##### Table of Contents









SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549




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FORM 10-K

|           |  |                                                                                                 
|---------- |  | ------------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                                 
|[X]        |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF
    THE SECURITIES EXCHANGE ACT OF 1934    
|           |  | For the fiscal year ended December 31, 2003                                                     
|           |  | OR                                                                                              
|[  ]       |  | 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



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TRIPATH IMAGING, INC.

(exact name of registrant as specified in its
charter)


|                                                                   |  |                                            
|------------------------------------------------------------------ |  | -------------------------------------------
|Delaware                                                           |  | 56-1995728                                 
|(State or other jurisdiction of
    incorporation or organization) |  | (I.R.S. Employer
    Identification Number)

780 Plantation Drive, Burlington, North
Carolina 27215

(Address of principal executive offices including
zip code)


Registrants telephone number, including
area code: (336) 222-9707

Securities registered pursuant to Section 12(b)
of the Act:

None

Securities registered pursuant to Section 12(g)
of the Act:

Common Stock, $0.01 Par Value

(Title of each class)


Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past
90 days.  YES x  NO o

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this
Form 10-K or any amendment to this
Form 10-K.  x

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Rule 12b-2 of the
Exchange
Act).  YES x  NO o

The aggregate market value of voting stock held
by non-affiliates of the registrant as of June 30, 2003
was: $201,195,456.

There were 37,940,284 shares of the
registrants Common Stock outstanding as of March 10,
2004.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement of the
Registrant for the Registrants 2004 Annual Meeting of
Shareholders to be held on May 20, 2004, which definitive
proxy statement will be filed with the Securities and Exchange
Commission not later than 120 days after the
registrants fiscal year of December 31, 2003, are
incorporated by reference into Part III of this Form 10-K.









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TriPath Imaging, Inc.

Table of Contents

|           |  |                                                                                                        |    |  |    | 
|---------- |  | ------------------------------------------------------------------------------------------------------ | -- |  | -- | 
|           |  |                                                                                                        |    | 
|Part I.    |  |                                                                                                        |    |  |    | 
|Item 1.    |  | Business                                                                                               |    |  | 2  | 
|Item 1A.   |  | Executive Officers of the
    Registrant                                                               |    |  | 36 | 
|Item 2.    |  | Properties                                                                                             |    |  | 37 | 
|Item 3.    |  | Legal Proceedings                                                                                      |    |  | 37 | 
|Item 4.    |  | Submission of Matters to a
    Vote of Security Holders                                                |    |  | 38 | 
|          
|Part II.   |  |                                                                                                        |    |  |    | 
|Item 5.    |  | Market for the
    Registrants Common Equity and Related Stockholder
    Matters                      |    |  | 38 | 
|Item 6.    |  | Selected Financial Data                                                                                |    |  | 39 | 
|Item 7.    |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations              |    |  | 39 | 
|Item 7A.   |  | Quantitative and Qualitative
    Disclosures About Market Risks                                        |    |  | 52 | 
|Item 8.    |  | Financial Statements and
    Supplementary Data                                                        |    |  | 53 | 
|Item 9.    |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure               |    |  | 53 | 
|Item 9A.   |  | Controls and Procedures                                                                                |    |  | 53 | 
|          
|Part III.  |  |                                                                                                        |    |  |    | 
|Item 10.   |  | Directors and Executive
    Officers of the Registrant                                                 |    |  | 53 | 
|Item 11.   |  | Executive Compensation                                                                                 |    |  | 53 | 
|Item 12.   |  | Security Ownership of
    Certain Beneficial Owners and Management and Related Stockholder
    Matters |    |  | 53 | 
|Item 13.   |  | Certain Relationships and
    Related Transactions                                                     |    |  | 54 | 
|Item 14.   |  | Principal Accountant Fees
    and Services                                                             |    |  | 54 | 
|          
|Part IV.   |  |                                                                                                        |    |  |    | 
|Item 15.   |  | Exhibits, Consolidated
    Financial Statement Schedules, and Reports on Form 8-K                      |    |  | 55 | 
|Signatures |  |                                                                                                        | 58 | 
|EX-10.2   
|EX-10.14  
|EX-10.21  
|EX-10.23  
|EX-14.1   
|EX-21.1   
|EX-23.1   
|EX-31.1   
|EX-31.2   
|EX-32     
|EX-99.1   



As used in this report, the terms we,
us, our, TriPath Imaging and
the Company mean TriPath Imaging, Inc. and its
subsidiaries, unless the context indicates another meaning.

Note Regarding Trademarks

AutoCyte®, AutoCyte Quic®,
AutoPap®, CytoRich®, ImageTiter®,
PrepMate®, SlideWizard®, and TriPath Imaging® are
registered trademarks of TriPath Imaging, Inc. TriPath Care
TechnologiesTM, i3
SeriesTM, FocalPointTM,
FocalPointTM GSPrepStainTM,
SurePathTM, and TriPath OncologyTM, are
trademarks of TriPath Imaging, Inc. All other products and
company names are trademarks of their respective holders.





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PART I






|        |         
|------- | --------
|Item 1. | Business

This Annual Report on Form 10-K contains
forward-looking statements, including statements regarding our
results of operations, research and development programs,
clinical trials and collaborations. Statements that are not
historical facts are based on our managements current
expectations, beliefs, assumptions, estimates, forecasts and
projections. These forward-looking statements are not guarantees
of future performance and involve certain risks, uncertainties
and assumptions that could cause actual results to differ
significantly from those discussed in these forward-looking
statements. Important factors that could cause or contribute to
these differences include those described in the section
entitled Managements Discussion and Analysis of
Financial Condition and Results of Operations 
Critical Accounting Policies and in Factors
Affecting Future Operating Results attached hereto as
Exhibit 99.1 and incorporated by reference into this
Form 10-K. You should not place undue reliance on the
forward-looking statements, which speak only as the date of this
report. We undertake no obligation to update these statements to
reflect events or circumstances occurring after the date of this
report 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s
website is not a part of this Annual Report on Form 10-K.
As soon as reasonably practical after they are filed or
furnished with the SEC, the Company makes available free of
charge on its website, or provides a link to, the Companys
Annual Report on Form 10-K, Quarterly Reports on
Form 10-Q, Current Reports on Form 8-K, and any
amendments to those reports filed or furnished with the SEC
pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act. To access these filings, go to the Companys
website and click on Investor Resources, then click
on SEC Filings. Alternatively, interested parties
may request, in writing, a copy of this Form 10-K, without
charge. 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 and clinical management of cancer. Specifically, we
develop, manufacture, market, and sell proprietary products for
cancer detection, diagnosis, staging, and treatment selection.
We are using our proprietary technologies and expertise to
create an array of products designed to improve the clinical
management of cancer. We were incorporated in October 1996 as
AutoCyte, Inc. and changed our name to TriPath
Imaging, Inc. in September 1999 in connection with the
merger of AutoCyte, Inc. and NeoPath, Inc. and
acquisition of the technology and intellectual property of
Neuromedical Systems, Inc. To date, we have developed and
marketed an integrated solution for cervical cancer screening
and other products that deliver image management, data handling,
and prognostic tools for cell diagnosis, cytopathology and
histopathology. We have created new opportunities and
applications for our proprietary technology by applying recent
advances in genomics, biology, and informatics to our efforts to
develop new molecular diagnostic and pharmacogenomic products
and services for malignant melanoma and cancers of the cervix,
breast, ovary, and prostate.

We are organized into two operating units:



| |   |                                                                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Commercial Operations, through which we manage
    the market introduction, sales, service, manufacturing and
    ongoing development of our products; and                  
|
| |  | TriPath Oncology, our wholly-owned subsidiary,
    through which we manage the development of molecular diagnostic
    and pharmacogenomic products and services for cancer.

We provide financial information by segment and
geographic area in Note 8 to our Consolidated Financial
Statements included in Item 8 of this report. We are
incorporating that information into this section by reference.

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Commercial Operations

During 2002, we adopted the trademark
TriPath Care Technologies to describe our commercial
product offerings and to communicate the broad nature of our
corporate vision and the value created by our growing product
portfolio, including the i3 Series
and SlideWizard product lines.

To further refine our market positioning and to
enhance brand awareness among our customers, in 2001 we
re-branded our cervical cancer screening products under the
i3 Series product line. Our
i3 Series product line for
cervical cancer screening is the first integrated system for the
collection, preparation, staining and computerized analysis of
conventional Pap smears and liquid-based, thin-layer slide
preparations. Our i3 Series
product line includes the following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | SurePath Test Packis a proprietary, liquid-based cytology sample collection,
    preservation and transport system. The SurePath Test Pack, or
    SurePath, includes the liquid-based Pap test collection vial and
    cervical sampling device. SurePath addresses errors in cell
    sample collection and slide preparation while providing a liquid
    medium for performing additional laboratory tests. The SurePath
    liquid-based Pap test was approved by the United States Food and
    Drug Administration (FDA) for slides prepared using
    the PrepStain Slide Processor in June 1999. In 2001, SurePath
    was approved by the FDA for manual slide processing in which the
    cell suspension obtained by using the SurePath Test Pack is
    layered onto the slide and stained by a prep technician. In May
    2003, we received approval for expanded labeling claims from the
    FDA to include study data showing a 64.4% (p<0.00001)
    increase in detection of High Grade Squamous Intraepithelial and
    more serious lesions (HSIL+), as compared to the conventional
    Pap smear, using our liquid based cytology system, which
    includes the SurePath liquid-based Pap test and the PrepStain
    Slide Processor. During the second quarter of 2003, we initiated
    data collection to support a submission to the FDA for approval
    for humanpapilloma virus (HPV) testing using the Digene
    Hybrid Capture® HPV Test on cells collected using our
    SurePath Test Pack. We expect to make a submission to the FDA
    containing the results from this clinical trial in the first
    half of 2004. During the fourth quarter of 2003 data were
    submitted in support of a Pre-Market Approval, or PMA,
    supplement to the FDA for the use of a brush and spatula to
    collect samples using our SurePath Test Pack.
|
| |  | PrepStain Slide
    Processoris an automated slide
    preparation system that produces slides with a standardized,
    thin layer of stained cervical cells. The PrepStain Slide
    Processor, or PrepStain, reduces the complexity of
    interpretation by providing a homogeneous, more representative
    and standardized thin layer of stained cells and a liquid medium
    for adjunctive laboratory testing of specimens. The FDA approved
    PrepStain in June 1999. In early 2003, we introduced a minor
    modification to the PrepStain slide processor that enables the
    system to be used either for cell transfer, slide preparation
    and staining, or for the cell transfer and preparation of slides
    that may be further processed using a laboratorys free
    standing automated slide staining system. We believe that this
    minor modification should provide more flexibility and
    facilitate the integration of the PrepStain system into
    laboratories whose workflow is organized around a free-standing
    automated slide staining system. The PrepMate system, an
    accessory to PrepStain, is designed to automate pre-processing
    steps in the preparation of SurePath thin-layer slides. PrepMate
    automatically mixes and removes specimens from the SurePath
    preservative fluid vials, and layers the specimens onto the
    SurePath density reagent in a test tube for automated slide
    preparation and staining. The FDA approved the PrepMate
    accessory in May 2001.                                                                                                                                                                                                                                                                                                                                  
|
| |  | FocalPoint Slide
    Profileris a computerized imaging
    system that uses proprietary technology to automatically screen
    SurePath or conventionally prepared Pap smear slides. The
    FocalPoint Slide Profiler, or FocalPoint, can identify those
    slides that have the highest likelihood of abnormality. Formerly
    known as the AutoPap Primary Screening System, FocalPoint was
    approved by the FDA as the first automated device for primary
    screening of conventional Pap smear slides for cancer of the
    cervix and its precursors in May 1998. In October 2001,
    FocalPoint was approved by the FDA to screen SurePath
    liquid-based slides. FocalPoint with Location Guided Screening
    (FocalPoint GS), the next generation FocalPoint system, was
    introduced outside of the U.S. in the fourth quarter of
    2000. FocalPoint GS integrates our proprietary Slide Wizard
    technology into the FocalPoint screening                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

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

Our SlideWizard product line consists of personal
computer-based applications that include (i) the Image
Titer, an FDA-cleared method for automating the measurement of
antinuclear antibody, research applications for DNA,
immunohistochemical quantification, cellular analysis, and
expression quantification, (ii) a system for the
transmission and interpretation of tissue specimens via remote
telecommunications, or telepathology, and
(iii) a software based storage and retrieval system for
microscopic images.

TriPath Oncology

Our TriPath Oncology business focuses on
developing and commercializing molecular diagnostic and
pharmacogenomic products for a variety of cancers. On
July 31, 2001, we entered into a series of agreements with
Becton, Dickinson and Company (BD) to develop and
commercialize these tests for malignant melanoma and cancers of
the cervix, breast, ovary and prostate using genomic and
proteomic markers identified at Millennium
Pharmaceuticals, Inc. (Millennium). In January 2004, the
molecular marker discovery process and transfer of all markers
from Millennium was completed. We intend to use these markers
and related intellectual property to continue to develop and
commercialize tests and other products for these cancers. We
will share commercial responsibilities with BD for any products
that we ultimately develop.

Historically, the cancer diagnostics market has
relied on tests or methods that identify surrogate markers or
cellular abnormalities that are correlated with the presence or
stage of disease, but provide limited information specific to
the disease or patient outcome. In recent years, however,
significant advances have occurred in the analysis and
characterization of cancer from a molecular mechanistic
perspective. Information derived from the analysis of gene and
protein expression differences is providing new insights into
the biology of cancer and is driving the discovery of novel
molecular markers which correlate to the presence and stage of
cancer and to patient outcome. The goal of our molecular
oncology program is to utilize these new discoveries in genomics
and proteomics research to develop and commercialize diagnostic
and pharmacogenomic tests to improve the early detection and
clinical management of cancer. Specifically, we have active
programs in development designed to identify individuals with
cancer at the earliest possible stage of the disease, provide
individualized predictive and prognostic information, guide
treatment selection for patients with cancer, and predict
disease recurrence. The core products and services we are
developing from our collaboration with BD will be based upon
genomic and proteomic markers that were identified through
discovery research conducted at Millennium, under its research
and development agreement with BD. TriPath Oncology will seek to
clinically validate and develop these proprietary cancer markers
into commercial diagnostic and pharmacogenomic oncology products
and services. Commercial responsibilities for any resulting
products will be shared between BD and TriPath Oncology.

The key components of our product development
strategy are as follows:

1. Identify and validate novel molecular marker
panels based upon predetermined clinical specifications based
upon genomic and proteomic markers identified predominantly
through discovery research conducted at Millennium. Utilizing
its proprietary technology and knowledge in genomics and
bioinformatics, Millennium has correlated the presence of
specific genetic sequences, or molecular markers, with a series
of clinical specifications for each of our targeted cancers.
These clinical specifications are based upon current unmet
clinical needs and what we perceive to be a significant
commercial opportunity. Since it is generally accepted that
cancer onset and progression are driven by multiple
inter-related genetic changes, our molecular assays will consist
of panels of molecular markers which will yield molecular
profiles, known as signatures, which are intended to be
descriptive of clinical phenotype and patient outcome.

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2. Format our molecular assay technology into
universally accepted laboratory assays. Our goal is to change
clinical practice, not laboratory practice. Therefore, our assay
technologies will be developed in commercially accepted formats
to facilitate rapid laboratory adoption. The technology format
selection is dependent upon sample type. For early detection
assays, we have chosen an immunoassay format that is capable of
detecting and quantifying multiple secreted proteins in blood.
Staging and prognostic assays will require the quantification of
molecular markers (proteins) within the context of cellular
morphology, and as such, these assays will be formatted in a
standard immunohistochemistry (IHC) assay with colorimetric
bright-field detection. Both formats are based on the detection
and quantification of specific proteins and will thus require us
to generate monoclonal antibodies targeted to each unique
protein. We do this by first translating the unique gene
sequences identified by Millennium into proteins using a number
of protein expression systems, then developing 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.

3. Link the staging and prognostic assays to
our proprietary image analysis technology. We 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.
Furthermore, we believe that tissue architecture, cell
morphology, and precise sub-cellular localization of molecular
markers will be an important tool for accurate cancer staging
and prognosis. Therefore, we intend to adapt our proprietary
image analysis platform to our molecular assays to allow
analysis and quantification of multiple, discrete molecular
markers within the context of tissue distribution and cellular
location.

We introduced an analyte specific reagent for a
laboratory-developed assay for malignant melanoma through our
relationship with AmeriPath, Inc. and provided technical
support for an independent Melastatin clinical utility study
conducted through a collaboration between Albany Medical College
and AmeriPath. The study was successfully completed in December
2003, and the results were presented at the March 2004 Annual
Meeting of the United States and Canadian Academy of Pathology
(USCAP). The study demonstrated that measurement of Melastatin
expression using our assay provides independent prognostic
information that may be useful in the clinical assessment of
melanoma.

We completed marker discovery for all cancer
development programs, including cancer of the breast, cervix,
ovary and prostate, and we have completed the transfer of these
markers from Millennium. We have developed functional prototype
assays to evaluate each markers clinical performance and
have completed the selection of the final marker panel for our
cervical and breast staging assays. We anticipate introduction
of Research Use Only reagents for our breast and cervical
staging programs by mid-year 2004.

We are also leveraging our proprietary imaging
technology to develop new collaborations to expand our
commercial opportunities. In early 2003, we established a
collaborative relationship with Bristol-Myers Squibb Company
(BMS) in which we provided quantitative tissue-based image
analysis in support of a BMS clinical study to assess the
pharmacokinetics and pharmacodynamics of one of their targeted
oncology therapeutics. We used our SlideWizard image analysis
platform and proprietary software applications to provide a
quantitative assessment of tumor marker expression levels from
tissue samples provided by BMS for patients enrolled in a
Phase I clinical trial. The data generated by our work was
used to evaluate patient response across varied dosing levels
based on changes in tumor marker expression levels, both before
and after treatment.

We believe that our proprietary assets and
technologies in imaging analysis, our broad access to novel
molecular markers provided under our relationship with BD and
Millennium, and our in-house expertise and capability in rare
reagent and assay development will provide us with the necessary
technology and expertise to successfully develop improved
diagnostic oncology products. We further believe that the
management of TriPath Oncology as a separate business unit
provides a focused organization and dedicated management team
with top-notch skills and expertise in assay formatting and
development to deliver new oncology products

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to our commercial team which will dramatically
improve the early detection and clinical management of cancer.


The Cancer Market

Cancer is a chronic and complex disease
characterized by uncontrolled growth and spread of abnormal
cells. According to the World Health Organization (WHO), the
worldwide incidence of cancer in the year 2000 exceeded
10 million cases, excluding basal and squamous cell cancers
of the skin. The WHO further estimates that approximately
6.2 million deaths worldwide were attributable to cancer in
2000. In the United States, the American Cancer Society
(ACS) estimates that roughly 1.3 million cases
of non-skin cancers will be diagnosed in 2004, roughly half of
which will occur in women. In the United States, women have
about a 1-in-3 lifetime risk of developing invasive cancer. It
is estimated that in 2004 approximately 668,470 women will be
newly diagnosed with cancer and an estimated 272,810 women will
succumb to the disease. It is anticipated that melanoma and
cancers of the breast, cervix, and ovary will account for over
41% of all cancers diagnosed in women in 2004.

Womens Cancers

2004 Cancer Estimates (U.S.)


|                                  |                    |                          |         |                          |  |  |         |        | 
|--------------------------------- | ------------------ | ------------------------ | ------- | ------------------------ |  |  | ------- | ------ | 
|                                  |                    | Estimated 2004 Incidence |         | Estimated 2004 Mortality
|                                  |                    |                          |         |                         
|All Cancers                       |                    |                          | 668,470 |                          |  |  | 272,810 |       
|TriPath Imaging Targeted Cancers: |                    |                          |         |                          |  |  |         |       
|                                  | Breast             |                          |         | 215,990                  |  |  |         | 40,110 | 
|                                  | Ovarian            |                          |         | 25,580                   |  |  |         | 16,090 | 
|                                  | Malignant Melanoma |                          |         | 25,200                   |  |  |         | 2,860  | 
|                                  | Cervical           |                          |         | 10,520                   |  |  |         | 3,900  | 






| |                                                           
| | ----------------------------------------------------------
| | Source: American Cancer Society, Facts &
    Figures, 2004

Treatments for cancer are expensive and often
ineffective. Current treatments for cancer include surgery,
radiation, and chemotherapy. Surgery is limited in its
effectiveness because it treats the tumor at a specific site and
may not remove all the cancer cells, particularly if the cancer
has spread. Radiation and chemotherapy can treat the cancer at
multiple sites but can cause serious adverse side effects
because they destroy healthy cells and tissues as well as cancer
cells. The ACS projects that in 2004 over 270,000 women will die
of cancer-related illness. Detecting cancer at the earliest
possible stage of disease is critical to patient survival and
outcome as reflected in the following five-year relative
survival rates:

Five Year Disease-Free Survival

by Stage at Diagnosis


|                                  |  |                       |    |                     |  |                        |    |  |  |  |    | 
|--------------------------------- |  | --------------------- | -- | ------------------- |  | ---------------------- | -- |  |  |  | -- | 
|TriPath Imaging Targeted Cancers: |  | Localized Disease (%) |    | Regional Spread (%) |  | Distant Metastases (%)
|                                  |  |                       |    |                     |  |                       
|Breast                            |  |                       | 97 |                     |  |                        | 78 |  |  |  | 23 | 
|Ovarian                           |  |                       | 95 |                     |  |                        | 72 |  |  |  | 31 | 
|Malignant Melanoma                |  |                       | 97 |                     |  |                        | 60 |  |  |  | 14 | 
|Cervical                          |  |                       | 92 |                     |  |                        | 51 |  |  |  | 15 | 






| |                                                           
| | ----------------------------------------------------------
| | Source: American Cancer Society, Facts &
    Figures, 2004

Development and utilization of modalities for
routine cancer screening is critical to early detection.
According to the ACS, whereas the five-year relative survival
rate for all cancers is approximately 63%, the relative survival
rate for currently screened cancers (i.e. including cancers of
the cervix, breast, rectum and skin) is approximately 84%. The
ACS estimates that the relative survival rates of these screened
cancers could

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be further increased to 95% if all Americans were
regularly screened for these cancers. In 2003, the National
Institutes of Health estimated the overall costs for
cancer-related illness in the U.S. to be
$189.5 billion.


We expect the market for cancer diagnostics will
grow substantially due to the increased incidence of cancer, an
aging population, early cancer awareness, pressure to reduce
cancer mortality rates and improvements in healthcare screening
systems. The existing cancer diagnostics market is characterized
predominantly by tests or methods that identify the presence of
surrogate markers of disease, cellular abnormalities or imaging
anomalies that are correlated with the presence or stage of
disease but, for the most part, do little to provide information
specific to the biology of the disease or the outcome of the
patient. The current technologies used in cancer diagnostics
consist primarily of tumor marker immunoassays, cytology
evaluation and imaging techniques such as mammography.

While some of the underlying causes of specific
cancers can be traced to a single genetic alteration, it is now
believed that multiple complex genetic changes underlie the
development of the vast majority of cancers. However, the
identification of genetic anomalies alone is unlikely to prove
clinically significant as many genetic events may have minimal
or no impact on a patients health, whereas others may pose
life-threatening health risks. Determining the interrelationship
of genes and proteins, and their interaction with one another is
likely to be as important as understanding the underlying cause
of the genetic change itself. The scientific communitys
knowledge of these underlying genetic and proteomic factors has
only recently come about through the development of more
sophisticated research and discovery tools, investment in
mapping of the human genome, and development of bioinformatics
capabilities to assess the clinical relevance of these genetic
and proteomic abnormalities.

In recent years, novel molecular oncology tests
have been introduced to provide additional clinical information
previously unavailable to assess an individuals
predisposition or lifetime risk of developing certain cancers.
Molecular tests are also used to screen and assist in the
diagnosis of the presence of disease, to assess patient
prognosis and outcome more accurately, to guide therapeutic
selection in the management of certain cancers and to monitor
for disease recurrence. Molecular tests offer the promise of
providing a more accurate, disease-specific understanding of
cancer to best address the needs of medical practitioners.

Cervical Cancer

Cancer of the uterine cervix, or cervical cancer,
is second only to breast cancer as the most common form of
malignancy in both incidence and mortality worldwide. According
to the WHO the worldwide incidence of cervical cancer in 2000
were 470,606 with a mortality rate of 233,372. In parts of the
developing world, cervical cancer is the major cause of death in
women of reproductive age. The ACS estimates that in 2004
approximately 10,520 cases of invasive cervical cancer will be
diagnosed in the United States with an estimated 3,900 deaths.

Invasive cervical cancer spreads from the surface
of the cervix to tissue deeper in the cervix or to other parts
of the body. Cervical cancer develops in stages over a period of
time beginning with pre-invasive changes that eventually
progress to invasion. Because of the progression to invasion,
most deaths due to invasive cervical cancer can be prevented
with early-stage detection and treatment. Early detection is
critical in promoting patient wellness. The more advanced the
cancer, the lower the chances are of managing and/or curing the
patient. Thus, regular cervical screening examinations are
recommended in the United States and many foreign countries.

The Conventional Pap Smear

Worldwide, the conventional Pap smear is the most
widely used screening test for cervical cancer. This test was
developed by Dr. George N. Papanicolaou in the 1940s
and has essentially remained unchanged until the advent of
liquid-based cytology and automated computer primary screening.
The Pap smear detects pre-cancerous lesions before they invade
the cervix while they are 100% curable. It is estimated that
clinical laboratories in the United States perform over
50 million Pap tests annually. We believe that annual test
volume outside of the United States is in excess of
80 million. Of the 50 million annual Pap tests
performed in the United States, industry sources estimate that
approximately 3.5 million, or seven percent, are diagnosed

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with a cytological abnormality requiring
additional follow-up or evaluation. (Jones BA, Davey DD. Quality
Management in gynecological cytology using interlaboratory
comparison. Arch Pathol Lab Med 2000; 124:672-681)


In the U.S., although widespread and regular use
of the conventional Pap smear has contributed to a greater than
70% decrease in deaths resulting from cervical cancer, the death
rate from the disease has declined at a rate of only
approximately 1.6% per year. We believe that despite the
success of the conventional Pap smear as a diagnostic tool,
there are practical limitations to this test which contribute to
in excess of $5.0 billion in annual costs. These costs are
associated with the treatment of advanced pre-cancerous and
cancerous cervical disease. Additional costs are also incurred
by third-party payors due to repeat testing for poor quality
smears and by clinical laboratories due to litigation associated
with inaccurate diagnoses. The introduction of liquid-based
cytology has improved specimen adequacy and automated computer
screening has improved diagnostic accuracy.

The evaluation of conventional Pap smears
involves the science of cytology, which includes the microscopic
evaluation and interpretation of pre-cancerous and malignant
morphological changes in cells. The process begins with the
collection of cervical cells during a gynecologic pelvic
examination. To obtain a Pap smear, a clinician uses a sampling
device to scrape the surface of a womans uterine cervix to
collect a sample of cervical cells. If the conventional Pap
smear method is used, this sample is smeared onto a microscope
slide and the sampling device is discarded. If our SurePath
liquid-based method is used, the head of the collection device
itself is placed into a vial containing our transport and
preservative solution and the cells are suspended in this liquid
medium.

After the cervical sample is taken, the sample
and patient information are sent to a clinical laboratory for
further processing, screening and diagnosis. A cytotechnologist
who is specially trained to evaluate cell changes screens and
interprets the slide using a microscope. Any abnormality is
further reviewed by a medical doctor or pathologist.

Typically, about 90% to 95% of all Pap smears are
classified as normal. Pap smears classified as other than normal
specify the degree of abnormal change. For example, atypical
cells, commonly referred to as atypia, represent the
least significant change with a very low likelihood to progress
to cancer if left untreated. They are generally classified as
ASC-US, which refers to atypical squamous cells of
undetermined significance; or ASC-H, which refers to
atypical squamous cells- cannot exclude a high-grade lesion. The
next classification is LSIL, which is defined as
low-grade squamous intraepithelial lesions, encompassing
HPV/mild dysplasia/ CIN 1 which has a slightly higher likelihood
of progressing to cancer if left untreated but overall is still
relatively low. CIN refers to cervical
intraepithelial neoplasia, and is categorized as CIN 1, CIN 2,
and CIN 3. HSIL, is defined as high-grade squamous
intraepithelial lesions, encompassing moderate and severe
dysplasia, CIN 2 and CIN 3, and represents changes that
biologically have the highest likelihood of progressing to
cancer if left untreated. The most serious classification is the
diagnosis of cancer itself. Optimally, the Pap tests
objective is to detect the atypical to HSIL lesions as well as
early invasive cancer so the lesion can be treated and the
patient cured.

Limitations of the Conventional Pap Smear Test
Process

Each conventional Pap smear slide sample
typically contains 50,000 to 300,000 cervical cells. The process
of manually screening and interpreting a conventional Pap smear
requires intense visual examination of the slide sample through
a microscope. Because abnormal cells are not always easily
visualized or recognized, errors may occur and abnormal cells
may not be seen by the cytotechnologist or may be misinterpreted
during the microscopic review process. Abnormal cells can be
obscured by blood, mucus or white blood cells making them
difficult to find and interpret. Other factors such as
air-drying distort the cells, resulting in normal cells being
misinterpreted as abnormal, or abnormal cells being
misinterpreted as normal. Most of these limitations are a result
of poor specimen quality and have been shown to be minimized by
using a liquid-based collection method.

Pap smears also have a highly variable
false-negative rate. A false-negative results when the patient
actually has evidence of disease but the Pap smear is reported
as negative. False-negative rates of the

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conventional Pap smear vary widely among
laboratories. For example, false-negatives have been reported to
range from 2% to 28% according to studies at both Mercy Hospital
in Janesville, Wisconsin and at Newport Hospital in Rhode Island
and have been reported in the range of 10% to 45% by the
Clinical Preventive Services, U.S. Factors that contribute
to false-negative results vary but have been shown to depend on
the skill and experience of the practitioner who collects the
sample and prepares the slide. In addition, studies (Howell, L.
et. al. The AutoCyte Preparation System for Gynecologic
Cytology, Acta Cytol, Jan-Feb 1998 Vol. 42(1)) suggest that the
highest percentage of false-negative diagnoses are the result of
inadequacies in sample collection and slide preparation. In this
situation, the abnormal cells are either not collected properly
on the sampling device or are collected properly on the sampling
device but are not transferred properly to the microscopic glass
slide. Other causes of false-negatives are attributable to
detection and interpretation errors where abnormal cells are
present on the Pap smear but they are either not seen at all, or
are seen but interpreted as negative.


