
                     Redmond, WA 98052

36
<PAGE>