**SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549** **Form 10-K**   (Mark One)  **þ** **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE    SECURITIES EXCHANGE ACT OF 1934**   **For the fiscal year ended December 31, 2004** **OR** **o** **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE    SECURITIES EXCHANGE ACT OF 1934**   **For the transition period    from           to****Commission File Number: 0-22885** **TRIPATH IMAGING, INC.***(exact name of registrant as specified in its charter)*   **Delaware** **56-1995728***(State or other jurisdiction of* *(I.R.S. Employer**incorporation or organization)* *Identification Number)***780 Plantation Drive, Burlington, North Carolina 27215***(Address of Principal Executive Offices including ZipCode)***Registrant’s telephone number, including area code:****(336) 222-9707****Securities registered pursuant to Section 12(b) of theAct:****None****Securities registered pursuant to Section 12(g) of theAct:****Common Stock, $0.01 Par Value***(Title of each class)*    Indicate by check mark whether the registrant (1) has filedall reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has beensubject to such filing requirements for the past90 days.     YES þ          No o     Indicate by check mark if disclosure of delinquent filerspursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best ofregistrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of thisForm 10-K or any amendment to thisForm 10-K.     YES o     Indicate by check mark whether the registrant is an acceleratedfiler (as defined in Rule 12b-2 of the ExchangeAct).     YES þ          NO o     The aggregate market value of voting stock held bynon-affiliates of the registrant as of June 30, 2004 was:$259,126,576.     There were 38,163,770 shares of the registrant’sCommon Stock outstanding as of March 29, 2005.**DOCUMENTS INCORPORATED BY REFERENCE**     Portions of the definitive proxy statement of the Registrant forthe Registrant’s 2005 Annual Meeting of Shareholders to beheld on May 24, 2005, which definitive proxy statement willbe filed with the Securities and Exchange Commission not laterthan 120 days after the registrant’s fiscal year ofDecember 31, 2004, are incorporated by reference intoPart III of this Form 10-K.  

 
**TriPath Imaging, Inc.****Table of Contents**       **Part I.**    Item 1.     Business  2     Item 1A.     Executive Officers of the Registrant  32     Item 2.     Properties  33     Item 3.     Legal Proceedings  33     Item 4.     Submission of Matters to a Vote of Security Holders  34  **Part II.**    Item 5.     Market for the Registrant’s Common Equity, Related    Stockholder Matters and Issuer Purchases of Equity Securities  34     Item 6.     Selected Financial Data  35     Item 7.     Management’s Discussion and Analysis of Financial Condition    and Results of Operations  35     Item 7A.     Quantitative and Qualitative Disclosures About Market Risks  60     Item 8.     Consolidated Financial Statements and Supplementary Data  61     Item 9.     Changes in and Disagreements with Accountants on Accounting and    Financial Disclosure  61     Item 9A.     Controls and Procedures  61  **Part III.**    Item 10.     Directors and Executive Officers of the Registrant  62     Item 11.     Executive Compensation  62     Item 12.     Security Ownership of Certain Beneficial Owners and Management    and Related Stockholder Matters  62     Item 13.     Certain Relationships and Related Transactions  62     Item 14.     Principal Accountant Fees and Services  62  **Part IV.**    Item 15.     Exhibits and Consolidated Financial Statement Schedules  62     Signatures  66      As used in this report, the terms “we,”“us,” “our,” “TriPath Imaging” andthe “Company” mean TriPath Imaging, Inc. and itssubsidiaries, unless the context indicates another meaning.*Note Regarding Trademarks*     We have registered trademarks in the United States forAutoCyte®, AutoCyte Quic®, CytoRich®,ImageTiter®, PAPMAP®, PrepMate®,SlideWizard®, and TriPath Imaging®. We have pendingU.S. trademark applications for*i3*Seriestm,FocalPointtm,PrepStaintm,ProExtm,SureDetecttm,SurePathtm,TriPath CareTechnologiestm,and TriPathOncologytm.Foreign registrations are maintained for several of ourtrademarks in Argentina, Australia, Brazil, Canada, Chile,China, the European Union, Finland, Hong Kong, Indonesia,Israel, Japan, Malaysia, Norway, the Russian Federation, SouthAfrica, Sweden, Switzerland, Taiwan, and the United Kingdom. Wehave pending foreign trademark applications forFocalPointtm,*i3*Seriestm,PAPNET®tm,PrepStaintm,SurePathtm,ProExtm,and TriPath CareTechnologiestm.In addition to trademark activity, we include a copyright noticeon all of our documentation and operating software. There can beno assurance that any trademarks or copyrights that we own willprovide competitive advantages for our products or will not bechallenged or circumvented by our competitors. All otherproducts and company names are trademarks of their respectiveholders.

 
**PART I****Item 1.*****Business***     This Annual Report on Form 10-K contains forward-lookingstatements, including statements regarding our results ofoperations, research and development programs, clinical trialsand collaborations. Statements that are not historical facts arebased on our management’s current expectations, beliefs,assumptions, estimates, forecasts and projections. Theseforward-looking statements are not guarantees of futureperformance and involve certain risks, uncertainties andassumptions that could cause actual results to differsignificantly from those discussed in these forward-lookingstatements. Important factors that could cause or contribute tothese differences include those described in the sectionentitled “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations —Critical Accounting Estimates” and in “FactorsAffecting Future Operating Results” attached hereto asExhibit 99.1 and incorporated by reference into thisForm 10-K. You should not place undue reliance on theforward-looking statements, which speak only as the date of thisreport. We undertake no obligation to update these statements toreflect events or circumstances occurring after the date of thisreport or to reflect the occurrence of unanticipated events,except as required by law.     The Company’s Internet website is*www.tripathimaging.com.* Information on the Company’swebsite is not a part of this Annual Report on Form 10-K.As soon as reasonably practical after they are filed orfurnished with the SEC, the Company makes available free ofcharge on its website, or provides a link to, the Company’sAnnual Report on Form 10-K, Quarterly Reports onForm 10-Q, Current Reports on Form 8-K, and anyamendments to those reports filed or furnished with the SECpursuant to Section 13(a) or 15(d) of the SecuritiesExchange Act. To access these filings, go to the Company’swebsite and click on “Investor Resources,” then clickon “SEC Filings.” Alternatively, interested partiesmay request, in writing, a copy of this Form 10-K, withoutcharge. Such requests should be made to TriPath Imaging, Inc.,Attn: Investor Relations, 780 Plantation Drive, Burlington,North Carolina 27215.**The Company**     We create solutions that redefine the early detection andclinical management of cancer. Specifically, we develop,manufacture, market, and sell proprietary products for cancerdetection, diagnosis, staging, and treatment selection. We areusing our proprietary technologies and expertise to create anarray of products designed to improve the clinical management ofcancer. We have developed and marketed an integrated solutionfor cervical cancer screening and other products that deliverimage management, data handling, and prognostic tools for celldiagnosis, cytopathology and histopathology. We have created newopportunities and applications for our proprietary technology byapplying recent advances in genomics, biology, and informaticsto our efforts to develop new molecular diagnostic products formalignant melanoma and cancers of the cervix, breast, ovary, andprostate.     We are organized into two operating units: (1) CommercialOperations, through which we manage the market introduction,sales, service, manufacturing and ongoing development of ourcurrent products; and (2) TriPath Oncology, ourwholly-owned subsidiary through which we manage the developmentand market introduction of molecular diagnostic products forcancer.     Our Commercial Operations unit is a commercial engine organizedto grow sales, drive margin and generate cash. TriPath Oncologyis the development engine of a broad based gene discoveryprogram created to develop new molecular diagnostic products forthe early detection and clinical management of cancer. Ourrevenues are primarily generated today through our CommercialOperations from the sale of our SurePath liquid-based Pap testand other cervical cytology screening products. The products andservices that we are developing in TriPath Oncology did notmaterially impact revenues in 2004; however, we do expect togenerate revenues from some of these reagents and instruments in2005 and continue to believe that sales related to productsdeveloped by TriPath Oncology may significantly impact ourgrowth in 2006 and beyond.
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     We provide financial information by segment and geographic areain Note 8 to our Consolidated Financial Statements includedin Item 8 of this report. We are incorporating thatinformation into this section by reference.**Our Products****Cervical Cytology Product Line (formerly the*i3*****Series Product Line)**     Our cervical cytology product line includes the followingproducts:***The SurePath Test Pack***     Our *SurePath Test Pack*is a proprietary, liquid-basedcytology sample collection, preservation and transport systemthat consists of the SurePath liquid-based Pap test, a samplecollection vial, proprietary preservative solution and samplecollection device. SurePath addresses errors in cell samplecollection and slide preparation while providing a liquid mediumfor performing additional laboratory tests. SurePath slides showa statistically significant reduction of unsatisfactory casescompared to conventional slides. During a clinical exam, aphysician or nurse will collect a sample of endocervical andectocervical cells, using a cervical broom or spatula and brushcombination collection device. Once collected, the healthpractitioner detaches the removable head of the collectiondevice and places it into the vial containing our proprietarySurePath preservative fluid, thereby retaining all of the cellscollected. The lid of the vial is then fastened and the vial isthen transported to a clinical laboratory for follow-onprocessing on the PrepStain system. The SurePath liquid-basedPap test was approved by the United States Food and DrugAdministration (“FDA”) for slides prepared using thePrepStain Slide Processor in June 1999. In 2001, SurePath wasapproved by the FDA for manual slide processing in which thecell suspension obtained by using the SurePath Test Pack islayered onto the slide and stained by a prep technician. In May2003, we received FDA approval for expanded labeling claims toinclude study data showing a 64.4% (p<0.00001) increase indetection of High Grade Squamous Intraepithelial and moreserious lesions (HSIL+), as compared to the conventional Papsmear. In June 2004, we received FDA approval for expandedlabeling claims to include the use of the spatula and brushcombination device for collecting cervical cells as analternative to the previously approved cervical broom collectiondevice. All SurePath devices come with detachable heads toensure 100% of the collected sample is sent to the laboratoryfor processing.***PrepStain Slide Processor***     Our *PrepStain Slide Processor*is an automated slidepreparation system that produces slides with a standardized,thin-layer of stained cervical cells. It consists of proprietaryreagents, plastic disposables and automated equipment forpreparing a thin-layer of cervical cells on a SurePathmicroscope slide. Once received in the laboratory, the sample isthoroughly mixed, resulting in a homogenized and randomized cellsuspension which is removed from the vial and layered onto aproprietary liquid density reagent in a plastic centrifuge tubeusing our patented syringe device. Batch density gradientcentrifugation is then conducted on the cell suspension toremove excess blood, inflammatory cells and other debris fromthe sample. Once centrifugation is completed, the laboratorytechnician places the centrifuge tubes containing the separateddiagnostic cells onto an automated pipetting system. Thispipetting system then distributes the cervical cells in athin-layer on the microscope slide. At this stage, discretestaining of the slides can be carried out by the PrepStainsystem, or staining can be performed off-line from the PrepStainusing alternative staining instrumentation. PrepStain iscurrently capable of preparing approximately 48 discretelystained or 96 unstained thin-layer slides in approximatelyone hour. A SurePath slide typically contains approximately50,000 to 100,000 diagnostic cells that are distributeduniformly over a 13-millimeter diameter circle. The PrepStainSlide Processor, or PrepStain, reduces the complexity ofinterpretation by providing a homogeneous, more representativeand standardized thin layer of stained cells. The FDA approvedPrepStain in June 1999. In early 2005, we received FDAapproval for expanded claims to include the processing ofpre-coated slides.     The *PrepMate*system, an accessory to PrepStain, isdesigned to automate pre-processing steps in the preparation ofSurePath thin-layer slides. PrepMate automatically mixes andremoves specimens from the
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SurePath preservative fluid vials, and layers the specimens ontothe SurePath density reagent in a test tube for automated slidepreparation and staining. The PrepMate accessory is intended toreduce the time required to prepare samples for processing onthe PrepStain instrument. The FDA approved the PrepMateaccessory in May 2001.     In August 2004, we submitted new clinical data to the FDA insupport of a supplemental filing to our Pre-Market Approval(PMAS) for the PrepStain System to include approval oftesting of cervical cells collected using the SurePath Test Packfor high-risk human papilloma virus (HPV) DNA with theDigene Corporation (Digene) hc2 High-Risk HPV DNATesttm.In February 2005, we announced that we had withdrawn thissubmission. This action was taken after we, through discussionswith the FDA, learned that additional clinical information andanalyses would be required which had not been part of theoriginal protocol accepted by the agency. The decision towithdraw is a procedural step and we are currently indiscussions with the FDA about the additional data orinformation requirements. We intend to advance these discussionsand evaluate the required additional data or information, withthe goal of resubmission of the PMAS at the earliest possibledate. There can be no assurance that our re-submission, if orwhen made, will receive the required regulatory approvals, whenanticipated, if at all.***FocalPoint Imaging System***     Our *FocalPoint Imaging System*is a computerized imagingsystem that applies proprietary technology to screen SurePath orconventionally prepared Pap smear slides by identifying thoseslides that have the highest likelihood of abnormality. TheFocalPoint Slide Profiler was approved by the FDA for primaryscreening of conventional Pap smears in May 1998 and forSurePath slides in October 2001. The FocalPoint GS ImagingSystem, which combines the automated sorting and rankingcapability of the currently approved FocalPoint Slide Profilerwith FocalPoint GS location guided screening of areas ofinterest, was introduced outside of the U.S. in the fourthquarter of 2000.     Our *FocalPoint Slide Profiler*is an automated primaryscreening device that combines computerized video microscopy andimage interpretation to distinguish between normal and abnormalSurePath liquid based and conventionally prepared Pap testslides. The FocalPoint Slide Profiler is intended to sort andrank slides based on the likelihood of abnormality, distinguishslides that need further cytotechnologist review from those thatrequire ‘No Further Review’ (up to 25% least likely tobe abnormal), and to identify slides in an enriched qualitycontrol population (a minimum of 15% of slides with a highestlikelihood of being abnormal) for a directed quality control(QC) review. In addition, sorting, ranking, adequacy andother slide information provided by the FocalPoint SlideProfiler facilitates the manual microscopic review of slidesdesignated for full microscopic review.     Our *FocalPoint GS Imaging System*(FocalPoint GS) combinesthe automated sorting and ranking capability of the FocalPointSlide Profiler with a rapid screen of areas of interest, orFields of View (FOV), on slides designated for review by theFocalPoint Slide Profiler. The FOV location coordinates andassociated images are communicated via a network connection fromthe FocalPoint Slide Profiler to a designated FocalPoint GSReview Station that has been equipped with commerciallyavailable microscopes and computer-controlled automated stagesfor FOV review. FOV’s determined by the FocalPoint GS todemonstrate the highest likelihood of abnormality are presentedfor a focused microscopic review that allows thecytotechnologist to quickly analyze the slide for the presenceof cellular abnormality. Abnormal findings thus identified canbe confirmed by full microscopic review. If no abnormality isidentified during this rapid cytologic assessment, no furtherreview is required. In October 2004, we submitted clinical datato the FDA in support of a PMAS for the FocalPoint SlideProfiler to expand our claims to include approval of theFocalPoint GS Imaging System. Review of this submission iscurrently pending. There can be no assurance that the FocalPointGS system will receive the required regulatory approvals forsale in the United States, when anticipated, if at all. Wecurrently market FocalPoint GS to certain markets outside the US.
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**SlideWizard Product Line**     Our *SlideWizard*product line consists of personalcomputer-based applications focused on the quantification of thenuclear DNA content of cells and the detection andquantification of specific molecules in cells or tissue sections(immunohistochemistry and immunocytochemistry assays), themanagement and archiving of images and patient information, theexchange of data via telepathology and the creation ofcomprehensive reports combining color images and patient data.Our SlideWizard line of products include: • *Telepathology Module:* a module for the transmission and    interpretation of high-resolution images captured at remote    sites for teaching and research;  • *Quantitative Image Cytometry-DNA:* an application that    performs quantitative analysis of DNA by quantifying nuclear    texture and morphology;  • *Quantitative Image Cytometry-Immuno:* an application that    offers general purpose image analysis that is ideal for    recognition and quantification of virtually any stain    application on a variety of biologic materials  • *ImageTiter:* a method to quantitatively measure abnormally    high levels of antinuclear antibodies through “titration    emulation” as an indication for a variety of immune system    problems; and  • *SlideWizard:* an electronic dotting and labeling system.     We received pre market notification, or 510(k) clearance throughone of our predecessor companies in November 1995 to market theImage Titer for automating antinuclear antibody testing. Our DNAand immuno-quantification applications are presently offered“For Research Only” in the United States. We currentlydo not meet the InVitro Diagnostics Directive requirements tosell and place the SlideWizard applications in Europe (except incombination with the FocalPoint GS). Specifically, a SlideWizardworkstation is also a component of the FocalPoint GS system thatis currently sold only outside the United States. We may electto pursue regulatory clearance to market additional SlideWizardapplications currently under development or developed by us inthe future.**Molecular Diagnostics Products**     Our molecular diagnostic products did not materially impactrevenues in 2004; but we do expect to generate revenues fromsome of these reagents and instruments in 2005 and continue tobelieve that sales related to these products may significantlyimpact our growth in 2006 and beyond. Our molecular diagnosticproducts are at various stages of development and include thefollowing:***Microscopic Slide Based Reagents***     Our *ProEx C*analyte specific reagent(ASR) incorporates molecular biomarkers that measure theover-expression of proteins whose over-expression is associatedwith aberrant S phase induction, an abnormal growth stateassociated with the development of cancer. Aberrant S phaseinduction has been associated with cancer of the cervix,esophagus, ovary, lung, and prostate. We expect that thisanalyte specific reagent will be available for purchase in theU.S. in the second quarter of 2005.     Our *ProEx Br*analyte specific reagents incorporatemolecular biomarkers that measure the over-expression of certainproteins that are believed to reflect increased activity inmolecular pathways that are associated with the progression ofcancer. These analyte specific reagents are currently availablefor purchase in the U.S.     Our *Cervical Staging Assay*incorporates proprietarymolecular biomarkers and reagents and is being developed toidentify biopsy proven underlying pre-malignant cervical diseaseand cervical cancer in patients who have tested positive forhigh-risk human papilloma virus infection or for whom theresults of cytologic screening with the SurePath liquid-basedPap test are equivocal. We expect to launch a cervical stagingdiagnostic kit outside the U.S. in the second quarter of2005 if we have received the necessary international
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regulatory approvals. Concurrently, we expect to release adetection kit for visualization of biomarkers on cytologyslides, an automated cervical cytology slide-staining platformand a series of assay control reagents.     Our *Cervical Screening Assay*incorporates proprietarymolecular biomarkers and reagents and is being developed forprimary screening for cervical cancer. The assay is beingdeveloped to test slides prepared using the SurePathliquid-based Pap test and to permit concurrent evaluation ofmorphologic features and measurement of the over-expression ofmolecular biomarkers that are associated with biopsy provenmoderate to severe cervical disease and cancer. The assay isbeing developed for use with and without our molecular cytologyimaging system (described below). We expect to initiate clinicaltrials in the second half of 2005 to collect data that couldsupport an application for pre-market approval by the FDA. Giventhe relatively low prevalence of moderate to severe cervicaldisease and cervical cancer and the fact that the resultsobtained with our molecular biomarkers may dictate a need foradditional follow-up of some clinical trial subjects over time,we believe that this clinical trial may require up to 12 to18 months to complete. If our clinical trial is successful,we would expect to introduce this assay in the U.S. as anin vitro diagnostic in late 2006 or 2007 depending, inlarge part, on the length of the clinical trial.     Our *Breast Staging Assay*incorporates proprietarymolecular biomarkers and reagents and is being developed topredict the risk of disease recurrence and to aid in treatmentselection in patients with early stage breast cancer. The assayis being developed for use with commercially available detectionkits and staining platforms and to utilize our interactivehistology imaging system (see below) to quantify biomarkerover-expression in tissue samples collected at the time ofinitial diagnosis of breast cancer. We expect to initiateclinical trials in the second half of 2005 to collect data thatcould support an application for pre-market approval by the FDA.Given a successful clinical trial, we would expect to introducethis as an in vitro diagnostic in the latter half of 2006.     Over the past two years we have also released several*Research Use Only (RUO)*products, including RUO reagentsfor staging of melanoma and cancer of the cervix and breast. Indata presented in 2004 from a study completed in 2003,investigators at Albany Medical College observed that themeasurement ofmelastatintmexpression using our melanoma assay was an independentprognostic factor that may be useful in determining the risk ofdisease recurrence and metastasis in patients with primary thinmelanoma lesions. We released our RUO reagents for cervical andbreast cancer staging in 2004. Investigators at theMassachusetts General Hospital, Johns Hopkins Hospital, and theUniversity of Colorado are currently evaluating the analyticaland clinical performance of our RUO reagents for cervical cancerstaging. Investigators at Albany Medical College are currentlyevaluating the clinical performance of our RUO reagents forbreast cancer staging.     There can be no assurance that the microscopic slide basedreagents that we are developing will be ready to launch orreceive required regulatory approvals when anticipated, if atall.***Molecular Imaging Systems***     Our *Interactive Histology Imaging System*is beingdeveloped to allow rapid, reliable and cost effectivequantification of molecular biomarkers in histologic tissuesections. This product is expected to provide on-demand digitalimaging, direct visualization of immuno-histochemistry(IHC) stained slides, and real-time quantitative analysisof tissue samples. Ventana Medical Systems, Inc. (Ventana) hasagreed to sell and distribute a Ventana-branded version of ourinteractive histology imaging system (Ventana Image AnalysisSystem (VIAS)) under a five-year global supply agreement that weentered into in September of 2004. We submitted data to the FDAin support of a 510(k) notification for processing of theVentana estrogen and progesterone receptor assays on the imagingsystem in January of 2005. Pending FDA clearance, we anticipatethat Ventana will launch VIAS in the second quarter of 2005. Weanticipate filing additional 510(k) notifications for processingof other Ventana assays throughout the year. There can be noassurance that we will obtain the desired FDA clearances whenanticipated, if at all, nor that Ventana will prioritize themarketing of VIAS.     Our *Molecular Cytology Imaging System*identifies abnormalcells on cytology slide preparations based on their specificreaction with molecular biomarkers. We intend to introduce thissystem outside the U.S. in the
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second quarter of 2005 and we expect to incorporate it in ourcervical screening clinical trial, which we anticipateinitiating in the second half of 2005. There can be no assurancethat this imaging system will receive the desired regulatoryapprovals, when anticipated, if at all.***Blood-Based Reagents***     We have initiated development of blood-based screening andmonitoring assays for ovarian and breast cancer. We anticipatereleasing our ovarian cancer screening reagents in an RUO formatin the second half of 2005. We anticipate releasing our breastscreening reagents in an RUO format by the end of 2006.Concurrent with the development of these reagents we areevaluating high volume testing platforms.**The Cancer Market**     Cancer is a chronic and complex disease characterized byuncontrolled growth and spread of abnormal cells. According tothe World Health Organization (WHO), the worldwide incidence ofcancer in the year 2000 exceeded 10 million cases,excluding basal and squamous cell cancers of the skin. The WHOfurther estimates that approximately 6.2 million deathsworldwide were attributable to cancer in 2000. In the UnitedStates, the American Cancer Society (ACS) estimates thatroughly 1.37 million cases of non-skin cancers will bediagnosed in 2005, roughly half of which will occur in women. Inthe United States, women have about a 1-in-3 lifetime risk ofdeveloping invasive cancer. It is estimated that in 2005approximately 663,000 women will be newly diagnosed with cancerand an estimated 275,000 women will succumb to the disease. Itis anticipated that melanoma and cancers of the breast, cervix,and ovary will account for over 40% of all new cancers diagnosedin women in 2005.**Women’s Cancers****2005 Cancer Estimates (U.S.)**            **Estimated 2005 Incidence** **Estimated 2005 Mortality**         All Cancers  662,847   275,000     TriPath Imaging Targeted Cancers:             Breast  211,240   40,410      Ovarian  22,220   16,210      Malignant Melanoma  26,000   2,860      Cervical  10,370   3,710  Source: American Cancer Society, Facts & Figures, 2005     Treatments for cancer are expensive and often ineffective.Current treatments for cancer include surgery, radiation,chemotherapy and targeted therapeutics. Surgery is limited inits effectiveness because it treats the tumor at a specific siteand may not remove all the cancer cells, particularly if thecancer has spread. Radiation and chemotherapy can treat thecancer at multiple sites but can cause serious adverse sideeffects because they destroy healthy cells and tissues as wellas cancer cells. The ACS projects that in 2005 over
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275,000 women will die of cancer-related illness. Detectingcancer at the earliest possible stage of disease is critical topatient survival and outcome as reflected in the followingfive-year relative survival rates:**Five Year Disease — Free Survival****by Stage at Diagnosis**             **TriPath Imaging Targeted Cancers:** **Localized Disease (%)** **Regional Spread (%)** **Distant Metastases (%)**           Breast  98   80   26     Ovarian  95   72   31     Malignant Melanoma  98   60   16     Cervical  92   51   15  Source: American Cancer Society, Facts & Figures, 2005     Development and utilization of modalities for routine cancerscreening is critical to early detection. According to the ACS,whereas the five-year relative survival rate for all cancers isapproximately 64%, the relative survival rate for currentlyscreened cancers (i.e. including cancers of the cervix, breast,rectum and skin) is approximately 84%. The ACS estimates thatthe relative survival rates of these screened cancers could befurther increased to 95% if all Americans were regularlyscreened for these cancers. In 2004, the National Institutes ofHealth estimated the overall costs for cancer-related illness inthe U.S. to be $189.8 billion.     We expect the market for cancer diagnostics will growsubstantially due to the increased incidence of cancer, an agingpopulation, early cancer awareness, pressure to reduce cancermortality rates and improvements in healthcare screeningsystems. The existing cancer diagnostics market is characterizedpredominantly by tests or methods that identify the presence ofsurrogate markers of disease, cellular abnormalities or imaginganomalies that are correlated with the presence or stage ofdisease but, for the most part, do little to provide informationspecific to the biology of the disease or the outcome of thepatient. The current technologies used in cancer diagnosticsconsist primarily of tumor marker immunoassays, cytologyevaluation and imaging techniques such as mammography.     While some of the underlying causes of specific cancers can betraced to a single genetic alteration, it is now believed thatmultiple complex genetic changes underlie the development of thevast majority of cancers. However, the identification of geneticanomalies alone is unlikely to prove clinically significant asmany genetic events may have minimal or no impact on apatient’s health, whereas others may pose life-threateninghealth risks. Determining the interrelationship of genes andproteins, and their interaction with one another is likely to beas important as understanding the underlying cause of thegenetic change itself. The scientific community’s knowledgeof these underlying genetic and proteomic factors has onlyrecently come about through the development of moresophisticated research and discovery tools, investment inmapping of the human genome, and development of bioinformaticscapabilities to assess the clinical relevance of these geneticand proteomic abnormalities.     In recent years, novel molecular oncology tests have beenintroduced to provide additional clinical information previouslyunavailable to assess an individual’s predisposition orlifetime risk of developing certain cancers. Molecular tests arealso used to screen and assist in the diagnosis of the presenceof disease, to assess patient prognosis and outcome moreaccurately, to guide therapeutic selection in the management ofcertain cancers and to monitor for disease recurrence. Moleculartests offer the promise of providing a more accurate,disease-specific understanding of cancer to best address theneeds of medical practitioners.***Cervical Cancer***     Cancer of the uterine cervix, or cervical cancer, is second onlyto breast cancer as the most common form of malignancy in bothincidence and mortality in women worldwide. According to the WHOthe worldwide incidence of cervical cancer in 2000 was 470,606with a mortality rate of 233,372. In parts of the developingworld, cervical cancer is the major cause of death in women ofreproductive age. The ACS estimates that in
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2005 approximately 10,370 cases of invasive cervical cancer willbe diagnosed in the United States with an estimated 3,710 deaths.     Invasive cervical cancer spreads from the surface of the cervixto tissue deeper in the cervix or to other parts of the body.Cervical cancer develops in stages over a period of timebeginning with pre-invasive changes that eventually progress toinvasion. Because of the progression to invasion, most deathsdue to invasive cervical cancer can be prevented withearly-stage detection and treatment. Early detection is criticalin promoting patient wellness. The more advanced the cancer, thelower the chances are of managing and/or curing the patient.Thus, regular cervical screening examinations are recommended inthe United States and many foreign countries.***Screening for Cervical Cancer***     Based on the concept that the physical appearance (ormorphology) of cells that have been scraped from the surface ofthe uterine cervix may correlate with and, therefore, signifythe presence of cancer or its precursors in underlying cervicaltissue, the Pap smear has been employed worldwide as a primaryscreen for cervical cancer and its precursors since the late1940s. It is the most widely used and most successful of allscreening tests for cancer having contributed to a greater than70% decrease in deaths resulting from cervical cancer in theU.S. since it was first introduced. It is estimated thatclinical laboratories in the United States perform over50 million Pap tests, including liquid based Pap tests,annually and we believe that the annual test volume outside ofthe United States is in excess of 80 million.     The Pap smear, as first developed by Dr. George N.Papanicolaou in the 1940s, remained essentially unchanged untilthe introduction of liquid based Pap tests, such as our SurePathliquid based Pap test, in the 1990s. The liquid based Pap testwas developed to remedy several practical limitations of theconventional Pap smear, including those related to specimencollection and slide interpretation. The use of a liquid mediumto transport cervical cells may facilitate the specimencollection process by reducing the time taken to prepare thespecimen for transport, by eliminating air drying and othercollection related artifacts that distort cell architecture, byproviding a readily accessible medium and adequate shelf life toallow for repeat testing from the original sample, by providinga readily accessible medium for potential adjunctive testing forinfectious, genetic or other diseases and, in the case of ourSurePath liquid based Pap test, by providing a standardizedtechnique for specimen collection that ensures that all cellscollected are transported to the laboratory. The thin layerslides prepared using liquid based Pap tests eliminate the depthof focus issues that may complicate the interpretation of therelatively thick conventional Pap smear and are relativelydevoid of blood, mucus, or inflammatory material that mayobscure significant cytologic pathology. In the case of ourSurePath liquid based Pap test, the combination of thesecollection and slide preparation features contributes to astatistically significant reduction in the number ofunsatisfactory cases when compared to the conventional Pap smear.     The Pap smear is prepared from scrapings of the surface of theuterine cervix that are collected during a gynecologic pelvicexamination. These exfoliated cervical cells are, in the case ofthe conventional Pap smear, directly transferred to a glassslide by the clinician who collects the specimen. In the case ofthe liquid based Pap test, such as our SurePath liquid based Paptest, these exfoliated cells are transferred by the clinicianinto a liquid medium from which a thin layer slide issubsequently prepared in the laboratory, most often using anautomated system such as our PrepStain slide processor, afterthe liquid medium, blood, mucus, and other obscuring materialsare removed by density gradient centrifugation. With theconventional Pap smear, the clinician discards the collectiondevice and whatever cells that remain attached to the device,after the sample is transferred to the glass slide. With theSurePath liquid based Pap test, the clinician simply detachesthe head of the collection device and places it into the liquidtransport medium, thus, ensuring that 100% of the cells thathave been collected are transported to the laboratory. Foreither the conventional or liquid based Pap tests, aPapanicolaou stain is applied to the slide to facilitatemicroscopic review. The slide is then analyzed microscopicallyby a cytotechnologist who evaluates the appearance of theex-foliated cells. The cytotechnologist looks for cell featuresthat are associated with cancer of the cervix or its precursors.Any abnormality so detected is further reviewed by apathologist. Depending on the cytologic classification that hasbeen assigned by the pathologist, abnormalities that areconfirmed by pathologist review are further evaluated by testingfor human papilloma virus (HPV) and/or direct visualexamination of the cervix using a colposcope and, if a