A study published in 1992 in Acta Cytologica
reported that with a conventional Pap smear as much as 80% of
the sample taken from a patient may not be transferred to the
slide and remains on the discarded collection device
(Hutchinson, M. Patten FW, Stetzer GT, et.al.). In addition
to inadequate cell transfer, the conventional Pap smear slide
preparation process may produce inconsistent and non-uniform
slides with extreme variability in quality, often making
examination difficult. If a Pap smear is interpreted as
unsatisfactory or less-than-optimal because of poor quality
sampling or because of obscuring factors, the clinician may be
prompted to call the patient back for a repeat test. A study
conducted with the SurePath liquid-based collection method and
published in 2003 in the Journal of Lower Genital Tract Disease
(Bigras, G. et.al. Vol. 7, No. 3: 168-174) found that
up to 37% of cellular material may be lost when the collection
device is discarded after a rinsing method for cell collection
is used. However, while that study employed a rinsing method for
cell collection, SurePath labeling requires that the collection
device be retained in the shipment vial ensuring that all of the
collected cells are sent to the laboratory for processing. The
Bigras study states that, while further investigations are
necessary, it is reasonable to optimize the sampling process by
simply placing the collection device in the shipment vial.

When using the conventional Pap smear process, a
physician is unable to perform additional testing using the
original patient sample. If additional testing is required, the
patient must return to the physicians office to provide a
second sample. This can cause a great deal of stress in the
patient, thereby potentially reducing the accuracy of the second
sample. To address these concerns, the SurePath method
statistically, significantly decreases unsatisfactory cases.
Also, the SurePath liquid-based collection method allows the
laboratory access to the remaining cellular material from the
original patient sample. Repeat and ancillary testing from the
residual cell solution may provide a more cost effective patient
management program for inconclusive Pap smear tests, and may
reduce a patients stress and anxiety associated with
repeat testing.

Due to the inherent limitations of the Pap smear
screening process, a number of notable lawsuits were filed in
the 1980s on behalf of women who died of cervical cancer and
whose Pap smears, initially classified as normal, were
subsequently determined to contain abnormal cells and, if
classified differently, may have led to treatment that would
have prevented death. These actions raised medicolegal concerns
related to the inherent false-negative rate of Pap smears
described above, resulting in a significant increase in the
number of Pap smears categorized as either ASC-US, AGUS or LSIL.
Consequently, the number of colposcopy procedures increased
dramatically leading to increased health care costs up to 80% of
the procedures performed do not uncover underlying HSIL or
cancer. To respond to this need by detecting abnormalities
sooner, tests for the detection of human papillomavirus have
become increasingly utilized for women with ASC-US pap results
because nearly all cervical cancers are directly linked to one
or more types of this virus.

Human Papilloma Virus

Human Papilloma Viruses, or HPVs, comprise a
group of more than 70 types of viruses. Certain (non-cancerous)
HPV types cause the common warts that grow on hands and feet and
those that develop in the mouth and genital areas. Genital HPVs
can be passed from one person to another through sexual
intercourse and oral or anal sex. Certain genital HPV types,
called high risk HPV types that include HPV-16,
HPV-18,

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HPV-31, HPV-45, as well as some others, are
implicated in the promotion of abnormal cell development in the
cervix that could potentially lead to the development of
invasive cervical cancer. In fact, it has been documented that
nearly all cervical cancers (99.7%) are directly linked to
previous infection with one or more of the oncogenic
(cancer-inducing) types of HPV (Judson 1992; Walboomers et. al.
1999).


Whereas the vast majority of cervical disease can
be traced to an underlying HPV infection, identification of
infection, even with a high-risk type, in and of itself is not
predictive of cervical disease. HPV is the most prevalent
sexually transmitted infection in the world, occurring at some
point in up to 75% of sexually active women (Groopman 1999).
Although HPV infection is widespread, few people even know they
are infected because they seldom have noticeable symptoms. While
women usually are infected shortly after they become sexually
active in their teens, twenties or thirties, progression to
cervical cancer generally takes place over a period of 10 to
20 years. In rare instances, some early lesions can become
cancerous over a shorter time interval such as a year or two.

It is estimated that for every one million women
infected with HPV, about 10% will develop pre-cancerous changes
in their cervical tissue (dysplasia). Of these, about 8% will
develop early cancer limited to the outer layers of the cervical
cells (carcinoma in situ,or CIS) and roughly 1,600 will
develop invasive cancer unless the pre-cancerous lesions and CIS
are detected and treated. Finally, women with active infection
can transfer the virus to their newborn (vertical transmission)
during delivery, which can result in papilloma virus infection
in the neonate and possible subsequent laryngeal papillomatosis
(Cason, Rice and Best 1998).

In most cases an active infection is controlled
by the immune system and with time becomes dormant. However, it
is not possible to predict whether or when the virus will become
active again. For example, one recent study followed more than
600 female university students who were tested every
6 months (Groopman 1999). Over the course of three years,
new HPV infections occurred in more than 40% of the women. Most
of the infections lasted about eight months and then subsided.
After two years, however, about 10% of the women still carried
active virus in the vagina and cervix. In this study, the
persistent infections were most commonly associated with the
virulent, cancer-linked types of viruses.

As noted, studies indicate that persistent
infection with cancer-causing HPV types is a precursor to the
development of cervical cancer. A positive test for high-risk
HPV is more meaningful in women over 30 years of age.
Clinical studies have shown that approximately 20% of women
age 30 and older with cancer-causing HPV have high grade
cervical disease. Additionally, women age 30 and older with
persistent HPV infection and who do not have associated cervical
disease are considered at significant risk of developing
cervical disease in the future.

On April 24, 2002, the Journal of the
American Medical Association, or JAMA, published Consensus
Guidelines recommending testing for HPV in the management of
women with ASCUS-US Pap test results. These new 2001
Consensus Guidelines were sponsored by the American
Society for Colposcopy and Cervical Pathology, or ASCCP, and
state that for managing women with ASCUS-US results, HPV testing
is the preferred approach when it can be performed
directly from a liquid-based Pap test, also known as
reflex HPV testing, or when the HPV testing specimen
can be co-collected during the initial office visit.

Limitations of HPV Testing

Over the past three years, HPV testing has gained
clinical acceptance in the U.S. for supplemental testing of
women for whom the results of primary cervical cytologic
screening are atypical, or ASC-US, but of uncertain significance
and not clearly diagnostic of pre-malignant or malignant
disease. Supplemental testing with HPV provides guidance as to
how these patients should be managed. A negative HPV test is
highly predictive of the absence of pre-malignant or malignant
cervical disease, and, therefore, is said to warrant no further
action. A positive HPV test is said to warrant further
examination including colposcopy. HPV infection rates in young
women, (i.e. less than 30 years of age), have been shown to
be as high as 75% in certain populations thereby limiting the
utility of the test for women of all ages. In addition, the high
positive rate in women with a cytology diagnosis of LSIL limits
the value of the test in this subset of patients, as well.

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Attempts have been made to promote HPV testing
without concurrent examination of cervical cytology as a primary
screening tool for cervical cancer in some countries outside the
U.S. where the infrastructure to interpret cervical
cytology slides is lacking. This approach is unlikely to be
utilized in the U.S. and other markets where cytology screening
capability exists, particularly given the high prevalence of HPV
in women less than 30 years of age.

In March 2003, the FDA approved a submission by
Digene® Corporation, the manufacturer of the only currently
FDA approved test for HPV, called the hc2 High-Risk HPV DNA
Test, for the use of that test as a primary adjunctive cervical
cancer screening test to be performed in conjunction with the
conventional Pap test for women age 30 and older. This test
is also referred to as the DNAwithPap Test. Recent
prospective trials conducted by the National Cancer Institute
(NCI) suggest that routine screening of HPV DNA combined
with cytology would result in the greatest detection of cervical
dysplasia. However, while a negative HPV test result is highly
predictive of the absence of pre-malignant or malignant cervical
disease, the predictive value of a positive HPV test result may
be limited because HPV testing cannot distinguish
non-progressive infection from infections that would benefit
from therapy.

Breast Cancer

With an estimated incidence of over one million
new cases per year, cancer of the breast is the most common
womens cancer in the world, accounting for 22% of all new
cases diagnosed. On a worldwide basis, breast cancer is the
leading cause of cancer mortality in women, representing an
estimated 14% of all cancer-related deaths in females.

The ACS estimates that in 2004, approximately
215,990 new cases of invasive breast cancer will be diagnosed
among women in the United States, with an estimated 40,110 women
dying of the disease. Breast cancer incidence increases with
age, and although significant progress has been made in
identifying women considered to be at high risk of developing
the disease, more than 50% of breast cancer occurs sporadically
in women with no known risk factors. According to the NCI, the
overall five-year survival rate for women diagnosed with breast
cancer is 86%. Early detection is paramount as the relative
survival rates vary significantly 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 of patient self-exam, clinical breast exam and
mammography. These methods are complementary and are not used as
stand-alone techniques. Film imaging mammography is the gold
standard for breast cancer screening and currently represents
the most effective means of early detection of breast cancer
with a sensitivity ranging from 54.0% to 94.0% and a specificity
ranging from 83.0% to 98.5%. More specifically, studies show
that mammography sensitivity ranges from 54.0% to 58.0% in women
under age 40 and from 81.0% to 94.0% in women over 65.
The primary purpose of mammography screening is the detection of
an abnormality. Numerous studies have shown that early detection
saves lives and provides more treatment options. For this
reason, annual screening by mammography is recommended for women
over age 40 in the U.S. and many foreign countries.

According to data from the 2000 Behavioral Risk
Factor Surveillance System (BRFSS), the percentage of
U.S. women aged 40 and older who had a recent
mammogram was 62.6%. Of the 32.5 million screening
mammograms currently performed in the U.S., approximately four
million indicate some form of abnormality requiring further
follow-up. Once an abnormality is detected on initial screening,
the need for a very sensitive and specific assay to detect early
breast cancer becomes critical. Although follow-up diagnostic
imaging and ultrasound may provide greater image clarity,
neither is able to distinguish between a benign condition and a
malignancy. Of the estimated 1.2 million breast biopsies
performed in the U.S., roughly 80% yield no form of malignancy
resulting in an estimated cost of $3.3 billion related to
unnecessary biopsies. (HCA Cancer Care, Nov 2002.
Informational Guide to Breast Cancer).

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Breast Cancer Staging and Treatment

Once breast cancer is diagnosed, it is staged,
(i.e. I, II, III or IV) based on a number of
factors including tumor pathology (T), nodal
involvement (N) and distant metastasis (M). In the
U.S., approximately 55% to 60% of newly diagnosed invasive
breast cancer is detected at a relatively early stage (i.e.
small tumor size and with no or minimal nodal involvement).

Although the TNM classification
system is useful in staging patients for follow up and
treatment, it is based solely on the morphologic features of the
tumor and its degree of spread and, thus does not take into
consideration the biologic make up of the cancer. The clinical
course of primary breast cancer varies from patient to patient.
Predicting which individuals are cured and which are not remains
difficult for both lymph node negative and lymph node positive
breast cancer patients. Clinicians are well aware that some
patients who have poor TNM scores have long disease-free
survival times, whereas others with good TNM scores experience a
rapid deterioration with early recurrence of breast cancer
followed by death. At best, current prognostic indicators serve
as guides for clinical decisions that require considerable
judgment.

Once the cancer is staged, treatment decisions
are typically made by an oncologist in consultation with the
patient and will take into consideration the patients age
and preferences, as well as the risks and benefits associated
with each treatment protocol. Nearly all women with breast
cancer have some form of surgery combined with other treatments
such as radiotherapy, chemotherapy, hormone therapy and/or
monoclonal antibody therapy. Prognostic tests for the
determination of estrogen receptor (ER), progesterone
receptor (PR) and her2/neu status have become standard of
care for selecting subsets of patients most likely to benefit
from certain hormone and monoclonal antibody therapies.

Post-Therapy Recurrence

In general, it has been widely assumed that early
detection of any cancer, whether as a new primary malignancy or
as a recurrence, leads to more effective therapy. As with
screening, the ability to detect small tumors and early
progression in asymptomatic situations is paramount to positive
outcomes. However, the recurrence rate can be as high as 25% to
30% within the first five years after diagnosis, even in
patients with good TNM scores.

Presently, a large number of markers exist for
the monitoring of breast cancer. These include
MUC-1 (CA15-3), carcinoembryonic antigen (CEA),
oncoproteins, milk proteins and cytokeratins. Of these, 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 these markers range in
sensitivity for Stage I disease of 9% to 10%, Stage II
of 19% to 54%, Stage III of 31% to 54% and Stage IV of
64% to 75%. Additionally, ASCO notes that CA15-3 exhibits a
limited sensitivity for detecting low tumor burden, when
treatments are most likely to be beneficial. Currently, only 20%
to 30% of recurrences are detected before the onset of symptoms.

Ovarian Cancer

Ovarian cancer is only the seventh most common
cancer in women with an estimated 192,379 cases diagnosed
worldwide in 2000, but it is among the most deadly. In the U.S.,
the five-year relative survival rate is only 53% for all women
diagnosed with ovarian cancer. According to the NCI, the five
year relative survival rate for localized ovarian cancer is
94.9%, but only 81.4% if the cancer has spread regionally, and
only 30.9% for women with distant metastases.

Ovarian cancer has been shown to be a clonal
disease in approximately 90% of cases suggesting that most
cancers could, in fact, be detected before they have
metastasized. Due to the lack of an adequate screening test, and
to the fact ovarian cancer is asymptomatic until the cancer has
progressed to a late stage, approximately 75% of newly diagnosed
patients are in advanced to late stages III and IV.

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Ovarian Cancer Screening

The effectiveness of routine screening of
asymptomatic women using pelvic examination, abdominal or
vaginal ultrasound or serum carcinoembryonic antigen (CEA-125)
has not been established. The ACS recommends annual pelvic
examinations for women starting at age 18 or at the onset
of sexual activity. In 1994, a National Institutes of Health
Consensus Conference on Ovarian Cancer concluded that there is
no evidence that screening with currently available modalities,
including CEA-125 and/or transvaginal ultrasound can be used
effectively to decrease ovarian cancer mortality or morbidity.

Currently, screening for ovarian cancer typically
occurs in one of 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. An even greater number
    of 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 of ovarian cancer would require that major abdominal
surgery (laparoscopy and/or laparotomy) be performed, as this is
the only means of a definitive diagnosis. Because of the low
incidence of ovarian cancer and the necessity of major abdominal
surgery, a screening program requires high accuracy with a high
specificity to minimize morbidity associated with major
abdominal surgery.

Malignant Melanoma

Although melanoma accounts for only a fraction of
all skin cancers diagnosed, it is by far the most serious.
Unlike the more common and curable basal cell and squamous cell
skin cancers, melanoma accounts for roughly 75% of all skin
cancer-related deaths. In 2000, the WHO estimated that 67,425
cases of melanoma were diagnosed in women and 17,045 female
deaths were attributable to this deadly disease. In 2004, an
estimated 25,200 women in the U.S. will be diagnosed with
melanoma and 2,860 are expected to die of the disease.

The overall five-year relative survival rate of
patients diagnosed with melanoma is 89% according to the ACS.
Because melanoma develops from biological changes in pigmented
lesions such as moles, early signs of melanoma development can
usually be seen through changes in the size, color or texture of
the lesion. As a result, about 82% of melanomas are diagnosed at
an early or localized stage where the five-year relative
survival rate approximates 96%. Survival rates drop considerably
to 60% and 14% for melanomas that have spread to regional nodes
or to distant organs, respectively.

Melanoma Staging and Treatment

Once melanoma is suspected, the lesion and
surrounding tissue are excised. Once diagnosed, biopsy of the
surrounding (sentinel) lymph nodes is common to determine
the degree of spread of disease. Like most cancers, melanomas
are staged, i.e. I, II, III or IV, based on a
number of factors including tumor pathology, nodal involvement
and distant metastasis, or the TNM classification system
discussed above. Prognostic factors such as tumor thickness
(Clark Score), mitoses and ulceration are among the criteria
used in tumor grading. Although the TNM classification system is
useful in staging patients for follow up and treatment, it is
based solely on the morphologic features of the tumor and its
degree of spread and, thus does not take into consideration the
biologic make up of the cancer.

Predicting which individuals are cured and which
are not remains difficult, as up to 20% of individuals with thin
lesions may relapse within five years. As with other types of
cancer, some patients who have poor

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TNM scores have long disease-free survival times,
whereas others with good TNM scores experience a rapid
deterioration with early recurrence of melanoma followed by
death. At best, current prognostic indicators serve as guides
for clinical decisions that require considerable judgement.


In addition to the standard treatment for
malignant melanoma, which includes adequate excision of the
primary tumor and may require removal of surrounding lymph
nodes, advanced cases are treated with chemotherapy or
immunotherapy. Although a number of markers have been studied to
determine their utility in predicting which patients with early
stage disease have biologically aggressive disease and,
therefore should be treated more aggressively, determination of
Melastatin mRNA expression levels appears to be the most
promising.

Our Products

The i3 Series Product
Line

Our i3 Series product line of
cervical cytology products is intended to address the current
limitations of the conventional Pap smear process and the lack
of automation in the typical cytopathology laboratory. The
products in our i3 Series product line work
together as part of an integrated system for the collection,
preparation, staining and computerized analysis of liquid-based,
thin-layer Pap preparations and the screening of conventional
Pap smears. The exponent 3 suggests the expertise
contributed by each of our three predecessor companies, AutoCyte
Inc., NeoPath Inc. and Neuromedical Systems, Inc., as well
as the value of these component products in providing
intelligent identification through innovation. Within the
i3 Series line, individual products were
renamed in 2001 to better communicate the value they provide to
the physician, patients and laboratory professionals. Our
i3 Series line of cervical cytology products
includes the SurePath Test Pack, a proprietary, liquid-based
cytology sample collection, cell preservation and transport
system, the PrepStain slide processor, an automated slide
preparation system that produces slides with a standardized,
thin layer of stained cervical cells, and the FocalPoint Slide
Profiler which utilizes proprietary technology to distinguish
normal liquid-based or conventional Pap smears from smears that
have the highest likelihood of abnormality.

The SurePath Test Pack

Our SurePath Test Pack consists of the SurePath
liquid-based Pap test, a sample collection vial, proprietary
preservative solution and sample collection device. During a
clinical exam, a physician or nurse will collect a sample of
endocervical and ectocervical cells, currently using a cervical
broom collection device. Once collected, the health practitioner
detaches the removable head of the collection device and places
it into the vial containing our proprietary SurePath
preservative fluid, thereby retaining all of the cells
collected. The lid of the vial is then fastened and the vial is
then transported to a clinical laboratory for follow-on
processing on the PrepStain system.

An independent study conducted with the SurePath
liquid-based collection method and published in the ASCCPs
Journal of Lower Genital Tract Disease (Bigras, G. et al,
April 2003, Vol. 7(3):168-174) found that up to 37% of
cellular material may be lost when the collection device is
discarded after using a rinsing method for cell collection. The
study states that, while further investigations are necessary,
it is reasonable to optimize the sampling process by simply
placing the collection device in the shipment vial.

Although SurePath has been FDA-approved for use
with a cervical broom collection device, we initiated clinical
trials in the third quarter of 2002 to evaluate the safety and
efficacy of alternate sample collection devices, including the
cervical spatula and endocervical brush. In November 2003, we
submitted new clinical data to the FDA to expand claims for the
SurePath liquid-based Pap test for cervical cancer screening. In
a supplemental filing to the Companys PMA supplement of
its liquid-based cytology system, we submitted data from a
prospective, paired sample clinical study to demonstrate that a
spatula/endocervical brush combination is as effective as the
currently approved broom-type collection device in transferring
representative cervical material from the sampling device to the
SurePath preservative fluid. We hope to receive FDA approval for
clinical use of these alternative collection devices in the
first half of 2004. There can be no assurance, however,

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that such approval will be obtained during the
first half of 2004, if ever, or that if approved, there will be
market acceptance of the alternate devices contemplated by our
clinical studies.


During the second quarter of 2003, we initiated
data collection to support a submission to the FDA for approval
for HPV testing using the Digene Hybrid Capture® 2 HPV
DNA Test on cells collected using our SurePath Test Pack. We
expect to submit our results from this clinical trial to the FDA
within the first half of 2004. There can be no assurance,
however, that such a submission will be made during the first
half of 2004, if ever, or that such a submission, if made, will
gain approval for the combined use of our products from the FDA.

The PrepStain System

Our PrepStain system consists of proprietary
reagents, plastic disposables and automated equipment for
preparing a thin-layer of cervical cells on a SurePath
microscope slide. Once received in the laboratory, the sample is
thoroughly mixed, resulting in an homogenized and randomized
cell suspension which is removed from the vial and layered onto
a proprietary liquid density reagent in a plastic centrifuge
tube using our patented syringe device. Batch density gradient
centrifugation is then conducted on the cell suspension to
remove excess blood, inflammatory cells and other debris from
the sample.

Once centrifugation is completed, the laboratory
technician places the centrifuge tubes containing the separated
diagnostic cells onto an automated pipetting system. This
pipetting system then distributes the cervical cells in a
thin-layer on the microscope slide. At this stage, discrete
staining of the slides can be carried out by the PrepStain
system, or staining can be performed off-line from the PrepStain
using alternative staining instrumentation. PrepStain is
currently capable of preparing approximately 48 discretely
stained or 96 unstained thin-layer slides in approximately one
hour. A SurePath slide typically contains approximately 50,000
to 100,000 diagnostic cells that are distributed uniformly over
a 13-millimeter diameter circle.

We have also developed an automated accessory to
the PrepStain system called PrepMate that reduces the number of
manual preparation steps required on the PrepStain system. The
PrepMate accessory is intended to reduce the time required to
prepare samples for processing on the PrepStain instrument. The
FDA approved PrepMate for use in the U.S. in May 2001.

In June 1999, as a condition of the approval of
the PrepStain system by the FDA, we were required to report
results of a direct to vial study of PrepStain in our periodic
post-approval reports. We worked in collaboration with the FDA
to design the clinical study protocol and subsequently initiated
the study following FDA approval of the protocol in August 2000.
In October 2002, the FDA approved our request for early
termination of this post-approval study based on the strength of
the data collected. In its approval order, the FDA stated that
it considered the conditions for approval to have been satisfied.

We believe that SurePath and PrepStain offer the
following advantages over the conventional Pap smear process:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | More Complete Sample
    Collection.Because the clinician
    places the collection device directly into the SurePath vial,
    the entire patient sample is contained in our preservative
    fluid. In a conventional Pap smear process, as much as 80% of
    the cervical sample can be inadvertently discarded with the
    disposable collection device after smearing the sample onto the
    slide. One study conducted with the SurePath liquid-based
    collection method found that up to 37% of cellular material may
    be lost when the collection device is discarded after using a
    rinsing method for cell collection. (Bigras, 2003)
|
| |  | Improved Sample
    Quality.By eliminating variations in
    preparation techniques and the fixative spraying step from the
    sample collection process, PrepStain virtually eliminates
    air-drying, generates a more complete fixation, and provides a
    more standardized preparation process in a controlled laboratory
    environment. This more uniform cell sample distribution also
    reduces cell clumping and obscuring from debris.                                                                                                                                                                                                    
|
| |  | Automated and Discrete Staining
    Function.PrepStain includes a
    discrete, or individualized, slide staining function performed
    by a computer-controlled robotic pipetting station. Unlike
    conventional                                                                                                                                                                                                                                                                                                                                                                                                                                       

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | Pap smear slides that are often manually stained
    in a batch process using common reservoirs of staining reagents,
    PrepStains staining reagents are directly applied to
    individual slides. As a result, staining reagents are not shared
    among slides. We believe this reduces the risk of
    cross-contamination among cell samples that can lead to
    inaccurate diagnoses.                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | Staining
    Flexibility.In early 2003, we
    introduced a minor modification to the PrepStain system that
    allows the system to be used for cell transfer, slide
    preparation and staining or for the cell transfer and
    preparation of slides that may be further processed using a
    laboratorys existing free-standing automated slide
    staining system. This provides flexibility and facilitates the
    integration of the system into laboratories whose workflow is
    organized around a free-standing automated staining system.                                                                                                                                                                                                                                                                                                    
|
| |  | Multiple Testing
    Capability.Because our proprietary
    SurePath preservative system enables the patient sample to be
    preserved for four weeks at room temperature and six months if
    refrigerated, it permits, if necessary, preparation of several
    slides from a single sample. We believe that the ability to
    perform adjunctive slide-based tests using a single sample,
    together with the improved quality of the slide itself, will
    reduce re-testing expenses typically associated with
    inconclusive Pap smear tests. We will evaluate use of the
    residual patient sample for other diagnostic protocols such as
    HPV testing, infectious disease testing and application of
    specific tumor markers. Residual sample testing will require FDA
    approval if and when such testing is determined to be viable.

FocalPoint Slide Profiler

The FocalPoint Slide Profiler is an automated,
computerized primary interpretation system designed to
distinguish between normal and abnormal Pap smears. FocalPoint
was approved by the FDA in May 1998 as a primary screening
device for conventional Pap smear slides. In October 2001, the
FDA approved the use of FocalPoint as a primary screening device
for our SurePath thin-layer slides prepared by PrepStain.
FocalPoint uses visual intelligence algorithms to improve
accuracy in the primary screening of conventional Pap smear
slides and our SurePath thin-layer slides. As approved by the
FDA, FocalPoint identifies up to 25% of slides as negative for
intraepithelial lesions or malignancies and requiring no further
review (also referred to as sort rate or no
further review rate). Cytotechnologists then manually
screen the remaining slides with the assistance of
FocalPoints ranked review report. This ranked review
report shows the relative scores of the remaining processed
slides. At least 15% of the highest-ranking slides that are
classified normal by manual review then undergo quality control
re-screening. Outside the United States, FocalPoint is used, in
some instances, to identify up to 50% of slides as within
normal limits.

FocalPoint works with a range of staining
procedures used on conventionally-prepared Pap smear slides.
FocalPoint analyzes a Pap smear in about five to six minutes,
holds 288 Pap smear slides at once, is easy to load and unload
and can operate continuously with minimal intervention for up to
24 hours per day. We provide each clinical laboratory with
on-site training, system documentation, a comprehensive quality
assurance program and ongoing customer and technical support.

FocalPoint GS

In the fourth quarter of 2000, we launched
FocalPoint GS, the next generation FocalPoint system for use
outside the United States. FocalPoint GS uses Location Guided
Screening to further improve the screening process by automating
the microscopic analysis of SurePath thin-layer slides or
conventional Pap smears designated for further review by the
FocalPoint Slide Profiler. FocalPoint GS integrates our
SlideWizard technology into the FocalPoint screening process.
The FocalPoint instrument is interfaced to our SlideWizard
platform and networked to one or more commercially available
microscopes that have been equipped with computer-controlled
automated stages for fast relocation of fields of
interest on microscopic slides. During the initial
screening process, and for each slide screened, FocalPoint GS
identifies and stores a pre-set number of fields of
interest in which it has calculated a higher probability
of abnormality. The FocalPoint GS communicates the location
coordinates of the fields of interest to the
computer controlled microscope stage via the SlideWizard
platform. The fields of interest are electronically
highlighted and located for easy identification. This
facilitates a focused microscopic review and allows the
cytotechnologist to quickly analyze

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the slide for the presence of cellular
abnormality. Abnormal findings thus identified can be confirmed
by full microscopic review. If no abnormality is identified
during this rapid cytologic assessment, no further review is
required.


We believe the established quality of the
FocalPoint algorithms, coupled with the highly focused nature of
location-guided screening, allow laboratories to improve
quality, increase capacity by up to 200% and alleviate backlogs
and/or labor shortages. To date, the FocalPoint GS has been used
to screen over 3 million slides outside of the U.S.

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

SlideWizard Product Line

Our SlideWizard product line consists of personal
computer-based applications focused on the quantification of the
nuclear DNA content of cells and the detection and
quantification of specific molecules in cells or tissue sections
(immunohistochemistry and immunocytochemistry assays), the
management and archiving of images and patient information, the
exchange of data via telepathology and the creation of
comprehensive 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;             
|
| |  | A system that quantitatively assesses the amount
    of up to three different absorption stains within the same
    microscopic slide, with some of the stains normally being
    related in a quantitative way to specific marker expressions;
|
| |  | 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.                                                                                                                                                                                    

In November 1995, we received pre-market
notification, or 510K, clearance by the FDA to market the
ImageTiter for automating antinuclear antibody testing. Our DNA
and immuno-quantification applications are presently offered
For Research Only in the United States. We currently
do not meet the InVitro Diagnostics Directive requirements to
sell and place the SlideWizard applications in Europe (except
combined with the FocalPoint GS). A SlideWizard workstation is
also a component of the FocalPoint GS system that is currently
sold only outside the United States. We expect to develop
additional applications or modules in the field of tissue
diagnosis and prognosis to run on the proprietary SlideWizard
platform. We may elect to pursue regulatory clearance to market
in the U.S. additional SlideWizard applications currently
under development or developed by us in the future.

Molecular Diagnostics Products

We are developing oncology products and services
derived from our collaboration with BD. These products and
services, if any, will be based upon genomic and proteomic
markers identified through discovery research conducted at
Millennium under its research and development agreement with BD.
In January 2004

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the molecular marker discovery process and
transfer of markers for malignant melanoma and cancers of the
cervix, breast, ovary and prostate from Millennium was
completed. TriPath Oncology is clinically validating and intends
to develop these proprietary cancer markers into commercial
diagnostic and pharmacogenomic oncology products and services.
Commercial responsibilities for any resulting products will be
shared between BD and TriPath Oncology.


Cervical Staging Assay

The focus of the cervical oncology program is to
develop and commercialize highly sensitive and specific novel
protein targets for the direct detection of pre-invasive
high-grade disease (CIN2/3 and CIS) and invasive cervical cancer
independent of age and HPV infection status. By attaining a high
level of clinical performance for both sensitivity and
specificity, we believe that the resulting assay may improve the
predictive value of both HPV and cytologic screening and, as a
result, will reduce false-positive referrals to colposcopy while
maintaining a high level of detection of high-grade disease and
cervical cancer as compared to the current clinical standards.
Addressing this medical decision point could lead to a
substantial cost savings for the health care system, which we
estimate at up to $2.3 billion per year as well as a
reduction in morbidity and discomfort associated with
unnecessary medical procedures.

Breast Cancer Screening Assay

We are developing reagents for screening of
breast cancer. Our goal is to develop a test that will be a
blood-based, quantitative immunoassay targeted at the
identification of multiple proteins specific for early stage
breast cancer. We believe that by distinguishing those women who
have an underlying malignancy from those who do not will lead to
reduced morbidity associated with the avoidance of unnecessary
biopsies and result in significant savings to the health care
system.

Breast Cancer Staging Assay

We are developing reagents for a slide-based test
to quantify protein expression for multiple cancers for staging
of breast cancer. Our goal is to develop a test that is
formatted for slide-based immunohistochemistry and will utilize
our proprietary imaging technology to quantify protein
expression for multiple cancer markers. We believe that such a
test would provide oncologists with a more accurate approach to
determine which patients are at highest risk of recurrence and
require more aggressive treatment. Although a high percentage of
early stage breast cancer patients are treated with adjuvant
chemotherapy, a more accurate prediction of direct tumor
behavior may help to guide the oncologists in their choice of
therapies to administer.

Breast Cancer Monitoring Assay

We intend to utilize cancer markers discovered
through our breast cancer-screening program to develop a
blood-based breast cancer-monitoring test for the detection of
early recurrence. The goal of our breast cancer-monitoring
program is to clinically validate the cancer markers discovered
for the breast screening panel to detect early stage breast
cancer recurrence in asymptomatic patients. The test would be
used to monitor patients for response to treatment and to detect
early recurrence post treatment. We believe that these changes
in patient management would result in improved health outcomes
and increased patient survival.

Ovarian Cancer Screening Assay

We have initiated development of a screening test
for ovarian cancer. Our goal is to develop an ovarian
cancer-screening test that will be a blood-based immunoassay
comprised of a panel of antibodies which will measure the
expression of target proteins specific from early stage ovarian
cancer. The test would be initially targeted for patients
considered to be at high-risk for ovarian cancer, a market we
estimate at about two million cases per year in the
U.S. Our ultimate goal is to validate such a test as a
means of routine screening of women aged 40 and older. By
detecting ovarian cancer at an earlier stage of disease we
believe that use of our test will lead to earlier initiation of
treatment and increased patient survival.

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Melanoma Staging Product

Through our agreements with BD and Millennium, we
received distribution rights to a novel gene expression target
for malignant melanoma shown in limited studies to be predictive
of risk of metastasis in Stage I and Stage II
melanomas. In February 2002, we executed a letter of intent to
collaborate with AmeriPath, Inc., a leading national
provider of cancer diagnostics, genomics, and related
information, on the validation and clinical use of a novel gene
expression assay for malignant melanoma. During 2002, AmeriPath
developed and validated a home brew assay utilizing
our novel Melastatin gene-based detection probe and our
SlideWizard imaging and telepathology platform. We finalized
this arrangement in late 2002 following the successful
completion of a series of key development and validation
milestones by the parties initiated during 2002. In 2003, we
introduced an analyte specific reagent for a laboratory
developed assay for malignant melanoma and provided technical
support for an independent Melastatin clinical utility study
which was completed in December, and we will continue to seek
collaboration partners for this assay.

We do not expect to generate any significant
revenue from our molecular diagnostic products at least until
2006. Consequently, we expect that our oncology business unit
will incur expenses in excess of revenues generated. Some of
these expenses include the lease of several laboratories at
BDs facility in Research Triangle Park, North Carolina.
This lease arrangement substantially ended in July 2002 after we
occupied our own newly equipped laboratory and office space in
Research Triangle Park. We do, however, maintain several small
laboratories at the BD facility.

In January 2003, we entered into an agreement
with BMS to provide quantitative tissue based image analysis in
support their oncology therapeutics programs targeted at
treating epithelial cancers including cancer of the cervix,
breast, and colon. We utilized our SlideWizard image analysis
platform and proprietary software applications to provide a
quantitative assessment of tumor marker expression levels from
tissue samples provided by BMS for patients enrolled in a
Phase I clinical trial. The data generated by our work was
used to evaluate patient response across varied dosing levels
based on changes in tumor marker expression levels both before
and after treatment.

We made significant progress during 2003 toward
our objective of developing and commercializing new
molecular-based diagnostic assays. We completed marker discovery
for all of our cancer development programs, including cancer of
the breast, cervix, ovary and prostate, and we have completed
the transfer of these markers from Millennium. We developed
functional prototype assays to evaluate each markers
clinical performance and completed the selection of the marker
panel for our cervical and breast staging assays. We introduced
an analyte specific reagent for a laboratory developed assay for
malignant melanoma through our relationship with
AmeriPath, Inc. and have provided technical support for an
independent Melastatin clinical utility study conducted through
a collaboration between Albany Medical College and AmeriPath.
The study was successfully completed in December 2003 and the
results were presented by the investigators at the March 2004
Annual Meeting of the USCAP. The study demonstrated that
measurement of Melastatin expression using our assay provides
independent prognostic information that may be useful in the
clinical assessment of melanoma.

Although the discovery process for the colon
cancer program was completed earlier in 2003 at Millennium, we,
in collaboration with BD, elected not to exercise rights to
these program markers. As such, markers for the colon cancer
program will not be transferred to us.

Finally, we believe that our automated visual
intelligence technology can be developed for use for other
diagnostic tests that involve microscopic analysis of biological
specimens on glass slides, such as tissue, blood, urine, sputum
or other samples. To develop our technologies for other
applications, we will need to adapt software algorithms to
analyze each of these other samples.

Marketing and Sales

Marketing Strategy

We believe that TriPath Oncology provides us with
an opportunity to develop and commercialize novel, molecular
oncology tests that provide a more accurate, disease-specific
understanding of cancer, thereby better

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addressing the needs of clinician medical
practitioners and our primary customer, the patient. In
furtherance of this goal, any such tests that we develop will be
designed to screen and assist in the diagnosis of the presence
of disease, assess patient prognosis and outcome more
accurately, guide therapeutic selection in the management of
certain cancers, and monitor for disease recurrence.


Historically, diagnostic companies have focused
on changing the laboratory practice of medicine primarily
through delivering the benefits of automation to laboratories
worldwide. Today, virtually all sectors of the clinical
diagnostics industry have been automated to a significant
extent. The two exceptions to this pattern of rapidly increasing
automation in in vitro diagnostics have been the
cytopathology and histopathology laboratories, where the
standard of practice is defined by the visual examination and
analysis of cells and tissues. We believe our integrated
cervical cytology screening solutions offer substantial value to
our laboratory customers worldwide today, and that through
continued focus on leveraging our assets and technologies
towards the delivery of novel molecular oncology tests we will
be well positioned to offer optimal clinical solution for
patients.

Our marketing strategy is focused on providing
solutions that address the unmet needs of our three broad market
stakeholders: clinical laboratories, clinicians and third-party
payors. We increased our marketing efforts during the first half
of 2002 by directing resources toward various marketing-related
initiatives designed to promote brand identification and
awareness, increase market acceptance of our products and
services and enhance product management. We have expanded our
presence in the marketplace through increased advertising and
promotion, company-sponsored seminars and trade shows, and peer
selling activities. To further educate and reinforce the
benefits of our products, we initiated a partnership with a
third-party physician/peer selling organization in 2001 that
continued into 2003. An important element of our marketing
strategy is to achieve broad market acceptance of our integrated
product consisting of our SurePath thin-layer slides for
cervical cancer screening by the FocalPoint system. In
implementing this strategy, we will seek to address the needs of
the constituencies described below.

Clinician/ OB-GYN

In 2002, we initiated a number of key initiatives
targeted at physician education activities including continuing
medical education programs. In 2003, we expanded our physician
educational programs to access a broader and more focused
segmentation. We also conducted a number of clinician-related
activities including the establishment of a Clinical Advisory
Board and numerous expert panels as forums to discuss and
receive feedback on unmet medical needs, standards of care,
market trends, product concept review and use, and clinical
trials strategies. Finally, we cultivated and developed
relationships with leading clinicians to identify current and
future potential product areas with the goal of expanding
peer-to-peer selling and influence.

Clinical Laboratory

The standard of practice in the cytopathology and
histopathology laboratories is defined by the visual examination
and analysis of cells and tissues. Cancer, in one of its many
forms, is the disease most often considered and evaluated in
laboratories. Samples being examined are typically tissue
biopsies or Pap smears. The collection and preparation of these
samples have been resistant to the general wave of automation
because they have required human observation and analysis under
a microscope. The observer is required to identify and interpret
what are often very subtle changes within human tissues. These
are often very complex, time consuming, tedious and exacting
tasks. The practices of cytopathology and histopathology remain
largely manual and labor intensive.

Previously, the complex biologic structural, or
morphologic changes exhibited by cancer were considered too
subtle for identification and interpretation by computer or
other automated apparatus. The conventional wisdom was that cell
and tissue diagnosis is an intrinsically qualitative process
that requires subjective visual judgment. However, as the
science of image processing and analysis has matured, it has
become increasingly accepted that these subjective
signals can be redefined in terms of mathematical algorithms.
These algorithms, in turn, provide the basis for computerization
and an automated solution.

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As the last frontier for automation in
in vitro diagnostics, the cytopathology and
histopathology laboratories present a major opportunity. We
believe that increased automation of these laboratories through
computerized image analysis will:



| |   |                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | significantly reduce labor costs;                                                                                                                           
|
| |  | 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 were introduced into the cervical cancer screening
market in the mid-1990s. We expect to benefit from the increased
awareness and growing acceptance of these new technologies.

i3Series Product Line

We currently market our cervical cytology
products as part of an integrated system and have combined them
under our i3 Series product line, as discussed
above. Our SurePath, PrepStain and FocalPoint systems, together,
provide an integrated solution for sample preparation,
processing, staining and computerized analysis of liquid based
thin-layer preparations. We began limited international
commercial sales of our PrepStain system in 1993 and commenced
commercialization in the United States following FDA approval in
1999. We began placements of AutoPap QC systems, a predecessor
to the current FocalPoint system, in 1995 and of the FocalPoint
primary screening system in 1998. FocalPoint is the only fully
automated Pap smear screening device to receive regulatory
clearance for marketing in the United States for both thin-layer
and conventional Pap smear slide preparations.

The principal market for gynecological
applications of PrepStain and FocalPoint are clinical
laboratories worldwide. Clinical laboratories are also the
primary focus for patients, physicians and third party payors in
connection with screening for cervical cancer. In an effort to
facilitate the adoption of our products, we engaged sales
professionals to educate and promote our products to each of
these groups. Furthermore, we have contractual relationships
with organizations that provide physician education and third
party payor/reimbursement support. We view these relationships
as a necessary extension of our business given their potential
to fuel our growth.

The principal market for non-gynecological
applications of PrepStain also includes clinical laboratories
worldwide, although these applications are performed in
significantly lower quantities than cervical cancer screening
applications. Non-gynecological applications for the detection
of cancer are performed on body fluids, including urine samples,
respiratory specimens and a variety of fine-needle aspirates of
specific organs.

Large clinical
laboratories.Pap smear testing has
become a concentrated market in the United States. We believe
that approximately 50% of cervical cancer test volume is
concentrated among a relatively small number of large
laboratories. We believe the PrepStains high throughput
and cost-effectiveness and FocalPoints ability to show
improved specificity over conventional practice will enable us
to market PrepStain and FocalPoint successfully to this
concentrated market segment. Moreover, the pressures associated
with rising health care costs, rising litigation costs, and the
limited supply of qualified cytotechnologists should further
facilitate adoption of PrepStain and FocalPoint by the large
laboratory market.

On March 5, 2003, we announced that we had
entered into a collaboration agreement with Quest Diagnostics
Incorporated (Quest), the largest provider of
diagnostic laboratory testing in the U.S. Under the terms
of the agreement, Quest will begin offering our
i3 Series integrated solution for cervical
cancer screening, including our SurePath test pack, our
PrepStain slide processor, and our FocalPoint slide profiler in
selected locations. Quest will evaluate the i3
Series relative to its immediate and future needs for cervical
cancer screening. During the second half of 2003, we continued
to train Quest personnel, and Quest initiated its in-house
validation process. However, sales to Quest in 2003 were of
minimal impact to our results of operations. There can be no
assurance that our agreement with Quest will generate
significant revenue. Nor

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can we assure that Quest will find our products
and services as effective and efficient in their network of
operations.


In October 2003, we entered into a new three-year
agreement with Laboratory Corporation of America Holdings
(LabCorp) to provide the SurePath Test Pack and the
PrepStain Slide Processor for cervical cancer screening. LabCorp
first introduced the SurePath liquid-based Pap test in 1999.
While LabCorp is one of our larger customers today, there can be
no assurance that our agreement with LabCorp will generate
additional, significant revenue.

Academic Centers of
Excellence.We expect to continue to
build a franchise among academic centers of
excellence and to continue to add high profile, opinion leaders
to our customer list. We believe these relationships reflect on
the quality of our products. Further, as early adopters of new
diagnostic technologies, the academic centers of excellence will
be key targets for the early introduction of our molecular
diagnostic products.

Medium and small clinical
laboratories.We also intend to
continue to devote a portion of our marketing and sales
resources to targeting medium-sized and small clinical
laboratories, including, in particular, laboratories that serve
hospitals and local and regional integrated health care provider
networks. These laboratories are often well integrated into the
local health care management process and delivery continuum and,
therefore, facilitate an integrated sales process that includes
the ordering clinician, the laboratory, and the payor. This is
of particular significance to our strategy for commercializing
molecular diagnostic and pharmacogenomic products and services
that will require significant interaction between the laboratory
and the clinician. We expect that the medium-sized and small
clinical laboratory segment of the market represents a promising
opportunity for our equipment rental programs.

Third-party payors.We have gained a significant level of market acceptance for our
products by third-party payors by devoting additional resources
to the area of reimbursement. We plan to continue promoting the
clinical and economic benefits of PrepStain and FocalPoint
systems to managed care companies, major private insurers and
other third-party payors. We have demonstrated that the overall
cost savings to the health care system, resulting from the early
detection of cervical cancer and the decrease in unnecessary
repeat Pap smears, biopsies and colposcopies resulting from
improved specimen adequacy, more than offset the cost of our
products. See also Third-Party Reimbursement below.

Molecular Diagnostic Products

The marketing strategy for the molecular
diagnostic products we are developing is predicated on several
key principles. First, our marker discovery programs are all
driven by clinical specifications developed from an ongoing
analysis of the current standards of care for cancer of the
cervix, breast, ovary and prostate. From these analyses, we have
identified areas of clinical need and, therefore, market
opportunity. Second, our product development strategy
comprehends minimal disruption of laboratory workflow and
current practice. We are designing our products to change the
clinical practice of medicine, not the laboratory practice of
medicine. Third, we employ a strategy for commercialization that
includes stacking clinical claims in which we will initially
target defined clinical problems in defined patient populations
to create specific and clearly defined clinical outcomes. Our
strategy comprehends the fact that the commercial opportunity
associated with our products will depend on the extent to which
they impact decisions made and actions taken in the course of
the early detection and clinical management of cancer, and that
the value generated by these products and the attendant level of
reimbursement derived from third-party payors will reflect the
extent to which the products positively impact patient outcome,
both clinical and economic. Fourth, we will employ a strategy
for early commercialization that includes initial introduction
of analyte specific reagents to be used in laboratory developed
assays. Fifth, we will leverage the recognition, relationships,
and infrastructure developed to market and sell our
i3 Series cervical cytology product line to
commercialize our molecular diagnostic products. In effect, the
infrastructure we have developed for our cervical cytology
product line will serve as a conduit for our molecular
diagnostic products.

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Sales Strategy



| |                      
| | ---------------------
| | i3Series Product Line

We generate PrepStain revenue from the sale,
rental and lease of PrepStain systems and from the sale of the
related SurePath and PrepStain test kits, comprised of
proprietary reagents and other disposables. Additionally, we
generate revenue from service contracts on the PrepStain
systems. For system sales, customers purchase the PrepStain
instrument and make separate purchases of SurePath and PrepStain
test kits. We recognize revenue on sales of the PrepStain system
at the time the system is installed and accepted at the customer
site. For system rentals, also known as reagent rentals, we
place PrepStain systems at the customers site free of
charge and the customer is obligated to purchase SurePath and
PrepStain test kits for a fixed term, typically three or four
years. Under these transactions, there is no revenue recognized
on the PrepStain system hardware. For system leases, we offer
two alternatives. The first alternative involves a lease
arrangement through which we lease the PrepStain system directly
to the customer. These leases require monthly payments for the
system and are typically for 36 or 48-month terms. The customer
purchases the SurePath and PrepStain reagents and disposables
that run on the system separately from the lease on an as-needed
basis. Under these transactions, there is no up front revenue
recognized on the PrepStain system hardware. The second
alternative is known as our IPO program, under which
PrepStain systems are purchased by a third party financial
institution and are placed at the customers site free of
charge. The customer then purchases the SurePath and PrepStain
reagents at a higher price that is sufficient to repay the
financial institution for the cost of the PrepStain system and
to provide us with an acceptable profit on the reagents and
disposables. Under the IPO program, we record revenue for the
system sale at the time the system is installed and accepted at
the customer site. Since 2001, our strategy has been to
emphasize in-house reagent rentals in an effort to permit us to
retain a greater percentage of the ongoing, higher margin
PrepStain reagent revenue stream. Regardless of whether
PrepStain systems are sold, rented or leased, however, each
system placed typically provides a recurring revenue stream as
customers process our SurePath test packs.

We generate FocalPoint related revenue from the
direct sale of FocalPoint systems and from the placement of
FocalPoint systems under fee-per-use contracts. In the latter
case, fee-per-use revenue commences in the month a system is
initially placed in commercial use at a customer site and
consists of per-slide monthly billings, fixed rental billings,
or certain fee-per-use contracts that require minimum payments.
Domestic customers may also elect to lease the FocalPoint system
under the IPO program. Additionally, we generate revenue from
service contracts on FocalPoint systems. We have and will
continue to consider arrangements that may involve the placement
of FocalPoint systems at customer sites free of instrument
charge for increased commitments to purchase our SurePath and
PrepStain test kits.

We also generate revenue from the sale and rental
of our SlideWizard line of products and from service contracts
on these products. For system sales, customers purchase the
products through distributors in countries where such
relationships exist. Where distributor arrangements do not
exist, we sell these products directly to the customer.

Marketing and Sales Organizations

We currently utilize in excess of
100 full-time marketing and sales personnel worldwide to
market, sell and provide post-sale support of our products. In
addition to expanding our existing cervical cytology business,
our intention is to leverage our existing sales and marketing
capabilities, our strong relationships with key influential
leaders in the anatomic pathology laboratory and clinician
segments, our customer base among the academic institutions to
pioneer the acceptance of imaging and to accelerate the adoption
of analyte specific reagents for laboratory developed assays in
the second half of 2004.

In the U.S., we have expanded our efforts to
market our cervical cancer screening products through a direct
sales organization focused both on the physician, primarily
OB-GYN and primary care physicians, and laboratory market
segments to optimize awareness and market penetration of our
products. Through an alliance with Nelson Professional Sales
(NPS) begun in late 2000, we targeted the physician
market directly for the first time by adding clinician sales
representatives on a contract basis, to augment our laboratory
sales efforts. The NPS relationship allowed us to quickly
establish a selling presence external to the

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laboratory and has served us well. In April 2002,
we terminated the agreement with NPS, simultaneously extended
offers of employment to the majority of the physician
representatives and created a direct physician sales force as a
critical element of our commitment to better focus on the needs
of our clinician customers. Concurrent to this effort, we
consolidated our laboratory and clinician sales organizations
under a single management umbrella to promote efficiency and
effectiveness. We also have a team of field based reimbursement
specialists who call on U.S. managed care organizations and
other third-party payors to achieve maximum reimbursement levels
and to further stimulate demand for our products. Where
appropriate, we also seek co-marketing agreements with major
clinical laboratories to leverage their sales capabilities and
more effectively market our products directly to health care
providers.


In May 2003, we received approval for expanded
labeling claims from the FDA to include study data showing a
64.4% (p<0.00001) increase in detection of High Grade
Squamous Intraepithelial and more serious lesions (HSIL+), as
compared to the conventional Pap smear, using our liquid based
cytology system, which includes the SurePath Test Pack and the
PrepStain Slide Processor.

Outside the U.S., with the exception of Canada
where we sell to and service customers through our own sales and
service organization, we market and sell our products primarily
through a distribution network. To support these efforts, we
employ eight full-time personnel, consisting of a sales
director, sales and marketing professionals, managers and
post-sales support personnel located in Europe. Our
international distribution network is comprised of both large
distribution organizations with products focused on the clinical
diagnostic market and smaller organizations with products
focused specifically on the anatomic pathology market.

We participated in a product evaluation in the
U.K. related to liquid-based cytology testing for cervical
cancer. In October 2003 the National Institute for Clinical
Excellence (NICE, or the Committee) in
the U.K. issued guidance which recommends the adoption of
liquid-based cytology for cervical cancer screening in England
and Wales. The formal guidance recommends that liquid-based
cytology be used as the primary means of processing cervical
cancer screening samples in England and Wales. However, the
Committee stated that there is currently insufficient evidence
to recommend one product over another but that it may wish to
consider evaluating further the different products as the method
is introduced. This guidance represents the final step in the
Technology Appraisal Process undertaken by NICE.

We offer post-sale support services, including
customer training, product installation, telephone technical
support and repair service directly to customers in the United
States. Our support personnel are located both at our
headquarters and in select major metropolitan areas.
Internationally, we provide these services through our employees
and distributor organizations.

Manufacturing

FocalPoint

We currently assemble, integrate and test the
electronic, mechanical and optical components and modules of
FocalPoint at our Redmond, Washington facility. Our operations
have produced sufficient FocalPoint systems to meet customer
demand since we began commercial operations in 1996 and we
believe we have sufficient capacity to meet anticipated
near-term customer needs for our FocalPoint product.

We purchase all components for the FocalPoint
system from outside vendors. Several components of the
FocalPoint system are supplied by sole-source vendors. If any of
these sole-source suppliers are unable to provide an adequate
and constant supply of components, we will need to modify any
components provided by additional or replacement suppliers. We
may be unable to quickly establish additional or replacement
sources of supply for several FocalPoint components. In
addition, we may need to obtain regulatory approval to
substitute certain components.

PrepStain

We currently assemble, test and package
components of PrepStain and Prepmate at our manufacturing
facility in Burlington, North Carolina. We also manufacture our
SurePath preservative fluid and our PrepStain line of reagents
and stains for PrepStain at the Burlington facility. We believe
that our existing manufacturing

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and assembly processes are adequate to meet the
near-term, full-scale production requirements of our SurePath
and PrepStain systems for cervical cancer screening.


The consumable items used with PrepStain are
purchased from a variety of third-party vendors, some of which
are sole-source suppliers. We have a multi-year, exclusive
contract with a European supplier of manufactured instrument
components that are incorporated into our PrepStain product
line, which expires in December 2004. Pricing for components is
fixed, but is subject to adjustment based upon changes in raw
material costs. Our obligation to use this supplier exclusively
for the components is contingent upon this supplier supplying us
at prices competitive with those offered by third parties on
similar terms, and upon this supplier meeting our quality and
production requirements. We believe that the supplier has
sufficient capacity to meet our present and future requirements
for these components through the end of 2004. To address the
time beyond that date, we are undertaking development
activities, with a U.S. supplier, to ensure uninterrupted
supply of PrepStain component parts.

Lean Manufacturing Strategy

In 2002, we introduced Lean Manufacturing into
our organization. Our Lean Manufacturing strategy incorporates
process improvement methodologies to eliminate non-value adding
activities within the operations area to reduce costs, improve
quality and product delivery. The Lean Manufacturing process
improvement strategy includes tools such as Value Stream
Mapping, One-Piece Flow, Kanban Materials Management and Kaizen
implementation methodology. During 2003, value stream driven
kaizen events occurred regularly, at a rate of at least one per
month. We believe these efforts will continuously serve to
remove waste and inefficiencies from our manufacturing
processes, resulting in lower costs, improved quality and
delivery to our customers.

SlideWizard Products

We currently manufacture the majority of our
SlideWizard product line at our Burlington, North Carolina
facility. We also manufacture a limited number of our
SlideWizard instruments and integrate them into the FocalPoint
GS at our Redmond, Washington facility. We believe we have
sufficient capacity to meet anticipated near-term customer
demand for our SlideWizard product line.

Our SlideWizard products consist primarily of
off-the-shelf components and proprietary software. The
components are supplied by a variety of vendors, some of which
are sole-source suppliers. We have been integrating and selling
SlideWizard products since 1993.

Molecular Diagnostics

Reagents for our Melastatin detection probe are
manufactured by BD. We believe BD has adequate capacity and
production capability to satisfy customer demand and technical
product requirements. We intend to consider in-house or
third-party manufacturing of additional molecular diagnostic
reagents that we develop. Our imaging platform hardware will
consist primarily of standard, off-the-shelf, components
available from a number of different suppliers. Integration of
the components, software loading and final testing will be
conducted at our manufacturing facility in Burlington, North
Carolina.

Our Suppliers

Several components of our products are supplied
by sole-source vendors. Subject to any of our exclusive
contractual arrangements, we may seek to establish relationships
with additional suppliers for components of our products. If any
of our current or future sole-source suppliers are unable to
provide an adequate and constant supply of components, we will
need to modify any components provided by additional or
replacement suppliers for use in our products. We may be unable
to quickly establish additional or replacement sources of supply
for several of these components. The incorporation of new
components, or replacement components from alternative suppliers
into our products may require us to submit PMA supplements to,
and obtain further regulatory approvals from, the FDA before
marketing the products with the new or replacement components.
There can be no assurance that we will be able to obtain the
necessary approvals.

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Manufacturing Standards

Our manufacturing process is subject to extensive
regulation by the FDA, including the FDAs Quality System
Regulation (QSR, also known as Good Manufacturing Practice, or
GMP) requirements. As part of the FDA regulatory process, we
face periodic FDA inspections and other periodic inspections by
U.S. and foreign regulatory agencies. See Governmental
Regulation. Both the Burlington, North Carolina and
Redmond, Washington facilities are subject to periodic FDA
inspections. Failure to comply with the FDAs QSR
requirements in the future would materially impair our ability
to 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 FocalPoint
would be impaired, which in turn would have a material adverse
effect on our business.

In addition to QSR requirements, we are required
to meet requirements relating to ISO 9001 certification,
including European regulatory requirements. A European
CE certification is required to successfully sell
PrepStain and FocalPoint in Europe according to certain
directives of the European Union. The OEM supplier of the
PrepStain instrument components has ISO 9001 certification
and has obtained CE certification for the main PrepStain
component. In December, we met the essential requirements of the
European In Vitro Diagnostic Medical Devices Directive
(IVDD), which will allow us to add the CE Mark to
our products, and we have obtained CE compliance for the entire
PrepStain system. The FocalPoint System is certified to
EN55022:94/ CISPR 22, Class A, EN 50082-1 92, AS/
NZS2064/ CISPR 11, Class A.

We obtained ISO 13485 certification at our
Burlington, North Carolina facility in 2003. Compliance audits
have been routinely conducted at our Burlington, North Carolina
facility by a certified ISO auditor, most recently in June 2003
and December 2003. We have no outstanding deficiencies related
to these compliance audits. In addition, the Burlington and
Redmond manufacturing facilities successfully underwent ISO
certification audits in order to comply with Canadian
requirements, which became effective on January 1, 2003.
Under the Canadian requirements, third-party certification of
compliance with ISO 13485 or 13488 and
Regulation SOR/980282, as amended, is required and was
obtained.

Research and Development

Development of Molecular Diagnostic and
Pharmacogenomic Products and Services

Our research and development programs are
currently focused on four major goals:



| |   |                                                                                                                                                                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | development of molecular diagnostic and
    pharmacogenomic products and services for malignant melanoma and
    cancer of the cervix, breast, ovary, and prostate.                                                                                                                                                                 
|
| |  | continued improvement and streamlining of the
    FocalPoint and FocalPoint GS products;                                                                                                                                                                                                                                            
|
| |  | additional enhancement of the PrepStain system,
    including adjunctive testing using the SurePath preservative
    solution, improvement of related PrepStain reagents and
    disposables, and further streamlining and automating the
    PrepStain slide processor with regard to the preparation and
    handling process; and
|
| |  | development of additional SlideWizard
    applications with scalable automation capabilities to support
    our molecular diagnostic programs, as well as the needs of
    potential strategic partners.                                                                                                                            

TriPath Oncology is developing molecular
diagnostic and pharmacogenomic products and services for
malignant melanoma and cancer of the cervix, breast, and ovary.
The goal of this research and development program is to develop
products that are designed to identify cancer at its earliest
stage and provide individualized diagnostic and prognostic
information for patients with cancer. We are also seeking
alternative applications for our technologies through internal
research and development, as well as through strategic
partnerships with other companies.

We completed the relocation of BDs
molecular oncology program to temporary facilities in North
Carolina at the end of December 2001. In January 2002, we signed
a multi-year lease for approximately

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22,000 square feet of laboratory and office
space to principally house our TriPath Oncology operations. This
space has been occupied by TriPath Oncology personnel since July
2002.


We introduced an analyte specific reagent for a
laboratory-developed assay for malignant melanoma through our
relationship with AmeriPath, Inc., the largest provider of
skin pathology services in the United States, and provided
technical support for an independent Melastatin clinical utility
study conducted through a collaboration between Albany Medical
College and AmeriPath. The study was successfully completed in
December 2003, and the results were presented by the
investigators at the March 2004 Annual Meeting of the USCAP. The
study demonstrated that measurement of Melastatin expression
using our assay provides independent prognostic information that
may be useful in the clinical assessment of melanoma.

We completed marker discovery for all cancer
development programs, including cancer of the breast, cervix,
ovary and prostate, and we have completed the transfer of these
markers from Millennium. We developed functional prototype
assays to evaluate each markers clinical performance and
completed the selection of the marker panels for our cervical
and breast staging assays.

Our product development process for molecular
assays begins with the identification and validation of genomic
molecular markers specific to predetermined clinical outcomes
and specifications. This discovery process, conducted at
Millennium, is based on gene profiling technology that
identifies genes which are uniquely over or under-expressed in
our targeted patient populations. Multiple genes have now been
identified for each of our oncology programs, and it is the
unique combination of genetic markers that we believe will allow
us to develop tests to improve the early detection of cancer and
provide more individualized prognostic information for patients
diagnosed with cancer.