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lesion is so detected, a biopsy to obtain cervical tissue forhistologic examination. Biopsied cervical tissue is evaluatedfor histologic evidence of the loss of uniformity of individualcells, the loss of architectural orientation, and other abnormalfindings that are associated with Cervical IntraepithelialNeoplasia (CIN) and cervical cancer. CIN, which is alsoreferred to as dysplasia, is characterized by pre-cancerouschanges in cervical tissue, and is further categorized intoCIN 1, CIN 2, or CIN 3 (mild, moderate, and severedysplasia) depending on the severity of abnormality. Furthertreatment or follow-up is dictated by the results of thecervical biopsy and most often follows consensus guidelines thathave been developed by opinion leaders in concert with variousclinical organizations and advocacy groups.     Typically, about 90% to 95% of all Pap smears are classified asnormal. Abnormal Pap smears are classified in order to specifythe degree of cytologic abnormality, according to The BethesdaSystem (2001). The prevalence of histologic evidence of CIN andcancer varies with each cytologic classification. For example,the cytologic classification of atypical squamous cells ofundetermined significance (ASC-US) represents the leastsignificant cytologic abnormality and is associated with only arelatively small number of biopsies that demonstrate underlyingpremalignant or malignant cervical disease. Low-grade squamousintraepithelial lesion (LSIL) is associated with a slightlyhigher likelihood of underlying disease, particularly CIN 1 and,most often, appears to reflect cytologic changes that areassociated with HPV infection. Atypical squamous cells ofundetermined significance-cannot exclude high grade (ASC-H), arecently introduced classification, is associated with asomewhat higher number of biopsies that demonstrate CIN 2 ormore severe disease. High-grade squamous intraepithelial lesion(HSIL), is a very significant cytologic abnormality that isassociated with a very high correlation to biopsy evidence ofCIN 2, CIN 3, and, not infrequently, cancer. The mostsignificant cytologic classification is cancer itself where thecorrelation to biopsy evidence of cancer or severe dysplasia isvery strong.***Human Papillomavirus***     Since the mid-1970’s Human Papillomavirus, or HPV, has beenrecognized as a sexually transmitted infection that isassociated with the development of genital tract neoplasia. Ofthe approximately 70 types of HPV viruses recognized to date,more than 20 have been associated with lesions in the femaleanogenital tract. The so-called low risk types (i.e.6,11,42,43,44) are mainly associated with benign lesions such ascondylomas, which rarely progress to malignancy. The so-calledhigh-risk types (i.e., 16,18,31,33,35,39,45,51,52,56, and 58)are detected in cancer of the cervix.     While it has been documented that nearly all cervical cancers(99.7%) are directly linked to previous infection with one ormore of the high-risk types of HPV (Judson 1992; Walboomers et.al. 1999), infection with HPV, even a high-risk type, in and ofitself is not predictive of cervical cancer or its precursors.Most HPV infections are transient and are not associated withthe development of cervical cancer or its precursors. Given thebiology of the infection and its association with cervicalneoplasia, if one were to test for high-risk HPV (even with atest that is 100% sensitive and specific for high-risk HPV) onewould expect that the negative predictive value for testing forhigh-risk HPV, that is the likelihood that a negative test forhigh-risk HPV is associated with absence of CIN 2 or more severecervical disease, would approach almost 100%. However, one wouldalso expect that the positive predictive value of a test forhigh-risk HPV, that is the likelihood that a positive test forhigh-risk HPV is associated with the presence of CIN 2 or moresevere lesions, would range from 10 to 25% depending on the ageof the population tested.     Over the past few years, testing for infection with high-risktypes of HPV has gained clinical acceptance in the U.S. incertain clinical situations. The 2001 Consensus Guidelinessponsored by the American Society for Colposcopy and CervicalPathology (ASCCP) recommend testing for HPV to assist inthe management of women with ASCUS-US Pap test results. Theseguidelines are supported by a number of studies including theNCI-sponsored *ASCUS/ LSIL Triage Study for Cervical Cancer(ALTS)*trial that demonstrated that HPV testing within theASC-US patient population was an effective method of triagingthese patients for subsequent referral to colposcopy because ofthe extremely low likelihood of finding cancer or its precursorsin the absence of infection with high-risk HPV. The Guidelinesrecommend that patients with ASC-US who test negative forhigh-risk HPV should be managed by follow-up Pap smear and HPVtesting and that patients with ASC-US who test positive forhigh-risk HPV should be immediately referred for colposcopy andpossible
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biopsy. In the ALTS trial, the positive predictive value(PPV) of HPV testing within the ASC-US patient population,however, was shown to be only 17%.     In March 2003, the FDA approved a submission by DigeneCorporation to include HPV as an adjunct to the Pap smear forprimary screening for cervical cancer in women age 30 andolder. The rationale for this approach is predicated on theextremely low likelihood of finding cancer or its precursors inthe absence of high-risk HPV infection when the Pap smear isnormal. In fact, the negative predictive value of the two testsin combination is greater than 99%. However, the lack ofspecificity and relatively low positive predictive value of HPVmay again be problematic. For example, approximately 2 to 6% ofwomen with normal Pap smears yield positive tests for high-riskHPV. The management of such patients is as yet unclear.Furthermore, although approximately 56% of patients with ASC-USand 85% of patients with LSIL test positive for high-risk HPV,the rate of detection of CIN 2 or more severe lesions on biopsyin these populations is only 10% and 20% respectively.***Breast Cancer***     With an estimated incidence of over one million new cases peryear, cancer of the breast is the most common women’scancer in the world, accounting for 22% of all new casesdiagnosed. On a worldwide basis, breast cancer is the leadingcause of cancer mortality in women, representing an estimated14% of all cancer-related deaths in females.     The ACS estimates that in 2005, approximately 211,240 new casesof invasive breast cancer will be diagnosed among women in theUnited States, with an estimated 40,410 women dying of thedisease. Breast cancer incidence increases with age, andalthough significant progress has been made in identifying womenconsidered to be at high risk of developing the disease, morethan 50% of breast cancer occurs sporadically in women with noknown risk factors. According to the NCI, the overall five-yearsurvival rate for women diagnosed with breast cancer is 86%.Early detection is paramount as the relative survival rates varysignificantly among localized disease (96.8%), regional spread(78.4%) and distant metastases (22.5%).***Breast Cancer Screening***     Breast cancer screening is currently defined as a combination ofpatient self-exam, clinical breast exam and mammography. Thesemethods are complementary and are not used as stand-alonetechniques. Film imaging mammography is the gold standard forbreast cancer screening and currently represents the mosteffective means of early detection of breast cancer with asensitivity ranging from 54.0% to 94.0% and a specificityranging from 83.0% to 98.5%. More specifically, studies showthat mammography sensitivity ranges from 54.0% to 58.0% in womenunder age 40 and from 81.0% to 94.0% in women over 65. Theprimary purpose of mammography screening is the detection of anabnormality. Numerous studies have shown that early detectionsaves lives and provides more treatment options. For thisreason, annual screening by mammography is recommended for womenover age 40 in the U.S. and many foreign countries.     According to data from the 2000 Behavioral Risk FactorSurveillance System (BRFSS), the percentage of U.S. womenaged 40 and older who had a recent mammogram was 62.6%. Of the32.5 million screening mammograms currently performed inthe U.S., approximately four million indicate some form ofabnormality requiring further follow-up. Once an abnormality isdetected on initial screening, the need for a very sensitive andspecific assay to detect early breast cancer becomes critical.Although follow-up diagnostic imaging and ultrasound may providegreater image clarity, neither is able to distinguish between abenign condition and a malignancy. Of the estimated1.2 million breast biopsies performed in the U.S., roughly80% yield no form of malignancy resulting in an estimated costof $3.3 billion related to unnecessary biopsies. (HCACancer Care, Nov 2002. Informational Guide to Breast Cancer).***Breast Cancer Staging and Treatment***     Once breast cancer is diagnosed, it is staged,(i.e. I, II, III or IV) based on a number offactors including tumor pathology (T), nodal involvement(N) and distant metastasis (M). In the U.S., approximately55% to
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60% of newly diagnosed invasive breast cancer is detected at arelatively early stage (i.e. small tumor size and with no orminimal nodal involvement).     Although the “TNM” classification system is useful instaging patients for follow up and treatment, it is based solelyon the morphologic features of the tumor and its degree ofspread and, thus does not take into consideration the biologicmake up of the cancer. The clinical course of primary breastcancer varies from patient to patient. Predicting whichindividuals are cured and which are not remains difficult forboth lymph node negative and lymph node positive breast cancerpatients. Clinicians are well aware that some patients who havepoor TNM scores have long disease-free survival times, whereasothers with good TNM scores experience a rapid deteriorationwith early recurrence of breast cancer followed by death. Atbest, current prognostic indicators serve as guides for clinicaldecisions that require considerable judgment.     Once the cancer is staged, treatment decisions are typicallymade by an oncologist in consultation with the patient and willtake into consideration the patient’s age and preferences,as well as the risks and benefits associated with each treatmentprotocol. Nearly all women with breast cancer have some form ofsurgery combined with other treatments such as radiotherapy,chemotherapy, hormone therapy and/or monoclonal antibodytherapy. Prognostic tests for the determination of estrogenreceptor (ER), progesterone receptor (PR) and her2/neustatus have become standard of care for selecting subsets ofpatients most likely to benefit from certain hormone andmonoclonal antibody therapies.***Breast Cancer Post-Therapy Recurrence***     In general, it has been widely assumed that early detection ofany cancer, whether as a new primary malignancy or as arecurrence, leads to more effective therapy. As with screening,the ability to detect small tumors and early progression inasymptomatic situations is paramount to positive outcomes.However, the recurrence rate can be as high as 25% to 30% withinthe first five years after diagnosis, even in patients with goodTNM scores.     Presently, a large number of markers exist for the monitoring ofbreast cancer. These include MUC-1 (CA15-3), carcinoembryonicantigen (CEA), oncoproteins, milk proteins and cytokeratins. Ofthese, CA15-3, CA27.29 and CEA are the most commonly used.According to the American Society of Clinical Oncologists(ASCO); Tumor Marker Guidelines, the performance of thesemarkers range in sensitivity for Stage I disease of 9% to 10%,Stage II of 19% to 54%, Stage III of 31% to 54% andStage IV of 64% to 75%. Additionally, ASCO notes thatCA15-3 exhibits a limited sensitivity for detecting low tumorburden, when treatments are most likely to be beneficial.Currently, only 20% to 30% of recurrences are detected beforethe onset of symptoms.***Ovarian Cancer***     Ovarian cancer is only the seventh most common cancer in womenwith an estimated 192,379 cases diagnosed worldwide in 2000, butit is among the most deadly. In the U.S., the five-year relativesurvival rate is only 53% for all women diagnosed with ovariancancer. According to the American Cancer Society Facts andFigures for 2005, the estimated five-year survival rate forlocalized ovarian cancer is 95%, but only 72% if the cancer hasspread regionally, and only 31% for women with distantmetastases.     Ovarian cancer has been shown to be a clonal disease inapproximately 90% of cases suggesting that most cancers could,in fact, be detected before they have metastasized. Due to thelack of an adequate screening test, and to the fact ovariancancer is asymptomatic until the cancer has progressed to a latestage, approximately 75% of newly diagnosed patients are inadvanced to late stages III and IV.***Ovarian Cancer Screening***     The effectiveness of routine screening of asymptomatic womenusing pelvic examination, abdominal or vaginal ultrasound orserum carcinoembryonic antigen (CEA-125) has not beenestablished. The ACS recommends annual pelvic examinations forwomen starting at age 18 or at the onset of sexualactivity. In 1994, a National Institutes of Health ConsensusConference on Ovarian Cancer concluded that there is no
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evidence that screening with currently available modalities,including CEA-125 and/or transvaginal ultrasound can be usedeffectively to decrease ovarian cancer mortality or morbidity.     Currently, screening for ovarian cancer typically occurs in oneof the following settings: • *Women considered at high risk for developing ovarian    cancer.*     The ACS states that women who are at high risk of epithelial    ovarian cancer, such as those with a very strong family history    of the disease, may be screened annually using transvaginal    ultrasound and/or CEA-125. • *Presence of adnexal (ovarian) or pelvic mass.*     In the United States the hospitalization rate for ovarian    neoplasms is reported to be as high as 289,000 women    annually. Roughly 80% to 90% of these women have a surgical    procedure to rule out and/or diagnose ovarian cancer. Typically,    women are found to have an adnexal or pelvic mass during a    routine physical examination or during evaluation for another    complaint.     A successful screening program aimed at the early detection ofovarian cancer would require that major abdominal surgery(laparoscopy and/or laparotomy) be performed, as this is theonly means of a definitive diagnosis. Because of the lowincidence of ovarian cancer and the necessity of major abdominalsurgery, a screening program requires high accuracy with a highspecificity to minimize morbidity associated with majorabdominal surgery.***Malignant Melanoma***     Although melanoma accounts for only a fraction of all skincancers diagnosed, it is by far the most serious. Unlike themore common and curable basal cell and squamous cell skincancers, melanoma accounts for roughly 75% of all skincancer-related deaths. In 2000, the WHO estimated that 67,425cases of melanoma were diagnosed in women and 17,045 femaledeaths were attributable to this deadly disease. In 2005, theACS estimates 26,000 women in the U.S. will be diagnosedwith melanoma and 2,860 are expected to die of the disease.     The overall five-year relative survival rate of patientsdiagnosed with melanoma is 89% according to the ACS. Becausemelanoma develops from biological changes in pigmented lesionssuch as moles, early signs of melanoma development can usuallybe seen through changes in the size, color or texture of thelesion. As a result, about 82% of melanomas are diagnosed at anearly or localized stage where the five-year relative survivalrate approximates 99%. Survival rates drop considerably to 60%and 16% for melanomas that have spread to regional nodes or todistant organs, respectively.***Melanoma Staging and Treatment***     Once melanoma is suspected, the lesion and surrounding tissueare excised. Once diagnosed, biopsy of the surrounding(sentinel) lymph nodes is common to determine the degree ofspread of disease. Like most cancers, melanomas are staged,i.e. I, II, III or IV, based on a number offactors including tumor pathology, nodal involvement and distantmetastasis, or the TNM classification system discussed above.Prognostic factors such as tumor thickness (Clark Score),mitoses and ulceration are among the criteria used in tumorgrading. Although the TNM classification system is useful instaging patients for follow up and treatment, it is based solelyon the morphologic features of the tumor and its degree ofspread and, thus does not take into consideration the biologicmake up of the cancer.     Predicting which individuals are cured and which are not remainsdifficult, as up to 20% of individuals with thin lesions mayrelapse within five years. As with other types of cancer, somepatients who have poor TNM scores have long disease-freesurvival times, whereas others with good TNM scores experience arapid deterioration with early recurrence of melanoma followedby death. At best, current prognostic indicators serve as guidesfor clinical decisions that require considerable judgment.
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     In addition to the standard treatment for malignant melanoma,which includes adequate excision of the primary tumor and mayrequire removal of surrounding lymph nodes, advanced cases aretreated with chemotherapy or immunotherapy. Although a number ofmarkers have been studied to determine their utility inpredicting which patients with early stage disease havebiologically aggressive disease and, therefore should be treatedmore aggressively, determination of Melastatin mRNA expressionlevels appears to be the most promising.**Marketing and Sales*****Marketing Strategy***     Our marketing strategy is focused on providing solutions thataddress the unmet needs of our three broad market stakeholders:clinical laboratories, clinicians and third-party payors. Weincreased our marketing efforts during the first half of 2002 bydirecting resources toward various marketing-related initiativesdesigned to promote brand identification and awareness, increasemarket acceptance of our products and services and enhanceproduct management. We have expanded our presence in themarketplace through increased advertising and promotion,company-sponsored seminars and trade shows, and peer sellingactivities. To further educate and reinforce the benefits of ourproducts, we initiated a partnership with a third-partyphysician/peer selling organization in 2001 that continued into2004. In September 2004, we initiated an expansion of sales andmarketing activities to leverage the opportunity created by ourgrowing relationship with the large commercial laboratories (seebelow) and to meet the challenge associated with expanding ourcervical cytology business in this heavily contested marketsegment while maintaining and growing our business within ourtraditional customer base.***Clinician/ OB-GYN***     Over the past 3 years we have expanded our clinicianeducational programs to better focus on this large segment. Wealso conducted a number of clinician-related activitiesincluding the establishment of a Clinical Advisory Board andnumerous expert panels as forums to discuss and receive feedbackon unmet medical needs, standards of care, market trends,product concept review and use, and clinical trials strategies.Finally, we cultivated and developed relationships with leadingclinicians to identify current and future potential productareas with the goal of expanding peer-to-peer selling andinfluence.***Clinical Laboratory***     The standard of practice in the cytopathology and histopathologylaboratories is defined by the visual examination and analysisof cells and tissues. Cancer, in one of its many forms, is thedisease most often considered and evaluated in laboratories.Samples being examined are typically tissue biopsies or Papsmears. The collection and preparation of these samples havebeen resistant to the general wave of automation because theyhave required human observation and analysis under a microscope.The observer is required to identify and interpret what areoften very subtle changes within human tissues. These are oftenvery complex, time consuming, tedious and exacting tasks. Thepractices of cytopathology and histopathology remain largelymanual and labor intensive.     Previously, the complex biologic structural, or morphologicchanges exhibited by cancer were considered too subtle foridentification and interpretation by computer or other automatedapparatus. The conventional wisdom was that cell and tissuediagnosis is an intrinsically qualitative process that requiressubjective visual judgment. However, as the science of imageprocessing and analysis has matured, it has become increasinglyaccepted that these “subjective” signals can beredefined in terms of mathematical algorithms. These algorithms,in turn, provide the basis for computerization and an automatedsolution.     As the last frontier for automation in*‘in vitro’*diagnostics, the cytopathologyand histopathology laboratories present a major opportunity. Webelieve that increased automation of these laboratories throughcomputerized image analysis will: •     significantly reduce labor costs;
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 •     drive improved standardization, reproducibility and quality    control;  •     enhance the efficiency of treatment by increasing the accuracy    and precision of diagnosis; and,  •     provide an opportunity to collect digitized information to    facilitate the development of highly specific and targeted    outcome patient care programs.     Automated slide preparation and screening products wereintroduced into the cervical cancer screening market in themid-1990s. We expect to benefit from the increased awareness andgrowing acceptance of these new technologies.***Cervical Cytology Product Line***     We currently market our cervical cytology products as part of anintegrated system. Our SurePath, PrepStain and FocalPointsystems, together, provide an integrated solution for samplepreparation, processing, staining and computerized analysis ofliquid based thin-layer slide preparations. We began limitedinternational commercial sales of our PrepStain system in 1993and commenced commercialization in the United Statesfollowing FDA approval in 1999. We began placements of AutoPapQC systems, a predecessor to the current FocalPoint system, in1995 and of the FocalPoint primary screening system in 1998.FocalPoint is the only fully automated Pap smear screeningdevice to receive regulatory approval for marketing in theUnited States for both thin-layer and conventional Papsmear slide preparations.     The principal market for gynecological applications of PrepStainand FocalPoint are clinical laboratories worldwide. Clinicallaboratories are also the primary focus for patients, physiciansand third party payors in connection with screening for cervicalcancer. In an effort to facilitate the adoption of our products,we engaged sales professionals to educate and promote ourproducts to each of these groups. Furthermore, we havecontractual relationships with organizations that providephysician education and third party payor/reimbursement support.We view these relationships as a necessary extension of ourbusiness given their potential to fuel our growth.     The principal market for non-gynecological applications ofPrepStain also includes clinical laboratories worldwide,although these applications are performed in significantly lowerquantities than cervical cancer screening applications.Non-gynecological applications for the detection of cancer areperformed on body fluids, including urine samples, respiratoryspecimens and a variety of fine-needle aspirates of specificorgans.     *Large commercial laboratories.* Pap smear testing hasbecome a concentrated market in the United States. We believethat approximately 50% of cervical cancer test volume isconcentrated among a relatively small number of largelaboratories. We believe the PrepStain’s high throughputand cost-effectiveness and FocalPoint’s ability to showimproved productivity over manual practice will enable us tomarket PrepStain and FocalPoint successfully to thisconcentrated market segment. Moreover, the pressures associatedwith rising health care costs, rising litigation costs, and thelimited supply of qualified cytotechnologists should furtherfacilitate adoption of PrepStain and FocalPoint by the largelaboratory market. We believe that the large clinicallaboratories offer a significant opportunity for our growth in2005 as we have entered into agreements and have establishedgrowing relationships with the four largest commerciallaboratories in the U.S.     In the first quarter of 2003, we entered into an agreement withQuest Diagnostics Incorporated (Quest Diagnostics or Quest) tointroduce our cervical cancer screening products in selectlocations. Quest Diagnostics completed an evaluation process ofthese products in late 2003. Early in the second quarter of2004, on the strength of the outcome of this evaluation, weentered into a new multi-year agreement with Quest Diagnostics.Under this agreement, Quest Diagnostics is adopting the SurePathliquid-based Pap test and the PrepStain system and is evaluatingthe FocalPoint Slide Profiler. During the term of the agreement,we will work together with Quest Diagnostics to expand the useof our products by educating physicians about the benefits ofour technology. We also renewed a multi-year agreement withLaboratory Corporation of America in the latter half of 2003 andentered into a new multi-year agreement with LabOne in mid-year2004. Further, in September of 2004, we initiated an expansionof our sales and marketing activities in the U.S., to leverageour growing relationship with the large commercial laboratoriesand to meet the challenge of
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expanding our cervical cytology business in this highlycompetitive segment while growing and maintaining our businesswithin our traditional customer base. We have reorganized oursales management to ensure accountability and support for alarger field sales organization and to ensure broad geographiccoverage. We completed expansion of our sales management team inthe fourth quarter of 2004 and expect to expand our field salesorganization over 2005. In addition, we expect to make increasedinvestments in marketing and sales related activities in supportof our current cytology products worldwide as well as to beginto prepare the market for the future introduction of ourmolecular oncology products. There can be no assurance that ouragreement with Quest, or other large laboratory customers, willgenerate significant revenue.     *Academic Centers of Excellence.* We expect to maintain andcontinue to build a “franchise” among academic centersof excellence and to continue to add high profile, opinionleaders to our customer list. We believe these relationshipsreflect on the quality of our products. Further, as earlyadopters of new diagnostic technologies, the academic centers ofexcellence will be key targets for the early introduction of ourmolecular diagnostic products.     *Medium and small clinical laboratories.* We also intend tocontinue to devote a portion of our marketing and salesresources to targeting medium-sized and small clinicallaboratories, including, in particular, laboratories that servehospitals and local and regional integrated health care providernetworks. These laboratories are often well integrated into thelocal health care management process and delivery continuum and,therefore, facilitate an integrated sales process that includesthe ordering clinician, the laboratory, and the payor. This isof particular significance to our strategy for commercializingmolecular diagnostic products that will require significantinteraction between the laboratory and the clinician. We expectthat the medium-sized and small clinical laboratory segment ofthe market represents a promising opportunity for our equipmentrental programs.     *Third-party payors.* We have gained a significant level ofmarket acceptance for our products by third-party payors bydevoting additional resources to the area of reimbursement. Weplan to continue promoting the clinical and economic benefits ofPrepStain and FocalPoint systems to managed care companies,major private insurers and other third-party payors. We havedemonstrated that the overall cost savings to the health caresystem, resulting from the early detection of cervical cancerand the decrease in unnecessary repeat Pap smears, biopsies andcolposcopies resulting from improved specimen adequacy, morethan offset the cost of our products. See also “Third-PartyReimbursement” below.**     *****Molecular Diagnostic Products***     The marketing strategy for the molecular diagnostic products weare developing is predicated on several key principles. First,our marker discovery programs are all driven by clinicalspecifications developed from an ongoing analysis of the currentstandards of care for cancer of the cervix, breast, ovary andprostate. From these analyses, we have identified areas ofclinical need and, therefore, market opportunity. Second, ourproduct development strategy comprehends minimal disruption oflaboratory workflow and current practice. We are designing ourproducts to change the clinical practice of medicine, not thelaboratory practice of medicine. Third, we employ a strategy forcommercialization that includes stacking clinical claims inwhich we will initially target defined clinical problems indefined patient populations to create specific and clearlydefined clinical outcomes. Our strategy comprehends the factthat the commercial opportunity associated with our productswill depend on the extent to which they impact decisions madeand actions taken in the course of the early detection andclinical management of cancer, and that the value generated bythese products and the attendant level of reimbursement derivedfrom third-party payors will reflect the extent to which theproducts positively impact patient outcome, both clinical andeconomic. Fourth, we will employ a strategy for earlycommercialization that includes initial introduction of ASRs tobe used in laboratory-developed assays. Fifth, we will leveragethe recognition, relationships, and infrastructure developed tomarket and sell our cervical cytology product line tocommercialize our molecular diagnostic products. In effect, theinfrastructure we have developed for our cervical cytologyproduct line will serve as a conduit for our moleculardiagnostic products.     In September 2004, we entered into a five-year global supplyagreement with Ventana under which Ventana obtained exclusiverights to sell and distribute worldwide a Ventana-brandedversion of our
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interactive histology imaging system that we are developing tobe optimized for both Ventana and TriPath Imaging assays. Theinteractive histology imaging system was developed to offeranatomic pathology laboratories a cost-effective solutionutilizing on-demand digital imaging, direct visualization of IHCstained slides, and real-time quantitative analysis of tissuesamples. We believe that in addition to non-recurring revenuealready recorded, the agreement provides the potential forcapital equipment and fee-per-use revenues in 2005 if wesuccessfully complete the development of the product, if weobtain FDA clearance for processing of Ventana assays on theproduct, additional FDA or other regulatory clearance orapproval if necessary with respect to the assays and imager, ifVentana is successful in placing the product with laboratorycustomers, and if customers migrate the processing of Ventanaassays to the product.***Sales Strategy****Cervical Cytology Product Line*     We record revenue from the sale, rental and/or lease of oursystems and from the sale of related consumables. Additionally,we record revenue from service contracts on our systems.     In the case of system sales to end-users, revenue recognition onsystem sales occurs at the time the instrument is installed andaccepted at the customer site. In the case of instrument salesto distributors, revenue recognition on system sales occursbased upon the contract governing the transaction, typically atthe time the instrument is shipped from our facility. This isthe predominant vehicle for international instrument sales. If,however, we sell an instrument directly to an international enduser, we record the revenue upon installation and acceptance ofthe instrument, consistent with our treatment in the U.S.     For system rentals, systems are placed at the customer’ssite free of charge and the customer is obligated either topurchase reagent kits for a fixed term, or are charged feesbased on monthly minimum, or actual, usage. Under thesetransactions, revenue recognition occurs at the time of shipmentof the reagent kits or on a monthly basis based on the actual orminimum usage. There is no capital equipment revenue recognizedunder these transactions.     We also offer leasing alternatives. Under these transactions, wemay, or may not, recognize revenue on system hardware dependingon the particular details of the lease. We respond to customerneeds by offering both capital and operating lease alternatives.Under the capital lease alternative, revenue is recognizedinitially as an instrument sale with part of the lease paymentsbeing allocated to interest income, and service revenues, ifapplicable, over the lease term. Under operating leases, we donot recognize any revenue related to the instrument sale, butrecognize revenue as rental income over the lease term.     We also generate revenue from the sale and rental of ourSlideWizard line of products and from service contracts on theseproducts. For system sales, customers purchase the productsthrough distributors in countries where such relationshipsexist. Where distributor arrangements do not exist, we sellthese products directly to the customer.*Molecular Diagnostic Reagents and Imaging Systems*     We intend to introduce some of our molecular diagnostic reagentsand imaging systems in 2005. We expect to introduce our ProEx Cand ProEx Br analyte specific reagents (ASRs) (see GovernmentRegulation) to early adopters among academic centers, hospitallaboratories, and independent clinical laboratories in theU.S. through our existing laboratory sales organization. Itis the responsibility of the laboratory that purchases the ASRto develop, validate, and promote the test as well as todemonstrate its clinical efficacy. We also expect to introduceour cervical and breast staging assays, and our molecularcytology imaging system outside the U.S. Our interactivehistology imaging system will be launched by Ventana pursuant toour five-year global supply agreement under which Ventanaobtained exclusive rights to sell and distribute worldwide aVentana-branded version of the system. We believe the agreementprovides the potential for capital equipment and fee-per-userevenues in 2005 should we be successful in gaining 510(k)clearance for processing Ventana’s estrogen andprogesterone assays on the imaging system.