Following gene discovery and initial pre-clinical
validation at Millennium, this genomic information was
transferred to the TriPath Oncology R&D organization to
begin assay development. Our ultimate goal is to change clinical
practice, not laboratory practice. As such, our assays are being
developed in commercially accepted formats to facilitate rapid
laboratory adoption. Our cancer screening assays are being
formatted as immunoassay (IA) tests that are capable of
detecting and quantifying multiple secreted markers (proteins)
in blood. Our staging and prognostic assays will be slide-based
utilizing tissue and cytology samples, and will allow for
precise quantification of molecular markers (proteins) within
the context of tissue and cellular morphology. For the
tissue-based assays, we are utilizing a standardized,
slide-based immunohistochemistry (IHC) format with
colorimetric bright-field detection. IHC has been routinely
practiced in histology and cytology labs for many years and most
labs are equipped with fully automated staining platforms. For
our cell-based assays, we have adapted the IHC protocol into a
slide-based immunocytochemistry (ICC) format, also with
colorimetric bright-field detection.

All of our assay technology formats (IA, IHC
and ICC) require monoclonal antibody reagents that will bind
specifically to the proteins (markers) which are uniquely
expressed by the genes identified by Millennium. These antibody
reagents are produced and screened at TriPath Oncology in a high
throughput format using our proprietary technology. We first
translate the unique gene sequences identified by Millennium
into antigens using state-of-the-art protein expression systems.
These antigens are then used to produce specific monoclonal
antibodies using mice immunization and cell culture technology.
Each monoclonal antibody is independently validated using
clinical samples with known patient outcome, and markers which
are selected will be combined into a panel which will be
optimized for assay sensitivity and specificity.

The final step in the development process is to
link the molecular assays to our proprietary image analysis
platform. We believe that clinical outcomes will be 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 precise quantification and
interpretation. Furthermore, we believe that tissue
architecture, cell morphology, and precise sub-cellular
localization of molecular markers will be an important tool for
accurate cancer staging and prognosis. Therefore, we will adapt
our proprietary image analysis platform to our molecular assays
to allow analysis and quantification of multiple, discrete
molecular markers within the context of tissue distribution and
cellular location.

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We are also leveraging our proprietary imaging
technology to develop new collaborations to expand our
commercial opportunities. In early 2003, we established a
collaborative relationship with BMS in which we provided
quantitative tissue-based image analysis in support of a BMS
clinical study to assess the pharmacokinetics and
pharmacodynamics of one of their targeted oncology therapeutics.
We utilized our SlideWizard image analysis platform and
proprietary software applications to provide a quantitative
assessment of tumor marker expression levels from tissue samples
provided by BMS for patients enrolled in a Phase I clinical
trial. The data generated by our work was used to evaluate
patient response across varied dosing levels based on changes in
tumor marker expression levels, both before and after treatment.

Improvement of FocalPoint, FocalPoint GS and
PrepStain Products

Enhancements to both FocalPoint and PrepStain are
specifically designed to increase the instruments
efficiency, ease of use, reliability and cost-effectiveness.
This also includes initiatives directed at extending the shelf
life of the SurePath and PrepStain lines of reagents and
preservatives used with the PrepStain system. We are also
continuing to explore alternative uses for adjunctive testing
using our SurePath preservative fluid and have sought approval
for the use of alternative collection devices in connection with
the specimen collection process related to the PrepStain system.

Development of Additional SlideWizard
Applications

We are continually enhancing our SlideWizard line
of products. We have expanded this product line to a modular
concept which allows rapid prototyping and product development.
The degree of automation for the resulting applications can be
adjusted to the needs of the corresponding market, from
interaction to complete automation. This technology takes
advantage of our intellectual property portfolio and will be
primarily applied to complement the existing portfolio of
applications with new developments focused on gene or protein
based cancer staging and prognostic testing.

There can be no assurance that any product
enhancement or development project that we undertake, either
currently or in the future, will be successfully completed,
receive regulatory approvals or be successfully commercialized.
The failure of any such enhancement or project to be completed,
approved or commercialized could prevent us from successfully
competing in our targeted markets.

As of December 31, 2003, we had
approximately 75 employees engaged in research and development
activities. Our expenditures for research and development were
approximately $5.9 million, $7.5 million and
$8.9 million for the years ended December 31, 2001,
2002 and 2003, respectively. See additional discussion in
Item 7  Managements Discussion and
Analysis of Financial Condition and Results of Operations.

Third-Party Reimbursement



| |          
| | ---------
| | i3 Series

The vast majority of private third-party medical
insurance providers and governmental agencies offer
reimbursement for laboratory testing associated with routine
medical examinations, including Pap smears as part of a wellness
program. In the United States, the level of reimbursement by
those third-party payors for wellness testing, including the Pap
smear, can vary considerably. However, on average, since the
majority of third party payors benchmark coverage and pricing
based on Medicare coverage and reimbursement determinations,
there has been a general increase in reimbursement amounts paid
for cervical cancer screening due to a minimum payment of $14.76
established in 2002 by the Center for Medicare and Medicaid
Services (CMS) which administers Medicare. In addition to
the minimum established by CMS, subsequent Medicare National
Limitation Amount (NLA) pricing for these procedures has
created a positive level of increased reimbursement for the
newer technologies, including both the PrepStain and the
FocalPoint. Successful commercialization of PrepStain and
FocalPoint for cervical cancer screening in the United States,
and some other countries, will depend on the availability of
reimbursement from such third-party payors. Because the up-front
costs of using our products are typically greater than the cost
of the conventional Pap smear, we have worked to convince
third-party payors that the overall cost savings to the health
care system, resulting from early detection of cervical cancer
and its precursors will more than offset the cost of our

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products. The Medicare NLA for the various
procedures that represent the technologies for cervical cancer
screening demonstrates the general revenue potential.


|         |       |             |  |                                                                                                                                                                                                                                    |  |   |       | 
|-------- | ----- | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | - | ----- | 
|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 rescreening 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
    rescreening, under physician supervision |  | $ | 37.01 | 

We have focused on obtaining coverage and
reimbursement from major national and regional managed care
organizations and insurance carriers throughout the United
States. We have a reimbursement team to work with third-party
insurers and managed care organizations to establish and improve
third-party reimbursement rates for our products. Most
third-party payor organizations independently evaluate new
diagnostic procedures by reviewing the published literature and
the Medicare coverage and reimbursement policies on the specific
diagnostic procedures. To assist third-party payors in their
respective evaluations of PrepStain and FocalPoint, we provide
scientific and clinical data to support our claims of the safety
and efficacy of our products. We focus on improved disease
detection and long-term cost savings benefits in obtaining
reimbursement for PrepStain and FocalPoint for cervical cancer
screening.

To date, the manually screened PrepStain
thin-layer slide preparation procedure has achieved near
universal coverage from third-party payors, as has the
FocalPoint primary screening procedure for
conventionally-prepared slides. Since the combined procedures of
the PrepStain and FocalPoint, as part of the
i3 Series, represent an enhancement over
the individual procedures themselves, we had anticipated and
have experienced a similar acceptance from third-party payors
and a general compliance with the CMS Medicare pricing and
coverage determinations. Over the past year, laboratories
utilizing the combined PrepStain/FocalPoint i3
Series application have realized positive coverage and
reimbursement from the vast majority of the third party payor
community demonstrating the added value of the
i3 Series for the routine screening for
cervical cancer.

We expect to continue to realize positive
reimbursement for our technologies throughout 2004 from the
payor community and will work to continue to demonstrate
diagnostic and economic value as new performance data is
realized and made available. However, there can be no assurance
that such favorable reimbursement will continue.

Proprietary Technology and Intellectual
Property

We currently hold over 110 issued or allowed
United States patents. We also hold over 100 foreign patents and
have applied for patent protection for certain aspects of our
technology in various foreign countries. We acquired many of
these patents in the merger of AutoCyte Inc. and NeoPath Inc.
and the acquisition of the intellectual property and technology
of Neuromedical Systems, Inc. We further expanded, and are
expanding, our patent portfolio through the acquisition of the
intellectual property of Cell Analysis Systems from BD in
September 1999 and through our current work undertaken at
TriPath Oncology. Our patents cover system components, such as
the disaggregation syringe, the PrepStain process, and various
aspects of our high-speed image-interpretation technology, as
applied to cytopathology and histopathology. Because of the
substantial length of time and expense required to bring new
products through development

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and regulatory approval to the marketplace, we
rely on a combination of patents, trade secrets, copyrights and
confidentiality agreements to protect our proprietary
technology, rights and know-how. We intend to continue to pursue
patent protection where it is available and cost-effective, both
in the United States as well as in other countries. Most of our
existing United States and foreign patents will expire between
2012 through 2019. A few of our foreign patents expired in 2003.
There can be no assurance, however, that the claims allowed in
any of our existing or future patents will provide competitive
advantages for our products, or will not be successfully
challenged or circumvented by our competitors.


Our molecular oncology program focuses on
developing and commercializing diagnostic and pharmacogenomic
tests to improve the early detection and clinical management of
cancer. The core products we are developing will be based upon
proprietary genomic and proteomic markers identified through
discovery research, conducted at Millennium, under its research
and development agreement with BD. We have sublicensed certain
of BDs rights to the proprietary markers. We are working
to identify and clinically validate novel molecular marker
panels, which will be used in developing molecular assays which
will produce molecular profiles descriptive of clinical
phenotype and patient outcome. Multiple genes have now been
identified for each of our oncology programs, and it is the
unique combination of the genetic markers that we believe will
allow us to develop tests to improve the early detection of
cancer and provide more individualized prognostic information
for patients diagnosed with cancer. We will seek U.S. and
foreign patent protection for the molecular marker panels that
we discover and other inventions based on the markers and our
product development process. We cannot be sure that our products
or technologies do not infringe patents that may be granted in
the future pursuant to pending patent applications or that our
products do not infringe any patents or proprietary rights of
third parties or that all of our issued patents are valid.

Under current law, patent applications in the
United States and in foreign countries are generally maintained
in secrecy for a period after filing. The right to a patent in
the United States is attributable to the first to invent, not
the first to file a patent application.

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

Competition

Commercial Operations

The cervical cancer screening market is comprised
of the conventional Pap smear process and certain technologies
that have been introduced in recent years or are currently under
development to provide improvements over the conventional Pap
smear process. Our competitors in the development and
commercialization of alternative cervical cancer screening
technologies include both publicly traded and privately held
companies. Alternative technologies known to us have focused on
improvements in slide sample preparation, the development of
automated, computerized screening systems and adjunctive testing
technologies. Nevertheless, some competitors products have
already received FDA approval and are being marketed in the
United States. In addition, one of our competitors has greater
financial, marketing, sales, distribution and technical
resources than us, and more experience in research and
development, clinical trials, regulatory matters, customer
support and marketing.

We believe that our products compete on the basis
of a number of factors, including slide specimen adequacy,
screening sensitivity, ease of use, efficiency, cost to
customers and performance claims. We believe

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a fully automated solution incorporating
collection, preparation, staining, and computerized imaging for
liquid based thin-layer preparations is required for sustaining
our competitive advantage. While we believe that our products
will have competitive advantages based on some of these factors,
there can be no assurance that our competitors products
will not have competitive advantages based on other factors,
including earlier market entry and scale, which may adversely
affect market acceptance of our products. Moreover, there can be
no assurance that we will be able to compete successfully
against current or future competitors or that competition,
including the development and commercialization of new products
and technologies, will not have a material adverse effect on our
business. Our products could be rendered obsolete or
uneconomical by technological advances of our current or
potential competitors, the introduction and market acceptance of
competing products, or by other alternative approaches for
cervical cancer screening.


Our primary competitor in thin-layer slide
preparation is Cytyc Corporation. Cytycs systems, the
ThinPrep 2000 and ThinPrep 3000 processors, are based on a
membrane-filtration separation system rather than the density
gradient and centrifugation approach used in our PrepStain
process. The Cytyc ThinPrep systems are presently the only other
thin-layer sample preparation systems approved by the FDA as a
replacement for the conventional Pap smear. They are also used
for non-gynecological applications. Additionally in Europe there
are a few small thin-layer competitors offering a manual method
liquid based product. Currently these manufacturers have very
little market share and are not actively pursuing FDA approval
for their products. Nonetheless, they are creating competitive
activity in France and in several other countries.

In addition, in October 1996, Cytyc originally
announced a non-exclusive co-marketing agreement (subsequently
made exclusive) with Digene Corporation. In September 1997, the
FDA approved PMA supplements submitted by Cytyc and Digene
enabling testing for HPV directly from Cytycs ThinPrep
process cell suspension. In January 2003, we began working with
Digene on a PMA supplement application for use of our SurePath
cell suspension with Digenes HPV test in the United
States. In July 2002, Digene informed us that it had received a
not approvable letter from the FDA for its PMA
supplement application to use our SurePath test pack as a
specimen collection medium for its Hybrid Capture® 2 (hc2)
HPV DNA Test. We are working with Digene and have taken a
leadership role in discussions with the FDA to resolve and
respond to the issues identified in the letter. We remain
hopeful that resolution of the issues identified by the FDA will
not significantly alter our expectations for submission to the
FDA in mid-2003. Failure to obtain this approval, however, will
likely impact our ability to compete in the liquid-based Pap
smear testing market. In Europe, our SurePath product is already
in routine use with Digenes HPV test.

In January 2000, Cytyc and Quest Diagnostics
announced a multi-year agreement naming ThinPrep as the
exclusive liquid-based cervical cancer screening methodology for
Quest. Exclusivity related to this agreement expired in December
2002. In October 2000, Cytyc announced an exclusive
U.S. strategic alliance for womens health with Roche
Diagnostics. In 2002, Cytyc announced that exclusivity related
to this agreement had been discontinued.

In February 2002, Cytyc and Digene announced
their intention to merge. The proposed transaction was subject
to review by the U.S. Federal Trade Commission
(FTC) under the Hart-Scott-Rodino
Antitrust Improvements Act of 1976. On June 24, 2002
the FTC authorized staff to seek a preliminary injunction to
block the merger. Cytyc subsequently terminated its merger
agreement with Digene on July 1, 2002.

We also face several competitors, or potential
competitors, in the imaging field. To date, the FocalPoint
system is the only FDA-approved device for the automated primary
screening of PrepStain, thin-layer and conventional Pap smear
slides. In June 2003, however, Cytyc announced that it had
received approval from the FDA for commercialization of its
ThinPrep Imaging System, an interactive computer system that is
designed to assist cytotechnologists in the primary screening
and diagnosis of its thin-layer slides. We are currently engaged
in litigation with Cytyc, as to whether its ThinPrep Imaging
System infringes certain of our patents. See
Item 3  Legal Proceedings below.
Other competitors include ChromaVision Medical
Systems, Inc., which develops, manufactures and markets an
automated cellular imaging system to assist in the detection,
diagnosis and treatment of cellular diseases such as cancer and
infectious disease, and Applied Imaging Corporation, which
develops and markets automated genetic testing systems and
imaging systems

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used in cancer pathology and research which are
capable of sending digital images electronically for remote
review and consultation. In 2002, ChromaVision entered into an
agreement with Ventana Medical Systems, Inc., to co-market
their imaging device with Ventanas test for detection of
HPV in slides prepared from cervical smears.


TriPath Oncology

Competition in the field of cancer diagnostic
products continues to be concentrated in a few areas and is
expected to further intensify. Aside from mammography screening
for breast cancer, the in vitrocancer diagnostics
market consists primarily of tumor marker immunoassays. The
cancer immunoassay market encompasses a number of blood-based
tumor marker tests that are utilized extensively to assess
therapeutic response and monitor for disease recurrence but have
limited applications for screening due to their lack of
sensitivity and specificity. Currently, prostate specific
antigen (PSA) is the only blood based tumor marker that is
universally utilized for cancer screening. Among the companies
competing in the tumor marker immunoassay market are Abbott
Diagnostics, Bayer Diagnostics, Roche Diagnostics, Ortho
Clinical Diagnostics, Beckman-Coulter and Dade-Behring.

We believe that genomic and proteomic-based
assays will likely provide a more accurate, disease-specific
understanding of cancer to improve the clinical management of
cancer. Although there are a number of companies that are
investing in genomic and proteomic discovery research, few have
invested as broadly in the cancer diagnostics area as we have
through our relationship with BD. We view our primary
competitors in this area to be Abbott Diagnostics, Bayer
Diagnostics, and Roche Diagnostics. Abbott Laboratories, through
its acquisition of Vysis, Inc., develops and markets
clinical laboratory products targeting DNA chromosomal and
genomic abnormalities for cancer and pre- and post-natal genetic
disorders. Bayer Diagnostics and Roche Diagnostics operate in
the immunoassay and tumor marker markets.

In addition to immunoassay-based tests, we
believe the staging, prognosis and prediction of outcomes will
also be heavily influenced by the assessment of special stains
utilizing immunohistochemical (IHC) and in situhybridization techniques on tissue specimens. The primary
companies currently competing in this area are Dako Corporation
and Ventana Medical Systems, Inc. Both companies specialize
in automated IHC staining instrumentation and offer a wide range
of validated IHC tumor markers.

We also have several competitors with competing
technology in the molecular diagnostics field. TriPath Oncology
faces a host of competition from companies such as Roche
Diagnostics, Abbott Laboratories, EXACT Sciences Corporation,
Correlogics Systems, Inc., Genomic Health, Ciphergen,
Celera Diagnostics, and Bayer Diagnostics, all of which have
announced active programs in this area. There can be no
assurance that these or other competitors will not succeed in
developing technologies and products that are more effective,
easier to use or less expensive that those which we currently
offer or are developing, or that would render our technology and
products obsolete. In addition, these or other competitors may
succeed in obtaining FDA and other regulatory clearances and
approvals of their products that we are unable to obtain or more
rapidly than we can.

Government Regulation

The manufacture and sale of our medical
diagnostic devices is subject to extensive governmental
regulation in the United States and in other countries where we
sell our products. In addition, our research and development
activities in the United 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 cytology applications in the United States as medical
devices by the FDA under the Food, Drug and Cosmetic Act, or the
FDC Act, and require pre-market approval by the FDA prior to
commercial distribution. In addition, certain modifications to
the design, performance, manufacturing process or labeling of
medical devices are subject to FDA review and approval before
marketing. Pursuant to the FDC Act, the FDA regulates the
pre-clinical and clinical testing,

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manufacture, labeling, distribution, record
keeping, reporting, sales, marketing, advertising and promotion
of medical devices in the United States. The FDA also regulates
the import and export of medical devices. Noncompliance with
applicable requirements, including good clinical practice
requirements and QSR requirements, can result in the suspension
or withdrawal of authorization of clinical studies, the refusal
of the government to grant pre-market approval for devices,
suspension or withdrawal of clearances or approvals, total or
partial suspension of production, distribution, sales and
marketing, fines, injunctions, civil penalties, recall or
seizure of products, and criminal prosecution 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
controls deemed by the FDA to be necessary to reasonably ensure
their safety and effectiveness. Class I devices are subject
to general controls (e.g., labeling and adherence to
FDA-mandated quality system requirements, including QSR, and, in
some cases, pre-market notification or 510(k) clearance.
Class II devices are subject to general controls including,
in most cases, pre-market notification, and special controls
(e.g., performance standards, patient registries and FDA
guidelines). Generally, Class III devices are those that must
receive pre-market approval by the FDA to ensure their safety
and effectiveness (e.g., life-sustaining, life-supporting and
implantable devices) and also includes new devices
that were not on the market before May 28, 1976 and for
which the FDA has not made a finding of substantial
equivalence based on a pre-market notification.
Class III devices usually require clinical testing that
demonstrates the device is safe and effective, and must have FDA
approval prior to marketing and distribution. The conduct of
clinical studies is subject to FDA regulations, including
requirements for institutional review board approval, informed
consent, record keeping, and reporting. Our PrepStain and
FocalPoint products, when intended for gynecological use, are
regulated as Class III medical devices. In addition, the
FDA has developed special rules for in vitrodiagnostic devices, including restrictions on the sale,
distribution, promotion and use of ASRs. Products that we
develop now and in the future may be subject to these and other
applicable FDA regulations.

Device manufacturers are required to register
their establishments and list their devices with the FDA and to
provide periodic reports containing information on safety and
effectiveness. The FDC Act requires that medical devices be
manufactured in accordance with the FDAs QSR requirements.
PrepStain and FocalPoint and any other products that we
manufacture or distribute pursuant to an approved PMA
application and any supplements, or pursuant to 510(k)
clearances, or as ASRs, are and will be subject to pervasive and
continuing regulation by the FDA, including record-keeping
requirements and reporting of adverse experience with the use of
the device. We have established and maintain a system for
tracking FocalPoint and PrepStain systems through the chain of
distribution and conduct post-market surveillance, including the
filing of medical device reports (MDRs), where appropriate. We
are also required to report to the FDA about corrections to our
device products and about any market removals. Product labeling
and promotional activities are also subject to scrutiny by the
FDA and, in certain instances, by the Federal Trade Commission.
We and our distributors may only promote products for their
approved indications. In this regard, violations of promotional
requirements may, in addition to implicating violations of the
FDC Act, also involve violations of the False Claims Act, the
Medicare and Medicaid anti-kickback laws, and any
other laws that the government may utilize to enforce these and
related requirements. In addition to the government bringing
claims under the Federal False Claims Act, qui tam, or
whistleblower, actions may be brought by private
individuals on behalf of the government. If the FDA requires us
to make modifications to our product labeling in the future,
these changes may adversely affect our ability to market or sell
PrepStain, FocalPoint or any of our other products.

To this end, we are subject to both routine and
directed inspections by the FDA for compliance with regulations
with respect to control activities, manufacturing, testing,
distribution, storage, product labeling and promotions
activities. We have been periodically inspected by the FDA at
both our Burlington, North Carolina and Redmond, Washington
facilities. In 2003 we underwent routine inspections at both our
Redmond and Burlington facilities, while in 2002, we were
inspected at our Burlington facility with respect to our
advertising and promotional activities, our manufacturing
activities relative to a contemplated move of PrepMate
manufacture from our Redmond to our Burlington facility and
other aspects of our manufacturing operations. All of these
inspections were concluded in 2003 without material adverse
results.

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In addition, the FDAs Medical Device
Reporting regulations require medical device companies to
provide information to the FDA whenever evidence reasonably
suggests that a device may have caused or contributed to a death
or serious injury. These regulations also apply if the device
malfunctions and the device or a similar device sold by the
company would be likely to cause or contribute to a death or
serious injury if the malfunction were to recur.

If the FDA believes that we have not complied
with the law, it can 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; or                                                                                  
|
| |  | 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 an indefinite period of time.

In the future, the Company may seek FDA approval
of medical products other than medical diagnostic devices. The
regulatory requirements for these products are similar in scope
to the requirements described above for medical devices,
particularly with respect to the need for, and the degree of FDA
oversight of, pre-market approval, manufacturing, promotion,
sale and post-market reporting.

Clinical Laboratory Improvement Act of 1988
and State Laboratory Laws

Congress has directed the Department of Health
and Human Services to issue regulations designed to improve the
quality of biomedical analytic services, particularly the
examination of Pap smears. These regulations require clinical
laboratories to randomly re-screen at least 10% of the Pap
smears classified on initial manual screen as normal. This 10%
must include normal cases selected from the laboratorys
total caseload, and from patients or groups of patients that
have a high probability of developing cervical cancer based on
available patient information. Laboratories that purchase our
PrepStain and FocalPoint products, or our ASRs, are
subject to extensive regulation under the Clinical Laboratory
Improvement Act of 1988, as amended (CLIA), which requires
laboratories to meet specified standards in the areas of
personnel qualifications, administration, participation in
proficiency testing, patient test management, quality control,
quality assurance and inspections. We believe that our PrepStain
and FocalPoint products operate in a manner that will allow
laboratories using our products to comply with CLIA
requirements. However, there can be no assurance that
interpretations of current CLIA regulations or future changes in
CLIA regulations would not make compliance by the laboratory
difficult or impossible and therefore have an adverse effect on
sales of our products.

In addition, laboratories often must comply with
state regulations, inspection, and licensing. In recent years, a
few states, including New York and California, have adopted
regulations that limit the number of slides that may be manually
examined by a cytotechnologist within a given period of time. We
cannot guarantee that states will not directly regulate
FocalPoint 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 laws relating to such matters as safe working
conditions, manufacturing practices, environmental protection,
fire hazard control and disposal of hazardous or potentially
hazardous substances. Our manufacturing activities involve the
use, storage, handling and disposal

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of hazardous materials and chemicals and, as a
result, we are required to comply with regulations and standards
of the Occupational Safety and Health Act and other safety and
environmental laws. Although we believe that our activities
currently comply with all applicable laws and regulations, the
risk of accidental contamination or injury cannot be completely
eliminated. In the event of such an accident, we could be held
liable for any damages that result, which could have a material
adverse effect on our business, financial condition and results
of operations. Further, we can give no assurance that we will
not be required to incur significant costs to comply with such
laws and regulations in the future, or that such laws or
regulations will not have a material adverse effect upon our
business, financial condition and results of operations.


Foreign Regulatory Approval

Sales of medical devices outside of the United
States are subject to foreign regulatory requirements that vary
widely from country to country. The time required to obtain
approval by a foreign country may be longer or shorter than that
required for FDA approval, and the requirements may differ. No
assurance can be given that such foreign regulatory approvals
will be granted on a timely basis, or at all. We have been
advised by various parties, including consultants we engaged and
foreign distributors, that no regulatory approvals for a device
analogous to FDA approval of a PMA are currently required by any
country where we currently sell PrepStain. Such approval
requirements may be imposed in the future. In addition to
regulatory approvals in the United States, the FocalPoint system
is approved or accepted for primary screening and quality
control re-screening in Japan, Canada, Australia, Germany,
Belgium, the United Kingdom, Ireland, Switzerland,
Denmark, Italy, Hong Kong, South Korea, and Taiwan.
Placements of FocalPoint are also possible in The Netherlands,
France, and many other countries where cervical screening is
performed. In September 2001, we announced receipt of a Medical
Device License in Canada to market both our PrepStain system and
the PrepMate accessory. We intend to pursue additional product
registrations in other foreign countries. We received an FDA
permit to export PrepStain and FocalPoint to all foreign
countries in which we are currently selling these products and
where such a permit was required. There can be no assurance that
we will meet the FDAs export requirements or receive
additional FDA export approval when such approval is necessary,
or that countries to which the devices are to be exported will
approve the devices for import. Our failure to meet the
FDAs export requirements or obtain FDA export approval
when required to do so, or to obtain approval for import, could
have a material adverse effect on our business, financial
condition and results of operations.

Our products are subject to a variety of
regulations in Europe, including the European Union. In vitromedical devices, including the SurePath, PrepStain and
FocalPoint systems, must now comply with the EUs In-Vitro
Diagnostic Medical Devices Directive also known as IVDD. The
IVDD was published in the Official Journal of European
Communities in December 1998. The EU member states were required
to implement the IVDD into national law by December 1999. A
transition period, which ended December 6, 2003, applies to
all devices placed on the market in the EU. By the end of this
transition period, our products were required to comply with the
requirements of the IVDD and member-state local language
requirements. At such time, products not bearing the CE mark
would have been prohibited from being commercially distributed
in EU member countries. In addition, member states may have
continued to restrict or prohibit the marketing of CE-marked
devices pursuant to the safeguard clause of the IVDD if the
member state determines a particular device may compromise the
health and/or safety of patients or users. In December 2003, we
announced that we met the essential requirements of the IVDD,
which allows us to add the CE mark to our products.

Other European countries may enact national laws
that would conform to the IVDD. Member states of the EU and the
European Economic Area may enact requirements in addition to
those imposed by the IVDD. Some European countries have
established national regulations relating to in vitrodiagnostic medical devices. EU directives and national laws
impose requirements for electrical safety and electromagnetic
compatibility that apply to the PrepStain system, PrepMate, and
the FocalPoint system. We have performed the requisite testing
procedures and related documentation to apply the European CE
mark to the FocalPoint, PrepStain and PrepMate systems. We
cannot guarantee that the FocalPoint system or any other product
we may develop will receive any required regulatory clearance or
approval on a timely basis, if at all.

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In addition, Canadian regulations have similar,
but distinct, requirements as those noted for the EUs IVDD
which also became effective January 1, 2003. We undertook
and achieved compliance with those requirements.

Product Liability

Commercial use of any of our products may expose
us to product liability claims. We currently maintain general
liability and product liability insurance coverage and believe
that the amount of such coverage is adequate to meet our present
needs. The medical device industry has experienced increasing
difficulty in obtaining and maintaining reasonable product
liability coverage, and substantial increases in insurance
premium costs in many cases have rendered coverage economically
impractical. To date, we have not experienced difficulty
obtaining an amount of insurance coverage commensurate with our
level of sales. As our sales expand, however, there can be no
assurance that our existing product liability insurance will be
adequate or that additional product liability insurance will be
available to us at a reasonable cost, or that any product
liability claim would not have a material adverse effect on our
business, financial condition and results of operations.

Employees

As of December 31, 2003, we employed
approximately 280 people on a full-time basis. We believe that
relations with our employees are good. None of our employees are
party to a collective bargaining agreement.




Item 1A. Executive Officers of the
Registrant

Our current executive officers are as follows:

|                        |  |     |    |          |  |                                                                 
|----------------------- |  | --- | -- | -------- |  | ----------------------------------------------------------------
|Name                    |  | Age |    | Position
|                        |  |     |    |         
|Paul R. Sohmer, M.D.    |  |     | 55 |          |  | President, Chief Executive Officer and Chairman
    of the Board
|Stephen P. Hall         |  |     | 53 |          |  | Senior Vice-President, Chief Financial Officer                  
|Ray W. Swanson          |  |     | 48 |          |  | Senior Vice-President, Commercial Operations                    
|Johnny D. Powers, Ph.D. |  |     | 42 |          |  | Senior Vice-President and General Manager,
    TriPath Oncology 

Paul R.
Sohmer, M.D.has served as our
Chairman of the Board of Directors since November 2000, and as
our President and Chief Executive Officer since June 2000. Prior
to joining us, Dr. Sohmer served as the President and Chief
Executive Officer of Neuromedical Systems, Inc., a supplier
of cytology screening and anatomic pathology diagnostic
equipment and services to laboratories, from 1997 through 1999.
From 1996 until 1997, Dr. Sohmer served as President of a
consulting firm which he founded. From 1993 to 1996, he served
as President and Chief Executive Officer of Genetrix, Inc.,
a genetic services company based in Scottsdale, Arizona. From
1991 through 1993, Dr. Sohmer was the Corporate
Vice-President of Professional Services and President of the
Professional Services Organization for Nichols Institute, a
clinical laboratory company, where he was responsible for sales,
marketing, information systems, logistics, and clinical studies.
From 1985 until 1991, Dr. Sohmer served as the President
and Chief Executive Officer of Pathology Institute in Berkeley,
California, during which time he founded and served as Medical
Director of the Chiron Reference Laboratory. Dr. Sohmer
received a B.A. degree from Northwestern University and an M.D.
from Chicago Medical School.