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*Marketing and Sales Organizations*     We currently employ more than 100 full-time marketing andsales personnel worldwide to market, sell and provide post-salesupport of our products, in addition to leveraging distributornetworks in our markets outside the U.S., with the exception ofCanada, where we sell through our own sales and marketingorganization. In addition to expanding our existing cervicalcytology business our intention is to leverage our sales andmarketing capabilities, our strong relationships with keyinfluential leaders in the anatomic pathology laboratory andclinician segments, and our customer base among the academicinstitutions to accelerate the adoption of molecular-basedreagents for laboratory developed assays in 2005.     In the U.S., we have expanded our efforts to market our cervicalcancer screening products through a direct sales organizationfocused both on the physician, primarily OB-GYN and primary carephysicians, and laboratory market segments to optimize awarenessand market penetration of our products. In September of 2004, weinitiated an expansion of our sales and marketing activities inthe U.S., targeted primarily towards our pursuit of additionalbusiness under our agreements with large commerciallaboratories. We have reorganized our sales management to ensureaccountability and support for a larger field sales organizationand to ensure broad geographic coverage. We completed expansionof our sales management team in the fourth quarter of 2004 andexpect to complete expansion of our field sales organization bymid-year of 2005. We also employ field based reimbursementspecialists who call on U.S. managed care organizations andother third-party payors to achieve maximum reimbursement levelsand to further stimulate demand for our products. Where, and if,appropriate, we also seek co-marketing agreements with majorclinical laboratories to leverage their sales capabilities andmore effectively market our products directly to health careproviders.     Outside the U.S., with the exception of Canada where we sell toand service customers through our own sales and serviceorganization, we market and sell our products primarily througha distribution network. To support these efforts, we employeight full-time personnel, consisting of a sales director, and asales, marketing and service staff located in Europe. Weanticipate expanding our international sales and service team in2005 to meet the requirements of our growing internationalbusiness. Our international distribution network is comprised ofboth large distribution organizations with products focused onthe clinical diagnostic market and smaller organizations withproducts focused specifically on the anatomic pathology market.     We participated in a product evaluation in the U.K. related toliquid-based cytology testing for cervical cancer. In October2003 the National Institute for Clinical Excellence(“NICE,” or the “Committee”) in the U.K.issued guidance that recommends the adoption of liquid-basedcytology for cervical cancer screening. The formal guidancerecommends that liquid-based cytology be used as the primarymeans of processing cervical cancer screening samples in Englandand Wales. We have been awarded contracts to supply our SurePathliquid-based Pap test by five regional healthcare providers inthe United Kingdom since NICE approved the conversion toliquid-based cytology for cervical screening. The United KingdomNational Health Service, which plans to convert completely toliquid-based cytology, represents attractive growth potentialfor our products. In June 2004, Cervical Screening Wales (thenational Welsh cervical screening organization) signed afive-year contract to use the SurePath liquid-based Pap testexclusively for its cervical screening program. In September2004, Birmingham Women’s Hospital and Good Hope Hospitalsigned a five-year contract to use the SurePath liquid-based Paptest exclusively for all women in its cervical screeningprogram. Birmingham Women’s Hospital will rollout theSurePath liquid-based Pap test to Primary Care Clinics in theSouth Birmingham Primary Care Trust (PCT) during late 2004and is scheduled to begin processing samples from Good HopeHospital in Spring 2005. In October 2004, Cheshire andMerseyside Strategic Health Authority (Liverpool) signed afive-year contract to use the SurePath liquid-based Pap test forits cervical screening program. In February 2005, Cumbria andLancashire Strategic Health Authority signed a five-yearexclusive contract to use the SurePath liquid-based Pap test forits cervical screening program. Also, in March 2005, the fourstrategic health authorities that comprise North East, Yorkshireand Humber regions of England signed a five-year exclusivecontract to use the SurePath liquid-based Pap test for itscervical screening program.     We offer post-sale support services, including customertraining, product installation, telephone technical support andrepair service directly to customers in the United States andCanada. Our support personnel are
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located both at our headquarters and in select majormetropolitan areas. Otherwise, internationally, we provide theseservices through our employees and distributor organizations.**Manufacturing*****SurePath and PrepStain***     We currently assemble, test and package components of PrepStain,and its accessory, PrepMate at our manufacturing facility inBurlington, North Carolina. We also manufacture our SurePathpreservative fluid and our PrepStain line of reagents and stainsfor PrepStain at the Burlington facility. We believe that ourexisting manufacturing and assembly processes are adequate tomeet the near-term, full-scale production requirements of ourSurePath and PrepStain systems for cervical cancer screening.     The consumable items used with PrepStain are purchased from avariety of third-party vendors, some of which are sole-sourcesuppliers. We completed a multi-year, exclusive contract with aEuropean supplier of manufactured instrument components that areincorporated into our PrepStain product line in December 2004.Those instrument components will now be purchased from aU.S. subsidiary. Service parts will continue to bepurchased from our European supplier. Pricing for components isfixed, but is subject to adjustment based upon changes in rawmaterial costs. We believe that our new supplier has sufficientcapacity to meet our present and future requirements for thesecomponents. We believe our new supplier will allow us to ensureuninterrupted supply of PrepStain component parts.***FocalPoint***     We currently assemble, integrate and test the FocalPointelectronic, mechanical and optical components and modules at ourRedmond, Washington facility. Our operations have producedsufficient FocalPoint systems to meet customer demand since webegan commercial operations in 1996 and we believe we havesufficient capacity to meet anticipated near-term customer needsfor our FocalPoint product.     We purchase all components for the FocalPoint system fromoutside vendors. Several components of the FocalPoint system aresupplied by sole-source vendors. If any of these sole-sourcesuppliers are unable to provide an adequate and constant supplyof components, we will need to modify any components provided byadditional or replacement suppliers. We may be unable to quicklyestablish additional or replacement sources of supply forseveral FocalPoint components. In addition, we may need toobtain regulatory approval to substitute certain components.***SlideWizard Products***     We currently manufacture the majority of our SlideWizard productline at our Burlington, North Carolina facility. We alsomanufacture a limited number of our GS Review Stations andintegrate them into the FocalPoint GS for international sales atour Redmond, Washington facility. We believe we have sufficientcapacity to meet anticipated near-term customer demand for ourSlideWizard product line.     Our SlideWizard products and GS Review Stations consistprimarily of off-the-shelf components and proprietary software.The components are supplied by a variety of vendors, some ofwhich are sole-source suppliers. We have been integrating andselling SlideWizard products since 1993.***Molecular Diagnostics****Reagents*     In 2004, we began in-house and initiated third-partymanufacturing of molecular diagnostic reagents that weredeveloped for commercialization at our TriPath Oncologyfacility. Our molecular diagnostic manufacturing is performed ina dedicated suite built at the Burlington, North Carolinafacility. Molecular reagent products consist of monoclonalantibodies grown and purified in house, diluted, filled, labeledand packaged for their anticipated commercial release in 2005.We believe we have sufficient manufacturing expertise andcapacity to meet anticipated near-term customer demand for ourmolecular diagnostic product line.
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*Molecular Imaging Systems*     In 2004, we began manufacturing our new Interactive HistologyImaging System in Burlington, North Carolina, in support of ourexclusive sales and distribution agreement with Ventana. OurInteractive Histology Imaging System consists primarily ofoff-the-shelf components and proprietary software. Thecomponents are supplied by a variety of vendors, some of whichare sole-source suppliers. We expect to begin manufacture of ourMolecular Cytology Imaging System in our Burlington, NorthCarolina facility in 2005. We believe we have sufficientcapacity to meet anticipated customer demand for our molecularimaging product line.***Lean Manufacturing Strategy***     In 2002, we introduced Lean Manufacturing into our organization.Our Lean Manufacturing strategy incorporates process improvementmethodologies to eliminate non-value adding activities withinthe operations area to reduce costs, improve quality and productdelivery. The Lean Manufacturing process improvement strategyincludes tools such as Value Stream Mapping, One-Piece Flow,Kanban Materials Management and Kaizen implementationmethodology. During 2004, value stream driven Kaizen eventscontinued, at a rate of at least one per month. We believe theseefforts continuously serve to remove waste and inefficienciesfrom our manufacturing processes, resulting in lower costs,improved quality and delivery to our customers.***Our Suppliers***     Several components of our products are supplied by sole-sourcevendors. Subject to any of our exclusive contractualarrangements, we may seek to establish relationships withadditional suppliers for components of our products. If any ofour current or future sole-source suppliers are unable toprovide an adequate and constant supply of components, we willneed to modify any components provided by additional orreplacement suppliers for use in our products. We may be unableto quickly establish additional or replacement sources of supplyfor several of these components. The incorporation of newcomponents, or replacement components from alternative suppliersinto our products may require us to submit PMA supplements to,and obtain further regulatory approvals from, the FDA beforemarketing the products with the new or replacement components.There can be no assurance that we will be able to obtain thenecessary approvals.***Manufacturing Standards***     Our manufacturing process is subject to extensive regulation bythe FDA, including the FDA’s Quality System Regulation(QSR, including Good Manufacturing Practice, or GMP)requirements. As part of the FDA regulatory process, we faceperiodic FDA inspections and other periodic inspections by U.S.and foreign regulatory agencies. See “GovernmentalRegulation.” Both the Burlington, North Carolina andRedmond, Washington facilities are subject to periodic FDAinspections. Failure to comply with the FDA’s QSRrequirements in the future would materially impair our abilityto achieve or maintain commercial-scale production. In addition,if we are unable to maintain full-scale production capability,acceptance by the market of PrepStain, SurePath and FocalPointwould be impaired, which in turn would have a material adverseeffect on our business.     In addition to QSR requirements, we are required to meetrequirements relating to ISO 9001 certification, and Europeanregulatory requirements. A European “CE” certificationis required to successfully sell PrepStain and FocalPoint in theEuropean Economic Area (EEA, the 25 European Union memberstates, plus Norway, Iceland and Liechtenstein) according tocertain European Community (EC) directives. The OEMsupplier of the PrepStain instrument components has ISO 9001certification and has obtained CE certification for the mainPrepStain component. In December 2003, we met the essentialrequirements of the European In Vitro Diagnostic Medical DevicesDirective (IVDD), which will allow us to add the CE Mark to ourcytology products, and we are now in a position to apply the CEmark to the entire PrepStain system. The FocalPoint System iscertified to EN55022:94/ CISPR 22, Class A, EN 50082-192, AS/ NZS2064/ CISPR 11, Class A.
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     We obtained ISO 13485 certification at our Burlington, NorthCarolina facility in 1999. We obtained ISO 13485 certificationat our Redmond facility in July 2003. Compliance audits havebeen routinely conducted at both our Burlington, North Carolinaand Redmond, Washington facilities by certified ISO auditors,most recently in October 2004 in Burlington and January andOctober 2004 in Redmond. We have no outstanding deficienciesrelated to these compliance audits. In addition, the Burlingtonand Redmond manufacturing facilities successfully underwent ISOcertification audits in order to comply with Canadianrequirements, which became effective on January 1, 2003.Under the Canadian requirements, third-party certification ofcompliance with ISO 13485 or 13488 andRegulation SOR/980282, as amended, is required and wasobtained.**Research and Development**     Our research and development programs are currently focused onthree major goals: •     development of molecular diagnostic products for malignant    melanoma and cancer of the cervix, breast, ovary, and prostate,  •     continued improvement of the FocalPoint Imaging System,    PrepStain System and reagents and disposables,  •     development of molecular imaging systems.***Development of Molecular Diagnostic Products***     On July 31, 2001 we entered into a series of agreementswith Becton, Dickinson and Company (BD) to develop andcommercialize molecular diagnostic products for melanoma andcancer of the cervix, breast, ovary and prostate using genomicand proteomic markers identified at Millennium Pharmaceuticals,Inc. (Millennium). The products we are developing incorporategenomic and proteomic markers that were identified throughdiscovery research conducted at Millennium under its researchand development agreement with BD as well as other markers thathave been or may be identified independently of that agreement.In January 2004, the molecular marker discovery process andtransfer of all markers from Millennium was completed. We haveused, and intend to use, these markers and related intellectualproperty to develop and commercialize tests and other productsfor these cancers. We will share commercial responsibilitieswith BD for any products that we ultimately develop utilizingthe markers developed pursuant to our research and developmentagreement with BD.     Five key components of our product development strategy areresponsible for what we believe are the differentiating featuresof our molecular diagnostic products:          1) Our biomarker discovery process was outcome driven. We    identified and validated our molecular biomarkers based upon    predetermined clinical specifications and correlated the    presence of specific molecular biomarkers with a series of    clinical specifications for each of our targeted cancers. These    clinical specifications are based upon unmet clinical needs and    what we perceive to be a significant commercial opportunity.           2) Given the biological and clinical complexity of cancer    it is generally accepted that cancer onset and progression are    driven by multiple gene-related changes. As a result, with the    exception of our RUO reagents for melanoma, each of our    molecular assays incorporates multiple molecular biomarkers.           3) We believe, that if properly selected, a finite number    of molecular biomarkers will yield molecular profiles, or    signatures, that are correlative with clinical phenotype and    patient outcome, thereby, limiting the complexity of testing    technology and information management that is required by the    performing laboratory. With the exception of our RUO reagents    for melanoma, our molecular products incorporate from three to    eight molecular biomarkers per assay.           4) Our assay technologies are being developed in    commercially accepted formats to facilitate rapid laboratory    adoption. For our slide-based assays, we have chosen a standard    IHC or immunocytochemistry (ICC) format with standard    colorometric bright field detection to facilitate the    quantification of
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     molecular markers (proteins) within the context of cellular    morphology. For our blood-based screening assays, we have chosen    an immunoassay format that is capable of detecting and    quantifying multiple secreted proteins in blood. This approach    requires us to generate monoclonal antibodies targeted to each    unique protein that we wish to quantify. We do this by first    translating the unique gene sequences identified by Millennium    under its research and development agreement with BD (as well as    other sequences that have been or may be identified    independently of that agreement) into proteins using a number of    protein expression systems and then develop monoclonal    antibodies specific to each protein through standard hybridoma    technology. After each monoclonal antibody marker is    independently validated using clinical samples with known    patient outcome, a marker panel will be assembled to achieve the    desired assay sensitivity and specificity.           5) We believe that the results obtained with molecular    biomarkers in slide-based assays will be interpreted, at least    initially, in the context of historical standards of practice,    such as morphology. Given that tissue architecture, cell    morphology, and precise sub-cellular localization of molecular    biomarkers will be an important tool for accurate cancer staging    and prognosis, we have adapted our proprietary image analysis    platform to allow analysis and quantification of multiple,    discrete molecular markers within the context of tissue    distribution and cellular location. We also believe that in many    cases clinical outcomes are determined by subtle differences in    gene or protein expression, and that these subtle differences in    gene and protein levels will require advanced imaging capability    for quantification and interpretation.     In November 2004, we announced that data generated from in-houseresearch studies of an early version of our proprietaryformulation of multiple biomarkers derived from our cervicalcancer development program demonstrated a sensitivity of 93%, aspecificity of 92%, a negative predictive value of 97%, and apositive predictive value of 79% for biopsy proven moderate tosevere cervical dysplasia in a retrospective cohort of cervicalsamples. These and other data relating to the performance ofindividual biomarkers and the proprietary formulation combiningmultiple biomarkers were presented at the Annual ScientificMeeting of the American Society of Cytopathology in Chicago,Illinois. For the purpose of these research studies, thebiomarkers were incorporated into a proprietary, reproducible,easy-to-use, research format that utilizes cervical cytologyslides prepared from samples collected with the SurePath testpack. Individual biomarkers and a combination of multiplebiomarkers were evaluated as to their ability to detect biopsyproven cervical dysplasia and cervical cancer as reflected in ahistologic grade of CIN2 or greater (moderate to severedysplasia) in a retrospective cohort of samples. There can be noassurance that any products we develop, when and if approved byapplicable regulatory authorities, will demonstrate results thatare the same as or are similar to the results we obtained in ourin-house studies.     In December 2004, we announced that data generated from in-houseresearch studies of our breast cancer biomarkers demonstrated astrong correlation between biomarker expression and recurrenceof breast cancer in archival breast tissue samples from aretrospective cohort of patients with early stage breast cancer.The results of these in-house research studies were presented atthe Annual San Antonio Breast Cancer Symposium at a Companysponsored symposium held in San Antonio, Texas. For thepurposes of these research studies, five biomarkers wereincorporated into a proprietary, reproducible, easy-to-use,research assay that involves the staining of tissue biopsies onglass microscope slides. Tissue slides prepared from archivalbreast tissue were stained with each of the five biomarkersallowing for evaluation of each biomarker individually and as apanel of biomarkers by evaluating the combined results of two ormore of the tissue section slides. Biomarker staining wasanalyzed using a prototype of our Interactive Histology ImagingSystem. While expression of each individual biomarker correlatedwith cancer recurrence, the strength of correlation wassignificantly improved when the analysis included the combinedresults of two or more biomarkers. The rate of breast cancerrecurrence was directly related to the number of biomarkers thatstained positive. When no biomarkers were positive, the cancerrecurrence rate was less than 20%. However, the recurrence rateincreased to 35% when one biomarker was positive, 65% when twobiomarkers were positive, and nearly 80% with three or morepositive biomarkers. These results were independent of otherknown prognostic indicators such as tumor size or HER-2/neustatus. There can be no assurance that any products
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we develop, when and if approved by applicable regulatoryauthorities, will demonstrate results that are the same as orare similar to the results we obtained in our in-house studies.     Over the past two years we have released several of ourmolecular diagnostic reagents in a RUO format to facilitateexternal research studies by independent investigators. Wereleased RUO reagents for cervical and breast cancer staging in2004. Investigators at the Massachusetts General Hospital, JohnsHopkins Hospital, and the University of Colorado are currentlyevaluating the analytical and clinical performance of our RUOreagents for cervical cancer staging. Investigators at AlbanyMedical College are currently evaluating the clinicalperformance of our RUO reagents for breast cancer staging. Weexpect the results of these research studies will be availablefor review in the latter half of 2005. In data presented in 2004from a study completed in 2003, investigators at Albany MedicalCollege observed that the measurement ofmelastatintmexpression using our melanoma assay provided independentprognostic information that may be useful in determining therisk of disease recurrence and metastasis in patients withprimary thin melanoma lesions. There can be no assurance thatthe results of these research studies will demonstrate theresults that are the same as or are similar to the results weobtained in our in-house studies.***Improvement of FocalPoint Imaging System, PrepStain    System, Reagents and Disposables***     Enhancements to both FocalPoint and PrepStain are specificallydesigned to increase the instruments’ efficiency, ease ofuse, reliability and cost-effectiveness. This also includesinitiatives directed at extending the shelf life of the SurePathand PrepStain lines of reagents and preservatives used with thePrepStain system. We are also continuing to explore alternativeuses for adjunctive testing using our SurePath preservativefluid.***Development of Molecular Imaging Systems***     We are leveraging our extensive intellectual property portfolio,know-how, and experience in image analysis to develop molecularimaging systems that we believe will enhance the performance ofour molecular diagnostic products. Our new interactive histologyimaging system is designed to allow fast, reliable and costeffective quantification of different breast cancer markersapplied to histological sections. Our Molecular Cytology ImagingSystem is being developed to identify abnormal cells on cytologyslide preparations based on their specific reaction withmolecular biomarkers.     There can be no assurance that any product enhancement ordevelopment project that we undertake, either currently or inthe future, will be successfully completed, receive regulatoryapprovals, be successfully commercialized or demonstrate resultsthat are the same as or are similar to our other early studies.The failure of any such enhancement or project to be completed,approved or commercialized could prevent us from successfullycompeting in our targeted markets.     As of December 31, 2004, we had approximately 70 employeesengaged in research and development activities. Our expendituresfor research and development were approximately$7.5 million, $8.9 million and $11.3 million forthe years ended December 31, 2002, 2003 and 2004,respectively. See additional discussion inItem 7 — “Management’s Discussion andAnalysis of Financial Condition and Results of Operations.”**Third-Party Reimbursement*****Cervical Cytology Product Line***     The vast majority of private third-party medical insuranceproviders and governmental agencies offer coverage andreimbursement for laboratory testing associated with routinemedical examinations, including Pap smears as part of a wellnessprogram. In the United States, the level of reimbursement bythose third-party payors for wellness testing, including the Papsmear, can vary considerably. However, on average, since themajority of third party payors benchmark coverage and pricingbased on Medicare coverage and reimbursement determinations,there has been a general increase in reimbursement amounts paidfor cervical cancer screening due to a minimum payment of $14.76established in 2002 by the Center for Medicare and MedicaidServices (CMS) which administers Medicare. In addition tothe minimum established by CMS, subsequent Medicare NationalLimitation Amount (NLA) pricing for these procedures hascreated a positive
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level of increased reimbursement for the newer technologies,including both the PrepStain and the FocalPoint. Successfulcommercialization of PrepStain and FocalPoint for cervicalcancer screening in the United States, and some other countries,will depend on the availability of reimbursement from suchthird-party payors. Because the up-front costs of using ourproducts are typically greater than the cost of the conventionalPap smear, we have worked to convince third-party payors thatthe overall cost savings to the health care system, resultingfrom early detection of cervical cancer and its precursors willmore than offset the cost of our products. The Medicare NLA forthe various procedures that represent the technologies forcervical cancer screening demonstrates the general revenuepotential. As a result of the Medicare Modernization Act of2003, the clinical laboratory fee schedule for 2005 will remainthe same as 2004. Below are the current NLA’s (as ofDecember 2004) for the various CPT codes affecting our business:       **CPT Code** **Description** **NLA**      88164      Cytopathology smears, cervical or vaginal (Bethesda System    reporting); manual screening under physician supervision     $14.76 88147      Cytopathology smears, cervical or vaginal; screening by    automated system under physician supervision     $15.90 88148      Cytopathology smears, cervical or vaginal; screening by    automated system with manual re-screening under physician    supervision     $21.23 88142      Cytopathology, cervical or vaginal (any reporting system),    collected in preservative fluid, automated thin layer    preparation; manual screening under physician supervision     $28.31 88174      Cytopathology, cervical or vaginal (any reporting system),    collected in a preservative fluid, automated thin layer    preparation; with screening by automated system, under physician    supervision     $29.85 88175      Cytopathology, cervical or vaginal (any reporting system),    collected in a preservative fluid, automated thin layer    preparation; with screening by automated system and manual    re-screening, under physician supervision     $37.01     We have focused on obtaining coverage and reimbursement frommajor national and regional managed care organizations andinsurance carriers throughout the United States. We have areimbursement team to work with third-party insurers and managedcare organizations to establish and improve third-partyreimbursement rates for our products. Most third-party payororganizations independently evaluate new diagnostic proceduresby reviewing the published literature and the Medicare coverageand reimbursement policies on the specific diagnosticprocedures. To assist third-party payors in their respectiveevaluations of PrepStain and FocalPoint, we provide scientificand clinical data to support our claims of the safety andefficacy of our products. We focus on improved disease detectionand long-term cost savings benefits in obtaining reimbursementfor PrepStain and FocalPoint for cervical cancer screening.     To date, the manually screened PrepStain thin-layer slidepreparation procedure has achieved near universal coverage fromthird-party payors, as has the FocalPoint primary screeningprocedure for conventionally-prepared slides. During 2004 thecombined procedure of screening PrepStain slides on theFocalPoint has also achieved near universal coverage from thecommercial and managed care insurers. Over the past year,laboratories utilizing the combined PrepStain/ FocalPointapplication have and continue to realize positive coverage andreimbursement from the vast majority of the third party payors.     We expect to continue to realize the positive reimbursement forour technologies we received in 2004 throughout 2005 from thepayor community and will work to continue to demonstratediagnostic and economic value as new performance data isrealized and made available. However, there can be no assurancethat such favorable reimbursement will continue.***Molecular Diagnostic Products and Imaging Systems***     As with our cervical cytology products, we expect that ourmolecular diagnostic reagents and imaging systems will beprimarily purchased by medical institutions and laboratoriesthat bill third-party payers such as government healthcareadministration authorities, private health coverage insurers,managed care organizations and other similar organizations. Ourability to earn sufficient returns on these products will dependin
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part on the extent to which reimbursement for these products andrelated treatments will be available to our customers fromthird-party payers. Generic billing codes and reimbursementschedules exist for slide based immunohistochemistry andimmunocytochemistry tests, including laboratory developed homebrew assays, and these codes reflect incremental reimbursementfor image analysis. All of our slide based molecular diagnosticreagents are being developed in either immunohistochemistry orimmunocytochemistry formats. For our *cervical screeningassay*, it is likely that we will apply for either a new codeor a code based on the Medicare NLA, to reflect the increasedutility of the test. For blood based screening reagents, we willmost likely be required to work with government healthcareadministrative authorities to establish new billing codes andreimbursement schedules. While opportunities exist to enhancethird party reimbursement if the results of future clinicaltrial and peer reviewed published studies support unique andhigh value clinical claims, third-party payers are increasinglyattempting to limit both the coverage and the level ofreimbursement of products to contain costs, and if they aresuccessful, our ability to generate revenue growth andprofitably from our molecular diagnostic products will beadversely affected.**Proprietary Technology and Intellectual Property**     We currently hold over 110 issued or allowed United Statespatents. We have aggressively filed patents to protect theintellectual property generated by TriPath Imaging through workdone in our TriPath Oncology segment for the molecular andimaging programs. We also hold over 70 foreign patents and haveapplied for patent protection for certain aspects of ourtechnology in various foreign countries. Many of our patentswere acquired in the merger of AutoCyte Inc. and NeoPath Inc.and the acquisition of the intellectual property and technologyof Neuromedical Systems, Inc. We further expanded, and areexpanding, our patent portfolio through the acquisition of theintellectual property of Cell Analysis Systems from BD inSeptember 1999 and through our current work undertaken atTriPath Oncology. Our patents cover system components, such asthe disaggregation syringe, the PrepStain process, and variousaspects of our high-speed image-interpretation technology, asapplied to cytopathology and histopathology. Because of thesubstantial length of time and expense required to bring newproducts through development and regulatory approval to themarketplace, we rely on a combination of patents, trade secrets,copyrights and confidentiality agreements to protect ourproprietary technology, rights and know-how. We intend tocontinue to pursue patent protection where it is available andcost-effective, both in the United States as well as in othercountries. Most of our existing United States and foreignpatents will expire between 2012 through 2020. Several of ourforeign patents expired in 2004. There can be no assurance,however, that the claims allowed in any of our existing orfuture patents will provide competitive advantages for ourproducts, or will not be successfully challenged or circumventedby our competitors.     Our molecular oncology program focuses on using new discoveriesin genomics and proteomics research to develop and commercializemolecular diagnostic products to improve the early detection andclinical management of certain types of cancer. We have activeprograms in development seeking to create tests to identifyindividuals with certain types of cancer at the earliestpossible stage of the disease, provide individualized predictiveand prognostic information, guide treatment selection forpatients with cancer, and predict disease recurrence. The coreproducts and services we are developing will be based upongenomic and proteomic markers that were identified throughdiscovery research conducted at Millennium under its researchand development agreement with BD as well as other markers thathave been or may be identified independently of that agreement.We have sublicensed certain of BD’s rights to theproprietary markers. Our approach to marker discovery,identification, and prioritization is based on correlation withpatient outcome and includes the evaluation of markers that havebeen previously identified by others as well as novel markersthat have not been previously associated with our specificproduct indications. As a result, to ensure our freedom toutilize known markers and integrate them into our productcandidates, we will in certain instances be required to licensethem from third parties. We are concurrently pursuingintellectual property protection for the novel markers that wehave identified and the proprietary formulations that we arecreating from the combination of either novel or known markersas well as for molecular imaging systems. However, we cannot besure that we will be able to license markers on acceptableterms, if at all, or establish intellectual property protectionof our novel markers, proprietary formulations or molecularimaging systems. During 2004, we filed provisional patents thatcovered our discoveries, validation, and clinical assay formatdevelopment in our