Stephen P. Hallhas
served as our Senior Vice-President and Chief Financial Officer
since September 2001. Prior to joining us, Mr. Hall served
as Chief Financial Officer and President of the Imaging and
Power System Division of Colorado Medtech, Inc., a
Colorado-based medical products and services company, from
September 1999 until August 2001. From September 1993 to January
1999, he served as Chief Financial Officer for BioTechnica
International, Inc., a publicly held agricultural products
company, as well as privately held operating companies in the
software development, wireless communication equipment and food
processing machinery industries. Mr. Hall spent nine years
in the commercial banking industry and four years

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with the accounting firm of Peat, Marwick,
Mitchell & Co. He earned a A.B. degree from Harvard
College and an MBA from the Stanford Graduate School of Business.


Ray W. Swansonhas
served as our Senior Vice-President of Commercial Operations
since May 2001. Prior to joining us, he served as General
Manager of e-Business for Dade-Behring, one of the worlds
largest clinical diagnostics companies. Mr. Swanson held a
number of senior management positions at Dade Behring and its
predecessor companies since 1987. From 1997 to 1999, he was the
general manager responsible for the introduction and market
development of Dade-Behrings platelet function business.
As President of Dade-Behrings Japanese subsidiary from
1994 to 1997, he was a member of the management team that
purchased Baxter Internationals diagnostics businesses and
created Dade International as a privately held, stand-alone
company. Prior to 1987, he held positions with Johnson and
Johnson, American Hospital Supply Corporation, Solvay (a global
chemical and pharmaceutical company) and Washington University
School of Medicines Department of Anatomy and
Neurobiology. Mr. Swanson has B.S. and M.S. degrees in
zoology from Eastern Illinois University and an MBA from the
University of Iowa.

Johnny D.
Powers, Ph.D.is our Senior
Vice-President and General Manager of TriPath Oncology. He
previously served as Vice-President and General Manager of
TriPath Oncology since July 2002. From November 2001 to June
2002, Dr. Powers served as our Vice-President of
Manufacturing Operations and Product Development in our
Commercial Operations segment. Prior to joining us, he held a
number of senior management positions at Ventana Medical
Systems, Inc., most recently serving as Vice-President and
General Manager of Manufacturing Operations. Prior positions
held at Ventana include Vice-President and General Manager of
Worldwide Strategic Marketing and Vice-President of the
Molecular Diagnostics Business Unit. Prior to 1996,
Dr. Powers held various management positions at Organon
Teknika Corporation, including Director of BioManufacturing and
Manufacturing Technologies. Dr. Powers has a B.S. degree in
Chemistry from Wake Forest University, a M.S. degree in Chemical
Engineering from Clemson University, a Ph.D. in BioChemical
Engineering from North Carolina State University and an MBA from
Duke University.






|        |           
|------- | ----------
|Item 2. | Properties

We currently lease a total of 43,000 square
feet of space devoted primarily to our Commercial Operations
manufacturing, warehousing, administrative, research and
development and engineering functions at 780 Plantation
Drive, Burlington, North Carolina under a seven-year lease
expiring in August 2005. The lease is renewable for additional
terms at our discretion. In 2003, we renegotiated our Redmond,
Washington lease in order to reduce office and manufacturing
space leased. We now lease approximately 51,000 square feet
of office and manufacturing space in Redmond, Washington under
operating leases. Of the total space rented in Redmond, the
leased 21,000 square feet expires in January 2008. We
sublease the remaining approximately 30,000 square feet as
sub-lessor, the lease for which expires in December 2004 with no
further obligation to us. We also currently lease approximately
10,000 square feet to serve as educational and corporate
office space at 1111 Huffman Mill Road in Burlington, North
Carolina under a three-year lease expiring in November 2004. We
also lease office space in Brussels, Belgium, under an operating
lease expiring in August 2007. We lease approximately
22,100 square feet near the Research Triangle Park area, in
Durham, North Carolina devoted primarily to the activities of
TriPath Oncology. This lease has a seven-year term expiring in
May 2009. We are currently analyzing the best leasing
alternatives for our future manufacturing space requirements in
Burlington, North Carolina. We believe that our facilities and
other available office space will be adequate for our current
and future planned needs.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

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

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On June 16, 2003, Cytyc filed an action in
the United States District Court for the District of
Massachusetts seeking a declaration that our patents are invalid
and that its ThinPrep Imaging System does not infringe our
patents. Cytyc is not claiming in either of its actions that our
FocalPoint or any of our other products infringe any of its
patents. On October 30, 2003, our motion to dismiss
Cytycs complaint on jurisdictional grounds was denied
without any findings on the merits of the case. Accordingly, on
November 10, 2003, we filed our answer to Cytycs
complaint, which included a counterclaim for infringement of our
patents by Cytycs ThinPrep Imaging System.

On January 5, 2004, the district court in
Massachusetts entered an order consolidating the North Carolina
and Massachusetts lawsuits into a single action. The
consolidated case is currently in the discovery phase and no
trial date has been set. We anticipate that a trial will be
scheduled sometime in 2005 based on the current case schedule.
At this time, because of the early stage of the case, we are
unable to predict its ultimate outcome. Similarly, we are unable
to predict the potential effect on our business and results of
operations that any outcome may ultimately have.

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






|        |                                                        
|------- | -------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders

There were no matters submitted to a vote of our
security holders during the fourth quarter of the fiscal year
ended December 31, 2003.




PART II






|        |                                                                          
|------- | -------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity and
    Related Stockholder Matters

Our common stock, $0.01 par value per share,
is traded on the Nasdaq National Market under the symbol
TPTH. The following table sets forth, for the
calendar periods indicated, the range of high and low bid and
ask prices for our common stock on the Nasdaq National Market.
These prices do not include retail mark-up, mark-down or
commissions and may not represent actual transactions.

|                              |  |      |       |     |  |   |      | 
|----------------------------- |  | ---- | ----- | --- |  | - | ---- | 
|                              |  | High |       | Low
|                              |  |      |       |    
|Year ended December 31, 2002: |  |      |       |     |  |   |      | 
|First Quarter                 |  | $    | 8.27  |     |  | $ | 3.84 | 
|Second Quarter                |  | $    | 5.82  |     |  | $ | 3.36 | 
|Third Quarter                 |  | $    | 4.38  |     |  | $ | 1.50 | 
|Fourth Quarter                |  | $    | 3.75  |     |  | $ | 1.60 | 
|                             
|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 | 

On March 10, 2004, the last reported sales
price of the Common Stock on the Nasdaq National Market was
$9.21 per share. As of March 10, 2004, there were
37,940,284 shares of our Common Stock outstanding, which
were held by approximately 340 Common Stockholders of record.

Dividend Policy

We have never declared or paid cash dividends on
our capital stock. We currently intend to retain our future
earnings, if any, for use in our business and therefore do not
anticipate paying cash dividends in the

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foreseeable future. Payment of future dividends,
if any, will be at the discretion of our Board of Directors
after taking into account various factors, including our
financial condition, operating results, current and anticipated
cash needs and plans for expansion.







|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

The selected consolidated financial data
presented below should be read in conjunction with
Item 7.  Managements Discussion and
Analysis of Financial Condition and Results of Operations
and our consolidated financial statements and related notes
thereto included elsewhere in this Form 10-K.

|                                          |  |                                       |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |        |  
|----------------------------------------- |  | ------------------------------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | - |  | - | ------ | -
|                                          |  |                                      
|                                          |  | Year Ended December 31,              
|                                          |  |                                      
|                                          |  | 1999                                  |         | 2000 |  | 2001 |         | 2002 |  | 2003
|                                          |  |                                       |         |      |  |      |         |      |  |     
|                                          |  |                                      
|                                          |  | (in thousands, except per share data)
|Statement of Operations Data(3):          |  |                                       |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |        |  
|Revenues                                  |  | $                                     | 18,466  |      |  | $    | 32,652  |      |  | $    | 27,017  |   |  | $ | 37,485  |   |  | $ | 53,764 |  
|Gross profit                              |  |                                       | 8,098   |      |  |      | 16,529  |      |  |      | 13,921  |   |  |   | 22,563  |   |  |   | 35,387 |  
|Research and development(1)               |  |                                       | 12,258  |      |  |      | 9,629   |      |  |      | 7,828   |   |  |   | 10,259  |   |  |   | 14,295 |  
|Selling, general and administrative       |  |                                       | 17,724  |      |  |      | 23,867  |      |  |      | 28,777  |   |  |   | 30,786  |   |  |   | 30,011 |  
|Operating loss                            |  |                                       | (33,251 | )    |  |      | (16,967 | )    |  |      | (22,684 | ) |  |   | (18,482 | ) |  |   | (8,919 | )
|Net loss                                  |  | $                                     | (32,557 | )    |  | $    | (17,369 | )    |  | $    | (21,680 | ) |  | $ | (18,064 | ) |  | $ | (8,538 | )
|                                          |  |                                       |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |        |  
|Net loss per Share (basic and diluted)(2) |  | $                                     | (1.17   | )    |  | $    | (0.60   | )    |  | $    | (0.61   | ) |  | $ | (0.48   | ) |  | $ | (0.23  | )
|                                          |  |                                       |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |        |  
|Weighted-average shares outstanding(3)    |  |                                       | 27,819  |      |  |      | 29,137  |      |  |      | 35,467  |   |  |   | 37,438  |   |  |   | 37,626 |  
|                                          |  |                                       |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |        |  

|                                                  |  |                |        |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 
|------------------------------------------------- |  | -------------- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------ |  |  | - | ------ | 
|                                                  |  |               
|                                                  |  | December 31,  
|                                                  |  |               
|                                                  |  | 1999           |        | 2000 |  | 2001 |        | 2002 |  | 2003
|                                                  |  |                |        |      |  |      |        |      |  |     
|                                                  |  |               
|                                                  |  | (in thousands)
|Balance Sheet Data(3):                            |  |                |        |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 
|Cash, cash equivalents and short-term investments |  | $              | 13,962 |      |  | $    | 54,340 |      |  | $    | 55,976 |  |  | $ | 32,571 |  |  | $ | 20,954 | 
|Working capital                                   |  |                | 17,338 |      |  |      | 62,316 |      |  |      | 62,898 |  |  |   | 38,837 |  |  |   | 33,446 | 
|Total assets                                      |  |                | 58,874 |      |  |      | 97,471 |      |  |      | 96,748 |  |  |   | 73,951 |  |  |   | 65,928 | 
|Long term obligations                             |  |                | 1,117  |      |  |      | 3,760  |      |  |      | 5,001  |  |  |   | 220    |  |  |   | 8      | 
|Total stockholders equity                        |  | $              | 47,025 |      |  | $    | 80,774 |      |  | $    | 77,291 |  |  | $ | 59,177 |  |  | $ | 52,371 | 






|    |                                                                                                                                                                          
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes regulatory expenses.                                                                                                                                            
|   
|(2) | See Note 2 of Notes to our financial
    statements for information concerning the computation of net
    loss per share and shares used in computing net loss per share.
|   
|(3) | The selected consolidated financial data has been
    restated to reflect the pooling transaction that occurred on
    September 30, 1999.                               






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis of
    Financial Condition and Results of Operations

The following discussion of our financial
condition and results of operations should be read in
conjunction with the Consolidated Financial Statements and Notes
thereto included elsewhere in this Form 10-K.

The discussion included in this section contains
contain forward-looking statements 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 similar expressions. Such statements
are subject to risks and uncertainties that could cause actual
results to differ from those projected. The forward-looking
statements include those made in the section entitled
Outlook below, as well as statements about our:
projected timetables for the pre-clinical and clinical
development of, regulatory submissions and approvals for, market
introduction and commercialization of our

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products and services; our expected future
revenues, operations and expenditures; and our projected cash
needs and the future of the markets in which we participate.


Statements that are not historical facts are
based on our current expectations, beliefs, assumptions,
estimates, forecasts and projections for our business and the
industry and markets in which we compete. These forward-looking
statements are not guarantees of future performance and involve
certain risks, uncertainties and assumptions that are difficult
to predict. Therefore, actual outcomes and results may differ
materially from what is expressed in such forward-looking
statements. We caution investors not to place undue reliance on
the forward-looking statements contained in this report, which
speak only as the date hereof. We undertake no obligation to
update these statements to reflect events or circumstances
occurring after the date of this report or to reflect the
occurrence of unanticipated events, except as required by law.

Certain factors, among others, that could cause
our actual results to differ materially from what is expressed
in those forward looking statements include the following: we
may be unable to successfully develop and commercialize the
diagnostic oncology products and services being developed by
TriPath Oncology; our products may not receive regulatory
approval when we expect, if at all; our products may not be
accepted by the market to the extent we expect; we may be unable
to establish and maintain licenses, strategic collaborations and
distribution arrangements; implementation of the new CPT codes
may not have the financial impact we expect; we may lack the
financial resources necessary to further develop our marketing
and sales capabilities domestically and internationally or to
expand our manufacturing capability; we may be unable to comply
with the extensive domestic and international governmental
regulatory approval and review procedures to which the
manufacture and sale of our products are subject, or lack the
financial resources to bear the expense associated with such
compliance; we may be unable to obtain and maintain adequate
patent and other proprietary rights protection of our products
and services; competition and technological change may make our
products or potential products and technologies less attractive
or obsolete; we may incur greater expenses than we expect with
our clinical trials or they may take longer to complete than we
expect; our promotional discounts, sales and marketing programs
and strategies may not have their expected effect. These factors
and others are discussed in more detail in Exhibit 99.1
Factors Affecting 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 and clinical management of cancer. Specifically, we
develop, manufacture, market, and sell proprietary products for
cancer detection, diagnosis, staging, and treatment selection.
We are using our proprietary technologies, and expertise to
create an array of products designed to improve the clinical
management of cancer. We have developed and marketed an
integrated solution for cervical cancer screening and other
products that deliver image management, data handling, and
prognostic tools for cell diagnosis, cytopathology and
histopathology. We have created new opportunities and
applications for our proprietary technology by applying recent
advances in genomics, biology, and informatics to our efforts to
develop new molecular diagnostic and pharmacogenomic products
and services for cancer of the cervix, breast, ovary, and
prostate.

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

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

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Commercial Operations

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

Our marketing strategy is focused on providing
solutions that address the unmet needs of our three broad market
stakeholders: clinical laboratories, clinicians and third-party
payors. We direct our marketing resources toward various
initiatives designed to promote brand identification and
awareness, increase market acceptance of our products and
services and enhance product management. We have expanded our
presence in the marketplace through increased advertising and
promotion, company-sponsored seminars and trade shows, and peer
selling activities. An important element of our marketing
strategy is to achieve broad market acceptance of our integrated
product consisting of our PrepStain thin-layer slides for
cervical cancer screening by the FocalPoint system.

TriPath Oncology

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

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

We are also leveraging our proprietary imaging
technology in an effort to develop new collaborations to expand
our commercial opportunities. In early 2003, we entered into an
agreement with BMS to provide quantitative tissue based image
analysis in support of their oncology therapeutics programs
targeted at treating epithelial cancers including cancer of the
cervix, breast and colon.

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

Challenges

As we enter 2004, the challenges and risks we
face are familiar on some fronts and new on others. Some
historical challenges and risks that still face us in 2004
include the competitive pressure from Cytyc Corporation. We have
made measurable strides in the cervical cytology marketplace
this past year, but we have more ground to gain. Balancing
existing cash reserves against effective marketing and selling
programs continues to be one of our prime areas of focus.
Additionally, successful movement of three product offerings
through the clinical trial and FDA approval processes is a
challenge we face in 2004. If we are able to obtain FDA approval
for (i) our FocalPoint GS system, (ii) use of our
SurePath product with alternate collection devices and
(iii) use of our preservative solution to collect specimens
for use in Digenes Hybrid Capture HPV test, we will have
additional opportunities to address the cervical cytology market
competitively.

The new challenges and risks that we will face in
2004 primarily reflect the progress we have made in our
molecular diagnostics development programs, to date, and the
fact that some of these programs will now move into the next
stages of development and commercialization. In 2003, we
completed the marker discovery for all of cancer development
programs, including cancer of the breast, cervix, ovary, and
prostate and completed the transfer of breast staging, cervical
staging, ovarian screening and breast screening markers. We made

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significant progress in translating the cervical,
breast, and ovarian markers into assay reagents, and developed
functional prototype assays to evaluate each markers
clinical performance. In 2004, we face the challenge of
optimizing our cervical and breast staging assays, release of
the resultant assays for external research, and initiation of
the process to gain regulatory approval for the sale of these
assays. We also face the challenges and risks associated with
selection of the final marker panel for screening for ovarian
cancer, for continuing clinical studies related to our melanoma
staging product, and for preparation of our facilities and
operations for manufacture of the molecular diagnostic products
that we are developing.


Results of Operations

Our reported operating results are affected by a
number of critical accounting policies, which are described
below in the section titled Critical Accounting
Polices. Certain reclassifications have been made to
research and development expenses and general and administrative
expenses for 2002 and 2001 to maintain consistency with 2003
results.

Years ended December 31, 2003 and
2002

Revenues.Total
revenues for the year ended December 31, 2003 were
$53.8 million, a 43.4% increase from revenues of
$37.5 million for 2002. Compared with 2002, this net
increase in total revenues was primarily due to (i) an
increase in reagent sales of $14.3 million, or 57.8%,
(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 of
fee-per-use sales, service on system placements, sales of
non-instrument related SlideWizard products, revenues at TriPath
Oncology and various international consumable products, and
freight.

In 2003, reagent sales increased
$14.3 million worldwide compared with 2002. Domestic sales
of our SurePath and PrepStain reagents increased
$12.5 million, or 70.0%, while international sales
increased $1.8 million, or 25.7%. As a percentage of total
revenues, reagent and disposable sales increased from 66.0% in
2002 to 72.6% in 2003. Net realized revenue per test in 2003
increased 11% from 2002, and we acquired in excess of 80 new
SurePath consumable domestic customers during the year.

Sales of instruments increased $1.0 million,
or 15.9%, during 2003 compared to 2002. Worldwide sales of
PrepStain instruments for preparation of thin-layer slides for
the Sure Path liquid based Pap test increased by approximately
$1.9 million, or 117.0%, during 2003, including a domestic
increase of $295,000, or 52.6%. Revenues related to PrepStain
instruments increased $1.6 million, or 152.1%,
internationally compared with 2002. This increase was seen most
notably in England, but also in Europe and Asia as our
distributors ordered more instruments to meet developing demand.
We placed 103 PrepStain instruments domestically and 64
internationally during 2003. This compares with 76 domestic
PrepStain units and 39 international units in 2002. There were
no PrepStain instrument placements under third party financed
IPO agreements in either 2002 or 2003. Worldwide sales of
FocalPoint systems, net of a partially offsetting increase of
$284,000 in revenue from systems placed under rental agreements,
decreased approximately $322,000 during 2003. Domestically,
FocalPoint system revenues increased $626,000, primarily due to
the sale of instruments to Kaiser Permanente earlier in 2003,
while internationally these revenues decreased
$1.2 million, primarily due to decreased sales in Asia. In
2003 we placed 17 domestic units and 4 international units. This
compares with 11 domestic units in 2002 and 16 international
units in 2002. Revenues recorded for SlideWizard system sales
decreased $505,000 between 2003 and 2002. We placed 8
SlideWizard 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 related SlideWizard products, revenues at TriPath
Oncology, and various international consumable products and
freight increased approximately $963,000 during 2003, mostly
attributable to FocalPoint fee-per-use revenue, service and
freight. FocalPoint fee-per-use revenues increased $218,000 in
2003 compared to 2002, while service revenues worldwide
increased $403,000 over 2002. Freight and royalty revenues also
increased $222,000 from 2002 to 2003. Revenues recorded at
TriPath Oncology increased $133,000 from 2002 to 2003. We saw a
slight decline in sales of non-instrument related SlideWizard
revenues of $126,000. Other net increases were $113,000.

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Gross Margin.Gross
margin improved significantly from 60.2% in 2002 to 65.8% in
2003. Gross margin increased as the result of continued growth
in higher margin reagent and disposable sales, higher product
prices to new accounts, the gradual phase out of third-party
leasing agreements, and the introduction of lean-based
efficiencies in our manufacturing operations.

Research and
Development.Research and development
expenses include salaries and benefits of scientific and
engineering personnel, testing equipment, relevant consulting
and professional services, components for prototypes and certain
facility costs. Consolidated research and development expenses
for 2003 were $8.9 million, a 17.6% increase from
$7.5 million in 2002. Our TriPath Oncology 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, reflect the redirection of all
imaging research and development activities to the development
of instrument platforms for our molecular diagnostic programs
and the incremental expenses related to the development of our
molecular diagnostic markers, reagents and assays. The increase
reflects the ramp of activity as marker selection and assay
development activities continued for selected cancer targets.
Our Commercial Operations segment incurred research and
development expenses of $1.7 million and $2.3 million
in 2002 and 2003, respectively, an increase of 31.5%. These
expenditures reflect research activity related to the
i3 Series product line and to activities
related to developing knowledge and manufacturing capabilities
for new molecular tests that we are developing, which are to be
manufactured by our Commercial Operations segment. We believe
that our research and development expenses will continue to
increase in both segments as we continue to develop and
commercialize products. The research and development expenses
related to TriPath Oncology for 2003 and 2002 include
$2.5 million per year of amortization, against expense, of
a deferred research and development credit arising out of the
accounting from our collaboration with BD. We accounted for this
transaction in accordance with Statement of Financial Accounting
Standard No. 68, Research and Development
Arrangements. We began amortizing the credit in August
2001 and continued the amortization at $206,600 per month
against research and development expenses through January 2004.

Regulatory.Regulatory expenses include salaries and benefits of regulatory
and quality personnel, costs related to clinical studies and
submissions to the FDA and foreign counterparts, and relevant
consulting services. Regulatory expenses for the year ended
December 31, 2003 were $5.4 million, representing a
99.4% increase from approximately $2.7 million in 2002.
This change was primarily attributable to the activities
surrounding several clinical trials, particularly the FocalPoint
GS and Alternative Collection Device (ACD) trials, and to
efforts surrounding compliance with the European IVDD. These
expenses will likely decrease somewhat in 2004 as the FocalPoint
GS and ACD clinical trials end. However, there will be costs
earlier in 2004 related to our clinical trial to support a
submission to the FDA for approval for HPV testing using the
Digene Hybrid Capture® HPV Test on cells collected using
our SurePath Test Pack. Also in 2004, we intend to initiate the
process to gain regulatory approval and clearance of our
cervical and breast staging assays being developed by TriPath
Oncology and the imaging platform to which these assays may be
linked. Later in 2004 we expect to initiate clinical trials
related to our cervical staging assay. These activities will add
some costs, particularly in the latter part of 2004. From a
segment perspective, regulatory expenses were $4.7 million
in the Commercial Operations segment in 2003, compared with
$2.2 million in 2002 while there were $671,000 of
regulatory expenses incurred by the TriPath Oncology segment in
2003 versus $519,000 in 2002.

Sales and Marketing.Sales and marketing expenses include salaries and benefits of
sales, marketing, sales support and service personnel, and their
related expenses, as well as non-personnel-related expenses
related to marketing our products. Sales and marketing expenses
for the year ended December 31, 2003 were
$18.3 million, including $1.0 million of expenses
related to TriPath Oncology and $17.3 million of expenses
related to Commercial Operations. This represented a 7.7%
decrease overall from $19.9 million in 2002, during which
$986,000 of sales and marketing expenses were attributable to
TriPath Oncology and $18.9 million were attributable to our
Commercial Operations segment. This year-over-year decrease
predominantly reflects savings that resulted from our
termination of our agreement with Nelson Professional Sales in
mid-2002 after which we employed the majority of the physician
sales representatives engaged under that arrangement. We
experienced some attrition of the sales force throughout the
latter half of 2002 and the early part of 2003, further adding
to the overall decrease. By the fourth quarter of 2003, however,
we had fully

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staffed the sales force. Additionally, we
reorganized the sales force into six divisions, as opposed to
three, to better divide the country into manageable territories
enabling us to better control travel costs.


General and
Administrative.General and
administrative expenses include salaries and benefits for
administrative personnel, legal and other professional fees and
certain facility costs. General and administrative expenses were
$11.7 million in 2003 compared with $10.9 million in
2002. The net increase of approximately $751,000, or 6.9%,
reflected increases in costs related to corporate insurance,
personnel-related expenses, and depreciation of assets acquired
in 2002 that were partially offset by reductions in costs
related to our provision for doubtful accounts and a contingent
liability. We recorded increases in corporate insurance costs
between 2003 and 2002 of approximately $613,000.
Personnel-related costs increased in 2003 principally due to
increases 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 further
increased by $374,000 due to depreciation on assets acquired in
2002. There were other net increases of $81,000. These increases
were partially offset by a decrease in our provision for
doubtful accounts of approximately $870,000 from 2002 to 2003
and a decrease in expense of $585,000 attributable to amounts
recorded under a contingent liability in 2002 which was settled
in January 2003. Of the total general and administrative
expenses, $4.4 million was recorded to our TriPath Oncology
segment for the year ended December 31, 2003 compared with
$4.7 million in 2002, while the Commercial Operations
segment recorded $7.3 million and $6.2 million in 2003
and 2002, respectively.

Net Loss from
Operations.Net loss from operations
during 2003 was $8.9 million, a 51.7% improvement from
$18.5 million in 2002. The improvement in net loss from
operations largely reflects incremental gross profit on new
sales of reagents. Total increases in gross profit contributed
$12.8 million to the net improvement in net loss from
operations in 2003, compared with 2002. The increase in gross
margin was partially offset by an increase in operating expenses
of $3.3 million or 7.9%, as described above.

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 2003
and to the continued depressed interest rate environment during
2003. The lower average cash, cash equivalent, and short-term
investment balances reflected our net cash burn during 2003
which averaged approximately $968,000 monthly, though our
cash burn rate during the fourth quarter of 2003 averaged
$511,000 per month. Interest expense for 2003 was $32,000
compared to $551,000 during 2002. This decrease is due to
reduced balances outstanding resulting from principal repayments
under our debt facilities.

Years ended December 31, 2002 and
2001

Revenues.Total
revenues for the year ended December 31, 2002 were
$37.5 million, a 38.7% increase from revenues of
$27.0 million for 2001. Compared with 2001, this net
increase in total revenues was primarily due to (i) an
increase in reagent sales of $13.8 million, or 126.6%,
(ii) a net decrease in instrument sales of
$3.7 million, or 36.5% and (iii) a net increase of
$393,000 in other revenues, which consisted primarily of
fee-per-use sales, service on system placements, sales of
non-instrument related SlideWizard products and various
international consumable products, and freight.

In 2002, reagent sales increased
$13.8 million worldwide compared with 2001. Domestic sales
of our SurePath and PrepStain reagents increased
$9.9 million, or 124.8%, while international sales
increased $3.9 million, or 131.4%. As a percentage of total
revenues, reagent and disposable sales increased from 40.4% in
2001 to 66.0% in 2002. Net realized revenue per test in 2002
increased 17% from 2001, and we acquired in excess of 70 new
SurePath consumable domestic customers during the year.

Sales of instruments decreased $3.7 million,
or 36.5%, during 2002 compared to 2001. Sales of PrepStain
instruments worldwide decreased by about $2.2 million, or
57.8%, during 2002, including a domestic decline of
$2.8 million related to our shift away from sales of
PrepStain instruments under our IPO program, partially offset by
an increase of $652,000 internationally compared with 2001. We
placed 76 PrepStain instruments domestically and 39
internationally during 2002. This compares with 97 domestic
PrepStain units and 14

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international units in 2001. There were no
PrepStain instrument placements under third party financed IPO
agreements in 2002. Worldwide sales of FocalPoint systems,
including a partially offsetting increase in revenue from
systems placed under rental agreements, decreased approximately
$2.2 million during 2002. In 2002 we placed 11 domestic
units and 16 international units. This compares with 21 domestic
units in 2001, 15 of which were sold replacing fee-per-use
contracts to one customer, and 10 international units. Revenues
recorded for SlideWizard system sales increased $634,000 between
2002 and 2001. We placed 19 SlideWizard units in 2002 compared
with 7 in 2001.


Other revenues, consisting primarily of
fee-per-use sales, service on system placements, sales of
non-instrument related SlideWizard products and various
international consumable products, and freight, increased
approximately $393,000 during 2002, mostly attributable to
various international consumable product sales. FocalPoint
fee-per-use revenues declined $1.1 million between 2002 and
2001, but we experienced an increase in other consumable sales
of $1.1 million, an increase in service revenue of
$213,000, and an increase in freight and royalties of $323,000.
We saw a slight decline in sales of non-system related
SlideWizard revenues of $232,000.

Gross Margin.Gross
margin improved significantly from 51.5% in 2001 to 60.2% in
2002. Gross margin increased as the result of growth in sales,
the continuing shift from capital equipment to higher margin
reagent and disposable sales, higher product prices to new
accounts, the gradual phase out of third-party leasing
agreements, and the introduction of lean-based efficiencies in
our manufacturing operations.

Research and
Development.Research and development
expenses include salaries and benefits of scientific and
engineering personnel, testing equipment, relevant consulting
and professional services, components for prototypes and certain
facility costs. Consolidated research and development expenses
for 2002 were $7.5 million, a $1.7 million, or 28.6%,
increase from $5.9 million in 2001. Prior to 2001, our
research and development expenses resulted entirely from
research and development activities related to the
i3 Series and the Slide Wizard product lines.
Incremental expenses related to the development of our molecular
diagnostic markers, reagents, and assays were first incurred in
the second half of 2001 immediately following the announcement
of our agreements with BD and the creation of our TriPath
Oncology operating segment. In 2001 and 2002, the increase in
research and development costs related to the development of our
molecular diagnostic markers, reagents and assays was partially
off-set by a reduction in research expenses related to the
PrepStain and FocalPoint systems as all research and development
activities related to these products were limited to sustaining
engineering and the development of specific customer driven
enhancements. In addition, all new imaging research and product
development activities unrelated to the development of
instrument platforms for our molecular diagnostic products were
eliminated. Since we initiated segment reporting in 2001, our
TriPath Oncology segment incurred research and development
expenses of $1.1 million and $5.8 million for 2001 and
2002, respectively, an increase of 434.8%. These expenditures
reflected the redirection of all imaging research and
development activities to the development of instrument
platforms for our molecular diagnostic programs and the
incremental expenses related to the development of our molecular
diagnostic markers, reagents and assays. Our Commercial
Operations segment incurred research and development expenses of
$4.8 million and $1.7 million in 2001 and 2002
respectively, a decrease of 63.1%. These expenditures reflected
reduced new research activity related to the
i3 Series product line and the transfer of
expenses related to our imaging technology group to TriPath
Oncology. In total, the expenses related to TriPath Oncology for
2002 include $2.5 million of amortization per year, against
expense, of a deferred research and development credit arising
out of the accounting for our transaction with BD. This compares
with $1.0 million of amortization in 2001. We accounted for
this transaction in accordance with Statement of Financial
Accounting Standard No. 68, Research and Development
Arrangements. We began amortizing the credit in August
2001 and continued the amortization at $206,600 per month
against research and development expenses through January 2004.