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cervical screening, breast prognosis and ovarian molecularoncology programs. We cannot be sure that our products ortechnologies do not infringe patents that may be granted in thefuture pursuant to pending patent applications or that ourproducts do not infringe any patents or proprietary rights ofthird parties or that all of our issued patents are valid.     Under current law, patent applications in the United States andin foreign countries are generally maintained in secrecy for aperiod after filing. The right to a patent in the United Statesis attributable to the first to invent, not the first to file apatent application.     We have registered trademarks in the United States forAutoCyte®, AutoCyte Quic®, CytoRich®,ImageTiter®, PAPMAP®, PrepMate®,SlideWizard®, and TriPath Imaging®. We have pendingU.S. trademark applications for*i3*Seriestm,FocalPointtm,PrepStaintm,ProExtm,SureDetecttm,SurePathtm,TriPath CareTechnologiestm,and TriPathOncologytm.Foreign registrations are maintained for several of ourtrademarks in Argentina, Australia, Brazil, Canada, Chile,China, the European Union, Finland, Hong Kong, Indonesia,Israel, Japan, Malaysia, Norway, the Russian Federation, SouthAfrica, Sweden, Switzerland, Taiwan and the United Kingdom. Wehave pending foreign trademark applications forFocalPointtm,*i3*Seriestm,PAPNET®,PrepStaintm,SurePathtm,ProExtmand TriPath CareTechnologiestm.In addition to trademark activity, we include a copyright noticeon all of our documentation and operating software. There can beno assurance that any trademarks or copyrights that we own willprovide competitive advantages for our products or will not bechallenged or circumvented by our competitors.**Competition*****Commercial Operations***     The cervical cancer screening market is comprised of theconventional Pap smear process and certain technologies thathave been introduced in recent years or are currently underdevelopment to provide improvements over the conventional Papsmear process. Our competitors in the development andcommercialization of alternative cervical cancer screeningtechnologies include both publicly traded and privately heldcompanies. Alternative technologies known to us have focused onimprovements in slide sample preparation, the development ofautomated, computerized screening systems and adjunctive testingtechnologies. Nevertheless, some competitors’ products havealready received FDA approval and are being marketed in theUnited States. In addition, one of our competitors has greaterfinancial, marketing, sales, distribution and technicalresources than us, and more experience in research anddevelopment, clinical trials, regulatory matters, customersupport and marketing.     We believe that our products compete on the basis of a number offactors, including slide specimen adequacy, screeningsensitivity, ease of use, efficiency, cost to customers andperformance claims. We believe a fully automated solutionincorporating collection, preparation, staining, andcomputerized imaging for liquid based thin-layer preparations isrequired for sustaining our competitive advantage. While webelieve that our products will have competitive advantages basedon some of these factors, there can be no assurance that ourcompetitors’ products will not have competitive advantagesbased on other factors, including earlier market entry andscale, which may adversely affect market acceptance of ourproducts. Moreover, there can be no assurance that we will beable to compete successfully against current or futurecompetitors or that competition, including the development andcommercialization of new products and technologies, will nothave a material adverse effect on our business. Our productscould be rendered obsolete or uneconomical by technologicaladvances of our current or potential competitors, theintroduction and market acceptance of competing products, or byother alternative approaches for cervical cancer screening.     Our primary competitor in the United States and abroad inthin-layer slide preparation is Cytyc Corporation (Cytyc).Cytyc’s systems, the ThinPrep 2000 and ThinPrep 3000processors, are based on a membrane-filtration separation systemrather than the density gradient and centrifugation approachused in our PrepStain process. The Cytyc ThinPrep systems arepresently the only other thin-layer sample preparation systemsapproved by the FDA as a replacement for the conventional Papsmear. They are also used for non-gynecological applications.Additionally, in Europe and in Latin America, there are a fewsmall thin-layer
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competitors offering a manual method liquid based product.Currently these manufacturers have very little market share andare not actively pursuing FDA approval for their products.Nonetheless, they are creating competitive activity in Franceand in many countries around the world.     We also face several competitors, or potential competitors, inthe imaging field. To date, the FocalPoint system is the onlyFDA-approved device for the automated primary screening ofthin-layer and conventional Pap smear slides. In June 2003,however, Cytyc announced that it had received approval from theFDA for commercialization of its ThinPrep Imaging System, aninteractive computer system that is designed to assistcytotechnologists in the primary screening and diagnosis of itsthin-layer slides. We are currently engaged in litigation withCytyc, as to whether its ThinPrep Imaging System infringescertain of our patents. See Item 3 — “LegalProceedings” below. Other competitors include ChromaVisionMedical Systems, Inc. (ChromaVision), which recently announcedits plans to change its name to Clarient, Inc. and has alsoannounced its intention to reposition itself as a diagnosticservices company, develops, manufactures and markets anautomated cellular imaging system to assist in the detection,diagnosis and treatment of cellular diseases such as cancer, andApplied Imaging Corporation, which develops and marketsautomated genetic testing systems and imaging systems used incancer pathology and research which are capable of sendingdigital images electronically for remote review and consultation.***Molecular Diagnostic Reagents***     Competition in the field of cancer diagnostic products continuesto be concentrated in a few areas and is expected to furtherintensify. Aside from mammography screening for breast cancer,the *in vitro*cancer diagnostics market consistsprimarily of tumor marker immunoassays. The cancer immunoassaymarket encompasses a number of blood-based tumor marker teststhat are utilized extensively to assess therapeutic response andmonitor for disease recurrence but have limited applications forscreening due to their lack of sensitivity and specificity.Currently, prostate specific antigen (PSA) is the onlyblood based tumor marker that is universally utilized for cancerscreening. Among the companies competing in the tumor markerimmunoassay market are Abbott Diagnostics, Bayer Diagnostics,Roche Diagnostics, Ortho Clinical Diagnostics, Beckman-Coulterand Dade-Behring.     We believe that genomic and proteomic-based assays will likelyprovide a more accurate, disease-specific understanding ofcancer to improve the clinical management of cancer. Althoughthere are a number of companies that are investing in genomicand proteomic discovery research, few have invested as broadlyin the cancer diagnostics area as we have through ourrelationship with BD. We view our primary competitors in thisarea to be Abbott Diagnostics, Bayer Diagnostics, and RocheDiagnostics. Abbott Laboratories, through its acquisition ofVysis, Inc., develops and markets clinical laboratory productstargeting DNA chromosomal and genomic abnormalities for cancerand pre- and post-natal genetic disorders. Bayer Diagnostics andRoche Diagnostics operate in the immunoassay and tumor markermarkets.     In addition to immunoassay-based tests, we believe the staging,prognosis and prediction of outcomes will also be heavilyinfluenced by the assessment of special stains utilizing IHC and*in situ*hybridization (ISH) techniques on tissuespecimens. The primary companies currently competing in thisarea are Dako Corporation and Ventana Medical Systems, Inc. Bothcompanies specialize in automated IHC staining instrumentationand offer a wide range of validated IHC tumor markers.     We also have several competitors with competing technology inthe molecular diagnostics field. TriPath Oncology faces a hostof competition from companies such as Roche Diagnostics, AbbottLaboratories, EXACT Sciences Corporation, Correlogics Systems,Inc., Genomic Health, Ciphergen, Celera Diagnostics, and BayerDiagnostics, all of which have announced active programs in thisarea. There can be no assurance that these or other competitorswill not succeed in developing technologies and products thatare more effective, easier to use or less expensive that thosewhich we currently offer or are developing, or that would renderour technology and products obsolete. In addition, these orother competitors may succeed in obtaining FDA and otherregulatory clearances and approvals of their products that weare unable to obtain or more rapidly than we can.
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**Government Regulation**     The design, testing, manufacture, labeling, distribution,advertising, promotion and sale of our medical diagnosticdevices is subject to extensive governmental regulation in theUnited States and in other countries where we sell our products.In addition, our research and development activities in theUnited States are subject to various health and safety,employment and other laws and regulations.***United States FDA Approval***     PrepStain and FocalPoint are regulated for cervical cytologyapplications in the United States as medical devices by the FDAunder the Federal Food, Drug, and Cosmetic Act, or the FDC Act,and require pre-market approval by the FDA prior to commercialdistribution. In addition, certain modifications to the design,performance, manufacturing process or labeling of medicaldevices are subject to FDA review and approval before marketing.FDA may impose conditions of approval or restrictions on thesale, distribution, or use of devices. Pursuant to the FDC Act,the FDA regulates the pre-clinical and clinical testing, design,manufacture, storage, labeling, distribution, record keeping,reporting, sales, marketing, advertising and promotion ofmedical devices in the United States. The FDA also regulates theimport and export of medical devices. Noncompliance withapplicable requirements, including good clinical practicerequirements and QSR requirements, can result in enforcementaction which can include any of the following sanctions: thesuspension or withdrawal of authorization of clinical studies,the refusal of the government to grant pre-market approval orpremarket clearance for devices, suspension or withdrawal ofclearances or approvals, warning letters, operatingrestrictions, total or partial suspension of production,distribution, sales and marketing, customer notification, ordersfor repair, replacement, or refund, fines, injunctions, civilpenalties, recall or seizure of products, and criminalprosecution of a company, its officers and employees.     Medical devices are classified into one of three classes,Class I, II or III, on the basis of the controlsdeemed by the FDA to be necessary to reasonably ensure theirsafety and effectiveness. Class I devices are subject togeneral controls (e.g., establishment registration, labeling,recordkeeping, reporting, and adherence to FDA-mandated qualitysystem requirements, including QSR), and, in some cases,pre-market notification under Section 510(k) of the FDCAct. Class II devices are subject to general controls, inmost cases to pre-market notification under Section 510(k)of the FDC Act, and to special controls (e.g., performancestandards, patient registries and FDA guidelines). Generally,Class III devices are those that must receive pre-marketapproval by the FDA to ensure their safety and effectiveness,including life-sustaining, life-supporting and implantabledevices, and also “new” devices that were not on themarket before May 28, 1976 and for which the FDA has notmade a finding of “substantial equivalence” based on apre-market notification. Class III devices usually requiredata from clinical testing that demonstrates the device is safeand effective, and must have FDA approval of a premarketapproval application, or PMA, under Section 515 of the FDCAct, prior to marketing and distribution. The conduct ofclinical studies is subject to FDA regulations, includingrequirements for institutional review board (or IRB) approval,informed consent, record keeping, and reporting. Clinicalstudies of “significant risk” devices, including manyClass III devices, also require FDA approval of aninvestigational device exemption (IDE) application prior toinitiating clinical trials. Clinical trials are conducted withthe oversight of the IRB at each study site. Our PrepStain andFocalPoint products, when intended for gynecological use, areregulated as Class III medical devices. In the future, someof our molecular diagnostic products may be regulated asClass III devices. In addition, to the extent moleculardiagnostic products may be intended for use as prognostic testsfor selecting subsets of patients most likely to benefit fromdrug therapies, such products may be studied in clinical trialsof drug products under the FDC Act regulatory provisionsgoverning pharmaceutical clinical trials.     FDA has developed special rules for *in vitro*reagents that are not approved or cleared as diagnosticproducts. FDA has imposed restrictions on the manufacture,labeling, sale, distribution, advertising, promotion and use ofAnalyte Specific Reagents (ASRs). FDA defines ASRs asantibodies, specific receptor proteins, ligands, nucleic acidsequences, and similar reagents which, through specific bindingor chemical reaction with substances in a specimen, are intendedfor use in a diagnostic application for identification andquantification of an individual chemical substance or ligand inbiological specimens. In simple terms, an ASR is the activeingredient of an in-house laboratory test and is used, inconjunction with general purpose reagents and general
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purpose instruments, by a laboratory that must be certified ashigh complexity under the Clinical Laboratory Improvement Act of1998 as amended (CLIA) and has developed and performs anin-house (“home brew”) test or laboratory testingservice. The in-house assay is used to test patient specimensonly by the clinical laboratory that developed and validated thetest for its own in-house use. It is the responsibility of thelaboratory using the ASR to develop the test procedures and totake responsibility for establishing and maintainingperformance. Most ASRs are exempt from premarket notificationunder Section 510(k) of the FDC Act, but they are subjectto GMP requirements and the restrictions on sale, distributionand use imposed by FDA regulation. ASRs intended for use inblood banking tests are not exempt from premarket notification.In addition, some ASRs are subject to premarket approval(PMA) requirements, including ASRs used in diagnosing acontagious condition that could be fatal (such as HIV) or inblood donor screening. In addition, FDA regulates Research UseOnly (RUO) products, which by their required labeling arenot intended for use in diagnostic procedures. The clinicalapplication of these RUO products is unknown andcommercialization is limited to research purposes only. Productsand reagents that we develop now and in the future may besubject to these and other applicable FDA regulations.     Device manufacturers are required to register theirestablishments and list their devices with the FDA. For deviceswith an approved PMA, the manufacturer must submit periodicreports containing information on safety and effectiveness andother information specified in FDA regulations. The FDC Actrequires that medical devices be manufactured in accordance withthe FDA’s QSR requirements. PrepStain and FocalPoint andany other products that we manufacture or distribute pursuant toan approved PMA application and any supplements, or pursuant to510(k) clearances, or as ASRs, are and will be subject topervasive and continuing regulation by the FDA, includingrecord-keeping and reporting requirements. We have establishedand maintain a system for tracking FocalPoint and PrepStainsystems through the chain of distribution. FDA’s MedicalDevice Reporting regulations require medical device companies toprovide information to the FDA whenever evidence reasonablysuggests that a device may have caused or contributed to a deathor serious injury. These regulations also apply if the devicemalfunctions and the device or a similar device sold by thecompany would be likely to cause or contribute to a death orserious injury if the malfunction were to recur. We are alsorequired to report to the FDA about corrections to our deviceproducts and about any market removals.     Product labeling and promotional activities are also subject toscrutiny by the FDA. Product advertising and promotionalactivities are also subject to regulation by the Federal TradeCommission. We, and our distributors, may only promote productsfor their approved indications. In this regard, violations ofpromotional requirements may, in addition to implicatingviolations of the FDC Act, also involve violations of the FalseClaims Act, the Medicare and Medicaid “anti-kickback”laws, and other federal or state laws that the government mayutilize to enforce these and related requirements. In additionto the government bringing claims under the Federal False ClaimsAct, *qui tam*, or “whistleblower,” actions maybe brought by private individuals on behalf of the government.Also, competitors may bring litigation under the Lanham Actrelating to product advertising. If the FDA requires us to makemodifications to our product labeling in the future, thesechanges may adversely affect our ability to market or sellPrepStain, FocalPoint or any of our other products.     We are subject to both routine and directed inspections by theFDA for compliance with regulations with respect to designcontrol activities, manufacturing, testing, distribution,storage, product labeling, recordkeeping, reporting, sales,advertising and promotional activities. We have beenperiodically inspected by the FDA at both our Burlington, NorthCarolina and Redmond, Washington facilities. In 2004, weunderwent a routine inspection at our Burlington facility toconclude the move of PrepMate manufacturing from Redmond toBurlington in addition to GMP compliance. In 2003 we underwentroutine inspections at both our Redmond and Burlingtonfacilities, while in 2002, we were inspected at our Burlingtonfacility with respect to our advertising and promotionalactivities, our manufacturing activities relative to acontemplated move of PrepMate manufacture from our Redmond toour Burlington facility and other aspects of our manufacturingoperations. All of these inspections were concluded in 2004without material adverse results.
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     If the FDA believes that we have not complied with the law, itcan take one or more of the following actions: •     refuse to review or clear applications to market our products in    the United States;  •     refuse to allow us to enter into government supply contracts;  •     withdraw approvals already granted;  •     require that we notify users regarding newly found risks;  •     request repair, refund or replacement of faulty devices;  •     request corrective advertisements, recalls or temporary    marketing suspension;  •     impose administrative civil penalties; and  •     initiate legal proceedings to detain or seize products, enjoin    future violations, or assess civil or criminal penalties against    us, our officers or employees.     These actions could seriously disrupt our operations for anindefinite period of time.     In the future, the Company may seek FDA approval of medicalproducts other than medical diagnostic devices. The regulatoryrequirements for these products are similar in scope to therequirements described above for medical devices, particularlywith respect to the need for, and the degree of FDA oversightof, pre-clinical and clinical testing, pre-market approval,manufacturing, labeling, recordkeeping, promotion, sale andpost-market reporting.***Clinical Laboratory Improvement Act of 1988 and State    Laboratory Laws***     Congress has directed the Department of Health and HumanServices to issue regulations designed to improve the quality ofbiomedical analytic services, particularly the examination ofPap smears. These regulations require clinical laboratories torandomly re-screen at least 10% of the Pap smears classified oninitial manual screen as normal. This 10% must include normalcases selected from the laboratory’s total caseload, andfrom patients or groups of patients that have a high probabilityof developing cervical cancer based on available patientinformation. Laboratories that purchase our PrepStain andFocalPoint products, or our ASR’s, are subject to extensiveregulation under CLIA, which requires laboratories to meetspecified standards in the areas of personnel qualifications,administration, participation in proficiency testing, patienttest management, quality control, quality assurance andinspections. We believe that our PrepStain and FocalPointproducts operate in a manner that will allow laboratories usingour products to comply with CLIA requirements. However, therecan be no assurance that interpretations of current CLIAregulations or future changes in CLIA regulations would not makecompliance by the laboratory difficult or impossible andtherefore have an adverse effect on sales of our products.     In addition, laboratories often must comply with stateregulations, inspection, and licensing. In recent years, a fewstates, including New York and California, have adoptedregulations that limit the number of slides that may be manuallyexamined by a cytotechnologist within a given period of time. Wecannot guarantee that states will not directly regulateFocalPoint in the future, nor can we predict the effect, if any,new regulations may have on our business or operations.***Environmental, Health, Safety and Other Regulations***     We also are subject to numerous federal, state and local lawsrelating to such matters as safe working conditions,manufacturing practices, environmental protection, fire hazardcontrol and disposal of hazardous or potentially hazardoussubstances. Our manufacturing activities involve the use,storage, handling and disposal of hazardous materials andchemicals and, as a result, we are required to comply withregulations and standards of the Occupational Safety and HealthAct and other safety and environmental laws. Although we believethat our activities currently comply with all applicable lawsand regulations, the risk of accidental contamination or injurycannot be completely eliminated. In the event of such anaccident, we could be held
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liable for any damages that result, which could have a materialadverse effect on our business, financial condition and resultsof operations. Further, we can give no assurance that we willnot be required to incur significant costs to comply with suchlaws and regulations in the future, or that such laws orregulations will not have a material adverse effect upon ourbusiness, financial condition and results of operations.***Foreign Regulatory Approval***     Sales of medical devices outside of the United States aresubject to foreign regulatory requirements that vary widely fromcountry to country. The time required to obtain approval by aforeign country may be longer or shorter than that required forFDA approval, and the requirements may differ. No assurance canbe given that such foreign regulatory approvals will be grantedon a timely basis, or at all. We have been advised by variousparties, including consultants we engaged and foreigndistributors, that no regulatory approvals for a deviceanalogous to FDA approval of a PMA are currently required by anycountry where we currently sell PrepStain. Such approvalrequirements may be imposed in the future. In addition toregulatory approvals in the United States, the FocalPoint systemis approved or accepted for primary screening and qualitycontrol re-screening in Japan, Canada, Australia, Germany,Belgium, the United Kingdom, Ireland, Switzerland, Denmark,Italy, Hong Kong, South Korea, and Taiwan. Placements ofFocalPoint are also possible in The Netherlands, France, andmany other countries where cervical screening is performed. InSeptember 2001, we announced receipt of a Medical Device Licensein Canada to market both our PrepStain system and the PrepMateaccessory. We intend to pursue additional product registrationsin other foreign countries. We received an FDA permit to exportPrepStain and FocalPoint to all foreign countries in which weare currently selling these products and where such a permit wasrequired. There can be no assurance that we will meet theFDA’s export requirements or receive additional FDA exportapproval when such approval is necessary, or that countries towhich the devices are to be exported will approve the devicesfor import. Our failure to meet the FDA’s exportrequirements or obtain FDA export approval when required to doso, or to obtain approval for import, could have a materialadverse effect on our business, financial condition and resultsof operations.     Our products are subject to a variety of regulations in Europe,including the EU. *In vitro*medical devices, including ourPrepStain system, FocalPoint Imaging System, moleculardiagnostic reagents, and molecular imaging systems, must nowcomply with the EC’s In-Vitro Diagnostic Medical DevicesDirective also known as IVDD. The IVDD was published in theOfficial Journal of European Communities in December 1998. TheEU member states were required to implement the IVDD intonational law by December 1999. A transition period, which endedDecember 6, 2003, applies to all devices placed on themarket in the EU. By the end of this transition period, ourproducts were required to comply with the requirements of theIVDD and member-state local language requirements. At such time,products not bearing the CE mark would have been prohibited frombeing commercially distributed in EU member countries. Productsbearing the CE mark may circulate freely within the EEA, butmember states may restrict or prohibit the marketing ofCE-marked devices pursuant to the safeguard clause of the IVDDif the member state determines a particular device maycompromise the health and/or safety of patients or users. InDecember 2003, we announced that we satisfied the essentialrequirements of the IVDD, which allows us to add the CE mark toour products including antibody-based diagnostic tests with theappropriate registration.     Other European countries may enact national laws that wouldconform to the IVDD. EU and EEA member states are required toimplement national laws that are consistent with IVDD. However,some European countries have established national regulationsrelating to *in vitro*diagnostic medical devices,including rules governing their supply, advertising, promotion,pricing or reimbursement. EC directives and national laws imposerequirements for electrical safety and electromagneticcompatibility that apply to the PrepStain system, PrepMate, andthe FocalPoint system. We have performed the requisite testingprocedures and related documentation to apply the European CEmark to the FocalPoint, PrepStain and PrepMate systems. Wecannot guarantee that the FocalPoint system or any other productwe may develop will receive any required regulatory clearance orapproval on a timely basis, if at all.     In addition, Canadian regulations have similar, but distinct,requirements as those noted for the EU’s IVDD, which alsobecame effective January 1, 2003. We undertook and achievedcompliance with those requirements.
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**Product Liability**     Commercial use of any of our products may expose us to productliability claims. We currently maintain general liability andproduct liability insurance coverage and believe that the amountof such coverage is adequate to meet our present needs. Themedical device industry has experienced increasing difficulty inobtaining and maintaining reasonable product liability coverage,and substantial increases in insurance premium costs in manycases have rendered coverage economically impractical. To date,we have not experienced difficulty obtaining an amount ofinsurance coverage commensurate with our level of sales. As oursales expand, however, there can be no assurance that ourexisting product liability insurance will be adequate or thatadditional product liability insurance will be available to usat a reasonable cost, or that any product liability claim wouldnot have a material adverse effect on our business, financialcondition and results of operations.**Employees**     As of December 31, 2004, we employed approximately 280people on a full-time basis. We believe that relations with ouremployees are good. None of our employees are party to acollective bargaining agreement.**Item 1A.     *****Executive Officers of the Registrant***     Our current executive officers are as follows:       **Name** **Age** **Position**         Paul R. Sohmer, M.D.   56      President, Chief Executive Officer and Chairman of the Board    Stephen P. Hall  54      Senior Vice-President, Chief Financial Officer    Ray W. Swanson  49      Senior Vice-President, Commercial Operations    Johnny D. Powers, Ph.D.   43      Senior Vice-President and General Manager, TriPath Oncology     *Paul R. Sohmer, M.D.* has served as our Chairman ofthe Board of Directors since November 2000, and as our Presidentand Chief Executive Officer since June 2000. Prior to joiningus, Dr. Sohmer served as the President and Chief ExecutiveOfficer of Neuromedical Systems, Inc., a supplier of cytologyscreening and anatomic pathology diagnostic equipment andservices to laboratories, from 1997 through 1999. From 1996until 1997, Dr. Sohmer served as President of a consultingfirm, which he founded. From 1993 to 1996, he served asPresident and Chief Executive Officer of Genetrix, Inc., agenetic services company based in Scottsdale, Arizona. From 1991through 1993, Dr. Sohmer was the Corporate Vice-Presidentof Professional Services and President of the ProfessionalServices Organization for Nichols Institute, a clinicallaboratory company, where he was responsible for sales,marketing, information systems, logistics, and clinical studies.From 1985 until 1991, Dr. Sohmer served as the Presidentand Chief Executive Officer of Pathology Institute in Berkeley,California, during which time he founded and served as MedicalDirector of the Chiron Reference Laboratory. Dr. Sohmerreceived a B.A. degree from Northwestern University and an M.D.from Chicago Medical School.     *Stephen P. Hall*has served as our Senior Vice-Presidentand Chief Financial Officer since September 2001. Prior tojoining us, Mr. Hall served as Chief Financial Officer andPresident of the Imaging and Power System Division of ColoradoMedtech, Inc., a Colorado-based medical products and servicescompany, from September 1999 until August 2001. From September1993 to January 1999, he served as Chief Financial Officer forBioTechnica International, Inc., a publicly held agriculturalproducts company, as well as privately held operating companiesin the software development, wireless communication equipmentand food processing machinery industries. Mr. Hall spentnine years in the commercial banking industry and four yearswith the accounting firm of Peat, Marwick, Mitchell &Co. He earned a A.B. degree from Harvard College and an MBA fromthe Stanford Graduate School of Business.     *Ray W. Swanson*has served as our Senior Vice-President ofCommercial Operations since May 2001. Prior to joining us, heserved as General Manager of e-Business for Dade-Behring, one ofthe world’s largest
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clinical diagnostics companies. Mr. Swanson held a numberof senior management positions at Dade Behring and itspredecessor companies since 1987. From 1997 to 1999, he was thegeneral manager responsible for the introduction and marketdevelopment of Dade-Behring’s platelet function business.As President of Dade-Behring’s Japanese subsidiary from1994 to 1997, he was a member of the management team thatpurchased Baxter International’s diagnostics businesses andcreated Dade International as a privately held, stand-alonecompany. Prior to 1987, he held positions with Johnson andJohnson, American Hospital Supply Corporation, Solvay (a globalchemical and pharmaceutical company) and Washington UniversitySchool of Medicine’s Department of Anatomy andNeurobiology. Mr. Swanson has B.S. and M.S. degrees inzoology from Eastern Illinois University and an MBA from theUniversity of Iowa.     *Johnny D. Powers, Ph.D.* is our Senior Vice-Presidentand General Manager of TriPath Oncology. He previously served asVice-President and General Manager of TriPath Oncology sinceJuly 2002. From November 2001 to June 2002, Dr. Powersserved as our Vice-President of Manufacturing Operations andProduct Development in our Commercial Operations segment. Priorto joining us, he held a number of senior management positionsat Ventana Medical Systems, Inc., most recently serving asVice-President and General Manager of Manufacturing Operations.Prior positions held at Ventana include Vice-President andGeneral Manager of Worldwide Strategic Marketing andVice-President of the Molecular Diagnostics Business Unit. Priorto 1996, Dr. Powers held various management positions atOrganon Teknika Corporation, including Director ofBioManufacturing and Manufacturing Technologies. Dr. Powersearned a B.S. degree in Chemistry from Wake Forest University, aM.S. degree in Chemical Engineering from Clemson University, aPh.D. in BioChemical Engineering from North Carolina StateUniversity and an MBA from Duke University.**Item 2.*****Properties***     We currently lease a total of 43,000 square feet of spacedevoted primarily to our Commercial Operations manufacturing,warehousing, administrative, research and development andengineering functions at 780 Plantation Drive, Burlington, NorthCarolina under a seven-year lease expiring in August 2005. In2004 we negotiated a long-term lease extension inclusive of theaddition of approximately 26,000 square feet to ourPlantation Drive facility. At the expiration of the currentlease in August 2005, the new lease extends through December2018. We also currently lease approximately 10,000 squarefeet to serve as educational and corporate office space at 1111Huffman Mill Road in Burlington, North Carolina under athree-year lease which expired in November 2004 and which wasextended on a month-by-month basis until our new addition iscomplete at Plantation Drive. When we complete the phase-in ofour new addition, with occupancy assumed between August andDecember 2005, we will incorporate the Huffman Mill Roadpersonnel and training space into our Plantation Drive facility.In 2003, we renegotiated our Redmond, Washington lease in orderto reduce office and manufacturing space leased. At the end of2004 an additional lease obligation for 30,000 square feetexpired and was not renewed. We now lease approximately20,000 square feet of office and manufacturing space inRedmond, Washington under an operating lease. That operatinglease expires in December 2007. We also lease approximately4,000 square feet of office space in Brussels, Belgium,under an operating lease expiring in January 2013. We leaseapproximately 22,000 square feet near Research TrianglePark, in Durham, North Carolina devoted primarily to theactivities of TriPath Oncology. This lease has a seven-year termexpiring in June 2009. We believe that our facilities and otheravailable office space will be adequate for our current andfuture planned needs.**Item 3.*****Legal Proceedings***     We compete with Cytyc Corporation (Cytyc) with respect to thesale of our FocalPoint and Cytyc’s sale of its ThinPrepImaging System. We believe Cytyc’s ThinPrep Imaging Systeminfringes our patents and, on June 16, 2003, we filed alawsuit in the United States District Court for the MiddleDistrict of North Carolina seeking damages and injunctive reliefto stop such infringement.     On January 5, 2004, the district court in Massachusettsentered an order consolidating this lawsuit into a single actionwith a lawsuit that Cytyc had filed in Massachusetts. OnApril 30, 2004, the district court granted us leave toamend our complaint and answer in the consolidated action toassert infringement against Cytyc’s ThinPrep Imaging Systemunder two additional patents. The fact discovery period has nowbeen completed.
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The expert discovery period runs through April 29, 2005.The court has set a scheduling conference for May 5, 2005.At present the court has not scheduled a Markman hearing to hearargument on the patent claim construction issues. We anticipatethat a trial will be scheduled sometime in 2006 based on thecurrent case schedule. We are unable to predict the ultimateoutcome. Similarly, we are unable to predict the potentialeffect on our business and results of operations that anyoutcome may ultimately have.     The case number for the action transferred from North Carolinato Massachusetts is 1:03-CV-12630-DPW and the case number forthe consolidated Massachusetts action is 1:03-CV-11142-DPW. Thecase numbers are for reference only and the correspondingpleadings are expressly not incorporated into this document byreference.**Item 4.*****Submission of Matters to a Vote of Security Holders***     There were no matters submitted to a vote of our securityholders during the fourth quarter of the fiscal year endedDecember 31, 2004.**PART II****Item 5.*****Market for Registrant’s Common Equity, Related    Stockholder Matters and Issuer Purchases of Equity    Securities***     Our common stock, $0.01 par value per share, is traded onthe Nasdaq National Market under the symbol “TPTH”.The following table sets forth, for the calendar periodsindicated, the range of high and low bid and ask prices for ourcommon stock on the Nasdaq National Market. These prices do notinclude retail mark-up, mark-down or commissions and may notrepresent actual transactions.           **High** **Low**     **Year ended December 31, 2003:**            First Quarter $4.49  $2.15     Second Quarter $7.70  $3.47     Third Quarter $9.69  $5.71     Fourth Quarter $10.00  $7.30 **Year ended December 31, 2004:**            First Quarter $10.95  $7.70     Second Quarter $10.45  $8.36     Third Quarter $9.49  $7.00     Fourth Quarter $9.52  $6.19      On March 29, 2005, the last reported sales price of theCommon Stock on the Nasdaq National Market was $6.95 pershare. As of March 29, 2005, there were38,163,770 shares of our Common Stock outstanding, whichwere held by 346 Common Stockholders of record.**Dividend Policy**     We have never declared or paid cash dividends on our capitalstock. We currently intend to retain our future earnings, ifany, for use in our business and therefore do not anticipatepaying cash dividends in the foreseeable future. Payment offuture dividends, if any, will be at the discretion of our Boardof Directors after taking into account various factors,including our financial condition, operating results, currentand anticipated cash needs and plans for expansion.
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**Item 6.*****Selected Financial Data***     The selected consolidated financial data presented below shouldbe read in conjunction with Item 7. —“Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and our consolidatedfinancial statements and related notes thereto includedelsewhere in this Form 10-K.                        **Year Ended December 31,**     **2000** **2001** **2002** **2003** **2004**             **(In thousands, except per share data)****Statement of Operations Data:**                        Revenues $32,652  $27,017  $37,485  $53,764  $68,504     Gross profit  16,529   13,921   22,563   35,387   47,274     Research and development(1)  9,629   7,828   10,259   14,295   15,162     Selling, general and administrative  23,867   28,777   30,786   30,011   31,778     Operating income/(loss)  (16,967)  (22,684)  (18,482)  (8,919)  334     Net income/(loss) $(17,369) $(21,680) $(18,064) $(8,538) $605                     Earnings/(loss) per share(2)                         Basic $(0.60) $(0.61) $(0.48) $(0.23) $0.02      Diluted $(0.60) $(0.61) $(0.48) $(0.23) $0.02     Weighted-average shares outstanding                         Basic  29,137   35,467   37,438   37,626   38,006      Diluted  29,137   35,467   37,438   37,626   39,151                        **December 31,**     **2000** **2001** **2002** **2003** **2004**             **(In thousands)****Balance Sheet Data:**                        Cash, cash equivalents, and short-term investments $54,340  $55,976  $32,571  $20,954  $18,949     Working capital  62,316   62,898   38,837   33,446   35,909     Total assets  97,471   96,748   73,951   65,928   67,534     Long-term obligations  3,760   5,001   220   8   —     Total stockholders’ equity $80,774  $77,291  $59,177  $52,371  $58,546  (1)     Includes regulatory expenses. (2)     See Note 2 of Notes to our consolidated financial    statements for information concerning the computation of    earnings/(loss) per share and shares used in computing    earnings/(loss) per share.**Item 7.     *****Management’s Discussion and Analysis of Financial    Condition and Results of Operations***     The following discussion of our financial condition and resultsof operations should be read in conjunction with theConsolidated Financial Statements and Notes thereto includedelsewhere in this Form 10-K.     The discussion included in this section contains forward-lookingstatements based on current expectations of our management.Generally, those forward-looking statements use words like“expect,” “believe,” “continue,”“anticipate,” “estimate,” “may,”“will,” “could,” “opportunity,”“future,” “project,” and similarexpressions. Such statements are subject to risks anduncertainties that could cause actual results to differ fromthose projected. The forward-looking statements includeprimarily those made in the section entitled “Outlook”below, as well as statements about our projected timetables forthe pre-clinical and clinical development of, regulatorysubmissions and approvals for, market introduction andcommercialization of our products and services; our expectedfuture revenues, operations and expenditures; and our projectedcash needs and the future of the markets in which we participate.
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     Statements that are not historical facts are based on ourcurrent expectations, beliefs, assumptions, estimates, forecastsand projections for our business and the industry and markets inwhich we compete. These forward-looking statements are notguarantees of future performance and involve certain risks,uncertainties and assumptions that are difficult to predict.Therefore, actual outcomes and results may differ materiallyfrom what is expressed in such forward-looking statements. Wecaution investors not to place undue reliance on theforward-looking statements contained in this report, which speakonly as the date hereof. We undertake no obligation to updatethese statements to reflect events or circumstances occurringafter the date of this report or to reflect the occurrence ofunanticipated events, except as required by law.     Certain factors, among others, that could cause our actualresults to differ materially from what is expressed in thoseforward looking statements include the following: we may beunable to successfully develop and commercialize the diagnosticoncology products and services being developed by TriPathOncology; our products may not receive regulatory, pricing orreimbursement approval when we expect, if at all; our productsmay not be accepted by the market to the extent we expect; wemay be unable to establish and maintain licenses, strategiccollaborations and distribution arrangements; we may lack thefinancial resources necessary to further develop our marketingand sales capabilities domestically and internationally or toexpand our manufacturing capability; we may be unable to complywith the extensive domestic and international governmentalregulatory, pricing or reimbursement approval and reviewprocedures to which the manufacture and sale of our products aresubject, or lack the financial resources to bear the expenseassociated with such compliance; we may be unable to obtain andmaintain adequate patent and other proprietary rights protectionof our products and services; competition and technologicalchange may make our products or potential products andtechnologies less attractive or obsolete; we may incur greaterexpenses than we expect with our clinical trials or they maytake longer to complete than we expect; our promotionaldiscounts, sales and marketing programs and strategies may nothave their expected effect. These factors and others arediscussed in more detail in Exhibit 99.1 “FactorsAffecting Future Operating Results” to this Form 10-K,which is incorporated into this item by this reference.**Overview**     We create solutions that redefine the early detection andclinical management of cancer. Specifically, we develop,manufacture, market, and sell proprietary products for cancerdetection, diagnosis, staging, and treatment selection. We areusing our proprietary technologies and expertise to create anarray of products designed to improve the clinical management ofcancer. We have developed and marketed an integrated solutionfor cervical cancer screening and other products that deliverimage management, data handling, and prognostic tools for celldiagnosis, cytopathology and histopathology. We have created newopportunities and applications for our proprietary technology byapplying recent advances in genomics, biology, and informaticsto our efforts to develop new molecular diagnostic products formalignant melanoma and cancers of the cervix, breast, ovary, andprostate.     We are organized into two operating units: (1) CommercialOperations, through which we manage the market introduction,sales, service, manufacturing and ongoing development of ourcurrent products; and (2) TriPath Oncology, ourwholly-owned subsidiary through which we manage the developmentand market introduction of molecular diagnostic products forcancer.     Our Commercial Operations unit is a commercial engine organizedto grow sales, drive margin and generate cash. TriPath Oncologyis the development engine of a broad based gene discoveryprogram created to develop new molecular products for the earlydetection and clinical management of cancer. Our revenues areprimarily generated today through our Commercial Operations unitfrom the sale of our cervical cytology screening products, inparticular, the SurePath liquid-based Pap test. Although theproducts that we are developing in TriPath Oncology did notmaterially impact revenues in 2004, we do expect to generaterevenues from some of these reagents and instruments in 2005 andcontinue to believe that sales related to products developed byTriPath Oncology may significantly impact our growth in 2006 andbeyond.     2004 was the first profitable year in our history, with earningsper share of $0.02, reflecting a $9.1 million improvementin net income from 2003. We grew our revenues by 27%, primarilyas a result of a 35% increase
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in revenues generated from the worldwide sales of SurePathreagents and disposables. Gross profit grew nearly 34% as wemaintained a gross margin on incremental revenues in excess of80%. Our commercial operations segment generated operatingincome in excess of $14.7 million, an $11.1 millionincrease from 2003. We reported our first three profitablequarters, our first two cash flow positive quarters and, giventhat we were cash flow positive for the entire second half of2004, a nearly 83% reduction in our net decrease in cash andcash equivalents for the year as compared to 2003. All of theseresults were driven by our continued revenue growth andaggressive management of our manufacturing and operatingexpenses and are further reflected in the fact that we generatedincremental operating income as a percent of incrementalrevenues of nearly 63%.     As striking as these financial results may be, our mostsignificant accomplishments in 2004 were more likely those thatcontributed to the development of pathways for growth in 2005and beyond: 1) We finalized agreements with QuestDiagnostics and LabOne and began to penetrate the largecommercial laboratory segment in the U.S., a market segment towhich we had only limited access in the past; 2) Weinitiated expansion of our U.S. sales force late in thethird quarter of 2004 to leverage the opportunity for growththat has been created by our growing relationships with thelarge commercial laboratories; 3) We continued to gainmomentum outside the U.S. as revenues generated frominternational sales grew 32% and we signed new contracts in theU.K. and, more recently, in Canada among others; 4) Wereceived FDA approval for expanded claims for our SurePathliquid based Pap test to include the use of the spatula andbrush combination as an alternative to the cervical broom deviceand, in early 2005, for processing of precoated slides with thePrepStain Slide Processor; 5) We made several newsubmissions to the FDA, including a PMA supplement applicationfor the FocalPoint GS Imaging System and a 510(k) filing forprocessing of the Ventana estrogen and progesterone receptortests on our interactive histology imager; 6) We releasedResearch Use Only (RUO) kits for microscopic slide basedstaging of cancer of the cervix and breast to independentinvestigators who will generate data from external researchstudies of these research kits; 7) We reported the resultsof in-house research studies of both our cervical and breaststaging biomarkers, and; 8) We entered into a worldwideagreement with Ventana to sell and distribute a Ventana brandedversion of our interactive histology imager whose developmentwas driven by our molecular diagnostic products developmentprograms. While the impact of these accomplishments on revenuesgenerated in 2004 was limited, except for international sales ofour cytology products, we expect each will impact our results inthe future and are contemplated in our forecasted revenues of$90.0 to $94.0 million in 2005 (see Outlook below).***Challenges***     Our primary challenges in 2005 relate to leveraging the pathwaysfor growth that we created in 2004.     We have made significant progress in penetrating the cervicalcytology marketplace with our SurePath liquid-based Pap testover the past five years. We believe that there is additionalground to be gained despite the fact that we continue to facesignificant competitive pressure. Our growing relationship withthe large commercial laboratory segment, as reflected in our newagreements with Quest and LabOne, presents a significant growthopportunity in 2005. Our success in 2005 will in large partdepend on our ability to accelerate conversion of these andother large commercial laboratory customers. As we transitionthe focus of our sales and marketing efforts to our largecommercial laboratory customers, however, we face the challengeof expanding our cervical cytology business in a heavilycontested market segment while maintaining and growing ourbusiness within our traditional customer base. We will need tosucceed at both if we are to achieve the revenues we haveforecasted for 2005 (see Outlook below).     As we complete the expansion of our domestic sales force that weinitiated in the third quarter of 2004, we will face thechallenge of ensuring the earliest possible return on thisincreased investment in sales and marketing by accelerating ourgrowth in revenues generated from increased sales to our largecommercial laboratories as well as to our traditional customerbase. Typically, a sales representative achieves optimal salesproductivity in approximately six months from date of hire. We,therefore, expect most of the impact of the expanded sales forceto be reflected in the second half of 2005. However, the extentto which we can reduce the learning curve and accelerateintegration of our expanded sales organization will impact onour results earlier in the year and make it more likely that wewill achieve or exceed our revenue forecast for 2005 (see
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Outlook below). The expanded sales organization also presentsnew challenges for our sales management, given our increasedsize and expanded geographic coverage.     Given the accelerated traction we gained outside theU.S. in 2004, we expect that our sales outside theU.S. will contribute significantly to our growth in 2005.The primary challenges presented outside the U.S. includegovernmental decisions regarding licensing and reimbursement,and regional variations in practices and product acceptance. Inaddition, since we sell predominantly through regionaldistributors in all markets outside the U.S. except forCanada, we face the challenges associated with managing theseindependent sales distributors in most international markets andour success, to a large extent, is dictated by the performanceof the regional distributor. In Canada, where we sell throughour own sales force, our greatest challenge in 2005 relates toour ability to translate the success we have enjoyed to date inthe province of Ontario to other population centers.     Successful movement of product offerings through the FDAapproval process is a continuing challenge that we face in 2005.Review of our PMAS Application for the FocalPoint GS ImagingSystem and a 510(k) notification for processing of the Ventanaestrogen and progesterone receptor assays on our interactivehistology imaging system are currently pending. In August 2004,we submitted new clinical data to the FDA in support of asupplemental filing to our Pre-Market Approval for the PrepStainSystem to include approval of testing of cervical cellscollected using the SurePath Test Pack for high-risk humanpapilloma virus (HPV) DNA with the Digene hc2 High-Risk HPVDNATesttm.In February 2005, we announced that we had withdrawn thissubmission. This action was taken after we, through discussionswith the FDA, learned that additional clinical information andanalyses would be required which had not been part of theoriginal protocol accepted by the agency. The decision towithdraw is a procedural step and we are currently indiscussions with the FDA about the additional data orinformation requirements. We intend to advance these discussionsand evaluate the required additional data or information, withthe goal of resubmission of the PMAS at the earliest possibledate. We also expect to submit additional 510(k) notificationsto process other Ventana assays on our interactive histologysystem throughout 2005. FDA approval of each of these productswill significantly impact on our ability to achieve our revenuesforecasted for 2005, although, there can be no assurance that wewill obtain FDA marketing clearance for these product offerings.We also face the challenge of developing clinical trialprotocols that are acceptable to the FDA for our slide basedcervical screening and breast staging molecular diagnosticproducts. The length, size, complexity, cost, and potentialoutcome of these clinical trials will be driven by our abilityto craft and execute a reasonable and well-designed clinicaltrial protocol. Successful development of these clinical trialprotocols will impact on our ability to initiate these trials inthe second half of 2005 as planned and will ultimately impact onrevenues that we expect to generate from the sale of theseproducts in 2006 and beyond.     We face new challenges and risks in 2005 that primarily reflectthe progress we have made in our molecular diagnosticsdevelopment programs to date and the fact that some of theseprograms will now move into the next stages of development. Ourapproach to marker discovery, identification and prioritizationis based on correlation with patient outcome and includes theevaluation of markers that have been previously identified byothers as well as novel markers that have not been previouslyassociated with our specific product indications. As a result,to ensure our freedom to utilize known markers and integratethem into our product candidates, we will in certain instancesbe required to license them from third parties. We are,concurrently, pursuing intellectual property protection for thenovel markers that we have identified as well as the proprietaryformulations that we are creating from the combination of eithernovel or known markers. There can be no assurance that we willbe able to license markers on acceptable terms, if at all, orestablish intellectual property protection for our novel markersand proprietary formulations or molecular imaging systems.     We expect that domestic and international sales of some of ourmolecular reagents and molecular imaging systems will contributeto our revenues for 2005 (see Outlook below). As a result, wewill face the challenge of introducing these as either RUOproducts or ASRs in the U.S. as well as the challengesassociated with the international introduction of product notyet approved for use in the U.S. The success of our slidebased cervical staging product, cervical screening product,breast staging product, and our molecular imaging systems willdepend, to a large extent, on the outcome of our ongoingin-house studies, as well as,
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external research studies that are being generated byindependent investigators. As we collect data from both internaland external research studies we face the challenge of buildingthe clinical case for the value of these developing products,the challenge of positioning ourselves for clinical trials, thechallenge of translating the results of these studies intomarket opportunity, the challenges of securing regulatoryapproval, and the challenge related to preparing the market fora broad introduction of these products in 2006 and beyond. Wealso face the challenges and risks associated with selection ofthe final marker panel for screening for ovarian cancer, foridentifying a high-volume testing platform for blood-basedscreening assays, for continuing clinical studies related to ourmelanoma staging product, and for preparation of our facilitiesand operations for manufacture of the molecular diagnosticproducts that we are developing.     Our sales and distribution agreement with Ventana is of bothshort and long term significance. In the short term, it is anopportunity to penetrate the Anatomic Pathology marketplace withour interactive imager and, as a result, to generate new revenuestreams as the agreement provides for potential capitalequipment and fee per use revenues beginning in 2005. In thelong term, it is an opportunity to ensure placement of ourmolecular imaging system in advance of the commercialintroduction of our slide-based breast staging product alongwith a battery of complementary assays from Ventana. Thechallenges that we will face as a result of this venture,include obtaining FDA clearances for Ventana assays processed onthe product and, if necessary, additional FDA or otherregulatory clearances or approvals with respect to the assaysand imager, and the challenges associated with supportingVentana in its market introduction of the product.     As always, we face the ongoing challenges associated withbalancing our existing cash reserves against the costsassociated with effective research, development, marketing andselling programs.**Results of Operations*****Non-GAAP Financial Measures***     Early in the second quarter of 2004, we entered into amulti-year agreement with Quest. In connection with the newagreement, we issued Quest incentive warrants with respect to anaggregate of 4,000,000 shares of our common stock asfollows: a three-year warrant exercisable immediately for800,000 shares at an exercise price of $9.25 pershare; a three-year warrant exercisable upon achievement of acertain sales-based milestone for 200,000 shares at anexercise price of $10.18 per share; a three-year warrantexercisable upon achievement of a certain sales-based milestonefor 500,000 shares at an exercise price of $10.64 pershare; a four-year warrant exercisable upon achievement of acertain sales-based milestone for 1,000,000 shares at anexercise price of $11.56 per share; and a four-year warrantexercisable upon achievement of a certain sales-based milestonefor 1,500,000 shares at an exercise price of$12.03 per share.     We have recorded the value of the 800,000 currently exercisablewarrants held by Quest as a deferred sales discount and areamortizing this amount as a reduction of revenue over the60-month life of our contract with Quest, because those warrantswere exercisable on the date the contract was executed in May2004. Accordingly, we recorded a non-cash sales discount of$519,000 in 2004. We will continue to record a non-cash salesdiscount of $65,000 per month, attributable to thesewarrants, over the remainder of the 60-month life of ouragreement with Quest. The deferred sales discount was calculatedon the basis of the fair value of the warrants at the date ofgrant, using the Black-Scholes valuation model, consistent withthe provisions of SFAS 123 and 148 (see Note 7 to theCondensed Consolidated Financial Statements) and was accountedfor as an adjustment against revenue, in accordance with theFASB’s Emerging Issues Task Force Release 01-9,*“Accounting for Consideration Given by a Vendor to aCustomer (Including a Reseller of the Vendor’sProducts).”*     When and if it becomes apparent that any of the four tranches ofcurrently unexercisable warrants held by Quest may vest upon theachievement of the applicable sales-based milestone, we willamortize the resulting deferred sales discounts over the relatednumber of tests in the six-month period for which the warrantswere earned. Since the deferred sales discount relating to thesetranches of warrants will be amortized over only six months, ifand when such warrants vest, the quarterly impact upon thefuture quarters in which they are recorded will bedisproportionately large compared to the ongoing quarterlynon-cash sales discount of $195,000 recorded in connection withthe initial currently exercisable warrants.