Regulatory.Regulatory expenses include salaries and benefits of regulatory
and quality personnel, costs related to clinical studies and
submissions to the FDA, and relevant consulting services.
Regulatory expenses for the year ended December 31, 2002
were $2.7 million, representing a 38.3% increase from
almost $2.0 million in 2001. This change was primarily
attributable to the initiation and continuation of activities
surrounding several clinical trials, particularly the FocalPoint
GS and ACD trials, and to continued efforts

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surrounding the implementation of an updated
quality management system. Regulatory expenses were
$2.2 million in the Commercial Operations segment in 2002,
compared with $2.0 million in 2001 while there were
$519,000 of regulatory expenses incurred by the TriPath Oncology
segment in 2002 versus none in 2001.


Sales and Marketing.Sales and marketing expenses include salaries and benefits of
sales, marketing, sales support and service personnel, and their
related expenses, as well as non-personnel-related expenses
related to marketing our products. Sales and marketing expenses
for the year ended December 31, 2002 were
$19.9 million, including $986,000 of expenses related to
TriPath Oncology, while our Commercial Operations incurred
$18.9 million in this area. This represented a 6.2%
increase overall from $18.7 million in 2001, during which
$221,000 of sales and marketing expenses were attributable to
TriPath Oncology and $18.5 million were incurred by our
Commercial Operations segment. This year-over-year increase is
modest and reflects our efforts in late 2000 to significantly
expand our sales and marketing capabilities, including the
addition of physician sales representatives in the third quarter
of 2001 and the building of a marketing organization during the
last half of 2001. During the second quarter of 2002, we
terminated our agreement with Nelson Professional Sales and
employed the majority of those physician sales representatives
engaged under that arrangement. Additionally, we reorganized the
sales force into six divisions, as opposed to three, to better
divide the country into manageable territories thereby enabling
us to better control travel costs.

General and
Administrative.General and
administrative expenses include salaries and benefits for
administrative personnel, legal and other professional fees and
certain facility costs. General and administrative expenses were
$10.9 million in 2002 compared with $10.1 million in
2001. The net increase resulted from several sources. First,
there was a net increase of approximately $620,000 during 2002
versus 2001 in amounts related to a contingent. Second, we
recorded increases in personnel-related and corporate insurance
costs between 2002 and 2001 of approximately $551,000. Third,
overall general and administrative expenses included a provision
for doubtful accounts of $1.1 million in 2002 and
$1.8 million in 2001, a decrease of approximately $760,000.
Other net increases amounted to $433,000. Of the total general
and administrative expenses, $4.7 million was recorded to
our TriPath Oncology segment for the year ended
December 31, 2002 with no expenses to the segment in 2001,
while the Commercial Operations segment recorded
$6.2 million and $10.1 million in 2002 and 2001,
respectively.

Net Loss from
Operations.Net loss from operations
during 2002 was $18.5 million, an 18.5% improvement from
$22.7 million in 2001. The improvement in net loss from
operations largely reflects incremental gross profit on new
sales of reagents. Total increases in gross profit contributed
$8.6 million to the net improvement in net loss from
operations in 2002, compared with 2001. The increase in gross
margin was partially offset by an increase in operating expenses
of $4.4 million or 12.1%, as described above.

Interest Income and
Expense.Interest income for 2002 was
$969,000, a 58.3% decrease from $2.3 million earned during
2001, primarily attributable to lower average cash balances in
2002 and to a continued depressed interest rate environment
during 2002. The lower average cash, cash equivalent, and
short-term investment balances reflected our net cash burn
during 2002 which averaged $1.7 million monthly, though our
cash burn rate during the fourth quarter of 2002 averaged
$1.0 million per month. Interest expense for 2002 was
$551,000 compared to $1.3 million during 2001. This
decrease was due to reduced balances outstanding resulting from
principal repayments under our debt facilities.

Liquidity and Capital Resources

Since our formation, our expenses have
significantly exceeded our revenues, resulting in an accumulated
deficit of $233.0 million as of December 31, 2003. We
have funded our operations primarily through the private
placement and public sale of equity securities, debt facilities
and product sales resulting in cumulative net proceeds of
$216.6 million as of December 31, 2003. We had cash
and cash equivalents of almost $21.0 million at
December 31, 2003.

We funded our operations in 2003 from cash and
cash equivalents on hand and revenues from our Commercial
Operations segment. Cash used in our operations was
$12.5 million in 2003, $18.1 million during 2002 and
$19.0 million during 2001. Negative operating cash flow
during all three years was caused primarily by operating losses.

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Our capital expenditures were $146,000 in 2003,
$2.3 million in 2002, and $936,000 in 2001, with
expenditures primarily attributable to the purchase of machinery
and equipment. We have no material commitments for future
capital expenditures.

We recorded $180,000 to bad debt expense in 2003,
compared with $1.1 million and $1.8 million in 2002
and 2001, respectively. We experienced another strong year of
collections of receivables during 2003. During 2003, cash
collected on receivables was $51.3 million compared with
$37.9 million in 2002. We continue to collect amounts on
some of our older international accounts and continue to monitor
them. We believe that our accounts receivable reserve is
adequate to cover any losses that may be realized. In addition,
our revenue mix has continued its shift throughout 2003 toward a
higher concentration of higher margin consumable sales and away
from a significant dependence on more sporadic sales of
instrumentation. This has contributed to the improvement in our
cash collections and days of sales outstanding we experienced
throughout 2002 and 2003. This not only has contributed to
improved gross margins on our sales of our products, but it has
further shortened the length of time our customers take to pay
their invoices.

During 2003, the continued depressed interest
rates in the U.S. impacted amounts earned on our invested
funds. This had been contrary to the fixed-rate nature of our
borrowings and other term debt, though our most expensive term
debt was retired during 2003. If this interest rate environment
continues, and if we are required to incur additional fixed-rate
debt, there may be a net negative impact on our cash relative to
net interest income.

Litigation

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

On June 16, 2003, Cytyc filed an action in
the United States District Court for the District of
Massachusetts seeking a declaration that our patents are invalid
and that its ThinPrep Imaging System does not infringe our
patents. Cytyc is not claiming in either of its actions that our
FocalPoint or any of our other products infringe any of its
patents. On October 30, 2003, our motion to dismiss
Cytycs complaint on jurisdictional grounds was denied
without any findings on the merits of the case. Accordingly, on
November 10, 2003, we filed our answer to Cytycs
complaint, which included a counterclaim for infringement of our
patents by Cytycs ThinPrep Imaging System.

On January 5, 2004, the district court in
Massachusetts entered an order consolidating the North Carolina
and Massachusetts lawsuits into a single action. The
consolidated case is currently in the discovery phase and no
trial date has been set. We anticipate that a trial will be
scheduled sometime in 2005 based on the current case schedule.
At this time, because of the early stage of the case, we are
unable to predict its ultimate outcome. Similarly, we are unable
to predict the potential effect on our business and results of
operations that any outcome may ultimately have.

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

Financing Arrangements

On February 8, 2000, we entered into a
$7.0 million subordinated term loan with a syndicate of
lenders to finance operations. We fully drew this facility
during the first quarter of 2000. We had remaining amounts
outstanding under this loan of approximately $758,000 at
December 31, 2002. This loan was fully repaid in

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April 2003. At the present time, we have no plans
to replace that loan with a similar facility (see Note 5 to
the Consolidated Financial Statements).


During August 2002, we secured a lease line of
credit from Bank of America. This line is secured by a letter of
credit against our line of credit with Silicon Valley Bank (see
Note 5 to the Consolidated Financial Statements and below).
This lease line of credit, which carries three-year lease terms
for items acquired under it, is being used to secure operating
leases for assets, primarily equipment. As of December 31,
2003, there were assets of $1.3 million leased under this
lease line compared with $1.0 million at December 31,
2002. There will be no further assets leased under this line of
credit.

In January 2004, we renewed and increased our
working capital facility with Silicon Valley Bank from
$5.0 million to $7.5 million. This facility will
expire on January 28, 2005. The entire amount of the line
is available as long as certain financial covenants are met. If
these covenants are not met, the available balance is limited to
an amount equal to 80% of eligible accounts receivable. At
December 31, 2003, we were entitled to borrow the full
amount of the line. The line bears interest at the banks
prime rate plus  1/2% and is collateralized by
substantially all of our assets. The line of credit carries
customary covenants, including the maintenance of a minimum
modified quick ratio, minimum tangible net worth, and other
requirements. We had no outstanding borrowings under this
agreement at December 31, 2003, though the availability
under the line of credit could provide additional funding if
needed.

In April 2003 we obtained a commitment for a
$2.5 million lease line of credit with GE Capital
Corporation. This commitment, which carries three-year lease
terms for items acquired under it, is used to secure operating
leases for assets, primarily equipment. As of December 31,
2003, there were assets of $820,000 leased under this lease
line. In March 2004, this line was renewed for
$2.0 million. Terms of the new line are substantially the
same as the expiring line. The primary difference is that lease
terms under the new line range from 30 to 36 months.

Contractual Obligations

Contractual obligations represent future cash
commitments and liabilities under agreements with third parties,
and exclude contingent liabilities which we cannot reasonably
predict future payment. The following chart represents our
contractual obligations, aggregated by type (in thousands):

|                               |  |                        |       |           |  |           |       |           |  |         |       |  |  |   |       |  |  |   |    | 
|------------------------------ |  | ---------------------- | ----- | --------- |  | --------- | ----- | --------- |  | ------- | ----- |  |  | - | ----- |  |  | - | -- | 
|                               |  |                       
|                               |  | Payments Due by Period
|                               |  |                       
|                               |  |                        |       | Less than |  |           |       | More than
|Contractual Obligations        |  | Total                  |       | 1 Year    |  | 2-3 Years |       | 3-5 Years |  | 5 Years
|                               |  |                        |       |           |  |           |       |           |  |        
|Capital leases                 |  | $                      | 29    |           |  | $         | 21    |           |  | $       | 8     |  |  | $ |      |  |  | $ |   | 
|Short-term debt                |  |                        | 19    |           |  |           | 19    |           |  |         |      |  |  |   |      |  |  |   |   | 
|Operating lease obligations    |  |                        | 5,370 |           |  |           | 2,093 |           |  |         | 2,243 |  |  |   | 1,004 |  |  |   | 30 | 
|Inventory purchase commitments |  |                        | 3,588 |           |  |           | 1,595 |           |  |         | 1,993 |  |  |   |      |  |  |   |   | 
|                               |  |                        |       |           |  |           |       |           |  |         |       |  |  |   |       |  |  |   |    | 
|Total contractual obligations  |  | $                      | 9,006 |           |  | $         | 3,728 |           |  | $       | 4,224 |  |  | $ | 1,004 |  |  | $ | 30 | 
|                               |  |                        |       |           |  |           |       |           |  |         |       |  |  |   |       |  |  |   |    | 

Off-Balance Sheet Arrangements

We have no other long-term debt commitments and
no off-balance sheet financing vehicles.

Outlook

In the fourth quarter of 2002, the Commercial
Operations segment achieved breakeven operations for the first
time. Our Commercial Operations segment continued its profitable
performance for each quarter and for the entire year of 2003. We
expect the Commercial Operations segment to continue to exhibit
profitability in all quarters of 2004, with the further
expectation that the entire Company will experience breakeven
financial results in the second quarter of 2004 and for the
entire year as a whole. The excess cash flow generated from the
Commercial Operations segment has been, and will continue to be
utilized in part to fund the operations of our TriPath Oncology
segment.

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The TriPath Oncology segment is not expected to
generate any significant revenue until 2006 and, consequently,
will continue to incur expenses in excess of revenues generated.
We anticipate that during 2004, the TriPath Oncology segment
will incur approximately $1.4 million to $1.6 million
of expenses per month as it moves toward completing the assay
optimization stage of development of our cervical and breast
staging assays, the release of the resultant assays for external
research, initiation of the process to gain regulatory approval
for the sale of these assays, selection of the final marker
panel for screening for ovarian cancer, continuing clinical
studies related to our melanoma staging product, and for
preparation of our facilities and operations for manufacture of
these molecular diagnostic products.

Our total operating expenses in 2003 were
$44.3 million. Our projected 2004 operating expenses should
fall in the range of $50.0 million to $53.0 million
reflecting our intention to keep operating expenses in line with
our expected top line growth.

We believe that we can continue to manage our
balance sheet to minimize the need for additional outside
sources of cash in 2004. We expect that our capital expenditures
for 2004 will again be under $1 million. We have a
commitment for a $2.5 million lease line of credit which
will be utilized for equipment placed under operating leases.
The expenses associated with these leases are anticipated in our
operating expense projections for 2004. We believe that our
existing cash, our expectation of generating positive cash flow
by the end of 2004, anticipated additional debt and/or lease
financing for internal use assets, rental placements of
PrepStain and fee-per-use placements of FocalPoint will be
sufficient to enable us to meet our future cash obligations for
at least the next 12 months.

While it is possible that marketing and sales
expenditures for the continued SurePath commercial rollout for
gynecological uses in the United States, capital expenditures
associated with placements of PrepStain units and FocalPoint
fee-per-use instruments, and expenditures related to clinical
trials, manufacturing, the TriPath Oncology segment and other
administrative costs may increase, we anticipate that our future
sales growth and the cost control measures we have implemented
should may allow us to avoid raising additional funds for
operating purposes in the future. If, however, our existing
resources prove insufficient to satisfy our liquidity
requirements, or if we need cash for any non-routine purpose, we
may need to raise additional funds through bank facilities, the
sale of additional equity or debt securities or other sources of
capital. In addition, we may opportunistically take advantage of
favorable conditions in the capital markets and raise debt or
equity publicly if such conditions are present and such
financing is advisable. The sale of any equity or debt
securities, if required, may result in additional dilution to
our stockholders. We cannot be certain that additional financing
will be available in amounts or on terms acceptable to us, if at
all. Our failure to raise such financing, if needed, would have
a material adverse effect on our liquidity and capital
resources, business, financial condition and results of
operations.

This Outlook section contains forward-looking
statements and should be read in conjunction with the
forward-looking statements disclosure beginning on page 39
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
future earnings, if any, the timing and amount of which are
uncertain. Accordingly, we have established valuation
allowances, in amounts equal to the net deferred tax assets as
of December 31, 2003 and 2002 in each period to reflect
these uncertainties.

At December 31, 2003, we had net tax losses
of approximately $216.0 million that may be carried forward
to offset future taxable income. In addition, we had research
credits available for carryforward of $3.8 million. These
amounts begin to expire in 2004. Utilization of net tax losses
and any tax credit carryforwards are subject to complex
treatment under the Internal Revenue Code of 1986, as amended
(the Code). Pursuant to Section 382 of the
Code, the change in ownership resulting from our initial public
offering in September 1997 and any other future sale of stock
may limit utilization of future losses in any one year. We
believe that the sale of Common Stock in the offering did not
create any immediate limitations on our utilization of net
operating losses.

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Critical Accounting Policies

The preparation of our Consolidated Financial
Statements, which have been prepared in accordance with
generally accepted accounting principles, requires us to make
estimates and judgments that affect the reported amounts of
assets, liabilities at the date of the financial statements;
revenues and expenses as of the date reported; and related
disclosure of contingent assets and liabilities. On an on-going
basis, we evaluate our estimates, including those related to
sales of our products, bad debts, inventories, investments,
intangible assets, warranty obligations, and legal issues. Since
not all of these accounting policies require management to make
difficult, subjective or complex judgments or estimates, they
are not all considered critical accounting policies. Actual
results may differ from these estimates under different
assumptions.

We believe the following critical accounting
policies involve our more significant judgments and estimates
used in the preparation of our consolidated financial
statements. We reviewed our policies and determined that those
policies identified below as our critical accounting policies
remain our most critical accounting policies for the year ended
December 31, 2003. We did not make any changes in those
policies during the year.

Revenue Recognition

We record revenue from the sale, rental and/or
lease of our systems 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 on system sales occurs at the time the instrument is
installed and accepted at the customer site. In the case of
instrument sales to distributors, revenue recognition on system
sales occurs based upon the contract governing the transaction,
typically at the time the instrument is shipped from our
facility. This was the predominant vehicle for international
instrument sales in 2003 and 2002. If, however, we sell an
instrument directly to an international end user, we record the
revenue upon installation and acceptance of the instrument,
consistent with our treatment in the U.S.

For system rentals, systems are placed at the
customers site free of charge and the customer is
obligated either to purchase reagent kits for a fixed term, or
are charged fees based on monthly minimum, or actual, usage.
Under these transactions, there is no capital equipment revenue
recognized.

We also offer leasing alternatives. Under these
transactions, we may, or may not, recognize revenue on system
hardware depending on the particular details of the lease.

We consider the accounting policies regarding
revenue recognition to be critical for several reasons. First is
due to the distributed nature of our sales network. We sell
through a direct sales force in the U.S., and the issues related
to revenue recognition are essentially clear-cut domestically.
Abroad, however, we sell both through various distributor
networks and directly to end user customers. This requires us to
examine each sales transaction to ensure that we properly and
consistently apply the appropriate accounting guidance covering
revenue recognition. Further, as is typical with many companies
that sell durable equipment, we often experience a flurry of
sales activity near, or at, the end of fiscal quarters. This
requires us to closely examine each equipment sale to ensure the
requisite terms have been met to allow revenue recognition under
GAAP. Additionally, certain of our equipment sales contracts may
contain terms that would grant certain evaluation,
or free-use periods, or terms that would allow the
customer to return equipment. These terms, when present, are
considered prior to our recording revenue.

Sales of consumable products are recorded at
shipment.

Allowance for Doubtful Accounts and Notes
Receivable

We continually monitor amounts due, and payments
from our customers and maintain an allowance for doubtful
accounts and notes receivable for estimated losses resulting
from the inability of our customers to make required payments.
When we evaluate the adequacy of our allowance for doubtful
accounts and notes, we take into account various factors
including our accounts and notes receivable aging, customer
credit-worthiness, historical bad debts and current economic
trends. We age receivables from customers based on contractual
terms. From time to time, customers are slow in paying amounts
due us.

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We closely monitor delinquent accounts with past
due balances outstanding, and will continue to do so, to
determine the need, if any, to further increase our allowance
for doubtful accounts and notes receivable. If the financial
condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional
allowances may be required. If a trade receivable ages past one
year, our policy is to consider the receivable balance
non-performing if there has been no measurable contact or
dialogue with the customer. These receivables would be fully
reserved for by this point. Once a receivable is classified as
non-performing, then we consider whether to charge-off the
receivable balance against our allowance for doubtful accounts.
Factors that figure into this determination include the extent
and nature of dialogue we have with the customer and whether the
customer is still in business.

In assessing the adequacy of our allowance for
doubtful accounts and notes, finance management meets weekly
with individuals responsible for collecting outstanding accounts
and notes receivable balances. Management reviews the work
undertaken during the course of the week by those responsible
for collections and guides activities for the following
weeks actions intended toward collections of outstanding
accounts and notes receivable. Accounts are discussed
specifically, and to the extent they show potential for aging
beyond acceptable limits, adjustments to our allowance for
doubtful accounts and notes are discussed and made. If required,
accounts are placed on credit hold status to stimulate payments
on aging accounts. We ensure the Sales organization is aware of
collection-related actions we take on individual accounts,
including placing accounts on credit hold, so that they can
intervene in the collection process as well.

At December 31, 2003 and 2002, our accounts
receivable balance, net of allowance for doubtful accounts and
notes receivable of $2.3 million and $3.6 million,
respectively, was $13.7 million and $9.4 million.

Inventory

Inventory is stated at the lower of cost or net
realizable value on a first-in, first-out basis. If we determine
that net realizable value is less than cost, then we write down
the related inventory to market value. We review net realizable
value of inventory in detail on an on-going basis, with
consideration given to deterioration, obsolescence, and other
factors. If actual market conditions are less favorable than
those projected by management, and our estimates prove to be
inaccurate, additional write-downs or adjustments to recognize
additional cost of goods for overstated inventory may be
required.

A significant portion, almost 62%, of our
inventory is related to our FocalPoint product. Of that
FocalPoint inventory, much of it is classified as raw material,
or component parts. A significant reason we consider accounting
policies around inventory as critical is due to the relatively
slower moving nature of the FocalPoint instrument. We continue
to monitor actual demand for the product and the economic
environment into which we will be selling it during 2004. We
have been recording additional expense during 2002 and 2003 to
build a reserve for this inventory. After reviewing these
factors, we do not believe that it is necessary to record any
further adjustments to inventory; however, we will continue to
monitor this inventory during 2004.

At December 31, 2003 and 2002, our total
inventory balance, net of reserves for obsolescence of
$2.3 million and $1.8 million, respectively was
$10.9 million and $11.0 million.

Valuation of long-lived and intangible
assets

We review the value of our long-lived assets,
including patents and other intangible assets, for impairment
whenever events or changes in business circumstances indicate
that the carrying amount of assets may not be fully recoverable
or that the useful lives of these assets are no longer
appropriate. If we determine that the carrying value of
intangibles and long-lived assets may not be recoverable based
upon one or more indicators of impairment, the asset is written
down to its estimated fair value based on a discounted cash flow
basis. There was no impairment loss recorded in 2003.

We consider long-lived and intangible assets to
warrant the designation of critical for several reasons. One is
tied to the issue mentioned in Inventory above, the
relatively slower moving nature of the FocalPoint instrument.
One of our ways of selling FocalPoint instruments is under
usage-based arrangements (fee-per-use). We have a number of
FocalPoint instruments recorded on the balance sheet in the
account Customer

51



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##### Table of Contents



use assets. We continue to monitor actual
demand for the product and the economic environment into which
we will be selling it during 2004. Should these instruments be
returned prior to the term of the agreements, there could be
possible impairment issues surrounding these assets. The second
reason we consider long-lived and intangible assets a critical
accounting area is due to the nature of our reliance on our
intellectual property. Should competitors develop and market
products that would render ours redundant or obsolete, then we
would face impairment issues surrounding our intangible assets
as well.


After reviewing the relevant factors affecting
our assets in these categories, we do not believe that it is
necessary to record any further adjustments to our long-lived
and intangible assets.

Recently Issued Accounting Standards

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

In May 2003, the FASB issued
SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and
Equity (SFAS 150). SFAS 150 establishes
standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset
in some circumstances). The standard became effective for us for
financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning
of the first interim period beginning after June 15, 2003
except for mandatorily redeemable financial instruments of
nonpublic entities which are subject to the provisions of this
SFAS 150 for the first fiscal period beginning after
December 15, 2003. The adoption of SFAS 150 had no
impact on our results of operations or financial position for
the year ending, nor as of, December 31, 2003.






|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures About
    Market Risk

We do not participate in derivative financial
instruments, other financial instruments for which the fair
value disclosure would be required under SFAS No. 107,
or derivative commodity instruments. All of our investments are
in short-term, investment-grade commercial paper, corporate
bonds and U.S. Government and agency securities that are
carried at fair value on our books. Accordingly, we have no
quantitative information concerning the market risk of
participating in such investments.

Our primary market risk exposures are in the
areas of interest rate risk and foreign currency exchange rate
risk. Our financial results and cash flows are subject to
fluctuation due to changes in interest rates, primarily from our
investment of available cash balances in highly rated
institutions. Under our current policies, we do not use interest
rate derivative instruments to manage exposure to interest rate
changes. See Item 7. Managements Discussion
and Analysis of Financial Condition and Results of
Operations under Liquidity and Capital
Resources for further discussion of the impact of
interest rates on our financial results. We operate in several
foreign countries and are subject to fluctuations in foreign
currencies to a minor extent. We have no foreign exchange
contracts, option contracts, or other foreign hedging
arrangements. However, the impact of fluctuations in foreign
currencies on our financial results has not been material and
are unlikely to have a material adverse effect on our business,
financial condition or results of operations in the future.

52



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|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

The information required by this item may be
found on pages F-1 through F-23 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 accountants on accounting or financial disclosure matters
in the last fiscal year.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

Our management, with the participation of our
principal executive officer and principal financial officer, has
evaluated the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange
Act of 1934, the Exchange Act) as of the end of the
period covered by this annual report. Based on this evaluation,
our principal executive officer and principal financial officer
concluded that these disclosure controls and procedures are
effective and designed to ensure that the information required
to be disclosed in our reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported
within the requisite time periods.

There was no change in our internal control over
financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) identified in connection with
the evaluation of our internal control that occurred during our
fourth fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal control
over 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 by reference from the
discussion responsive thereto under the captions Election
of Directors, Election of Directors 
Board and Committee Matters, and Section 16(a)
Beneficial Reporting Compliance in our Proxy Statement
relating to our Annual Meeting of Stockholders scheduled for
May 20, 2004 (the Proxy Statement).

We have adopted a Code of Business Conduct and
Ethics (the code of ethics) that applies to all of
our directors, officers and employees. The code of ethics is
filed as an exhibit to this Report and we intend to post the
text of the code of ethics on our website which can be accessed
at http://www.tripathimaging.com. In addition, if we make any
substantive amendments to the code of ethics or grant any
waiver, including any implicit waiver, from a provision of the
code to any of our executive officers or directors, we will
disclose the nature of such amendment or waiver on a
Form 8-K.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The response to this item is incorporated herein
by reference from the discussion responsive thereto under the
captions Election of Directors, Director
Compensation, and Executive Compensation in
the 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 reference from the discussion responsive thereto under the
captions Share Ownership and Approval of
Amendment to the 1996 Equity Plan in the Proxy Statement.

53



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|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

The response to this item is incorporated herein
by reference from the discussion responsive thereto under the
caption Certain Relationships and Related
Transactions in the Proxy Statement.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accountant Fees and
    Services

The response to this item is incorporated herein
by reference from the discussion responsive thereto under the
caption Information Concerning Our Auditor in the
Proxy Statement.

54



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PART IV






|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K

(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.

3. Exhibits

The exhibits are listed under
Part IV, Item 15(c) of this report.

(b) Reports on Form 8-K

None.

(c) 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 Appendix B to our Definitive Proxy Statement on
    Schedule 14A filed with the Commission on April 30,
    2002 (File No. 0-22885) and incorporated herein by
    reference.                                                                                     
| | 10.2* |  |  | 1997 Director Stock Option Plan filed herewith.
    Filed herewith.                                                                                                                                                                                                                                                             
| | 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.

55



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| |        |  |  |                                                                                                                                                                                                                                                                                                                                        
| | ------ |  |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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.   
| | 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 herewith.                                                                                              
| | 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
    herewith.                                                                                                                                         
| | 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
    herewith.                                                                                                                                                          
| | 14.1   |  |  | Code of Business Conduct and Ethics of the
    Company. Filed herewith.                                                                                                                                                                                                                                                                
| | 21.1   |  |  | List of all subsidiaries of the Company. Filed
    herewith.                                                                                                                                                                                                                                                                           
| | 23.1   |  |  | Consent of Ernst & Young LLP,
    independent auditors to the Company. Filed herewith.                                                                                                                                                                                                                                                 

56



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| |      |  |  |                                                                                                                                                            
| | ---- |  |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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.

57



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of
Burlington, State of North Carolina, on March 15, 2004.



| |                      
| | ---------------------
| | 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 of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the
capacities indicated on this 15th day of March, 2004.

|                                                     |  |                                                                                                                     
|---------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------
|Signature                                            |  | Title                                                                                                               
|                                                     |  |                                                                                                                     
|                                                    
|/s/ PAUL R. SOHMER, M. D.Paul R. Sohmer, M. D.       |  | President, Chief Executive Officer and Director
    (Principal Executive Officer)                                   
|                                                    
|/s/ STEPHEN P. HALLStephen P. Hall                   |  | Senior Vice-President and Chief Financial Officer
    (Principal Financial Officer and Principal Accounting Officer)
|                                                    
|/s/ HAYWOOD D. COCHRANE, JR.Haywood D. Cochrane, Jr. |  | Director                                                                                                            
|                                                    
|/s/ ROBERT E. CURRY, PH.D.Robert E. Curry, Ph.D.     |  | Director                                                                                                            
|                                                    
|/s/ RICHARD FRANCORichard Franco                     |  | Director                                                                                                            
|                                                    
|/s/ ARTHUR T. KING, PH.D.Arthur T. King, Ph.D.       |  | Director                                                                                                            
|                                                    
|/s/ ROBERT L. SULLIVANRobert L. Sullivan             |  | Director                                                                                                            

58



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TRIPATH IMAGING, INC.

INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS

|                                                                                                          |  |      |     | 
|--------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                          |  | Page
|                                                                                                          |  |     
|Report of Independent Auditors                                                                            |  |      | F-2 | 
|Consolidated Balance Sheets as of
    December 31, 2003 and 2002                                          |  |      | F-3 | 
|Consolidated Statements of Operations for the
    Years Ended December 31, 2003, 2002, and 2001           |  |      | F-4 | 
|Consolidated Statements of Stockholders
    Equity for the Years Ended December 31, 2003, 2002, and 2001 |  |      | F-5 | 
|Consolidated Statements of Cash Flows for the
    Years Ended December 31, 2003, 2002, and 2001           |  |      | F-6 | 
|Notes to Consolidated Financial Statements                                                                |  |      | F-7 | 

F-1



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##### Table of Contents



TRIPATH IMAGING, INC.

REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders

TriPath Imaging, Inc.


We have audited the accompanying consolidated
balance sheets of TriPath Imaging, Inc. and subsidiaries as
of December 31, 2003 and 2002, and the related consolidated
statements of operations, stockholders equity and cash
flows for each of the three years in the period ended
December 31, 2003. These financial statements are the
responsibility of the Companys management. Our
responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the financial statements referred
to above present fairly, in all material respects, the
consolidated financial position of TriPath Imaging, Inc.
and subsidiaries at December 31, 2003 and 2002, and the
consolidated results of their operations and their cash flows
for each of the three years in the period ended
December 31, 2003 in conformity with accounting principles
generally accepted in the United States.