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     The following tables present pro forma versions of our revenues,gross profit, net income and earnings per share (basic anddiluted) to illustrate our results from operations excluding therecorded non-cash sales discount relating to the warrants heldby Quest. The table presents the most comparable GAAP measure toeach non-GAAP measure, as well as the reconciliation to thecorresponding GAAP measure. Our management believes that thesenon-GAAP financial measures provide a useful measure of ourresults of operations, excluding discounts that are notnecessarily reflective of, or directly attributable to, ouroperations. We believe that these non-GAAP measures will allowinvestors to monitor our ongoing operating results and trends,gain a better understanding of our period-to-period performance,and gain a better understanding of our business and prospectsfor future performance. These non-GAAP results are not inaccordance with, or an alternative for, generally acceptedaccounting principles and may be different from similar non-GAAPmeasures used by other companies.                **Year Ended December 31, 2004**       **Reconciliation: Add**      **Back Non-Cash Sales**    **GAAP** **Discount** **Non-GAAP**         **(In thousands, except per share data)**    Revenues $68,504   $519  $69,023     Gross profit  47,274   519   47,793     Net income  605   519   1,124     Earnings per share:                 Basic $0.02   $519 to revenues  $0.03        used in calculation          Diluted $0.02   $519 to revenues  $0.03        used in calculation     ***Years ended December 31, 2004 and 2003***     The tables below summarize our segment results for the yearsended December 31, 2004 and 2003. Comments made throughoutthis discussion related to our segments refer to the figures inthese tables:                     **Commercial Operations**       **Change vs**    **2004** **2003** **2003** **% Change**           **(In thousands)**    Revenues $67,862  $53,631  $14,231   26.5%    Cost of revenues  21,072   18,361   2,711   14.8%                  Gross profit  46,790   35,270   11,520   32.7%    Operating expenses:                     Research and development  2,005   2,319   (314)  (13.5)%     Regulatory  3,263   4,763   (1,500)  (31.5)%     Sales and marketing  18,126   17,318   808   4.7%     General and administrative  8,652   7,264   1,388   19.1%                32,046   31,664   382   1.2%                   Operating income/(loss) $14,744  $3,606  $11,138   308.9%             
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                     **TriPath Oncology**       **Change vs**    **2004** **2003** **2003** **% Change**           **(In thousands)**    Revenues $642  $133  $509   382.7%    Cost of revenues  158   16   142   887.5%                  Gross profit  484   117   367   313.7%    Operating expenses:                     Research and development  9,275   6,542   2,733   41.8%     Regulatory  619   671   (52)  (7.7)%     Sales and marketing  514   1,006   (492)  (48.9)%     General and administrative  4,486   4,423   63   1.4%                14,894   12,642   2,252   17.8%                   Operating income/(loss) $(14,410) $(12,525) $(1,885)  15.0%             **Revenues**     *Total Revenues.* Total revenues for the year endedDecember 31, 2004 were $68.5 million, a 27.4% increasefrom revenues of $53.8 million for 2003. Compared with2003, this net increase in total revenues was primarily due to(i) an increase in reagent sales of $13.7 million, or35.0%, (ii) a net decrease in instrument sales of $499,000,or 6.6%, (iii) a net increase of $1.1 million in otherrevenues, which consisted primarily of fee-per-use sales,service on system placements, and freight and (iv) anincrease in revenues recorded at TriPath Oncology of $509,000.     *Commercial Operations Revenues.* Revenues for the yearended December 31, 2004 from the Commercial Operationssegment were $67.9 million, a 26.5% increase from revenuesof $53.6 million for 2003. In 2004, reagent sales increased$13.7 million worldwide compared with 2003. Domestic salesof our SurePath and PrepStain reagents increased$10.1 million, or 33.3%, while international salesincreased $3.6 million, or 41.3%. As a percentage of totalrevenues, reagent and disposable sales increased from 72.6% in2003 to 76.9% in 2004. Worldwide we acquired in excess of 80 newSurePath laboratory customers, 37 in the U.S. Net realizedrevenue per test in 2004 decreased domestically 5% from 2003.This resulted from a decline in average price per test that waspredominantly attributable to a shift in our revenue mix as asignificantly larger percentage of revenues resulted from salesto the large commercial laboratory segment in the U.S. Thelarge commercial laboratory segment accounted for 24.1% of allSurePath cervical cytology test kits sold in the U.S. in2004 as compared to 16.1% in 2003. The increase in business fromlarge commercial laboratory customers is a result of our growingrelationships with Quest, LabCorp, AmeriPath and LabOne andincreasing focus of our sales and marketing efforts on the largecommercial laboratory segment. As we shifted our focus to thelarge commercial laboratory segment, we did experience adeceleration in the rate of growth of our traditional and morefully penetrated customer base. Our SurePath Test Pack share ofthe domestic Pap smear testing market in the U.S. wasapproximately 15% at the end of 2004 versus approximately 12% atthe end of 2003.     Sales of instruments decreased $499,000, or 6.6%, during 2004compared to 2003. Worldwide sales of PrepStain instruments forpreparation of thin-layer slides for the SurePath liquid-basedPap test decreased by approximately $1.1 million, or 32.0%,during 2004, including a domestic decrease of $281,000, or32.8%. Revenues related to the sale of PrepStain instrumentsdecreased $824,000, or 31.8%, internationally compared with2003. This decrease occurred most notably in England as asignificant number of instruments were acquired in 2003 by ourdistributor in anticipation of the UK’s adoption ofliquid-based Pap methodology. We placed 76 PrepStain instrumentsin the U.S., 66 under reagent rental agreements, and 46 outsidethe U.S., 2 under reagent rental agreements, during 2004. Thiscompares with 103 PrepStain units placed in the U.S., 87 underreagent rental agreements, and 64 units placed outside theU.S., 2 under reagent rental agreements, in 2003. Worldwidesales of FocalPoint systems increased approximately $507,000during 2004. In the U.S.,
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revenues generated from the sale of FocalPoint systems decreased$917,000 while revenues generated from fee-per-use agreementsincreased $295,000 (revenues generated from fee-per-useagreements are considered Other Revenue). The 2003 FocalPointsystem revenues included non-recurring revenues from a largesale of instruments to Kaiser Permanente. Revenues generatedfrom the sale and rental of FocalPoint systems outside theU.S. increased $1.4 million, primarily due toincreased sales in Europe. In 2004 we placed 11 units netof returns in the U.S., 5 under fee-per-use agreements net ofreturns, and sold 10 units outside the U.S. Thiscompares with 17 units in the U.S., 11 under fee-per-useagreements, and 4 units sold outside the U.S., in 2003. In2003, 27 units were returned in total, of which 25 werefrom U.S. customers, as part of our ongoing efforts torationalize the use of systems originally placed for screeningof conventional Pap smears. Revenues recorded for SlideWizardsystem sales increased $99,000 between 2004 and 2003. We placed13 SlideWizard units in 2004 compared with 8 in 2003.     Other revenues, consisting primarily of fee-per-use sales,service on system placements, and freight increasedapproximately $1.1 million during 2004. FocalPointfee-per-use revenues increased $296,000 in 2004 compared to2003, while service revenues worldwide increased $811,000 over2003. Freight revenues also increased $203,000 from 2003 to2004. Other net decreases were $251,000.     *TriPath Oncology Revenues.* Revenues recorded at TriPathOncology increased $509,000 from $133,000 in 2003 to $642,000 in2004, an increase of 382.7%. This increase is largelyattributable to $500,000 of non-recurring revenues recorded in2004 and resulted primarily from an imaging related feeresulting from the sale of an imaging research system. Althoughthe sale of products that we are developing in TriPath Oncologydid not materially impact revenues in 2004, we do expect togenerate revenues from the sale of some of these reagents andinstruments in 2005 and continue to expect that sales related toproducts developed by TriPath Oncology may significantly impactour growth in 2006.**Gross Margin**     *Total Gross Margin.* Gross margin improved from 65.8% in2003 to 69.0% in 2004. Our Commercial Operations segment isprimarily responsible for the increase in gross margin becauseof continued growth in higher margin reagent and disposablesales and lean-based efficiencies in our manufacturingoperations, which includes tools such as Value Stream Mapping,One-Piece Flow, Kanban Materials Management and Kaizenimplementation methodology. Additionally, TriPath Oncologyrecorded increased gross margin due to a non-recurring imagingrelated fee.     *Commercial Operations Gross Margin.* Gross margin in ourCommercial Operations segment improved from 65.8% in 2003 to68.9% in 2004. Gross margin increased as the result of continuedgrowth in higher margin reagent and disposable sales andlean-based efficiencies in our manufacturing operations, asmentioned above.     *TriPath Oncology Gross Margin.* Gross margin in ourTriPath Oncology segment was 88.0% in 2003 compared with 75.4%in 2004. The gross margin recorded in our TriPath Oncologysegment in 2003 had minimal impact on the overall gross margindue to the relatively small amount of gross profit contribution.The gross margin recorded in 2004 was primarily attributable tonon-recurring revenues and resulted primarily from an imagingrelated fee resulting from the sale of an imaging researchsystem.**Research and Development**     *Total Research and Development.* Research and developmentexpenses include salaries and benefits of scientific andengineering personnel, testing equipment, relevant consultingand professional services, components for prototypes and certainfacility costs. Consolidated research and development expensesfor 2004 were $11.3 million, a 27.3% increase from$8.9 million in 2003. We believe that our research anddevelopment expenses will continue to increase, primarily in ourTriPath Oncology segment as we continue to develop andcommercialize molecular diagnostic products.     *Commercial Operations Research and Development.* OurCommercial Operations segment incurred research and developmentexpenses of $2.3 million and $2.0 million in 2003 and2004, respectively, a decrease
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of 13.5%. Research and development expenditures relating to ourCommercial Operations segment reflect research activity relatedto our cervical cytology product line and the development ofmanufacturing capabilities for new molecular tests that we aredeveloping. As manufacturing operations are managed through ourCommercial Operations segment, cost related to the manufactureof our new molecular tests will be assigned to our CommercialOperations segment. The reduction in Commercial Operationsresearch and development costs was primarily attributable toreduced personnel expenses.     *TriPath Oncology Research and Development.* Our TriPathOncology segment incurred research and development expenses of$6.6 million and $9.3 million for 2003 and 2004,respectively, an increase of 41.8%. These expenditures, reflectthe redirection of imaging research and development activitiesto the development of instrument platforms for our moleculardiagnostic programs and the incremental expenses related to thedevelopment of our molecular diagnostic markers, reagents andassays. The increase in expenses incurred in 2004 versus 2003largely reflects the loss of the amortization of a deferredcredit that we had been recording as an offset to research anddevelopment expense over the 30 months ended January 2004,when this credit expired. Whereas 2003 contained a credit ofnearly $2.5 million offset against research and developmentexpenses, 2004 reflected only $207,000 of this expense credit,resulting in an increase to expenses of $2.3 millionrelated to this item. The balance of the net increase in theseexpenses was related to the acceleration of efforts on ourexisting molecular diagnostic programs.**Regulatory**     *Total Regulatory.* Regulatory expenses include salariesand benefits of regulatory and quality personnel, costs relatedto clinical studies and submissions to the FDA, and relevantconsulting services. Regulatory expenses for the year endedDecember 31, 2004 were $3.9 million, representing a28.6% decrease from approximately $5.4 million in 2003.     *Commercial Operations Regulatory.* Regulatory expenseswere $3.3 million in the Commercial Operations segment in2004, compared with $4.8 million in 2003, a decrease of$1.5 million, or 31.5%. This reduction in regulatoryexpense primarily reflected the winding down of clinical trials,in particular, the FocalPoint GS and HPV related clinical trialsthat were initiated in 2003. In addition, costs were higher in2003 as the result of activities related to the European IVDDcompliance initiatives.     *TriPath Oncology Regulatory.* There were $619,000 ofregulatory expenses incurred by the TriPath Oncology segment in2004 versus $671,000 in 2003. While we experienced this modestdecrease, as efforts to complete several clinical trials in ourCommercial Operations segment were a primary focus, we expectregulatory expenses will likely be higher in 2005 than in 2004as we increase efforts surrounding our cervical assay, andother, clinical trials.**Sales and Marketing**     *Total Sales and Marketing.* Sales and marketing expensesinclude salaries and benefits of sales, marketing, sales supportand service personnel, and their related expenses, as well asnon-personnel-related expenses related to marketing ourproducts. Sales and marketing expenses for 2004 were$18.6 million. This represented a 1.7% increase from$18.3 million in 2003.     *Commercial Operations Sales and Marketing.* Sales andmarketing expenses for 2004 incurred by the CommercialOperations segment were $18.1 million. This represented a4.7% increase from $17.3 million in 2003. Thisyear-over-year increase predominantly reflects the beginning ofour sales force expansion in the third quarter of 2004 and tothe reintroduction of a number of targeted marketing programsduring late 2003 and the first half of 2004.     *TriPath Oncology Sales and Marketing.* Sales and marketingexpenses for 2004 incurred by the TriPath Oncology segment were$514,000. This represented a 48.9% decrease from$1.0 million in 2003 and was largely attributable to aredirection of efforts aimed to support the early stagereorganization and expansion of our sales and marketingactivities targeted primarily towards our pursuit of additionalbusiness under our
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agreements with large commercial laboratories, as well as inanticipation of the potential launch of our future moleculardiagnostic products.**General and Administrative**     *Total General and Administrative.* General andadministrative expenses include salaries and benefits foradministrative personnel, legal and other professional fees andcertain facility costs. General and administrative expenses were$13.1 million in 2004 compared with $11.7 million in2003. This reflects a net increase of approximately$1.4 million, or 12.4%, between 2003 and 2004 and islargely attributable to increases in costs related toprofessional fees, principally litigation and costs incurred tocomply with the requirements of Section 404 and 302 of theSarbanes-Oxley Act of 2002 (which relate to internal controlsover financial reporting and certification of disclosure),corporate insurance, and consulting fees. These increases wereoffset somewhat by lower personnel-related expenses, includinglower incentive compensation expenses, and a lower provision fordoubtful accounts. Professional fees increased by approximately$1.9 million between 2003 and 2004, largely attributable tolitigation costs. We recorded increases in corporate insurancecosts between 2004 and 2003 of approximately $154,000, whileconsulting costs related to Board of Director fees increasedapproximately $126,000. In total, these expenses increased byabout $2.2 million. Personnel-related costs decreased in2004 by approximately $600,000. Additionally, we experienced adecrease in our provision for doubtful accounts of approximately$180,000 from 2003 to 2004. Other net increases and decreaseswere individually, and collectively, insignificant.     *Commercial Operations General and Administrative.* Generaland administrative expenses incurred by the CommercialOperations segment increased $1.4 million, or 19.1% between2003 and 2004, from $7.3 million to $8.7 million. Thisincrease is largely attributable to increases in costs relatedto professional fees, principally litigation and costs incurredto comply with the requirements of Section 404 and 302 ofthe Sarbanes-Oxley Act of 2002, corporate insurance, andconsulting fees as discussed above. Also, as discussed above,these increases were offset somewhat by lower personnel-relatedexpenses and a lower provision for doubtful accounts.     *TriPath Oncology General and Administrative.* General andadministrative expenses incurred by the TriPath Oncology segmentincreased $63,000, or 1.4% between 2003 and 2004, from$4.4 million to $4.5 million. This increase largelyreflected increases in professional fees and costs incurred tocomply with requirements of Section 404 and 302 of theSarbanes-Oxley Act of 2002 and insurance costs offset bydecreases in personnel-related incentive expenses.**Operating Income/(Loss)**     *Total Operating Income/(Loss).* Operating income fromoperations during 2004 was $334,000, a $9.3 millionimprovement compared with an operating loss of $8.9 millionin 2003. The improvement in operating income largely reflectsincremental gross profit on new sales of reagents. Totalincreases in gross profit contributed $11.9 million to thenet improvement in operating income in 2004, compared with 2003.The increase in gross profit was partially offset by an increasein operating expenses of $2.6 million or 5.9%, as describedabove.     *Commercial Operations Operating Income/(Loss).* Operatingincome during 2004 attributable to Commercial Operations was$14.7 million, an $11.1 million, or 308.9%,improvement from operating income of $3.6 million in 2003.The improvement in operating income largely reflects incrementalgross profit on new sales of reagents. Total increases in grossprofit contributed $11.5 million to the net improvement inoperating income in 2004, compared with 2003. The increase ingross profit was partially offset by an increase in operatingexpenses of $382,000, or 1.2%, as described above.     *TriPath Oncology Operating Income/(Loss).* Net operatingloss during 2004 attributable to TriPath Oncology was$14.4 million, a $1.9 million, or 15.0%, largeroperating loss compared with $12.5 million in 2003. Thelarger net operating loss reflects increased operating expensesof $2.3 million, or 17.8%, as described above, offset inpart by modest gross profit, attributable mainly to anon-recurring imaging-related fee of $367,000.
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**Interest Income and Expense**     *Total Interest Income and Expense.* Interest income for2004 was $289,000, a 30.0% decrease from the $413,000 earnedduring 2003, primarily attributable to lower average cash andcash equivalents balances in 2004. The lower average cash andcash equivalent balances reflected our net decrease in cash andcash equivalents balances averaged approximately$167,000 per month during 2004, though we did generatepositive cash flow during both the third and fourth quarters of2004 for the first time in our history. Interest expense for2004 was $18,000 compared to $32,000 during 2003. This decreaseis due to reduced balances outstanding resulting from principalrepayments under our debt facilities.**Net Income/(Loss)**     *Total Net Income/(Loss).* We recorded net income in 2004of $605,000, which compares with a net loss of $8.5 millionin 2003, and improvement of $9.1 million, or 107.1%.Although we recorded net income in 2004, we had consolidatedfederal income tax losses in all periods presented.***Years ended December 31, 2003 and 2002***     The table below summarizes our segment results for the yearsended December 31, 2003 and 2002. Comments made throughoutthis discussion related to our segments refer to the figures inthese tables:                     **Commercial Operations**       **Change vs**    **2003** **2002** **2002** **% Change**           **(In thousands)**    Revenues $53,631  $37,485  $16,146   43.1%    Cost of revenues  18,361   14,922   3,439   23.0%                  Gross profit  35,270   22,563   12,707   56.3%    Operating expenses:                     Research and development  2,319   1,764   555   31.5%     Regulatory  4,763   2,206   2,557   115.9%     Sales and marketing  17,318   18,864   (1,546)  (8.2)%     General and administrative  7,264   6,245   1,019   16.3%                31,664   29,079   2,585   8.9%                   Operating income (loss) $3,606  $(6,516) $10,122   NM               NM-Not meaningful                     **TriPath Oncology**       **Change vs**    **2003** **2002** **2002** **% Change**           **(In thousands)**    Revenues $133  $—  $133         Cost of revenues  16   —   16                       Gross profit  117   —   117         Operating expenses:                     Research and development  6,542   5,770   772   13.4%     Regulatory  671   519   152   29.3%     Sales and marketing  1,006   986   20   2.0%     General and administrative  4,423   4,691   (268)  (5.7)%                12,642   11,966   676   5.6%                   Operating income (loss) $(12,525) $(11,966) $(559)  4.7%             
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**Revenues**     *Total Revenues.* Total revenues for the year endedDecember 31, 2003 were $53.8 million, a 43.4% increasefrom revenues of $37.5 million for 2002. Compared with2002, this net increase in total revenues was primarily due to(i) an increase in reagent sales of $14.3 million, or57.8%, (ii) a net increase in instrument sales of$1.0 million, or 15.9% and (iii) a net increase of$963,000 in other revenues, which consisted primarily offee-per-use sales, service on system placements, sales ofnon-instrument related SlideWizard products, revenues at TriPathOncology and various international consumable products, andfreight.     *Commercial Operations Revenues.* Revenues for the yearended December 31, 2003 from the Commercial Operationssegment were $53.6 million, a 43.1% increase from revenuesof $37.5 million for 2002. In 2003, reagent sales increased$14.3 million worldwide compared with 2002. Domestic salesof our SurePath and PrepStain reagents increased$12.5 million, or 70.0%, while international salesincreased $1.8 million, or 25.7%. As a percentage of totalrevenues, reagent and disposable sales increased from 66.0% in2002 to 72.6% in 2003. Net realized revenue per test in 2003increased 11% from 2002, and we acquired in excess of 80 newSurePath consumable domestic customers during the year.     Sales of instruments increased $1.0 million, or 15.9%,during 2003 compared to 2002. Worldwide sales of PrepStaininstruments for preparation of thin-layer slides for theSurePath liquid based Pap test increased by approximately$1.9 million, or 117.0%, during 2003, including a domesticincrease of $295,000, or 52.6%. Revenues related to PrepStaininstruments increased $1.6 million, or 152.1%,internationally compared with 2002. This increase was seen mostnotably in England, but also in Europe and Asia as ourdistributors ordered more instruments to meet developing demand.We placed 103 PrepStain instruments domestically and 64internationally during 2003. This compares with 76 domesticPrepStain units and 39 international units in 2002. Worldwidesales of FocalPoint systems, net of a partially offsettingincrease of $284,000 in revenue from systems placed under rentalagreements, decreased approximately $322,000 during 2003.Domestically, FocalPoint system revenues increased $626,000,primarily due to the sale of instruments to Kaiser Permanenteearlier in 2003, while internationally these revenues decreased$1.2 million, primarily due to decreased sales in Asia. In2003 we placed 17 domestic units and 4 international units. Thiscompares with 11 domestic units in 2002 and 16 internationalunits in 2002. Revenues recorded for SlideWizard system salesdecreased $505,000 between 2003 and 2002. We placed 8SlideWizard units in 2003 compared with 19 in 2002.     Other revenues, consisting primarily of fee-per-use sales,service on system placements, sales of non-instrument relatedSlideWizard products, various international consumable productsand freight increased approximately $830,000 during 2003, mostlyattributable to FocalPoint fee-per-use revenue, service andfreight. FocalPoint fee-per-use revenues increased $218,000 in2003 compared to 2002, while service revenues worldwideincreased $403,000 over 2002. Freight and royalty revenues alsoincreased $222,000 from 2002 to 2003. We saw a slight decline insales of non-instrument related SlideWizard revenues of$126,000. Other net increases were $113,000.     *TriPath Oncology Revenues.* Revenues recorded at TriPathOncology increased $133,000 from 2002 to 2003. The revenuesrecorded in 2003 were all attributable to services sold.**Gross Margin**     *Total Gross Margin.* Gross margin improved significantlyfrom 60.2% in 2002 to 65.8% in 2003. Gross margin increased asthe result of continued growth in higher margin reagent anddisposable sales, higher product prices to new accounts, thegradual phase out of third-party leasing arrangements which havelower margins, and the introduction of lean-based efficienciesin our manufacturing operations, which includes tools such asValue Stream Mapping, One-Piece Flow, Kanban MaterialsManagement and Kaizen implementation methodology. The totalgross margin was almost entirely attributable to CommercialOperations in 2003 and totally attributable to CommercialOperations in 2002. The gross margin recorded in our TriPathOncology segment in 2003 was 88.0% but had minimal impact on theoverall gross margin due to the relatively small amount of grossprofit contribution. There was no gross profit recorded inTriPath Oncology in 2002.
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**Research and Development**     *Total Research and Development.* Research and developmentexpenses include salaries and benefits of scientific andengineering personnel, testing equipment, relevant consultingand professional services, components for prototypes and certainfacility costs. Consolidated research and development expensesfor 2003 were $8.9 million, a 17.6% increase from$7.5 million in 2002.     *Commercial Operations Research and Development.* OurCommercial Operations segment incurred research and developmentexpenses of $1.7 million and $2.3 million in 2002 and2003, respectively, an increase of 31.5%. These expendituresreflect research activity related to the cervical cytology line(then known as the*i3*Series products line) and development of manufacturingfacilities for new molecular tests that we are developing.     *TriPath Oncology Research and Development.* Our TriPathOncology segment incurred research and development expenses of$5.8 million and $6.6 million for 2002 and 2003,respectively, an increase of 13.4%. These expenditures, reflectthe redirection of all imaging research and developmentactivities to the development of instrument platforms for ourmolecular diagnostic programs and the incremental expensesrelated to the development of our molecular diagnostic markers,reagents and assays. The increase reflects the ramp up ofactivity as marker selection and assay development activitiescontinued for selected cancer targets. The research anddevelopment expenses related to TriPath Oncology for 2003 and2002 include $2.5 million per year of amortization, againstexpense, of a deferred research and development credit arisingout of the accounting from our collaboration with BD. Weaccounted for this transaction in accordance with Statement ofFinancial Accounting Standard No. 68, “Research andDevelopment Arrangements”. We began amortizing the creditin August 2001 and continued the amortization at$207,000 per month against research and developmentexpenses through January 2004.**Regulatory**     *Total Regulatory.* Regulatory expenses include salariesand benefits of regulatory and quality personnel, costs relatedto clinical studies and submissions to the FDA and foreigncounterparts, and relevant consulting services. Regulatoryexpenses for the year ended December 31, 2003 were$5.4 million, representing a 99.4% increase fromapproximately $2.7 million in 2002.     *Commercial Operations Regulatory.* Regulatory expenseswere $4.7 million in the Commercial Operations segment in2003, compared with $2.2 million in 2002. This change wasprimarily attributable to the activities surrounding severalclinical trials, particularly the FocalPoint GS and AlternativeCollection Device (ACD) trials, and to efforts surroundingcompliance with the European IVDD.     *TriPath Oncology Regulatory.* There were $671,000 ofregulatory expenses incurred by the TriPath Oncology segment in2003 versus $519,000 in 2002. This was primarily attributable tothe building of a regulatory function to facilitate theinitiation of the process of seeking regulatory approval andclearance of our cervical and breast staging assays beingdeveloped by TriPath Oncology and the imaging platform to whichthese assays may be linked.**Sales and Marketing**     *Total Sales and Marketing.* Sales and marketing expensesinclude salaries and benefits of sales, marketing, sales supportand service personnel, and their related expenses, as well asnon-personnel-related expenses related to marketing ourproducts. Sales and marketing expenses for the year endedDecember 31, 2003 were $18.3 million. This representeda 7.7% decrease overall from $19.9 million in 2002.     *Commercial Operations Sales and Marketing.* Sales andmarketing expenses for the year ended December 31, 2003incurred by the Commercial Operations segment were$17.3 million. This represented an 8.2% decrease overallfrom $18.9 million in 2002. This year-over-year decreasepredominantly reflects savings that resulted from ourtermination of our agreement with Nelson Professional Sales inmid-2002 after which we employed the majority of the physiciansales representatives engaged under that arrangement. Weexperienced some attrition of the sales force throughout thelatter half of 2002 and the early part of 2003,
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further adding to the overall decrease. By the fourth quarter of2003, however, we had fully staffed the sales force.Additionally, we reorganized the sales force into six divisions,as opposed to three, to better divide the country intomanageable territories enabling us to better control travelcosts.     *TriPath Oncology Sales and Marketing.* Sales and marketingexpenses for the year ended December 31, 2003 incurred bythe TriPath Oncology segment were $1.0 million. Thisrepresented a modest 2.0% increase from $986,000 in 2002.**General and Administrative**     *Total General and Administrative.* General andadministrative expenses include salaries and benefits foradministrative personnel, legal and other professional fees andcertain facility costs. General and administrative expenses were$11.7 million in 2003 compared with $10.9 million in2002. This reflects a net increase of approximately $751,000, or6.9%, between 2002 and 2003 and is largely attributable toincreases in costs related to corporate insurance,personnel-related expenses, and depreciation of assets acquiredin 2002 that were partially offset by reductions in costsrelated to our provision for doubtful accounts and a contingentliability. We recorded increases in corporate insurance costsbetween 2003 and 2002 of approximately $613,000.Personnel-related costs increased in 2003 principally due toincreases in incentive compensation of approximately $306,000,severance of $202,000 and additional costs related to new hires.In total, these expenses increased by about $1.2 million.Additionally, general and administrative expenses were furtherincreased by $374,000 due to depreciation on assets acquired in2002. There were other net increases of $81,000. These increaseswere partially offset by a decrease in our provision fordoubtful accounts of approximately $870,000 from 2002 to 2003and a decrease in expense of $585,000 attributable to amountsrecorded under a contingent liability in 2002 which was settledin January 2003.     *Commercial Operations General and Administrative.* Generaland administrative expenses incurred by the CommercialOperations segment increased $1.1 million, or 16.3% between2002 and 2003, from $6.2 million to $7.3 million. Thisincrease largely reflected increases in costs related tocorporate insurance, personnel-related expenses, professionalfees and depreciation of assets acquired in 2002 that werepartially offset by reductions in costs related to our provisionfor doubtful accounts and a contingent liability. We recordedincreases in corporate insurance costs between 2003 and 2002 ofapproximately $306,000. Personnel-related costs increased in2003 principally due to increases in incentive compensation,severance and additional costs related to new hires. In total,these expenses increased by about $1.0 million.Additionally, general and administrative expenses were furtherincreased by $501,000 due to professional fees and $374,000 dueto depreciation on assets acquired in 2002. There were other netincreases of $295,000. These increases were partially offset bya decrease in our provision for doubtful accounts ofapproximately $870,000 from 2002 to 2003 and a decrease inexpense of $585,000 attributable to amounts recorded under acontingent liability in 2002, which was settled in January 2003.     *TriPath Oncology General and Administrative.* General andadministrative expenses incurred by the TriPath Oncology segmentdecreased $268,000, or 5.7% between 2002 and 2003, from$4.7 million to $4.4 million. This decrease largely,reflected decreases in professional fees and facility costsoffset by increases in personnel-related expenses and insurancecosts. Professional fees decreased by $475,000 and facilitycosts by $209,000 between 2002 and 2003. These decreases wereoffset in part by increases in personnel-related costs of$110,000 and corporate insurance costs of $306,000.**Operating Income/(Loss)**     *Total Operating Income/(Loss).* Operating loss during 2003was $8.9 million, a 51.7% improvement from$18.5 million in 2002. The improvement in operating losslargely reflects incremental gross profit on new sales ofreagents. Total increases in gross profit contributed$12.8 million to the net improvement in operating loss in2003, compared with 2002. The increase in gross profit waspartially offset by an increase in operating expenses of$3.3 million or 7.9%, as described above.     *Commercial Operations Operating Income/(Loss).* Net incomefrom operations during 2003 attributable to CommercialOperations was $3.6 million, a 155.3% improvement from aloss of $6.5 million in 2002.
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The improvement in operating income largely reflects incrementalgross profit on new sales of reagents. Total increases in grossprofit contributed $12.7 million to the net improvement inoperating income in 2003, compared with 2002. The increase ingross margin was partially offset by an increase in operatingexpenses of $2.6 million, or 8.9%, as described above.     *TriPath Oncology Operating Income/(Loss).* Operating lossduring 2003 attributable to TriPath Oncology was$12.5 million, a 4.7% decline from $12.0 million in2002. The increased operating loss largely reflects increasedoperating expenses of $676,000, or 5.6%, as described above,offset in part by modest gross profit attributable to sales ofservices of $117,000.**Interest Income and Expense**     *Interest Income and Expense.* Interest income for 2003 was$413,000, a 57.4% decrease from the $969,000 earned during 2002,primarily attributable to lower average cash balances in 2003and to the continued depressed interest rate environment during2003. The lower average cash, cash equivalent, and short-terminvestment balances reflected our net cash used during 2003which averaged approximately $968,000 monthly, though ouruse of cash rate during the fourth quarter of 2003 averaged$511,000 per month. Interest expense for 2003 was $32,000compared to $551,000 during 2002. This decrease is due toreduced balances outstanding resulting from principal repaymentsunder our debt facilities.**Liquidity and Capital Resources**     Since our formation and until 2004, our expenses havesignificantly exceeded our revenues, resulting in an accumulateddeficit of $232.4 million as of December 31, 2004. Wehave funded our operations primarily through the privateplacement and public sale of equity securities, debt facilitiesand product sales resulting in cumulative net proceeds of$285.1 million as of December 31, 2004. We had cashand cash equivalents of approximately $18.9 million atDecember 31, 2004.     We funded our operations in 2004 from cash and cash equivalentson hand and revenues from both our Commercial Operations andTriPath Oncology segments.     The table below summarizes certain key components of our cashflow and working capital for 2004, 2003 and 2002, as well aschanges between 2004 and 2003 and changes between 2003 and 2002.Comments made throughout this discussion refer to the figures inthis table.                                     **2004 vs. 2003** **2003 vs. 2002**             **2004** **2003** **2002** **$ Change** **% Change** **$ Change** **% Change**                 **(In thousands)**    Cash Flow Type                                Operating $(1,900) $(12,534) $(18,127) $10,634   84.8% $5,593   30.9%    Investing  (1,541)  50   253   (1,591)  NM   (203)  (80.2)%    Financing  1,186   843   (3,050)  343   40.7%  3,893   NM     Cash and cash equivalents $18,949  $20,954  $32,571  $(2,005)  (9.6)% $(11,617)  (35.7)% NM — not meaningful**Operating**     Cash used in our operations was $1.9 million in 2004,$12.5 million during 2003 and $18.1 million during2002. Negative operating cash flow during 2004 was caused inlarge part by investments in customer use asset placements of$3.7 million, included in inventory changes, and reductionsin accounts payable and accrued expenses of $4.5 million.These uses of cash were partially offset by non-cash items,primarily depreciation of $4.1 million, amortization ofintangible assets of $841,000 and amortization of non-cash salesdiscount of $519,000. Additionally, we generated net income of$605,000 in 2004. Negative operating cash flow during 2003 wascaused primarily by operating losses of $8.5 million andthe settlement of a contingent liability of $2.4 million,and in 2002 primarily by operating losses of $18.1 million.The net improvement in cash used in
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operations between 2004 and 2003 was $10.6 million and waslargely attributable to improved earnings (reduced net loss) of$9.1 million from 2003 to 2004. This improvement inearnings was augmented by a further $1.5 million,comprising an increase in non-cash items of $3.3 million,offset by an increase of $1.8 million in the use of cash inoperating assets and liabilities between 2003 and 2004. Theincrease in non-cash items of $3.3 million was primarilydue to an increase in depreciation of $558,000, amortization ofnon-cash sales discount of $519,000, and a decrease in theamortization of deferred research and development credits of$2.3 million. The primary factors affecting the increase inthe use of cash in operating assets and liabilities between 2003and 2004 were decreases in accounts payable and accrued expensesof $8.4 million, primarily attributable to decreasedincentive compensation and clinical trial accruals, offset byfunding from accounts receivable of $4.4 million, as weheld receivables essentially flat in 2004 in spite of increasingrevenues, and $2.4 million attributable to the payment ofan amount in settlement of a contingent liability in 2003.     The net improvement in cash used in operations between 2003 and2002 was $5.6 million and was largely attributable toimproved earnings (reduced net loss) of $9.5 million in2003. This improvement in earnings was partially offset by areduction in non-cash items of $563,000 and an increase of$3.3 million in the use of cash in operating assets andliabilities between 2002 and 2003. The reduction in non-cashitems of $563,000 was primarily attributable to a reduction innon-cash debt issuance costs of $225,000 and other non-cashitems of $885,000, partially offset by an increase indepreciation of $495,000. The primary factors affecting the netincrease in the use of cash in operating assets and liabilitiesbetween 2002 and 2003 were increases in accounts receivable of$4.4 million attributable primarily to increased revenues,increases in other assets of $1.1 million attributable toprepaid items, and $2.4 million attributable to the paymentof an amount in settlement of a contingent liability. Offsettingthese negative operating cash flow elements were increases inaccounts payable and accrued expenses of $4.7 million,primarily attributable to increased incentive compensation andclinical trial accruals.     We recorded $3,000 of additional bad debt expense in 2004,compared with $180,000 and $1.1 million in 2003 and 2002,respectively. We experienced another strong year of collectionsof receivables during 2004. During 2004, cash collected onreceivables was $68.8 million compared with$51.3 million in 2003 and $37.9 million in 2002. Wecontinue to collect amounts on some of our older internationalaccounts and continue to routinely monitor them. We believe thatour accounts receivable reserve is adequate to cover any lossesthat may be realized. In both 2002 and 2001, we built ourallowance for doubtful accounts in consideration ofcollectibility concerns related to certain international anddomestic receivables. During 2003, in light of the strongcollections of receivables we experienced, and in light of theoverall adequacy of the allowance for doubtful accounts recordedin our records, we decreased the amount of bad debt expenserecorded. In 2004 we recorded $3,000 of additional bad debtexpense based on our assessment of the overall adequacy of theallowance for doubtful accounts and notes receivable we hadrecorded on our balance sheet. Further, our revenue mix hascontinued its shift throughout 2004 toward a higherconcentration of higher-margin consumable sales and away from ahistoric, significant dependence on more sporadic sales ofinstrumentation. This has contributed to the improvement in ourcash collections and days of sales outstanding we experiencedthroughout 2003 and 2004. This not only has contributed toimproved gross margins on our sales of our products, but it hasfurther shortened the length of time our customers take to paytheir invoices. While revenues increased 27.4% between 2003 and2004, net inventories decreased 1.6% from 2003 to 2004. This isin large part due to lean-based efficiencies in ourmanufacturing operations. We have, and will continue to activelymanage inventories and exploit lean-based efficiency initiativesin our manufacturing processes. During 2003 and 2004 weincreased reserves for certain slower-moving raw materialinventories and believe that our reserves are adequate to coverany potential losses that might arise.**Investing**     Cash used in investing activities in 2004 was $1.5 millioncompared with cash provided by investing activities of $50,000in 2003 and $253,000 in 2002. Our capital expenditures were$1.2 million in 2004, $146,000 in 2003, and$2.3 million in 2002, with expenditures primarilyattributable to the purchase of machinery and equipment. We haveno material commitments for future capital expenditures, thoughwe
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anticipate higher capital expenditures in 2005 as we expand andupgrade our manufacturing capabilities. In 2004, we acquiredrights to certain intellectual property in connection with ourwork at TriPath Oncology for an initial payment of $319,000. In2002, short-term investment maturities, which were purchased in2001, provided cash of $2.5 million.**Financing**     Cash provided by financing activities was $1.2 million in2004 and $843,000 in 2003. The primary reason for the$343,000 net improvement in cash provided by financingactivities between 2003 and 2004 was $990,000 of lower debt andlease payments as we paid off our term debt in early 2003.Partially offsetting this improvement were less proceeds fromdebt of $268,000, as we did not finance insurance premiums asheavily in 2004 as in 2003 and less funds were received from theexercise of stock options and purchases made by employees underour employee stock purchase plan, by $379,000 in 2004 versus2003.     Comparing 2003 to 2002, net cash from financing activitiesimproved by $3.9 million, with cash provided by financingactivities of $843,000 in 2003 compared with cash used infinancing activities in 2002 of $3.1 million. Cash receivedfrom the exercise of stock options and purchases made byemployees under our employee stock purchase plan in 2003exceeded that from 2002 by $1.4 million. Additionally,payments on debt decreased by $1.9 million between theyears as we paid off our term debt early 2003. Proceeds fromdebt amounted to $633,000 in 2003, attributable to financinginsurance premiums, with none in 2002.     During 2003, the continued depressed interest rates in theU.S. impacted amounts earned on our invested funds. Thishad been contrary to the fixed-rate nature of our borrowings andother term debt, though our most expensive term debt was retiredduring 2003. During 2004 the Federal Reserve began a policy ofincreasing its Federal funds interest rates from 46-year lows of1.0%. By December 31, 2004, the Federal Reserve hadincreased this key interest rate to 2.0% with additionalincreases in early 2005, to 2.75% in March 2005. While thisincreasing interest rate environment, if it continues, willpositively impact earnings on our invested cash, it will alsonegatively affect our earnings and our cash if we are requiredto incur additional debt.***Litigation***     We compete with Cytyc Corporation (Cytyc) with respect to thesale of our FocalPoint and Cytyc’s sale of its ThinPrepImaging System. We believe Cytyc’s ThinPrep Imaging Systeminfringes our patents and, on June 16, 2003, we filed alawsuit in the United States District Court for the MiddleDistrict of North Carolina seeking damages and injunctive reliefto stop such infringement.     On January 5, 2004, the district court in Massachusettsentered an order consolidating this lawsuit into a single actionwith a lawsuit that Cytyc had filed in Massachusetts. OnApril 30, 2004, the district court granted us leave toamend our complaint and answer in the consolidated action toassert infringement against Cytyc’s ThinPrep Imaging Systemunder two additional patents. On October 14, 2004, ascheduling conference was held in this consolidated action. Atthis conference, the court scheduled the deadline for the closeof fact discovery at January 31, 2005, and the close ofexpert discovery at April 29, 2005. The court also setanother scheduling conference for May 5, 2005. At present,the court has not scheduled a Markman hearing to hear argumenton the patent claim construction issues. We anticipate that atrial will be scheduled sometime in late 2005 or early 2006based on the current case schedule. We are unable to predict theultimate outcome. Similarly, we are unable to predict thepotential effect on our business and results of operations thatany outcome may ultimately have.     The case number for the action transferred from North Carolinato Massachusetts is 1:03-CV-12630-DPW and the case number forthe consolidated Massachusetts action is 1:03-CV-11142-DPW. Thecase numbers are for reference only and the correspondingpleadings are expressly not incorporated into this document byreference.***Financing Arrangements***     In January 2005, we renewed our $7.5 million workingcapital facility with Silicon Valley Bank. We also extended theterm of the line of credit to 15 months with an expirationdate of April 27, 2006. The entire
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amount of the line is available as long as certain financialcovenants are met. If these covenants are not met, the availablebalance is limited to an amount equal to 80% of eligibleaccounts receivable. At December 31, 2004, we were entitledto borrow the full amount of the line, less amounts secured bythe letter of credit referred to below. The renewed line offerseither a prime-based (prime plus 0.25%) or LIBOR-based (LIBORplus 2.0%) pricing option for advances made under it and iscollateralized by substantially all of our assets. The line ofcredit carries customary covenants, including the maintenance ofa minimum modified quick ratio, minimum tangible net worth, andother requirements. We had no outstanding borrowings under thisagreement at December 31, 2004, though the availabilityunder the line of credit could provide additional funding ifneeded.     In April 2003 we obtained a one-year commitment for a$2.5 million lease line of credit with General ElectricCapital Corporation (GE Capital). This commitment, which carriedthree-year lease terms for items acquired under it, was used tosecure operating leases for assets, primarily equipment. InMarch 2004, this line was renewed for $2.0 million (inaddition to amounts for assets already leased under the line).Terms of the new line were substantially the same as theexpiring line. The primary difference is that lease terms underthe new line range from 30 to 36 months. The interest rateson the various schedules under this lease line range from 2.85%to 3.45%. As of December 31, 2004, assets with an originalcost of $1.7 million were leased under this lease line.Future minimum lease payments under this lease line are$1.6 million.     During August 2002, we secured a $1.5 million lease line ofcredit from Bank of America. Bank of America assigned the leasesunder this line to GE Capital in 2004. This line is secured by aletter of credit against our line of credit with Silicon ValleyBank (see Note 5 to the Condensed Consolidated FinancialStatements). This lease line of credit, which carries three-yearlease terms for items acquired under it, is being used to secureoperating leases for assets, primarily equipment. The interestrates on the various schedules under this lease line range from2.75% to 2.90%. As of December 31, 2004, assets with anoriginal cost of $1.3 million were leased under this leaseline. As this line has expired, no further assets will be leasedunder this line of credit. Future minimum lease payments underthis lease line are $429,000.**Contractual Obligations**     Contractual obligations represent future cash commitments andliabilities under agreements with third parties, and excludecontingent liabilities which we cannot reasonably predict futurepayment. The following chart represents our contractualobligations, aggregated by type (in thousands):                       **Payments Due by Period**       **Less Than** **1-3** **3-5** **More Than****Contractual Obligations** **Total** **1 Year** **Years** **Years** **5 Years**               Short-term debt $19  $19  $—  $—  $—     Operating lease obligations  13,057   1,915   3,307   1,653   6,182     Inventory purchase commitments  295   295   —   —   —                     Total contractual obligations $13,371  $2,229  $3,307  $1,653  $6,182                 **Off-Balance Sheet Arrangements**     We have no other long-term debt commitments and no off-balancesheet financing vehicles.**Outlook**     Our performance in 2005 and beyond will depend on our ability totake advantage of the opportunities for growth that we createdin 2004, our ability to continue to balance the costs associatedwith effective research, development, marketing and sellingprograms with revenue growth, and the extent to which we cancontinue to leverage our operating infrastructure.     We estimate that full year revenues for 2005 will be in therange of $90.0 to $94.0 million and will reflect continuedgrowth in our cervical cytology business as well as revenuesgenerated from the early commerciali-
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zation of some of our molecular diagnostic reagents andmolecular imaging systems. Given that we expect to completeexpansion of our sales force in the U.S. in the first halfof 2005 and that we anticipate that Ventana will launch aVentana branded version of our interactive histology imager inthe second quarter, we believe that our sequential growth in thefirst half of 2005 will be similar to what we experienced in thelatter half of 2004 and that our rate of growth shouldaccelerate in the second half of 2005. In addition, revenues forany particular period will also depend significantly upon thetiming of certain deferred sales discounts that we will amortizeover a six-month period if and when it becomes apparent that anyof four currently unexercisable tranches of warrants held byQuest Diagnostics may vest upon achievement of certainsales-based milestones. While not certain, it is possible thatcertain sales-based milestones will be achieved by QuestDiagnostics that, if met, will result in additional non-cashsales discounts of up to $1.9 million in 2005.     As in 2004, we expect that our growth in revenues in 2005 willbe primarily driven by the sale of SurePath reagents anddisposables. We believe that worldwide sales of SurePathreagents and disposables will account for approximately 70% to75% of revenues in 2005. We believe that the growth in SurePathsales will be driven by three factors: 1) acceleratedpenetration of the large commercial laboratory segment in theU.S. as well as continued growth from our traditionalcustomer base; 2) expansion of our sales force in the U.S.;and 3) accelerated market penetration outside the U.S.     We expect that approximately 10% to 15% of our growth from 2004to 2005 will result from revenues generated from the earlycommercialization of some of our molecular diagnostic reagentsand molecular imaging systems. We believe that the sales ofmolecular diagnostic reagents and molecular imaging systems willbe driven by four factors: 1) introduction and marketacceptance of our *ProEx C*and *ProEx Br*ASRs;2) introduction and market acceptance of our cervicalcancer staging reagents and molecular cytology imaging systemoutside the U.S.; 3) FDA 510K clearance for processing ofVentana assays on our interactive histology imaging system, and;4) introduction and market acceptance of theVentana-branded version of our interactive histology imagingsystem (VIAS).     In December 2004, the FASB issued SFAS No. 123(revised 2004), “Share-Based Payment”(“SFAS 123(R)”, which is a revision of FASBStatement No. 123, “Accounting for Stock-BasedCompensation.” The adoption of SFAS 123(R)’s fairvalue method will have a significant impact on our results ofoperations, although it will have no impact on our overallfinancial position or overall cash flow. The impact of adoptionof SFAS 123(R) cannot be predicted at this time because itwill depend on levels of share-based payments granted in thefuture. However, had we adopted SFAS 123(R) in priorperiods, the impact of that standard would have approximated theimpact of SFAS 123 as described in the disclosure of Proforma net loss and loss per share in footnote 3 (Stock BasedCompensation) of our financial statements. SFAS 123(R) alsorequires the benefits of tax deductions in excess of recognizedcompensation cost to be reported as a financing cash flow,rather than as an operating cash flow as required under currentliterature. This requirement will reduce net operating cashflows and increase net financing cash flows in periods afteradoption. We cannot estimate what those amounts will be in thefuture (because they depend on, among other things, whenemployees exercise stock options and our ability to generatetaxable income in the future), however no such operating cashflows for excess tax deductions were recognized in any of theperiods presented. This is discussed further below under“Recently Issued Accounting Standards.”     Looking beyond 2005, we believe that sales related to ourmolecular diagnostic products will significantly impact ourrevenues in 2006 and beyond. To accomplish this, we believe thatthe future sales of our molecular diagnostic products will bedriven by five factors in 2005: 1) the results of in-houseand external research studies on the analytical and clinicalperformance of our cervical and breast staging assays;2) completion of the development of our cervical screeningassay and our molecular cytology imaging system;3) initiation of clinical trials that could support futurePremarket Approval applications to the FDA for our cervicalscreening and breast staging assays; 4) release of researchuse only (RUO) reagents for ovarian cancer screening, and;5) identification of a high-volume testing platform for ourblood based screening assays.     Given our anticipated revenue mix, we expect that our grossmargins should fall into a range of between 66% and 70% in 2005.As we shift our focus to the large commercial laboratorysegment, we expect a corresponding deceleration in the relativegrowth of business within our traditional and more fullypenetrated
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customer base. As sales to large commercial laboratoriesincrease, there may be some downward pressure on gross margin asthe selling prices of our tests to higher volume customers, suchas these large commercial laboratories, tend to be lower thanselling prices to our other laboratory customers. We anticipatethis downward trend may be somewhat offset as continuedimprovements to our manufacturing costs, due to higher volumesand efficiencies from our lean-based manufacturing programs,continue to favorably impact cost of goods sold. The extent towhich gross margin is affected as the result of this trend willdepend upon the relative number of tests sold to the highervolume laboratories at any point in time.     The structure of our agreement with Ventana relating to the saleof a Ventana branded version (VIAS) of our interactivehistology imager may also impact our gross margin in 2005.Pursuant to the agreement we will receive a fixed payment foreach imager manufactured for Ventana and usage fees for eachVentana test processed on each imaging system after placementwith a Ventana customer. The instrument transfer price includesa small premium over our cost of manufacture and, as a result,will generate a gross margin for each instrument sold that islower than is typical for our instrument sales. The anticipatedgross margin associated with the usage fees approaches 100%.Since most of the activity in the first year of this agreementwill logically relate to the initial placement of imagingsystems, we anticipate that most revenues generated from thisrelationship in 2005 will reflect the lower gross marginassociated with the instrument transfer price. We expect thatthis downward trend will be offset by the higher gross margingenerated over time from usage fees. The extent to which theoverall gross margin is affected will depend on the extent towhich Ventana is successful in placing instruments andgenerating tests from each instrument placed.     Our 2004 operating expenses were $46.9 million, compared to$44.3 million in 2003. We expect our operating expenses toincrease in 2005 to be in the range of $57.0 million to$60.0 million, in large part due to the expansion our salesand marketing activities that we initiated in the third quarterof 2004. Our Commercial Operations segment has been profitablefor over two years and generated operating income ofapproximately $14.7 million in 2004. We expect that thissegment will continue to generate significant operating incomeand cash. The excess cash flow generated from the CommercialOperations segment has been, and will continue to be utilized inpart to fund the operations of our TriPath Oncology segment. Weanticipate that the TriPath Oncology segment, which includes allresearch and development, regulatory, sales and marketing, andadministrative expenses relating to our molecular diagnosticprograms, will incur approximately $1.4 million to$1.6 million of expenses per month during 2005 as we awaitthe results of internal and external studies related to ourbreast and cervical assays, complete the development of ourcervical screening assay and our molecular cytology imagingsystem, prepare for clinical trials with respect to our cervicalscreening and breast staging assays, select the final markerpanel for screening for ovarian cancer, develop our RUO reagentsfor ovarian cancer screening, continue clinical studies relatedto our melanoma staging product, and initiate the commercialintroduction of some of our molecular diagnostic reagents andmolecular imaging systems. We have completed the preparation ofour facilities and operations for manufacture of our moleculardiagnostic products, and further expenses are not expected inconnection with this effort.     We believe that we can continue to manage our cash to minimizethe need for additional outside sources of cash in 2005. For thefirst time in our history, we experienced positive cash flowfrom the business during the third and fourth quarters of 2004.While our positive cash flow this last half of 2004 was animportant milestone, we may experience one or two additionalquarters of negative cash flow prior to becoming cash flowpositive on an ongoing basis. We expect that our capitalexpenditures for 2005 may range from $2.5 million to$5.0 million as we expand and upgrade our manufacturingoperations. We may borrow from our line of credit with SiliconValley Bank to finance part, or all, of those capitalexpenditures. We have remaining availability under a commitmentfor a $2.0 million lease line of credit that will beutilized for equipment placed under operating leases. Theexpenses associated with these leases are anticipated in ouroperating expense projections for 2005. We believe that ourexisting cash, our expectation of continuing to generatepositive cash flow for the full-year 2005, anticipatedadditional debt and/or lease financing for internal use assets,rental placements of PrepStain and fee-per-use placements ofFocalPoint instruments will be sufficient to enable us to meetour future cash obligations for at least the next 12 months.     While it is expected that marketing and sales expenditures forthe continued SurePath commercial rollout for gynecological usesin the United States will increase, and it is possible that,capital expenditures
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associated with placements of PrepStain units and FocalPointfee-per-use instruments, and expenditures related to clinicaltrials, manufacturing, the TriPath Oncology segment and otheradministrative costs may increase, we anticipate that our futuresales growth and the cost control measures we have implementedshould allow us to avoid raising additional funds for operatingpurposes in the near future. If, however, our existing resourcesprove insufficient to satisfy our liquidity requirements, or ifwe need cash for any non-routine purpose, we may need to raiseadditional funds through bank facilities, the sale of additionalequity or debt securities or other sources of capital. Inaddition, we may opportunistically take advantage of favorableconditions in the capital markets and raise debt or equitypublicly if such conditions are present and such financing isadvisable. The sale of any equity or debt securities, ifrequired, may result in additional dilution to our stockholders.We cannot be certain that additional financing will be availablein amounts, or on terms, acceptable to us, if at all. Ourfailure to participate in such financing, if needed, could havea material adverse effect on our liquidity and capitalresources, business, financial condition and results ofoperations.     This Outlook section contains forward-looking statements andshould be read in conjunction with the forward-lookingstatements disclosure at the beginning of this“Management’s Discussion and Analysis of FinancialCondition and Results of Operations” above.**Income Taxes and Tax Loss Carryforwards**     We have not generated any taxable income to date and, therefore,have not paid any federal income taxes since inception.Realization of deferred tax assets is dependent on futuretaxable earnings, if any, the timing and amount of which areuncertain. Accordingly, we have established valuationallowances, in amounts equal to the net deferred tax assets asof December 31, 2004 and 2003 in each period to reflectthese uncertainties.     At December 31, 2004, we had net tax losses ofapproximately $218.8 million that may be carried forward tooffset future taxable income. These net tax loss carryforwardshave an expiration period that begins in 2005 and ends in 2024for federal income tax purposes. In addition, we had researchcredits available for carryforward of $4.2 million thathave an expiration period that begins in 2006 and ends in 2024.Utilization of net tax losses and any tax credit carryforwardsare subject to complex treatment under the Internal Revenue Codeof 1986, as amended (the “Code”). Pursuant toSection 382 of the Code, prior issuance and sale of sharesof preferred stock, the change in ownership resulting from ourinitial public offering in September 1997, the Merger in 1999,changes in ownership generally and any other future sale ofstock may limit utilization of future losses in any one year.**Critical Accounting Policies**     The preparation of our Consolidated Financial Statements, whichhave been prepared in accordance with generally acceptedaccounting principles (GAAP) in the U.S., requires us tomake estimates and judgments that affect the reported amounts ofassets and liabilities at the date of the financial statements;revenues and expenses as of the date reported; and relateddisclosure of contingent assets and liabilities. On an on-goingbasis, we evaluate our estimates, including those related tosales of our products, bad debts, inventories, investments,intangible assets, warranty obligations, and legal issues. Sincenot all of these accounting policies require management to makedifficult, subjective or complex judgments or estimates, theyare not all considered critical accounting policies. Actualresults may differ from these estimates under differentassumptions.     We believe the following critical accounting policies involveour more significant judgments and estimates used in thepreparation of our consolidated financial statements. Wereviewed our policies and determined that those policiesidentified below as our critical accounting policies remain ourmost critical accounting policies for the year endedDecember 31, 2004. We did not make any changes in thosepolicies during the year.***Revenue Recognition***     We record revenue from the sale, rental and/or lease of oursystems and from the sale of related consumables. Additionally,we record revenue from service contracts on our systems.     In the case of system sales to end-users, revenue recognition onsystem sales occurs at the time the instrument is installed andaccepted at the customer site. In the case of instrument salesto distributors, revenue recognition on system sales occursbased upon the contract governing the transaction, typically atthe
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time the instrument is shipped from our facility. This is thepredominant vehicle for international instrument sales. If,however, we sell an instrument directly to an international enduser, we record the revenue upon installation and acceptance ofthe instrument, consistent with our treatment in the U.S.     For system rentals, systems are placed at the customer’ssite free of charge and the customer is obligated either topurchase reagent kits for a fixed term, or are charged feesbased on monthly minimum, or actual, usage. Under thesetransactions, revenue recognition occurs at the time of shipmentof the reagent kits or on a monthly basis based on the actual orminimum usage. There is no capital equipment revenue recognizedunder these transactions.     We also offer leasing alternatives. Under these transactions, wemay, or may not, recognize revenue on system hardware dependingon the particular details of the lease. We respond to customerneeds by offering both capital and operating lease alternatives.Under the capital lease alternative, revenue is recognizedinitially as an instrument sale with part of the lease paymentsbeing allocated to interest income, and service revenues, ifapplicable, over the lease term. Under operating leases, we donot recognize any revenue related to the instrument sale, butrecognize revenue as rental income over the lease term.     In 2004 we entered into an agreement that contained multipleelements with respect to revenue recognition. For thatagreement, as well as any others that we may enter into in thefuture, we research the relevant authoritative literaturerelated to the various elements contained within the agreementand document our interpretation of the relevant GAAP within thequarter we first recognize revenue from the agreement.     We consider the accounting policies regarding revenuerecognition to be critical for several reasons. The first is dueto the distributed nature of our sales network. We sell througha direct sales force in the U.S., and the issues related torevenue recognition are essentially clear-cut domestically.Abroad, however, we sell both through various distributornetworks and directly to end-user customers. This requires us toexamine each sales transaction to ensure that we properly andconsistently apply the appropriate accounting guidance coveringrevenue recognition. Further, as is typical with many companiesthat sell durable equipment, we often experience increased salesactivity near, or at, the end of fiscal quarters. This requiresus to closely examine each equipment sale to ensure therequisite terms have been met to allow revenue recognition underGAAP. Additionally, certain of our equipment sales contracts maycontain terms that would grant certain “evaluation,”or “free-use” periods, or terms that would allow thecustomer to return equipment. These terms, when present, areconsidered prior to our recording revenue. Finally, because ofthe multiple elements in one of our agreements, and thepotential for additional agreements with multiple elements, webelieve that the complexity of these agreements warrants aheightened scrutiny on the part of accounting and financemanagement.     Sales of consumable products are recorded at shipment. Billingsand costs related to shipping products to customers are includedin both revenues and cost of revenues, respectively.***Allowance for Doubtful Accounts and    Notes Receivable***     We continually monitor amounts due, and payments from ourcustomers and maintain an allowance for doubtful accounts andnotes receivable for estimated losses resulting from theinability of our customers to make required payments. When weevaluate the adequacy of our allowance for doubtful accounts andnotes, we take into account various factors including ouraccounts and notes receivable aging, customer credit-worthiness,historical bad debts and current economic trends. We agereceivables from customers based on contractual terms. From timeto time, customers are slow in paying amounts due us.     We closely monitor delinquent accounts with past due balancesoutstanding, and will continue to do so, to determine the need,if any, to further increase our allowance for doubtful accountsand notes receivable. If the financial condition of ourcustomers were to deteriorate, resulting in an impairment oftheir ability to make payments, additional allowances may berequired. If reimbursement from third party payors to ourlaboratory customers was to be reduced or otherwise changedsubstantially, our ability to collect outstanding accountsreceivable could be impacted significantly as the laboratorywould have to look to other sources (like the patient) forpayment, and that could complicate the laboratory’s billingand collection efforts by increasing the
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number, and decreasing the size, of customers from whom theywould need to collect amounts. If a trade receivable ages pastone year, our policy is to consider the receivable balancenon-performing if there has been no measurable contact ordialogue with the customer. These receivables would typically befully reserved for by this point. Once a receivable isclassified as non-performing, then we consider whether tocharge-off the receivable balance against our allowance fordoubtful accounts. Factors that figure into this determinationinclude the extent and nature of dialogue we have with thecustomer and whether the customer is still in business.     In assessing the adequacy of our allowance for doubtful accountsand notes, finance management meets, typically weekly, withindividuals responsible for collecting outstanding accounts andnotes receivable balances. Management reviews the workundertaken during the course of the week by those responsiblefor collections and guides activities for the followingweek’s actions intended toward collections of outstandingaccounts and notes receivable. Accounts are discussedspecifically, and to the extent they show potential for agingbeyond acceptable limits, adjustments to our allowance fordoubtful accounts and notes are discussed and made. If required,accounts are placed on credit hold status to stimulate paymentson aging accounts. We ensure the sales organization is aware ofcollection-related actions we take on individual accounts,including placing accounts on credit hold, so that they canintervene in the collection process as well.     At December 31, 2004 and 2003, our accounts receivablebalance, net of allowance for doubtful accounts and notesreceivable of $1.3 million and $2.3 million,respectively, was $13.6 million and $13.7 million. Seeadditional commentary under *“Liquidity and CapitalResources — Operating”* above for furtherdiscussion of our allowance for doubtful accounts and notesreceivable and related bad debt expense.***Inventory***     Inventory is stated at the lower of cost or net realizable valueon a first-in, first-out basis. If we determine that netrealizable value is less than cost, then we write down therelated inventory to market value. We review net realizablevalue of inventory in detail on an on-going basis, withconsideration given to deterioration, obsolescence, and otherfactors. If actual market conditions are less favorable thanthose projected by management, and our estimates prove to beinaccurate, additional write-downs or adjustments to recognizeadditional cost of goods for overvalued inventory may berequired.     Over half, approximately 52%, of our inventory is related to ourFocalPoint product. Of that FocalPoint inventory, much of it isclassified as raw material, or component parts. A significantreason we consider accounting policies around inventory ascritical is due to the relatively slower moving nature of theFocalPoint instrument. We continue to monitor actual demand forthe product and the economic environment into which we will beselling it during 2005. We have been recording additionalexpense during 2003 and 2004 to build a reserve for thisinventory. After reviewing these factors, we do not believe thatit is necessary to record any further adjustments to inventory;however, we will continue to monitor this inventory during 2005.     At December 31, 2004 and 2003, our total inventory balance,net of reserves for obsolescence of $3.1 million and$2.3 million, respectively was $10.7 million and$10.9 million.***Valuation of long-lived and intangible assets***     We review the value of our long-lived assets, including patentsand other intangible assets, for impairment whenever events orchanges in business circumstances indicate that the carryingamount of assets may not be fully recoverable or that the usefullives of these assets are no longer appropriate. If we determinethat the carrying value of intangibles and long-lived assets maynot be recoverable based upon one or more indicators ofimpairment, the asset is written down to its estimated fairvalue based on a discounted cash flow basis. There was noimpairment loss recorded in either 2004 nor 2003.     We consider long-lived and intangible assets to warrant thedesignation of critical for several reasons. One is tied to theissue mentioned in “Inventory” above, the relativelyslower moving nature of the FocalPoint instrument. One of ourways of selling FocalPoint instruments is under usage-basedarrangements (fee-per-use). We have a number of FocalPointinstruments recorded on the balance sheet in the account“Customer use assets.” We continue to monitor actualdemand for the product and the economic environment into which
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we will be selling it during 2005. Should these instruments bereturned prior to the term of the agreements, there could bepossible impairment issues surrounding these assets. The secondreason we consider long-lived and intangible assets a criticalaccounting area is due to the nature of our reliance on ourintellectual property. Should competitors develop and marketproducts that would render ours redundant or obsolete, then wewould face impairment issues surrounding our intangible assetsas well.     After reviewing the relevant factors affecting our assets inthese categories, we do not believe that it is necessary torecord any further adjustments to our long-lived and intangibleassets.***Income taxes and valuation allowances***     We account for income taxes using the liability method inaccordance with SFAS No. 109, “Accounting forIncome Taxes.” Under the liability method, deferred taxassets and liabilities are determined based on differencesbetween the financial reporting and tax bases of assets andliabilities. We have not generated any taxable income to dateand, therefore, have not paid any federal income taxes since ourinception. We have, however, generated significant deferred taxassets, the realization of which is dependent on the generationof future taxable income. Until 2004 we had not generated anyearnings and the generation of future taxable income will bepredominantly dependent on our ability to generate futureearnings, the timing and amount of which are uncertain. Due tothe uncertainty of our ability to generate taxable income torealize our deferred tax assets, a valuation allowance has beenestablished for financial reporting purposes equal to the amountof the net deferred tax assets. We will evaluate and review theneed to reduce our valuation allowance on a quarterly basis,primarily based on our estimates of future taxable income,beginning in 2005. Changes in our assessment of the need for avaluation allowance could give rise to a credit to income taxexpense in the period of change. A portion of the deferred taxvaluation allowance attributed to the deduction for stockoptions, if released, will be reflected as a direct increase tostockholder’s equity and will not impact the consolidatedstatement of operations.     At December 31, 2004, we had net tax loss carryforwards ofapproximately $218.8 million, which have an expirationperiod that begins in 2005 and ends in 2024 for federal incometax purposes. We also have approximately $4.2 million inresearch and development carryforwards that have an expirationperiod that begins in 2006 and ends in 2024. Utilization of nettax losses and any tax credit carryforwards are subject tocomplex treatment under the Internal Revenue Code of 1986, asamended (the “Code”). Pursuant to Section 382 ofthe Code, prior issuance and sale of shares of preferred stock,the change in ownership resulting from our initial publicoffering in September 1997, the Merger in 1999, changes inownership generally and any other future sale of stock may limitutilization of future losses in any one year.     We consider the accounting around this area to be critical fortwo primary reasons: first, the size of the valuation allowancewe have in our financial statements is significant and, second,utilization of net tax losses and any tax credit carryforwardsare subject to complex treatment under the Code and may expireunused.**Recently Issued Accounting Standards**     In December 2003, the FASB issued a revised FASB InterpretationNo. 46, “Consolidation of Variable Interest Entities,an Interpretation of ARB No. 51”(“FIN 46”), which requires a new approach indetermining if a reporting entity should consolidate certainlegal entities, including partnerships, limited liabilitycompanies, or trusts, among others, collectively defined asvariable interest entities, or “VIE’s.” A legalentity is considered a VIE if it does not have sufficient equityat risk to finance its own activities without relying onfinancial support from other parties. If the legal entity is aVIE, then the reporting entity that is the primary beneficiarymust consolidate it. Even if a reporting entity is not obligatedto consolidate a VIE, then certain disclosures must be madeabout the VIE if the reporting entity has a significant variableinterest. Certain transition disclosures are required for allfinancial statements issued after December 15, 2003. Theadoption of FIN 46 had no impact on our results ofoperations or our financial position as of and for the yearending December 31, 2004.