/s/ Ernst & Young LLP

Raleigh, North Carolina

February 5, 2004


F-2



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##### Table of Contents



TRIPATH IMAGING, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)


|                                                                                                                                                                             |                                                                                                                    |                                            |          |        |        |  |          |        |        | 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------ | ------------------------------------------ | -------- | ------ | ------ |  | -------- | ------ | ------ | 
|                                                                                                                                                                             |                                                                                                                    |                                           
|                                                                                                                                                                             |                                                                                                                    | December 31,                              
|                                                                                                                                                                             |                                                                                                                    |                                           
|                                                                                                                                                                             |                                                                                                                    | 2003                                       |          | 2002  
|                                                                                                                                                                             |                                                                                                                    |                                            |          |       
|ASSETS                                                                                                                                                                      
|Current assets:                                                                                                                                                              |                                                                                                                    |                                            |          |        |        |  |          |       
|                                                                                                                                                                             | Cash and cash equivalents                                                                                          |                                            | $        | 20,954 |        |  | $        | 32,571 |       
|                                                                                                                                                                             | Accounts receivable, less allowance of $2,277 and
    $3,554 at December 31, 2003 and 2002, respectively           |                                            |          | 13,650 |        |  |          | 9,370  |       
|                                                                                                                                                                             | Inventory, less reserves for obsolescence of
    $2,302 and $1,828 at December 31, 2003 and 2002,
    respectively |                                            |          | 10,896 |        |  |          | 10,973 |       
|                                                                                                                                                                             | Other current assets                                                                                               |                                            |          | 1,495  |        |  |          | 477    |       
|                                                                                                                                                                             |                                                                                                                    |                                            |          |        |        |  |          |       
|                                                                                                                                                                             |                                                                                                                    | Total current assets                       |          |        | 46,995 |  |          |        | 53,391 | 
|Customer use assets, net                                                                                                                                                     |                                                                                                                    |                                            | 6,634    |        |        |  | 6,357    |       
|Property and equipment, net                                                                                                                                                  |                                                                                                                    |                                            | 3,418    |        |        |  | 4,063    |       
|Other assets                                                                                                                                                                 |                                                                                                                    |                                            | 488      |        |        |  | 930      |       
|Patents, less accumulated amortization of $3,085
    and $2,419 at December 31, 2003 and 2002, respectively                                                                  |                                                                                                                    |                                            | 6,459    |        |        |  | 7,126    |       
|Other intangible assets, less accumulated
    amortization of $1,066 and $916 at December 31, 2003 and
    2002, respectively                                                |                                                                                                                    |                                            | 1,934    |        |        |  | 2,084    |       
|                                                                                                                                                                             |                                                                                                                    |                                            |          |        |        |  |          |       
|                                                                                                                                                                             |                                                                                                                    | Total assets                               |          | $      | 65,928 |  |          | $      | 73,951 | 
|                                                                                                                                                                             |                                                                                                                    |                                            |          |        |        |  |          |       
|                                                                                                                                                                            
|LIABILITIES AND STOCKHOLDERS
    EQUITY                                                                                                                                    
|Current liabilities:                                                                                                                                                         |                                                                                                                    |                                            |          |        |        |  |          |       
|                                                                                                                                                                             | Accounts payable                                                                                                   |                                            | $        | 4,425  |        |  | $        | 2,341  |       
|                                                                                                                                                                             | Accrued expenses                                                                                                   |                                            |          | 7,378  |        |  |          | 5,436  |       
|                                                                                                                                                                             | Deferred revenue and customer deposits                                                                             |                                            |          | 1,499  |        |  |          | 1,103  |       
|                                                                                                                                                                             | Deferred research and development funding                                                                          |                                            |          | 207    |        |  |          | 2,479  |       
|                                                                                                                                                                             | Current portion of debt                                                                                            |                                            |          | 40     |        |  |          | 785    |       
|                                                                                                                                                                             | Other current liabilities                                                                                          |                                            |          |       |        |  |          | 2,410  |       
|                                                                                                                                                                             |                                                                                                                    |                                            |          |        |        |  |          |       
|                                                                                                                                                                             |                                                                                                                    | Total current liabilities                  |          |        | 13,549 |  |          |        | 14,554 | 
|Long-term debt, less current portion                                                                                                                                         |                                                                                                                    |                                            | 8        |        |        |  | 13       |       
|Other long-term liabilities                                                                                                                                                  |                                                                                                                    |                                            |         |        |        |  | 207      |       
|Stockholders equity:                                                                                                                                                        |                                                                                                                    |                                            |          |        |        |  |          |       
|Preferred stock, $0.01 par value;
    1,000,000 shares authorized; none issued and outstanding                                                                               |                                                                                                                    |                                            |         |        |        |  |         |       
|Common stock, $0.01 par value;
    98,000,000 shares authorized; 37,855,967 and
    37,454,234 shares issued and outstanding at
    December 31, 2003 and 2002, respectively |                                                                                                                    |                                            | 379      |        |        |  | 375      |       
|Additional paid-in capital                                                                                                                                                   |                                                                                                                    |                                            | 285,035  |        |        |  | 283,396  |       
|Deferred compensation                                                                                                                                                        |                                                                                                                    |                                            | (52      | )      |        |  | (78      | )     
|Accumulated deficit                                                                                                                                                          |                                                                                                                    |                                            | (233,020 | )      |        |  | (224,482 | )     
|Accumulated other comprehensive income (loss)                                                                                                                                |                                                                                                                    |                                            | 29       |        |        |  | (34      | )     
|                                                                                                                                                                             |                                                                                                                    |                                            |          |        |        |  |          |       
|                                                                                                                                                                             |                                                                                                                    | Total stockholders equity                 |          |        | 52,371 |  |          |        | 59,177 | 
|                                                                                                                                                                             |                                                                                                                    |                                            |          |        |        |  |          |       
|                                                                                                                                                                             |                                                                                                                    | Total liabilities and stockholders equity |          | $      | 65,928 |  |          | $      | 73,951 | 
|                                                                                                                                                                             |                                                                                                                    |                                            |          |        |        |  |          |       

See accompanying notes

F-3



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##### Table of Contents



TRIPATH IMAGING, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

(In thousands, except share and per share amounts)


|                                              |  |                         |        |      |  |      |         |   |  |   |         |  
|--------------------------------------------- |  | ----------------------- | ------ | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                              |  |                        
|                                              |  | Year Ended December 31,
|                                              |  |                        
|                                              |  | 2003                    |        | 2002 |  | 2001
|                                              |  |                         |        |      |  |     
|Revenues                                      |  | $                       | 53,764 |      |  | $    | 37,485  |   |  | $ | 27,017  |  
|Cost of revenues                              |  |                         | 18,377 |      |  |      | 14,922  |   |  |   | 13,096  |  
|                                              |  |                         |        |      |  |      |         |   |  |   |         |  
|Gross profit                                  |  |                         | 35,387 |      |  |      | 22,563  |   |  |   | 13,921  |  
|Operating expenses:                           |  |                         |        |      |  |      |         |   |  |   |         |  
|Research and development                      |  |                         | 8,861  |      |  |      | 7,534   |   |  |   | 5,858   |  
|Regulatory                                    |  |                         | 5,434  |      |  |      | 2,725   |   |  |   | 1,970   |  
|Sales and marketing                           |  |                         | 18,324 |      |  |      | 19,850  |   |  |   | 18,685  |  
|General and administrative                    |  |                         | 11,687 |      |  |      | 10,936  |   |  |   | 10,092  |  
|                                              |  |                         |        |      |  |      |         |   |  |   |         |  
|                                              |  |                         | 44,306 |      |  |      | 41,045  |   |  |   | 36,605  |  
|                                              |  |                         |        |      |  |      |         |   |  |   |         |  
|Operating loss                                |  |                         | (8,919 | )    |  |      | (18,482 | ) |  |   | (22,684 | )
|Interest income                               |  |                         | 413    |      |  |      | 969     |   |  |   | 2,321   |  
|Interest expense                              |  |                         | (32    | )    |  |      | (551    | ) |  |   | (1,317  | )
|                                              |  |                         |        |      |  |      |         |   |  |   |         |  
|Net loss                                      |  | $                       | (8,538 | )    |  | $    | (18,064 | ) |  | $ | (21,680 | )
|                                              |  |                         |        |      |  |      |         |   |  |   |         |  
|Net loss per common share (basic and diluted) |  | $                       | (0.23  | )    |  | $    | (0.48   | ) |  | $ | (0.61   | )
|                                              |  |                         |        |      |  |      |         |   |  |   |         |  
|Weighted-average common shares outstanding    |  |                         | 37,626 |      |  |      | 37,438  |   |  |   | 35,467  |  
|                                              |  |                         |        |      |  |      |         |   |  |   |         |  

See accompanying notes

F-4



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##### Table of Contents



TRIPATH IMAGING, INC.



CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY


(In thousands, except share and per share amounts)


|                                 |                                                                              |                    |     |            |  |              |         |             |   |               |     |               |   |   |          |         |   |   |     |     |   |   |        |         |         |  
|-------------------------------- | ---------------------------------------------------------------------------- | ------------------ | --- | ---------- |  | ------------ | ------- | ----------- | - | ------------- | --- | ------------- | - | - | -------- | ------- | - | - | --- | --- | - | - | ------ | ------- | ------- | -
|                                 |                                                                              |                    |     |            |  |              |         |             |   | Accumulated   |     |              
|                                 |                                                                              |                    |     | Additional |  |              |         |             |   | Other         |     | Total        
|                                 |                                                                              | Common             |     | Paid-in    |  | Deferred     |         | Accumulated |   | Comprehensive |     | Stockholders
|                                 |                                                                              | Stock              |     | Capital    |  | Compensation |         | Deficit     |   | Income(Loss)  |     | Equity       
|                                 |                                                                              |                    |     |            |  |              |         |             |   |               |     |              
|Balance at January 1, 2001       |                                                                              | $                  | 341 |            |  | $            | 265,260 |             |   | $             | (89 | )             |   | $ | (184,738 | )       |   | $ |    |     |   | $ | 80,774 |        
|Exercise of options and warrants |                                                                              |                    | 3   |            |  |              | 934     |             |   |               |    |               |   |   |         |         |   |   |    |     |   |   | 937    |        
|                                 | Private issuance of common stock                                             |                    |     | 29         |  |              |         | 17,777      |   |               |     |              |   |   |          |        |   |   |     |    |   |   |        | 17,806  |        
|                                 | Re-pricing of warrants issued as consideration
    under term loan agreement |                    |     |           |  |              |         | (576        | ) |               |     |              |   |   |          |        |   |   |     |    |   |   |        | (576    | )      
|                                 | Amortization of deferred compensation                                        |                    |     |           |  |              |         |            |   |               |     | 89            |   |   |          |        |   |   |     |    |   |   |        | 89      |        
|                                 | Foreign currency translation                                                 |                    |     |           |  |              |         |            |   |               |     |              |   |   |          |        |   |   |     | (59 | ) |   |        | (59     | )      
|                                 | Net loss                                                                     |                    |     |           |  |              |         |            |   |               |     |              |   |   |          | (21,680 | ) |   |     |    |   |   |        | (21,680 | )      
|                                 |                                                                              |                    |     |            |  |              |         |             |   |               |     |               |   |   |          |         |   |   |     |     |   |   |        |        
|                                 |                                                                              | Comprehensive loss |     |            |  |              |         |             |   |               |     |               |   |   |          |         |   |   |     |     |   |   |        |         | (21,739 | )
|                                 |                                                                              |                    |     |            |  |              |         |             |   |               |     |               |   |   |          |         |   |   |     |     |   |   |        |        
|Balance at December 31, 2001     |                                                                              |                    | 373 |            |  |              | 283,395 |             |   |               |    |               |   |   | (206,418 | )       |   |   | (59 | )   |   |   | 77,291 |        
|                                 | Exercise of options and warrants                                             |                    |     | 2          |  |              |         | 234         |   |               |     |              |   |   |          |        |   |   |     |    |   |   |        | 236     |        
|                                 | Re-pricing of warrants issued as consideration
    under term loan agreement |                    |     |           |  |              |         | (350        | ) |               |     |              |   |   |          |        |   |   |     |    |   |   |        | (350    | )      
|                                 | Deferred compensation related to grant of stock
    options                  |                    |     |           |  |              |         | 152         |   |               |     | (152          | ) |   |          |        |   |   |     |    |   |   |        |        |        
|                                 | Adjustment to deferred compensation                                          |                    |     |           |  |              |         | (35         | ) |               |     | 35            |   |   |          |        |   |   |     |    |   |   |        |        |        
|                                 | Amortization of deferred compensation                                        |                    |     |           |  |              |         |            |   |               |     | 39            |   |   |          |        |   |   |     |    |   |   |        | 39      |        
|                                 | Foreign currency translation                                                 |                    |     |           |  |              |         |            |   |               |     |              |   |   |          |        |   |   |     | 25  |   |   |        | 25      |        
|                                 | Net loss                                                                     |                    |     |           |  |              |         |            |   |               |     |              |   |   |          | (18,064 | ) |   |     |    |   |   |        | (18,064 | )      
|                                 |                                                                              |                    |     |            |  |              |         |             |   |               |     |               |   |   |          |         |   |   |     |     |   |   |        |        
|                                 |                                                                              | Comprehensive loss |     |            |  |              |         |             |   |               |     |               |   |   |          |         |   |   |     |     |   |   |        |         | (18,039 | )
|                                 |                                                                              |                    |     |            |  |              |         |             |   |               |     |               |   |   |          |         |   |   |     |     |   |   |        |        
|Balance at December 31, 2002     |                                                                              |                    | 375 |            |  |              | 283,396 |             |   |               | (78 | )             |   |   | (224,482 | )       |   |   | (34 | )   |   |   | 59,177 |        
|                                 | Exercise of options and warrants                                             |                    |     | 4          |  |              |         | 1,590       |   |               |     |              |   |   |          |        |   |   |     |    |   |   |        | 1,594   |        
|                                 | Re-pricing of stock options                                                  |                    |     |           |  |              |         | 49          |   |               |     |              |   |   |          |        |   |   |     |    |   |   |        | 49      |        
|                                 | Amortization of deferred compensation                                        |                    |     |           |  |              |         |            |   |               |     | 26            |   |   |          |        |   |   |     |    |   |   |        | 26      |        
|                                 | Foreign currency translation                                                 |                    |     |           |  |              |         |            |   |               |     |              |   |   |          |        |   |   |     | 63  |   |   |        | 63      |        
|                                 | Net loss                                                                     |                    |     |           |  |              |         |            |   |               |     |              |   |   |          | (8,538  | ) |   |     |    |   |   |        | (8,538  | )      
|                                 |                                                                              |                    |     |            |  |              |         |             |   |               |     |               |   |   |          |         |   |   |     |     |   |   |        |        
|                                 |                                                                              | Comprehensive loss |     |            |  |              |         |             |   |               |     |               |   |   |          |         |   |   |     |     |   |   |        |         | (8,475  | )
|                                 |                                                                              |                    |     |            |  |              |         |             |   |               |     |               |   |   |          |         |   |   |     |     |   |   |        |        
|Balance at December 31, 2003     |                                                                              | $                  | 379 |            |  | $            | 285,035 |             |   | $             | (52 | )             |   | $ | (233,020 | )       |   | $ | 29  |     |   | $ | 52,371 |        
|                                 |                                                                              |                    |     |            |  |              |         |             |   |               |     |               |   |   |          |         |   |   |     |     |   |   |        |        

See accompanying notes.

F-5



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##### Table of Contents



TRIPATH IMAGING, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

(In thousands, except share and per share amounts)


|                                               |                                                                                 |                                                                              |        |         |        |      |         |         |        |   |         |         |        |  
|---------------------------------------------- | ------------------------------------------------------------------------------- | ---------------------------------------------------------------------------- | ------ | ------- | ------ | ---- | ------- | ------- | ------ | - | ------- | ------- | ------ | -
|                                               |                                                                                 |                                                                             
|                                               |                                                                                 | Year Ended December 31,                                                     
|                                               |                                                                                 |                                                                             
|                                               |                                                                                 | 2003                                                                         |        | 2002    |        | 2001
|                                               |                                                                                 |                                                                              |        |         |        |     
|OPERATING ACTIVITIES                           |                                                                                 |                                                                              |        |         |        |      |         |         |        |   |         |        
|Net loss                                       |                                                                                 | $                                                                            | (8,538 | )       |        | $    | (18,064 | )       |        | $ | (21,680 | )      
|                                               | Adjustments to reconcile net loss to net cash
    used in operating activities: |                                                                              |        |         |        |      |         |         |        |   |         |         |       
|                                               |                                                                                 | Depreciation                                                                 |        |         | 3,539  |      |         |         | 3,044  |   |         |         | 3,071  |  
|                                               |                                                                                 | Amortization of intangible assets                                            |        |         | 817    |      |         |         | 817    |   |         |         | 817    |  
|                                               |                                                                                 | Amortization of deferred compensation                                        |        |         | 26     |      |         |         | 39     |   |         |         | 89     |  
|                                               |                                                                                 | Non-cash equity compensation                                                 |        |         | 49     |      |         |         |       |   |         |         |       |  
|                                               |                                                                                 | Amortization of deferred research and development                            |        |         | (2,479 | )    |         |         | (2,479 | ) |         |         | (1,033 | )
|                                               |                                                                                 | Amortization of non-cash debt issuance costs                                 |        |         |       |      |         |         | 225    |   |         |         | 487    |  
|                                               |                                                                                 | Loss (Gain) on disposal of fixed assets                                      |        |         | 13     |      |         |         | (3     | ) |         |         | (9     | )
|                                               |                                                                                 | Other non-cash items                                                         |        |         |       |      |         |         | 885    |   |         |         | 695    |  
|                                               | Changes in operating assets and liabilities:                                    |                                                                              |        |         |        |      |         |         |        |   |         |         |       
|                                               |                                                                                 | Accounts receivable                                                          |        |         | (4,183 | )    |         |         | 233    |   |         |         | 2,005  |  
|                                               |                                                                                 | Inventory                                                                    |        |         | (3,122 | )    |         |         | (3,005 | ) |         |         | (2,135 | )
|                                               |                                                                                 | Other current assets                                                         |        |         | (1,011 | )    |         |         | 603    |   |         |         | (218   | )
|                                               |                                                                                 | Other long-term assets                                                       |        |         | 443    |      |         |         | (28    | ) |         |         | (809   | )
|                                               |                                                                                 | Accounts payable and accrued expenses                                        |        |         | 3,927  |      |         |         | (767   | ) |         |         | 100    |  
|                                               |                                                                                 | Deferred revenue and customer deposits                                       |        |         | 395    |      |         |         | 373    |   |         |         | (427   | )
|                                               |                                                                                 | Other current liabilities                                                    |        |         | (2,410 | )    |         |         |       |   |         |         |       |  
|                                               |                                                                                 |                                                                              |        |         |        |      |         |         |        |   |         |        
|                                               | Net cash used in operating activities                                           |                                                                              |        | (12,534 | )      |      |         | (18,127 | )      |   |         | (19,047 | )     
|INVESTING ACTIVITIES                           |                                                                                 |                                                                              |        |         |        |      |         |         |        |   |         |        
|                                               | Purchases of property and equipment                                             |                                                                              |        | (146    | )      |      |         | (2,251  | )      |   |         | (936    | )     
|                                               | Disposals of property and equipment                                             |                                                                              |        |        |        |      |         | 5       |        |   |         | 9       |       
|                                               | Sales (Purchases) of short-term investments                                     |                                                                              |        |        |        |      |         | 2,499   |        |   |         | (2,499  | )     
|                                               | Other                                                                           |                                                                              |        | 196     |        |      |         |        |        |   |         | 107     |       
|                                               |                                                                                 |                                                                              |        |         |        |      |         |         |        |   |         |        
|                                               | Net cash provided by (used in) investing
    activities                         |                                                                              |        | 50      |        |      |         | 253     |        |   |         | (3,319  | )     
|FINANCING ACTIVITIES                           |                                                                                 |                                                                              |        |         |        |      |         |         |        |   |         |        
|                                               | Net proceeds from issuance of common stock and
    warrants                     |                                                                              |        |        |        |      |         |        |        |   |         | 17,806  |       
|                                               | Proceeds from exercise of stock options and
    warrants                        |                                                                              |        | 1,594   |        |      |         | 236     |        |   |         | 937     |       
|                                               | Other                                                                           |                                                                              |        |        |        |      |         |        |        |   |         | (41     | )     
|                                               | Proceeds from research and development agreement                                |                                                                              |        |        |        |      |         |        |        |   |         | 6,198   |       
|                                               | Proceeds from debt                                                              |                                                                              |        | 633     |        |      |         |        |        |   |         |        |       
|                                               | Payments on debt and leases                                                     |                                                                              |        | (1,384  | )      |      |         | (3,286  | )      |   |         | (3,292  | )     
|                                               |                                                                                 |                                                                              |        |         |        |      |         |         |        |   |         |        
|                                               | Net cash provided by (used in) financing
    activities                         |                                                                              |        | 843     |        |      |         | (3,050  | )      |   |         | 21,608  |       
|                                               | Effect of exchange rate changes on cash                                         |                                                                              |        | 24      |        |      |         | 18      |        |   |         | (105    | )     
|                                               |                                                                                 |                                                                              |        |         |        |      |         |         |        |   |         |        
|                                               | Net decrease in cash and cash equivalents                                       |                                                                              |        | (11,617 | )      |      |         | (20,906 | )      |   |         | (863    | )     
|                                               |                                                                                 | Cash and cash equivalents at beginning of year                               |        |         | 32,571 |      |         |         | 53,477 |   |         |         | 54,340 |  
|                                               |                                                                                 |                                                                              |        |         |        |      |         |         |        |   |         |        
|                                               |                                                                                 | Cash and cash equivalents at end of year                                     |        | $       | 20,954 |      |         | $       | 32,571 |   |         | $       | 53,477 |  
|                                               |                                                                                 |                                                                              |        |         |        |      |         |         |        |   |         |        
|SUPPLEMENTAL CASH FLOW INFORMATION             |                                                                                 |                                                                              |        |         |        |      |         |         |        |   |         |        
|                                               |                                                                                 | Cash paid for interest                                                       |        | $       | 32     |      |         | $       | 326    |   |         | $       | 830    |  
|                                               |                                                                                 |                                                                              |        |         |        |      |         |         |        |   |         |        
|NONCASH INVESTING AND FINANCING
    ACTIVITIES |                                                                                 |                                                                              |        |         |        |      |         |         |        |   |         |        
|                                               |                                                                                 | Re-pricing of warrants issued as consideration
    under term loan agreement |        | $       |       |      |         | $       | (350   | ) |         | $       | (576   | )
|                                               |                                                                                 |                                                                              |        |         |        |      |         |         |        |   |         |        

See accompanying notes.

F-6



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##### Table of Contents



TRIPATH IMAGING, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

(In thousands, except share and per share amounts)




|   |           
|-- | ----------
|1. | Background

We create solutions that redefine the early
detection and clinical management of cancer. Specifically, we
develop, manufacture, market, and sell proprietary products for
cancer detection, diagnosis, staging, and treatment selection.
We are using our proprietary technologies, and know-how to
create an array of products designed to improve the clinical
management of cancer. We were incorporated in October 1996 as
AutoCyte, Inc. and changed our name to TriPath
Imaging, Inc. in September 1999 in connection with the
merger of AutoCyte, Inc. and NeoPath, Inc. and
acquisition of the technology and intellectual property of
Neuromedical Systems, Inc. (NSI). We were created to
leverage the complementary nature of the products, technologies,
and intellectual property developed by our predecessor
companies, all of whom were early pioneers in the application of
computerized image processing and analysis to detect the often
subtle cellular abnormalities associated with cancer and its
precursors. To date, we have developed and marketed an
integrated solution for cervical cancer screening and other
products that deliver image management, data handling, and
prognostic tools for cell diagnosis, cytopathology and
histopathology. We have created new opportunities and
applications for our proprietary technology by applying recent
advances in genomics, biology, and informatics to our efforts to
develop new molecular diagnostic and pharmacogenomic products
and services for malignant melanoma and cancers of the cervix,
breast, ovary, and prostate.

We are organized into two operating units:



| |   |                                                                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Commercial Operations, through which we manage
    the market introduction, sales, service, manufacturing and
    ongoing development of our products; and                  
|
| |  | TriPath Oncology, our wholly-owned subsidiary,
    through which we manage the development of molecular diagnostic
    and pharmacogenomic products and services for cancer.

Our TriPath Oncology business focuses on
developing and commercializing molecular diagnostic and
pharmacogenomic products for a variety of cancers. On
July 31, 2001, we entered into a series of agreements with
Becton, Dickinson and Company (BD) to develop and
commercialize these tests for malignant melanoma and cancers of
the cervix, breast, ovary and prostate using genomic and
proteomic markers identified at Millennium
Pharmaceuticals, Inc. (Millennium). In January 2004, the
molecular marker discovery process and transfer of all markers
from Millennium was completed. We intend to use these markers
and related intellectual property to continue to develop and
commercialize tests and other products for these cancers. We
will share commercial responsibilities with BD for any products
that we ultimately develop.

Information on our operations by segment and
geographic area is included in Note 8.

Revenues from sales of products have not
generated sufficient cash to fully support our operations. We
have incurred substantial losses since inception. We have funded
our operations primarily through the private placement and
public sale of equity securities, debt and lease financing, and
product sales. We continue to be subject to certain risks and
uncertainties common to early stage medical device companies
including the uncertainty of availability of additional
financing, extensive government regulation, uncertainty of
market acceptance of our products, limited manufacturing,
marketing and sales experience and uncertainty of future
profitability.



|   |                                
|-- | -------------------------------
|2. | Significant Accounting Policies



| |                            
| | ---------------------------
| | Principles of Consolidation

The consolidated financial statements include our
accounts and those of our wholly-owned subsidiaries. All
significant intercompany balances and transactions have been
eliminated in consolidation.

F-7



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)




| |                 
| | ----------------
| | Use of Estimates

The preparation of consolidated financial
statements in conformity with accounting principles generally
accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes.
Actual results could differ from those estimates.



| |                  
| | -----------------
| | Reclassifications

Certain amounts for 2002 and 2001 have been
reclassified to conform to the 2003 presentation, principally
between research and development into general and administrative
expenses. These reclassifications had no effect on previously
reported net earnings or financial position.



| |                    
| | -------------------
| | Revenue Recognition

We record revenue from the sale, rental and/or
lease of our systems 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 occurs at the time the instrument is installed and
accepted at the customer site. In the case of instrument sales
to distributors, revenue recognition occurs based upon the
contract governing the transaction, typically at the time the
instrument is shipped from our facility. This was the
predominant vehicle for international instrument sales for all
years presented. If, however, we sell an instrument directly to
an international end user, we record the revenue upon
installation and acceptance of the instrument, as we do in the
U.S. For system rentals, systems are placed at the
customers site free of charge and the customer is
obligated either to purchase reagent kits for a fixed term, or
are charged fees based on a monthly minimum, or actual usage.
Under these transactions, there is no capital equipment revenue
recognized. We also offer leasing alternatives. Under these
transactions, we may, or may not, recognize revenue on system
hardware depending on the particular details of the lease. Sales
of consumable products are recorded on shipment. Revenue and
costs related to shipping products to customers are included in
both revenues and cost of revenues, respectively.



| |                          
| | -------------------------
| | Cash and Cash Equivalents

We consider all highly liquid investments with
maturities of three months or less when purchased to be cash
equivalents.



| |          
| | ---------
| | Inventory

Inventory is stated at the lower of cost or net
realizable value (first-in first-out basis). Net realizable
value of inventory is reviewed in detail on an on-going basis,
with consideration given to deterioration, obsolescence, and
other factors.



| |                    
| | -------------------
| | Customer-Use Assets

PrepStain and FocalPoint systems manufactured for
rental or fee-per-use placements are carried in inventory until
the systems are shipped, at which time they are reclassified to
customer-use assets (non-current assets). Reclassifications of
$3,198, $2,473, and $418 occurred between customer-use assets,
property and equipment and inventory during 2003, 2002, and
2001, respectively. Customer-use assets are depreciated on a
straight-line basis over an estimated useful life of four years.
Depreciation expense of customer-use assets amounted to $2,103,
$1,516, and $1,850 during 2003, 2002, and 2001, respectively.

F-8



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)




| |                       
| | ----------------------
| | Property and Equipment

Property and equipment is stated at cost.
Depreciation is computed using the straight-line method over the
estimated useful lives (typically three to seven years) of the
individual assets. Depreciation expense of property and
equipment amounted to $1,436, $1,251, and $943 during 2003,
2002, and 2001, respectively.



| |        
| | -------
| | Patents

Patents consist of patents and core technology
acquired from NSI. Such assets are amortized using the
straight-line method over estimated useful lives ranging from 14
to 20 years (See also Other Intangible Assets
below).



| |                        
| | -----------------------
| | Other Intangible Assets

As of January 1, 2002, we adopted Financial
Accounting Standards Board (FASB) Statement of
Financial Accounting Standards (SFAS) No. 142
Goodwill and Other Intangible Assets
(SFAS 142), which was issued in July 2001.
SFAS 142 requires that ratable amortization of goodwill be
replaced with periodic tests of the goodwills impairment
and that intangible assets other than goodwill be amortized over
their useful lives. We completed our evaluation of goodwill
under SFAS 142 and assigned the net book value of $2,234 at
December 31, 2001 to specifically identifiable intangible
assets, being in respect of acquired rights to certain
intellectual property surrounding our pathology workstation
products and our location-guided screening technology. These
intangible assets will be amortized over the next 14 years.
Included in 2003, 2002 and 2001 is $150 of amortization
attributable to the specifically identifiable intangible assets.



| |                 
| | ----------------
| | Asset Impairment

We periodically review the value of our
long-lived assets to determine if an impairment has occurred. If
this review indicates that the assets will not be recoverable,
as determined based on an analysis of undiscounted cash flows
over the remaining amortization period, we would reduce the
carrying value of our long-lived assets accordingly. During
2001, we recognized $430 of such a loss for the placement of
certain Customer-Use Assets free of charge at a customer under a
two-year contract. There were no such losses recognized in 2002
or 2003.



| |                 
| | ----------------
| | Deferred Revenue

Deferred revenue principally consists of up-front
cash receipts related to FocalPoint and PrepStain service and
equipment contracts and the revenue portion subject to
contingencies under capitalized leases. The deferred revenue
subject to contingencies under capitalized leases will be
recognized once those contingencies have been met. Revenue
related to service and equipment contracts is recognized as
earned.



| |             
| | ------------
| | Income Taxes

We account for income taxes using the liability
method in accordance with SFAS No. 109,
Accounting for Income Taxes. Under the liability
method, deferred tax assets and liabilities are determined based
on differences between the financial reporting and tax bases of
assets and liabilities. We have not generated any taxable income
to date and, therefore, have not paid any federal income taxes
since our inception. Realization of deferred tax assets is
dependent on future earnings, if any, the timing and amount of
which are uncertain. Accordingly, we have established valuation
allowances, in amounts equal to the net deferred tax assets as
of December 31, 2003 and 2002, in each period to reflect
these uncertainties (see Note 6).