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     In November 2004, the FASB issued SFAS No. 151,“Inventory Costs — an Amendment of ARBNo. 43, Chapter 4” (“SFAS 151”),to clarify the accounting for abnormal amounts of idle facilityexpense, freight, handling costs, and wasted material(spoilage). Paragraph 5 of ARB 43, Chapter 4,previously stated that “. . . under somecircumstances, items such as idle facility expense, excessivespoilage, double freight, and re-handling costs may be soabnormal as to require treatment as current periodcharges. . . .”. SFAS 151 requires thatthose items be recognized as current-period charges regardlessof whether they meet the criterion of “so abnormal.”In addition, SFAS 151 requires that allocation of fixedproduction overheads to the costs of conversion be based on thenormal capacity of the production facilities. The provisions ofSFAS 151 will be effective for inventory costs incurredduring fiscal years beginning after June 15, 2005, withearlier adoption permitted. The provisions of SFAS 151shall be applied prospectively. We had not adopted SFAS 151at December 31, 2004, but we believe that its adoption willhave no material impact on our results of operations or on ourfinancial condition.     In December 2004, the FASB issued SFAS No. 152,“Accounting for Real Estate Time-SharingTransactions — an amendment of FASB StatementsNo. 66 and 67” (“SFAS 152”).SFAS 152 amends FASB Statement No. 66,“Accounting for Sales of Real Estate,” to referencethe financial accounting and reporting guidance for real estatetime-sharing transactions that is provided in AICPA Statement ofPosition (SOP) 04-2, “Accounting for Real EstateTime-Sharing Transactions”. SFAS 152 also amends FASBStatement No. 67, “Accounting for Costs and InitialRental Operations of Real Estate Projects”, to state thatthe guidance for (a) incidental operations and(b) costs incurred to sell real estate projects does notapply to real estate time-sharing transactions. The accountingfor those operations and costs is subject to the guidance in SOP04-2. SFAS 152 is effective for financial statements forfiscal years beginning after June 15, 2005. Its provisionsare not expected to have any impact on our results ofoperations, financial position or cash flow.     In December 2004, the FASB issued SFAS No. 153,“Exchanges of Non-monetary Assets — an Amendmentof APB Opinion No. 29” (“SFAS 153”).The guidance in APB Opinion No. 29, “Accounting forNon-monetary Transactions”, is based on the principle thatexchanges of non-monetary assets should be measured based on thefair value of the assets exchanged. The guidance in thatOpinion, however, included certain exceptions to that principle.SFAS 153 amends Opinion 29 to eliminate the exception fornon-monetary exchanges of similar productive assets and replacesit with a general exception for exchanges of non-monetary assetsthat do not have commercial substance. A non-monetary exchangehas commercial substance if the future cash flows of the entityare expected to change significantly as a result of theexchange. The provisions of SFAS 153 will be effective fornon-monetary exchanges occurring in fiscal periods beginningafter June 15, 2005, with earlier adoption permitted. Theprovisions of SFAS 153 shall be applied prospectively. Wehad not adopted SFAS 153 at December 31, 2004, but webelieve that its adoption will have no material impact on ourresults of operations, financial condition or cash flow.     In December 2004, the FASB issued SFAS No. 123(revised 2004), “Share-Based Payment”(“SFAS 123(R)”, which is a revision of FASBStatement No. 123, “Accounting for Stock-BasedCompensation.” SFAS 123(R) supersedes APB OpinionNo. 25, “Accounting for Stock Issued toEmployees,” and amends FASB Statement No. 95,“Statement of Cash Flows.” SFAS 123(R)establishes standards for the accounting for transactions inwhich an entity exchanges its equity instruments for goods orservices. It also addresses transactions in which an entityincurs liabilities in exchange for goods or services that arebased on the fair value of the entity’s equity instrumentsor that may be settled by the issuance of those equityinstruments. SFAS 123(R) focuses primarily on accountingfor transactions in which an entity obtains employee services inshare-based payment transactions. SFAS 123(R) does notchange the accounting guidance for share-based paymenttransactions with parties other than employees provided inSFAS 123 as originally issued and EITF IssueNo. 96-18, “Accounting for Equity Instruments That AreIssued to Other Than Employees for Acquiring, or in Conjunctionwith Selling, Goods or Services.” Generally, the approachin SFAS 123(R) is similar to the approach described inSFAS 123. However, SFAS 123(R) *requires*allshare-based payments to employees, including grants of employeestock options, to be recognized in the income statement based ontheir fair values. Pro forma disclosure is no longer analternative. SFAS 123(R) requires a public entity tomeasure the cost of employee services received in exchange foran award of equity instruments based on the grant-date fairvalue of the award (with limited exceptions). That cost will berecognized over the period during which an employee is requiredto provide service in exchange for the
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award — the requisite service period (usually thevesting period). No compensation cost is recognized for equityinstruments for which employees do not render the requisiteservice. Employee share purchase plans will not result inrecognition of compensation cost if certain conditions are met;those conditions are much the same as the related conditions inSFAS 123. A public entity will initially measure the costof employee services received in exchange for an award ofliability instruments based on its current fair value; the fairvalue of that award will be remeasured subsequently at eachreporting date through the settlement date. Changes in fairvalue during the requisite service period will be recognized ascompensation cost over that period. The grant-date fair value ofemployee share options and similar instruments will be estimatedusing option-pricing models adjusted for the uniquecharacteristics of those instruments (unless observable marketprices for the same or similar instruments are available). If anequity award is modified after the grant date, incrementalcompensation cost will be recognized in an amount equal to theexcess of the fair value of the modified award over the fairvalue of the original award immediately before the modification.Excess tax benefits, as defined by SFAS 123(R), will berecognized as an addition to paid-in capital. Cash retained as aresult of those excess tax benefits will be presented in thestatement of cash flows as financing cash inflows. The write-offof deferred tax assets relating to unrealized tax benefitsassociated with recognized compensation cost will be recognizedas income tax expense unless there are excess tax benefits fromprevious awards remaining in paid-in capital to which it can beoffset. The notes to financial statements will discloseinformation to assist users of financial information tounderstand the nature of share-based payment transactions andthe effects of those transactions on the financial statements.SFAS 123(R) must be adopted no later than July 1,2005. We expect to adopt SFAS 123(R) on July 1, 2005,as required.     The adoption of SFAS 123(R)’s fair value method willhave a significant impact on our results of operations, althoughit will have no impact on our overall financial position oroverall cash flow. The impact of adoption of SFAS 123(R)cannot be predicted at this time because it will depend onlevels of share-based payments granted in the future. However,had we adopted SFAS 123(R) in prior periods, the impact ofthat standard would have approximated the impact ofSFAS 123 as described in the disclosure of Pro forma netloss and loss per share in Footnote 3 (*Stock BasedCompensation*above) of our Financial Statements.SFAS 123(R) also requires the benefits of tax deductions inexcess of recognized compensation cost to be reported as afinancing cash flow, rather than as an operating cash flow asrequired under current literature. This requirement will reducenet operating cash flows and increase net financing cash flowsin periods after adoption. We cannot estimate what those amountswill be in the future (because they depend on, among otherthings, when employees exercise stock options and our ability togenerate taxable income in the future), however no suchoperating cash flows for excess tax deductions were recognizedin any of the periods presented.**Item 7A.*****Quantitative and Qualitative Disclosures About Market    Risk***     We do not participate in derivative financial instruments, otherfinancial instruments for which the fair value disclosure wouldbe required under SFAS No. 107, or derivativecommodity instruments. All of our investments are in short-term,investment-grade commercial paper, corporate bonds andU.S. Government and agency securities that are carried atfair value on our books. Accordingly, we have no quantitativeinformation concerning the market risk of participating in suchinvestments.     Our primary market risk exposures are in the areas of interestrate risk and foreign currency exchange rate risk. Our financialresults and cash flows are subject to fluctuation due to changesin interest rates, primarily from our investment of availablecash balances in highly rated institutions. Under our currentpolicies, we do not use interest rate derivative instruments tomanage exposure to interest rate changes. See*“Item 7. Management’s Discussion and Analysisof Financial Condition and Results of Operations”*under*“Liquidity and Capital Resources”*for furtherdiscussion of the impact of interest rates on our financialresults. We operate in several foreign countries and are subjectto fluctuations in foreign currencies to a minor extent. We haveno foreign exchange contracts, option contracts, or otherforeign hedging arrangements. However, the impact offluctuations in foreign currencies on our financial results hasnot been material and are unlikely to have a material adverseeffect on our business, financial condition or results ofoperations in the future.
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**Item 8.*****Financial Statements and Supplementary Data***     The information required by this item may be found beginning onpage F-1 of this Form 10-K.**Item 9.*****Changes In and Disagreements with Accountants on    Accounting and Financial Disclosure***     There have been no changes in or disagreements with accountantson accounting or financial disclosure matters in the last fiscalyear.**Item 9A.*****Controls and Procedures******Conclusion Regarding the Effectiveness of Disclosure    Controls and Procedures***     Our management, with the participation of our Chief ExecutiveOfficer and Chief Financial Officer, has evaluated theeffectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Rule 13a-15(e) underthe Securities Exchange Act of 1934, the “ExchangeAct”) as of the end of the period covered by this annualreport. Based on this evaluation, our Chief Executive Officerand Chief Financial Officer concluded that these disclosurecontrols and procedures are effective and designed to ensurethat the information required to be disclosed in our reportsfiled or submitted under the Exchange Act is recorded,processed, summarized and reported within the requisite timeperiods.***Management’s Report on Internal Control over    Financial Reporting***     Our management is responsible for establishing and maintainingadequate internal control over financial reporting, as such termis defined in Rule 13a-15(f) under the Exchange Act. Ourmanagement assessed the effectiveness of the Company’sinternal control over financial reporting as ofDecember 31, 2004. In making this assessment, theCompany’s management used the criteria set forth by theCommittee of Sponsoring Organizations of the Treadway Commission(COSO) in Internal Control-Integrated Framework. Based onour assessment, management has concluded that, as ofDecember 31, 2004, the Company’s internal control overfinancial reporting is effective as of December 31, 2004.Ernst & Young LLP, an independent registered publicaccounting firm that audited the Company’s financialstatements included in this annual report, has issued anattestation report on management’s assessment of theCompany’s internal control over financial reporting. Thisreport is included in our Consolidated Financial Statements.     The company’s management, including our Chief ExecutiveOfficer and Chief Financial Officer, does not expect that ourdisclosure controls and procedures or our internal control overfinancial reporting will prevent or detect all error and allfraud. A control system, no matter how well designed andoperated, can provide only reasonable, not absolute, assurancethat the control system’s objectives will be met. Thedesign of a control system must reflect the fact that there areresource constraints, and the benefits of controls must beconsidered relative to their costs. Further, because of theinherent limitations in all control systems, no evaluation ofcontrols can provide absolute assurance that misstatements dueto error or fraud will not occur or that all control issues andinstances of fraud, if any, within the company have beendetected. These inherent limitations include the realities thatjudgments in decision-making can be faulty and that breakdownscan occur because of simple error or mistake. Controls can alsobe circumvented by the individual acts of some persons, bycollusion of two or more people, or by management override ofthe controls. The design of any system of controls is based inpart on certain assumptions about the likelihood of futureevents, and there can be no assurance that any design willsucceed in achieving its stated goals under all potential futureconditions. Projections of any evaluation of controlseffectiveness to future periods are subject to risks. Over time,controls may become inadequate because of changes in conditionsor deterioration in the degree of compliance with policies orprocedures.***Changes in Internal Control***     There was no change in our internal control over financialreporting (as defined in Rule 13a-15(f) under the ExchangeAct) identified in connection with the evaluation of ourinternal control that occurred during our
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fourth fiscal quarter that has materially affected, or isreasonably likely to materially affect, our internal controlover financial reporting.**PART III****Item 10.*****Directors and Executive Officers of the Registrant***     The response to this item is contained in part under the caption“Executive Officers of the Registrant” in Part I,Item 1A hereof and the remainder is incorporated herein byreference from the discussion responsive thereto under thecaptions “Election of Directors,” “Election ofDirectors — Board and Committee Matters,” and“Section 16(a) Beneficial Reporting Compliance”in our Proxy Statement relating to our Annual Meeting ofStockholders scheduled for May 24, 2005 (the “ProxyStatement”).     We have adopted a Code of Business Conduct and Ethics (the“code of ethics”) that applies to all of ourdirectors, officers and employees. The code of ethics is filedas an exhibit to this Report and we intend to post the text ofthe code of ethics on our website which can be accessed athttp://www.tripathimaging.com. In addition, if we make anysubstantive amendments to the code of ethics or grant anywaiver, including any implicit waiver, from a provision of thecode to any of our executive officers or directors, we willdisclose the nature of such amendment or waiver on aForm  8-K.**Item 11.*****Executive Compensation***     The response to this item is incorporated herein by referencefrom the discussion responsive thereto under the captions“Election of Directors,” “DirectorCompensation,” and “Executive Compensation” inthe Proxy Statement.**Item 12.*****Security Ownership of Certain Beneficial Owners and    Management and Related Shareholder Matters***     The response to this item is incorporated herein by referencefrom the discussion responsive thereto under the captions“Share Ownership” and “Securities Authorized forIssuance Under Equity Compensation Plans” in the ProxyStatement.**Item 13.*****Certain Relationships and Related Transactions***     The response to this item is incorporated herein by referencefrom the discussion responsive thereto under the caption“Certain Relationships and Related Transactions” inthe Proxy Statement.**Item 14.*****Principal Accountant Fees and Services***     The response to this item is incorporated herein by referencefrom the discussion responsive thereto under the caption“Information Concerning Our Auditor” in the ProxyStatement.**PART IV****Item 15.*****Exhibits and Financial Statement Schedules***     (a) 1.* Financial Statements*          The consolidated financial statements are listed under    Part II, Item 8 of this report.          2.* Financial Statement Schedule*          Schedules have been omitted because the information required to    be set forth therein is not applicable or is shown in the    accompanying Consolidated Financial Statements.
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          3.* Exhibits*          The exhibits are listed under Part IV, Item 15(b) of    this report. (b)*Exhibits*      3.1     Restated Certificate of Incorporation of the Company. Filed as    Exhibit 3.1 to our Form 10-Q for the quarter ended    June 30, 2002 (File No. 0-22885) and incorporated herein by    reference.  3.2     Amended and Restated By-laws of the Company. Filed as    Exhibit 3.2 to our Form 10-Q for the quarter ended    June 30, 2002 (File No. 0-22885) and incorporated herein by    reference.  4.1     Specimen of Common Stock Certificate. Filed as Exhibit 4.1    to our Registration Statement on Form S-1 (File    No. 333-30227) and incorporated herein by reference.  10.1*     Amended and Restated 1996 Equity Incentive Plan. Filed as    Exhibit 10.2 to the Company’s Form 10-Q for the    quarter ended June 30, 2004 (File No. 0-22885) and    incorporated herein by reference.  10.2*     Amended and Restated 1997 Director Stock Option Plan. Filed    as Exhibit 10.3 to the Company’s Form 10-Q for    the quarter ended June 30, 2004 (File No. 0-22885) and    incorporated herein by reference.  10.3*     Form of Indemnification Agreement between the Company and its    Directors and Executive Officers. Filed as Exhibit 10.11 to    the Company’s Registration Statement on Form S-1 (File    No. 333-30227) and incorporated herein by reference.  10.4     Lease Agreement dated as of July 28, 1997 by and between    Carolina Hosiery Mills, Inc. and the Company. Filed as    Exhibit 10.12 to the Company’s Registration Statement    on Form S-1 (File No. 333-30227) and incorporated    herein by reference.  10.5     Lease Agreement dated June 12, 1998 by and between Carolina    Hosiery Mills, Inc. and AutoCyte, Inc. Filed as    Exhibit 10.1 to the Company’s Form 10-Q for the    quarter ended June 30, 1998 (File No. 0-22885) and    incorporated herein by reference.  10.6     Amendment dated March 2, 1999 to Lease Agreement dated    July 28, 1997 by and between Carolina Hosiery Mills, Inc.    and AutoCyte, Inc. Filed as Exhibit 10.1 to the    Company’s Form 10-Q for the quarter ended March 31,    1999 (File No. 0-22885) and incorporated herein by reference.  10.7     Intellectual Property Purchase Agreement dated as of    April 24, 1999 by and between NeoPath, Inc. and AutoCyte,    Inc. Filed as Exhibit 10.21 to the Amendment No. 2 to    the Company’s S-1 (File No. 333-82121) and    incorporated herein by reference.  10.8     Loan and Security Agreement dated as of January 31, 2000    (the “Loan and Security Agreement”) by and between    Silicon Valley Bank and TriPath Imaging, Inc. Filed as    Exhibit 10.2 to the Company’s Form 10-Q for the    quarter ended March 31, 2000 (File No. 0-22885) and    incorporated herein by reference.  10.9     Securities Purchase Agreement dated as of July 31, 2001 by    and between the Company and Becton, Dickinson and Company. Filed    as Exhibit 10.1 to the Company’s Form 10-Q for the    quarter ended June 30, 2001 (File No. 0-22885) and    incorporated herein by reference.  10.10     License and Intellectual Property Access Agreement dated as of    July 31, 2001 by and between the Company and Becton,    Dickinson and Company. Filed as Exhibit 10.3 to the    Company’s Form 10-Q for the quarter ended June 30,    2001 (File No. 0-22885) and incorporated herein by reference.  10.11     Development and License Agreement dated as of July 31, 2001    by and among the Company, Becton, Dickinson and Company and    TriPath Oncology, Inc. Filed as Exhibit 10.4 to the    Company’s Form 10-Q for the quarter ended June 30,    2001 (File No. 0-22885) and incorporated herein by reference.  10.12     Sublicense Agreement dated as of July 31, 2001 by and among    the Company, Becton, Dickinson and Company and TriPath Oncology,    Inc. Filed as Exhibit 10.5 to the Company’s Form 10-Q    for the quarter ended June 30, 2001 (File No. 0-22885) and    incorporated herein by reference.  10.13     Lease Agreement between NeoPath, Inc. and Teachers    Insurance & Annuity Association dated October 1,    1994 (the “Lease Agreement”) and all amendments    thereto. Filed as Exhibit 10.25 to the Company’s Form    10-K for the year ended December 31, 2001 (File No.    0-22885) and incorporated herein by reference.
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       10.14     Sixth Amendment dated September 30, 2003 to Lease Agreement    between TriPath Imaging, Inc. (as successor-in-interest to    NeoPath, Inc.) and Teachers Insurance & Annuity    Association dated October 1, 1994. Filed as    Exhibit 10.14 to the Company’s Form 10-K for the year    ended December 31, 2003 (File No. 0-22885) and incorporated    herein by reference.  10.15     Sublease Agreement by and between NeoPath, Inc. and Antioch    Bible Church dated as of August 31, 1999. Filed as    Exhibit 10.26 to the Company’s Form 10-K for the year    ended December 31, 2001 (File No. 0-22885) and incorporated    herein by reference.  10.16†     OEM Supply Agreement dated November 1, 2001 by and between    Tecan Schweiz AG and the Company. Filed as Exhibit 10.28 to    the Company’s Form 10-K for the year ended    December 31, 2001 (File No. 0-22885) and incorporated    herein by reference.  10.17     Amendment dated December 1, 2001 to Lease Agreement dated    June 12, 1998 by and between Carolina Hosiery Mills, Inc.    and TriPath Imaging, Inc. Filed as Exhibit 10.29 to the    Company’s Form 10-K for the year ended December 31,    2001 (File No. 0-22885) and incorporated herein by reference.  10.18     Lease Agreement dated as of February 6, 2002 by and between    TBC Place Partners II, LLC and TriPath Oncology, Inc. Filed    as Exhibit 10.31 to the Company’s Form 10-K for the    year ended December 31, 2001 (File No. 0-22885) and    incorporated herein by reference.  10.19     Lease Agreement dated as of July 1, 2002 by and between    Banc of America Leasing & Capital, LLC and TriPath    Imaging, Inc. Filed as Exhibit 10.24 to the Company’s    Form 10-K for the year ended December 31, 2002 (File No.    0-22885) and incorporated herein by reference.  10.20     Fourth Loan Modification Agreement to the Loan and Security    Agreement effective as of January 31, 2003 by and between    Silicon Valley Bank and TriPath Imaging, Inc. Filed as    Exhibit 10.25 to the Company’s Form 10-K for the year    ended December 31, 2002 (File No. 0-22885) and incorporated    herein by reference.  10.21     Fifth Loan Modification Agreement to the Loan and Security    Agreement effective as of January 28, 2004 by and between    Silicon Valley Bank and TriPath Imaging, Inc. Filed as    Exhibit 10.21 to the Company’s Form 10-K for the    year ended December 31, 2003 (File No. 0-22885) and    ncorporated herein by reference.  10.22     Lease Agreement dated as of March 13, 2003 by and between    General Electric Capital Corporation and TriPath Imaging, Inc.    Filed as Exhibit 10.1 to our Form 10-Q for the quarter    ended March 31, 2003 (File No. 0-22885) and incorporated    herein by reference.  10.23     Addendum No. 1, dated September 1, 2003, to Sublease    Agreement by and between NeoPath, Inc. and Antioch Bible Church    dated as of August 31, 1999. Filed as Exhibit 10.23 to the    Company’s Form 10-K for the year ended    December 31, 2003 (File No. 0-22885) and incorporated    herein by reference.  10.24*     Form of the Company’s Incentive Stock Option Certificate    under the Company’s Amended and Restated 1996 Equity    Incentive Plan for all its employees, including its executive    officers. Filed as Exhibit 10.1 to the Company’s Form    10-Q for the quarter ended September 30, 2004 (File    No. 0-22885) and incorporated herein by reference.  10.25*     Form of the Company’s Non-Statutory Stock Option    Certificate under the Company’s Amended and Restated 1996    Equity Incentive Plan for all its employees, including its    executive officers, and its directors. Filed as    Exhibit 10.2 to the Company’s Form 10-Q for the    quarter ended September 30, 2004 (File No. 0-22885) and    incorporated herein by reference.  10.26*     Form of the Company’s Non-Statutory Stock Option Agreement    under the Company’s 1997 Director Stock Option Plan    for its directors. Filed as Exhibit A to Appendix D to our    Definitive Proxy Statement on Schedule 14A filed with the    Commission on April 22, 2004 (File No. 0-22885) and    incorporated herein by reference.  10.27*     Form of Director Option Agreement Amendment dated as of    August 3, 2004 between the Company and Haywood D.    Cochrane, Jr., Robert E. Curry, Ph.D., Richard A.    Franco, R. Ph., Arthur King, Ph.D. and Robert L. Sullivan.    Filed as Exhibit 10.4 to the Company’s Form 10-Q for    the quarter ended June 30, 1998 (File No. 0-22885) and    incorporated herein by reference.
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       10.28*     Change of Control Agreement dated as of August 3, 2004    between the Company and Paul R. Sohmer, M.D. Filed as    Exhibit 10.5 to the Company’s Form 10-Q for the    quarter ended September 30, 2004 (File No. 0-22885) and    incorporated herein by reference.  10.29*     Form of Change of Control Agreement dated as of August 3,    2004 between the Company and Stephen P. Hall, Johnny D.    Powers, Ph.D. and Ray W. Swanson, Jr. Filed herewith.    Filed as Exhibit 10.6 to the Company’s Form 10-Q for    the quarter ended September 30, 2004 (File    No. 0-22885) and incorporated herein by reference.  10.30*     TriPath Imaging, Inc. 2005 Bonus Plan, adopted by the    Compensation Committee of the Board of Directors on    January 26, 2005. Filed herewith.  10.31*     Director Compensation at March 31, 2005. Filed herewith.  10.32     Amendment to Lease dated August 1, 2004 between Carolina    Hosiery Mills, Inc. and the Company. Filed herewith.  10.33*     Tripath Imaging, Inc. 2001 Employee Stock Purchase Plan. Filed    as Appendix B to the Company’s Definitive Proxy Statement    on Schedule 14A filed with the Commission on April 24,    2001 (File No. 0-22885) and incorporated herein by    reference.  10.34     Warrant Purchase Agreement between the Company and Quest    Diagnostics Incorporated, dated as of May 5, 2004. Filed as    Exhibit 10.1 to the Company’s Form 10-Q for the    quarter ended June 30, 2004 (File No. 0-22885) and    incorporated herein by reference.  14.1     Code of Business Conduct and Ethics of the Company. Filed as    Exhibit 14.1 to the Company’s Form 10-K for the year    ended December 31, 2003 (File No. 0-22885) and incorporated    herein by reference.  21.1     List of all subsidiaries of the Company. Filed herewith.  23.1     Consent of Ernst & Young LLP, independent registered    public accounting firm. Filed herewith.  31.1     Certification of Chief Executive Officer Pursuant to    § 240.13a-14 or § 240.15d-14 of the    Securities Exchange Act of 1934, as amended. Filed herewith. 31.2     Certification of Chief Financial Officer Pursuant to    § 240.13a-14 or § 240.15d-14 of the    Securities Exchange Act of 1934, as amended. Filed herewith.  32      Certification pursuant to 18 U.S.C. Section 1350.    Filed herewith.  99.1     Factors Affecting Future Operating Results. Filed herewith. *     Indicates a management contract or compensatory plan.†     Certain confidential material contained in the document has been    omitted and filed separately with the Securities and Exchange    Commission pursuant to both Rule 406 of the Securities Act    of 1933, as amended, and Rule 24b-2 of the Securities    Exchange Act of 1934, as amended, as applicable. Omitted    information is identified with asterisks in the appropriate    places in the agreement.
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**SIGNATURES**     Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, the registrant has duly causedthis report to be signed on its behalf by the undersigned,thereunto duly authorized, in the City of Burlington, State ofNorth Carolina, on March 31, 2005. TRIPATH IMAGING, INC.     By:     /s/ Paul R. Sohmer           Paul R. Sohmer, M.D.     Chairman, President and Chief Executive Officer     Pursuant to the requirements of the Securities Exchange Act of1934, this report has been signed below by the following personson behalf of the registrant and in the capacities indicated onthis 31st day of March, 2005.     **Signature** **Title**        /s/ Paul R. Sohmer