F-9



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)




| |                               
| | ------------------------------
| | Research and Development Costs

Research and development costs are charged to
operations as incurred.



| |                         
| | ------------------------
| | Stock Based Compensation

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

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

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

Had compensation cost for our stock options been
determined based on the fair value at the date of grant
consistent with the provisions of SFAS 123 and 148, with
respect to our Equity Incentive Plan and our Employee Stock
Purchase Plan (see Note 7), our pro forma net loss and net
loss per share would have been as follows:

|                                                                                 |             |                         |         |       |   |      |         |       |   |   |         |       |  
|-------------------------------------------------------------------------------- | ----------- | ----------------------- | ------- | ----- | - | ---- | ------- | ----- | - | - | ------- | ----- | -
|                                                                                 |             |                        
|                                                                                 |             | Year Ended December 31,
|                                                                                 |             |                        
|                                                                                 |             | 2003                    |         | 2002  |   | 2001
|                                                                                 |             |                         |         |       |   |     
|Net loss, as reported                                                            |             | $                       | (8,538  | )     |   | $    | (18,064 | )     |   | $ | (21,680 | )    
|Stock-based compensation included in reported net
    loss                       |             |                         | 26      |       |   |      | 39      |       |   |   | 89      |      
|Stock-based compensation expense under fair value
    based method for all plans |             |                         | (3,536  | )     |   |      | (2,969  | )     |   |   | (3,298  | )    
|                                                                                 |             |                         |         |       |   |      |         |       |   |   |         |      
|Pro forma net loss                                                               |             | $                       | (12,048 | )     |   | $    | (20,994 | )     |   | $ | (24,889 | )    
|                                                                                 |             |                         |         |       |   |      |         |       |   |   |         |      
|Net loss per common share (basic &
    diluted):                                 |             |                         |         |       |   |      |         |       |   |   |         |      
|                                                                                 | As reported |                         | $       | (0.23 | ) |      | $       | (0.48 | ) |   | $       | (0.61 | )
|                                                                                 | Pro forma   |                         | $       | (0.32 | ) |      | $       | (0.56 | ) |   | $       | (0.70 | )



| |                          
| | -------------------------
| | Net Loss Per Common Share

Per share information is based upon the
weighted-average number of shares of common stock outstanding
during the period. We incurred losses during all periods
presented. As a result, 4,050,600 options and warrants were not
used to compute diluted loss per share since the effect would be
anti-dilutive. Accordingly, there is no difference between basic
and diluted loss per share in the periods presented.

F-10



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)




| |                    
| | -------------------
| | Advertising Expense

The cost of advertising is expensed as incurred.
Advertising and marketing expense, including expenses related to
participation in trade shows, amounted to $793, $1,044, and
$1,333 during 2003, 2002, and 2001, respectively.



| |                             
| | ----------------------------
| | Foreign Currency Translation

The financial statements of foreign subsidiaries
and branches have been translated into U.S. dollars in
accordance with SFAS No. 52, Foreign Currency
Translation. All balance sheet accounts have been
translated using the exchange rates in effect at the balance
sheet date. Income statement amounts have been translated using
the average exchange rate for the year. The gains and losses
resulting from the changes in exchange rates has been reported
in other comprehensive income (loss). The effect on the
consolidated statements of operations of transaction gains and
losses is insignificant for all years presented.



| |                   
| | ------------------
| | Comprehensive Loss

We follow SFAS No. 130, Reporting
Comprehensive Income (SFAS 130) which
requires that we display an amount representing comprehensive
income (loss), which represents total net income (loss) and all
other non owner changes in equity including foreign currency
translation adjustments, net of tax, for the year in a financial
statement, which is displayed with the same prominence as other
financial statements. We elected to present this information in
the Statement of Stockholders Equity.



| |                             
| | ----------------------------
| | Concentration of Credit Risk

Our principal financial instruments subject to
potential concentration of credit risk are cash, cash
equivalents, accounts receivable and notes receivable. We invest
our funds in highly rated institutions, and limit our investment
in any individual debtor. We provide an allowance for doubtful
accounts equal to the estimated losses to be incurred in the
collection of accounts and notes receivable.



| |                                     
| | ------------------------------------
| | Recently Issued Accounting Standards

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

In May 2003, the FASB issued
SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and
Equity (SFAS 150). SFAS 150
establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a
financial instrument that is within its scope as a liability (or
an asset in some circumstances). The standard became effective
for us for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning
of the first interim period beginning after June 15, 2003
except for mandatorily redeemable financial instruments of
nonpublic entities which are subject to the provisions of this
SFAS 150 for the first fiscal period beginning after
December 15, 2003. The adoption of

F-11



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)


SFAS 150 had no impact on our results of
operations or financial position for the year ending, nor as of,
December 31, 2003.



|   |                          
|-- | -------------------------
|3. | Balance Sheet Information

Select detailed balance sheet information is as
follows:

|                       |                                        |                              |        |        |         |   |        |        |         |  
|---------------------- | -------------------------------------- | ---------------------------- | ------ | ------ | ------- | - | ------ | ------ | ------- | -
|                       |                                        |                             
|                       |                                        | December 31,                
|                       |                                        |                             
|                       |                                        | 2003                         |        | 2002  
|                       |                                        |                              |        |       
|Accounts receivable    |                                        |                              |        |        |         |   |        |       
|                       | Trade accounts receivable              |                              | $      | 10,093 |         |   | $      | 6,219  |        
|                       | Current portion of notes receivable    |                              |        | 2,408  |         |   |        | 2,818  |        
|                       | Other accounts receivable              |                              |        | 1,149  |         |   |        | 333    |        
|                       |                                        |                              |        |        |         |   |        |       
|                       |                                        | $                            | 13,650 |        |         | $ | 9,370  |       
|                       |                                        |                              |        |        |         |   |        |       
|                      
|Inventory              |                                        |                              |        |        |         |   |        |       
|                       | Raw materials                          |                              | $      | 6,226  |         |   | $      | 6,934  |        
|                       | Work-in-process                        |                              |        | 1,925  |         |   |        | 629    |        
|                       | Finished goods                         |                              |        | 2,745  |         |   |        | 3,410  |        
|                       |                                        |                              |        |        |         |   |        |       
|                       |                                        | $                            | 10,896 |        |         | $ | 10,973 |       
|                       |                                        |                              |        |        |         |   |        |       
|                       | Instruments                            |                              | $      | 9,758  |         |   | $      | 9,761  |        
|                       | Reagents and consumables               |                              |        | 1,138  |         |   |        | 1,212  |        
|                       |                                        |                              |        |        |         |   |        |       
|                       |                                        | $                            | 10,896 |        |         | $ | 10,973 |       
|                       |                                        |                              |        |        |         |   |        |       
|                      
|Customer-use assets    |                                        |                              |        |        |         |   |        |       
|                       | Customer-use systems                   |                              | $      | 11,667 |         |   | $      | 11,525 |        
|                       | Accumulated depreciation               |                              |        | (5,033 | )       |   |        | (5,168 | )      
|                       |                                        |                              |        |        |         |   |        |       
|                       |                                        | $                            | 6,634  |        |         | $ | 6,357  |       
|                       |                                        |                              |        |        |         |   |        |       
|                      
|Property and equipment |                                        |                              |        |        |         |   |        |       
|                       | Machinery and equipment                |                              | $      | 3,438  |         |   | $      | 3,313  |        
|                       | Demonstration equipment                |                              |        | 777    |         |   |        | 756    |        
|                       | Furniture, fixtures and improvements   |                              |        | 1,697  |         |   |        | 1,695  |        
|                       | Leasehold improvements                 |                              |        | 1,318  |         |   |        | 1,318  |        
|                       | Vehicles                               |                              |        | 10     |         |   |        | 24     |        
|                       | Computer equipment and software        |                              |        | 10,332 |         |   |        | 9,157  |        
|                       |                                        |                              |        |        |         |   |        |       
|                       |                                        | Total property and equipment |        |        | 17,572  |   |        |        | 16,263  |  
|                       |                                        | Accumulated depreciation     |        |        | (14,154 | ) |        |        | (12,200 | )
|                       |                                        |                              |        |        |         |   |        |       
|                       |                                        | $                            | 3,418  |        |         | $ | 4,063  |       
|                       |                                        |                              |        |        |         |   |        |       
|                      
|Other assets           |                                        |                              |        |        |         |   |        |       
|                       | Notes receivable, less current portion |                              | $      | 459    |         |   | $      | 838    |        
|                       | Deposits and other assets              |                              |        | 29     |         |   |        | 92     |        
|                       |                                        |                              |        |        |         |   |        |       
|                       |                                        | $                            | 488    |        |         | $ | 930    |       
|                       |                                        |                              |        |        |         |   |        |       

F-12



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)


|                 |                                      |              |       |       |  |   |       |       | 
|---------------- | ------------------------------------ | ------------ | ----- | ----- |  | - | ----- | ----- | 
|                 |                                      |             
|                 |                                      | December 31,
|                 |                                      |             
|                 |                                      | 2003         |       | 2002 
|                 |                                      |              |       |      
|Accrued expenses |                                      |              |       |       |  |   |       |      
|                 | Accrued payroll and related benefits |              | $     | 4,719 |  |   | $     | 3,177 | 
|                 | Accrued warranty costs               |              |       | 387   |  |   |       | 440   | 
|                 | Other accrued expenses               |              |       | 2,272 |  |   |       | 1,819 | 
|                 |                                      |              |       |       |  |   |       |      
|                 |                                      | $            | 7,378 |       |  | $ | 5,436 |      
|                 |                                      |              |       |       |  |   |       |      



|   |                                
|-- | -------------------------------
|4. | Allowance for Doubtful Accounts

A summary of the allowance for doubtful accounts
activity is as follows:

|                           |  |              |        |      |  |      |       |   |  |   |       | 
|-------------------------- |  | ------------ | ------ | ---- |  | ---- | ----- | - |  | - | ----- | 
|                           |  |             
|                           |  | December 31,
|                           |  |             
|                           |  | 2003         |        | 2002 |  | 2001
|                           |  |              |        |      |  |     
|Balance, beginning of year |  | $            | 3,554  |      |  | $    | 3,285 |   |  | $ | 1,475 | 
|Amounts charged to expense |  |              | 180    |      |  |      | 1,050 |   |  |   | 1,810 | 
|Amounts written off        |  |              | (1,457 | )    |  |      | (781  | ) |  |   |      | 
|                           |  |              |        |      |  |      |       |   |  |   |       | 
|Balance, end of year       |  | $            | 2,277  |      |  | $    | 3,554 |   |  | $ | 3,285 | 
|                           |  |              |        |      |  |      |       |   |  |   |       | 



|   |                                          
|-- | -----------------------------------------
|5. | Long-Term Obligations and
    Commitments



| |                       
| | ----------------------
| | Subordinated Term Loan

On February 8, 2000, we entered into a
$7,000 subordinated term loan with a syndicate of lenders to
finance operations. We drew the entire facility during the first
quarter of 2000. As of December 31, 2002, the balance
outstanding was $758, all current. The loan was fully repaid
during the second quarter of 2003. The loan, which was secured
by substantially all of our assets, including intellectual
property, accrued interest at the three-year U.S. Treasury
note rate plus 8% (14.6% at December 31, 2002). Accrued
interest was due monthly for the first six months of each draw,
at which time the outstanding principal balance became payable
over thirty-month terms. In connection with this term loan, we
issued to the lenders warrants to purchase 223,253 shares
of our common stock. Using a Black-Scholes pricing model, the
warrants were valued upon issuance at $675, which represented
non-cash debt issuance costs. These warrants, which expire in
2007, were recorded as additional paid-in capital, and the
resulting debt issuance costs were amortized to interest expense
over the three-year term of the loan. These warrants have a
weighted-average exercise price of $4.70 and were exercisable
upon issuance. 122,670 of these warrants were exercised in
January 2004 using the net issuance feature resulting in the
issuance of 41,677 shares.



| |                                
| | -------------------------------
| | Note Payable to Finance Company

In December 1998, we entered into an agreement
with an equipment financing company to provide us with a $5,000
line of credit to finance certain of our equipment purchases.
The line was fully repaid in January 2003. We had outstanding
borrowings of $3 at December 31, 2002, all current. The
agreement had a loan term of 48 months, and the loan was
secured by a security interest in the financed equipment.
Interest was calculated based on the four-year Treasury Bill
Weekly Average rate plus 6.121%.



| |                         
| | ------------------------
| | Working Capital Facility

In January 2003, we renewed our $5,000 working
capital facility with Silicon Valley Bank. The outstanding
balance is limited to an amount equal to 80% of eligible
accounts receivable. The line

F-13



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)


commitment expires on January 31, 2004 and
management has subsequently renewed and increased the line to
$7,500 for an additional year until January 28, 2005. The
line bears interest at the banks prime rate
plus  1/2% and is collateralized by substantially all of
our assets. The line of credit carries customary covenants,
including the maintenance of a minimum modified quick ratio and
other requirements. We had no outstanding borrowings under this
agreement at December 31, 2003.

At December 31, 2003, maturities of other
outstanding debt, principally related to capital leases, are as
follows:

|     |  |   |    | 
|---- |  | - | -- | 
|2004 |  | $ | 40 | 
|2005 |  |   | 8  | 
|     |  |   |    | 
|     |  | $ | 48 | 
|     |  |   |    | 

The fair value of our long-term debt, which
approximates the carrying value, is estimated using discounted
cash flow analysis based on our current incremental borrowing
rates for similar type borrowing arrangements.



| |                                 
| | --------------------------------
| | Leases and Lease Lines of Credit

During August 2002, we obtained a $1,500 lease
line of credit from Bank of America. Amounts used under this
lease line are secured by a letter of credit against our line of
credit with Silicon Valley Bank discussed above. Assets leased
under this lease line carry three-year lease terms for items
acquired under it and financing charges based on three-year
constant Treasury Maturities. The lease line was used as an
alternative source of capital to secure operating leases for
assets, primarily equipment. As of December 31, 2003,
assets with an original cost of $1,286 were leased under this
lease line. There will be no further assets leased under this
line of credit.

During April 2003, we obtained a $2,500 lease
line of credit from General Electric Capital Corporation. This
lease line carries three-year lease terms for items acquired
under it and financing charges based on the fixed basic term
lease rate factor. The lease line will be used as an alternative
source of capital to secure operating leases for assets,
primarily equipment. As of December 31, 2003, assets with
an original cost of $820 were leased under this lease line.

We also lease our office and manufacturing
facilities and certain other office equipment under operating
leases, with various renewal options, expiring at various times
through 2010.

At December 31, 2003, future minimum lease
payments under these leases are as follows:

|           |  |   |       | 
|---------- |  | - | ----- | 
|2004       |  | $ | 2,093 | 
|2005       |  |   | 1,412 | 
|2006       |  |   | 831   | 
|2007       |  |   | 582   | 
|2008       |  |   | 422   | 
|Thereafter |  |   | 30    | 
|           |  |   |       | 
|           |  | $ | 5,370 | 
|           |  |   |       | 

Rent expense amounted to $2,280, $1,656 and
$1,220 during 2003, 2002 and 2001, respectively.

F-14



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)




| |                                  
| | ---------------------------------
| | Other Liabilities and Commitments

As of December 31, 2002, we had recorded a
short-term contingent liability of $2,410 in accordance with the
provisions of SFAS No. 5, Accounting for
Contingencies, on the basis that the likelihood of a
future event occurring was probable and reasonably estimable.
This contingency related to our obligation to pay a third party,
who received 180,000 shares of our common stock in January
2001 under a settlement agreement, an amount in cash equal to
the difference between the market price of our common stock on a
specified date in January 2003 and a predetermined target price.
An amount of $2,410, attributable to this contingent liability,
was paid to the third party in settlement of this liability in
January 2003.

On July 31, 2001, we entered into a series
of agreements with Becton, Dickinson and Company (BD) to
develop and commercialize these tests for malignant melanoma and
cancers of the cervix, breast, ovary and prostate using genomic
and proteomic markers identified at Millennium
Pharmaceuticals, Inc. (Millennium). We have accounted for
the transaction in accordance with the provisions of
SFAS No. 68, Research and Development
Arrangements. In connection with the transaction, we
recorded $6,198 in deferred research and development
(R&D) funding, which will be amortized against
such expenses over thirty months on a straight line basis.
During both 2003 and 2002, $2,479 of amortization was recorded
against R&D expenses. Included in current liabilities at
December 31, 2003 is the unamortized balance of $207.

During 2001 we entered into a contract with a
vendor in Switzerland to purchase a minimum of 300 and up to 525
base units for our PrepStain instrument. We committed to
purchase at least 300 complete units by December 31, 2004,
and to the extent that we purchase less than 525 complete units,
we will be obligated to purchase component parts for the
balance. At December 31, 2003 we had taken delivery of 235
complete base units. Our remaining commitment under this
contract approximates $3,588 based on the exchange rate in
effect at December 31, 2003.



|   |             
|-- | ------------
|6. | Income Taxes

At December 31, 2003, we had net tax loss
carryforwards of approximately $215,946, which begin to expire
in 2004 for federal income tax purposes. We also have
approximately $3,831 in research and development carryforwards
that begin to expire in 2006. Due to the prior issuance and sale
of shares of preferred stock, the Merger in 1999 and changes in
ownership, we have incurred ownership changes
pursuant to applicable regulations in effect under the Internal
Revenue Code of 1986, as amended.

Our use of losses incurred through the date of
these ownership changes may limit the ultimate utilization of
these losses. To the extent that any single-year loss is not
utilized to the full amount of the limitation, such unused loss
is carried over to subsequent years until the earlier of its
utilization or the expiration of the relevant carryforward
period.

Approximately $5,820 of the net tax loss
carryforward is attributed to the deduction for stock options,
the tax effect of which will be credited to equity when
recognized.

F-15



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)


Deferred income taxes reflect the net tax effects
of temporary differences between the tax basis of assets and
liabilities and the corresponding financial statement amounts.
Significant components of our deferred income tax assets
(liabilities) are as follows:

|                                       |  |              |         |      |  |   |         |  
|-------------------------------------- |  | ------------ | ------- | ---- |  | - | ------- | -
|                                       |  |             
|                                       |  | December 31,
|                                       |  |             
|                                       |  | 2003         |         | 2002
|                                       |  |              |         |     
|Net tax loss carryforwards             |  | $            | 75,581  |      |  | $ | 69,953  |  
|Research and development credits       |  |              | 3,831   |      |  |   | 3,746   |  
|Accrued vacation                       |  |              | 177     |      |  |   | 159     |  
|Accrued warranty costs                 |  |              | 136     |      |  |   | 154     |  
|Allowance for doubtful accounts        |  |              | 797     |      |  |   | 1,244   |  
|Charitable contribution carryforwards  |  |              | 11      |      |  |   | 15      |  
|Deferred research and development      |  |              | 72      |      |  |   | 940     |  
|Intangible assets, net of amortization |  |              | 2,691   |      |  |   | 2,528   |  
|Inventory                              |  |              | 1,291   |      |  |   | 1,515   |  
|Other                                  |  |              | 1,044   |      |  |   | 1,470   |  
|Property and equipment                 |  |              | (89     | )    |  |   | (859    | )
|Valuation allowance                    |  |              | (85,542 | )    |  |   | (80,865 | )
|                                       |  |              |         |      |  |   |         |  
|                                       |  | $            |        |      |  | $ |        |  
|                                       |  |              |         |      |  |   |         |  

Due to the uncertainty of our ability to generate
taxable income to realize our deferred tax assets, a valuation
allowance has been established for financial reporting purposes
equal to the amount of the net deferred tax assets. Our
valuation allowance was $85,542 and $80,865 at December 31,
2003 and 2002, respectively.



|   |                     
|-- | --------------------
|7. | Stockholders Equity



| |                
| | ---------------
| | Preferred Stock

Pursuant to our amended and restated Certificate
of Incorporation, the Board of Directors has the authority,
without further vote or action by the stockholders, to issue up
to 1,000,000 shares of Preferred Stock in one or more
series and to fix the relative rights, preferences, privileges,
qualifications, limitations and restrictions thereof, including
dividend rights, dividend rates, conversion rights, voting
rights, terms of redemption, redemption prices, liquidation
preferences, sinking fund terms and the number of shares
constituting any series or the designation of such series, any
or all of which may be greater than the rights of Common Stock.
At December 31, 2003 there were no shares of Preferred
Stock outstanding.



| |                           
| | --------------------------
| | Private Equity Transaction

On July 31, 2001, we completed a private
placement of securities under Regulation D of the
Securities Act with BD pursuant to which BD acquired
2,500,000 shares of our common stock for $10.00 per
share. We accounted for a portion of these proceeds in
accordance with the provisions of FASB SFAS No. 68,
Research and Development Arrangements and recorded
$6,198 thereof as deferred research and development funding,
which was amortized against such expenses over thirty months on
a straight line basis. The transaction with BD provided us with
an additional $25,000 in cash. In a separate agreement, in July
2001 we entered into a research license for our evaluation of
certain patents in the area of colon cancer with Millennium. In
consideration of this agreement, we issued to Millennium
400,000 shares of our common stock. We also paid $1,000 in
connection with other aspects of the transaction. In May 2003,
we decided not to exercise our rights

F-16



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)


to the colon cancer license and not to develop
technology related to colon cancer through our collaboration
with BD.



| |                       
| | ----------------------
| | Equity Incentive Plans

We have stock option plans (the
Plans) under which incentive and non-statutory stock
options, stock appreciation rights and restricted stock may be
granted to our employees, directors or consultants. For years
covered by this report, options are the only instrument granted
or issued under these plans. Generally, options grants vest
ratably over a 48-month term. Stock options expire ten years
from the date of grant.

A summary of activity under the Plans is as
follows:

|                                 |                          |                     |           |                  |   |   |      |      | 
|-------------------------------- | ------------------------ | ------------------- | --------- | ---------------- | - | - | ---- | ---- | 
|                                 |                          |                    
|                                 |                          | Options Outstanding
|                                 |                          |                    
|                                 |                          | Number of           |           | Weighted-Average
|                                 |                          | Shares              |           | Exercise Price  
|                                 |                          |                     |           |                 
|Outstanding at December 31, 2001 |                          |                     | 3,487,462 |                  |   | $ | 7.26 |     
|                                 | Options granted          |                     |           | 897,850          |   |   |      | 4.78 | 
|                                 | Options exercised        |                     |           | (127,354         | ) |   |      | 1.19 | 
|                                 | Options canceled/expired |                     |           | (490,975         | ) |   |      | 8.23 | 
|                                 |                          |                     |           |                  |   |   |      |     
|Outstanding at December 31, 2002 |                          |                     | 3,766,983 |                  |   |   | 6.74 |     
|                                 | Options granted          |                     |           | 594,400          |   |   |      | 4.04 | 
|                                 | Options exercised        |                     |           | (233,493         | ) |   |      | 5.34 | 
|                                 | Options canceled/expired |                     |           | (300,543         | ) |   |      | 7.19 | 
|                                 |                          |                     |           |                  |   |   |      |     
|Outstanding at December 31, 2003 |                          |                     | 3,827,347 |                  |   | $ | 6.37 |     
|                                 |                          |                     |           |                  |   |   |      |     

|            |              |                     |  |                       |           |                  |  |                    |     |                  |  |   |       |  |  |  |           |  |  |   |       | 
|----------- | ------------ | ------------------- |  | --------------------- | --------- | ---------------- |  | ------------------ | --- | ---------------- |  | - | ----- |  |  |  | --------- |  |  | - | ----- | 
|            |              |                     |  |                      
|            |              | Options Outstanding |  | Options Exercisable  
|            |              |                     |  |                      
|            |              | Number Outstanding  |  | Weighted-Average      |           |                  |  | Number Exercisable |     |                 
|            |              | At                  |  | Remaining Contractual |           | Weighted-Average |  | At                 |     | Weighted-Average
|Price Range |              | December 31, 2003   |  | Life (Years)          |           | Exercise Price   |  | December 31, 2003  |     | Exercise Price  
|            |              |                     |  |                       |           |                  |  |                    |     |                 
|            | $0.20-$0.20  |                     |  |                       | 75,611    |                  |  |                    | 2.9 |                  |  | $ | 0.20  |  |  |  | 75,611    |  |  | $ | 0.20  | 
|            | 1.52-2.28    |                     |  |                       | 55,344    |                  |  |                    | 8.3 |                  |  |   | 2.04  |  |  |  | 19,023    |  |  |   | 2.02  | 
|            | 2.35-3.25    |                     |  |                       | 377,483   |                  |  |                    | 9.0 |                  |  |   | 2.56  |  |  |  | 78,537    |  |  |   | 2.59  | 
|            | 3.63-5.38    |                     |  |                       | 1,672,596 |                  |  |                    | 6.5 |                  |  |   | 4.65  |  |  |  | 1,277,845 |  |  |   | 4.75  | 
|            | 5.46-8.13    |                     |  |                       | 804,542   |                  |  |                    | 7.1 |                  |  |   | 6.24  |  |  |  | 534,664   |  |  |   | 6.17  | 
|            | 8.25-10.94   |                     |  |                       | 643,292   |                  |  |                    | 7.1 |                  |  |   | 10.59 |  |  |  | 443,294   |  |  |   | 10.80 | 
|            | 14.24-20.09  |                     |  |                       | 158,174   |                  |  |                    | 3.9 |                  |  |   | 16.40 |  |  |  | 158,174   |  |  |   | 16.40 | 
|            | 21.51-29.89  |                     |  |                       | 40,305    |                  |  |                    | 2.9 |                  |  |   | 26.44 |  |  |  | 40,305    |  |  |   | 26.44 | 
|            |              |                     |  |                       |           |                  |  |                    |     |                  |  |   |       |  |  |  |           |  |  |   |       | 
|            | $0.20-$29.89 |                     |  |                       | 3,827,347 |                  |  |                    | 6.8 |                  |  | $ | 6.37  |  |  |  | 2,627,453 |  |  | $ | 6.88  | 
|            |              |                     |  |                       |           |                  |  |                    |     |                  |  |   |       |  |  |  |           |  |  |   |       | 

F-17



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)




| |                             
| | ----------------------------
| | Employee Stock Purchase Plan

In 2002, we introduced an employee stock purchase
plan with 1,000,000 shares of common stock for authorized
issuance. The plan permits substantially all employees to
purchase a limited number of shares of the Corporations
stock at 85% of market value. We issue shares to employees
semi-annually in June and December of each year. A summary of
shares issued is as follows:

|         |  |      |        |      |  |  |        | 
|-------- |  | ---- | ------ | ---- |  |  | ------ | 
|         |  | 2003 |        | 2002
|         |  |      |        |     
|June     |  |      | 50,631 |      |  |  | 24,142 | 
|December |  |      | 22,940 |      |  |  | 51,157 | 



| |         
| | --------
| | SFAS 123

We have adopted the disclosure-only provisions of
SFAS 123. In accordance with SFAS 123, the fair value
of each grant under its plans was determined by using the
Black-Scholes option-pricing model with the following
weighted-average assumptions:

|                                      |  |                         |           |      |  |      |           |  |  |   |           | 
|------------------------------------- |  | ----------------------- | --------- | ---- |  | ---- | --------- |  |  | - | --------- | 
|                                      |  |                        
|                                      |  | Year Ended December 31,
|                                      |  |                        
|                                      |  | 2003                    |           | 2002 |  | 2001
|                                      |  |                         |           |      |  |     
|Risk-free interest rate               |  |                         | 2.45%     |      |  |      | 3.86%     |  |  |   | 4.59%     | 
|Expected dividend yield               |  |                         | 0.00%     |      |  |      | 0.00%     |  |  |   | 0.00%     | 
|Expected lives                        |  |                         | 48 months |      |  |      | 48 months |  |  |   | 48 months | 
|Expected volatility                   |  |                         | 0.93      |      |  |      | 1.02      |  |  |   | 1.02      | 
|Weighted-average fair value of grants |  | $                       | 4.04      |      |  | $    | 4.78      |  |  | $ | 9.13      | 



| |         
| | --------
| | Warrants

On February 9, 1999, we completed a $14,500
private equity transaction. In connection with the financing, we
issued to a related party five-year warrants to purchase
79,030 shares of common stock at an exercise price of
$7.45 per share. These warrants were exercised during
November 2003 using a net issuance provision resulting in the
issuance of 12,997 shares.

On February 8, 2000, we closed a $7,000
subordinated term loan with a syndicate of lenders to finance
operations (see Note 5). We issued warrants to the lenders
to purchase 223,253 shares of common stock at a
weighted-average exercise price of $4.70 per share. The
warrants were exercisable upon issuance and expire in 2007. None
of these warrants had been exercised as of December 31,
2003. In January 2004, 122,670 of these warrants were exercised
using a net issuance provision resulting in the issuance of
41,677 shares.

On November 14, 2000, we completed a $43,000
private equity transaction with a subsidiary of
Hoffmann-La Roche (Roche) in terms of which
Roche acquired 5,000,000 shares of our common stock for
$8.00 per share. Additionally, Roche simultaneously
acquired, for an aggregate purchase price of $3,000, warrants to
purchase an additional 5,000,000 shares at strike prices
ranging from $10.00 to $15.00 per share. The proceeds from
the sale of these warrants were recorded as additional paid-in
capital. The warrants were not exercised and expired in November
2003 pursuant to their terms.

As of December 31, 2003, there were 223,253
warrants outstanding with a weighted-average exercise price of
$4.70. 122,670 of these warrants were exercised in January 2004
and the balance of 100,583 warrants expires in January 2007.

F-18



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)




| |                                              
| | ---------------------------------------------
| | Common Stock Reserved for Future
    Issuance

At December 31, 2003, we have reserved
authorized shares of common stock for future issuance as follows:

|                                                                |  |              |           | 
|--------------------------------------------------------------- |  | ------------ | --------- | 
|                                                                |  | December 31,
|                                                                |  | 2003        
|                                                                |  |             
|Outstanding stock options                                       |  |              | 3,827,347 | 
|Possible future issuance under equity incentive
    plans       |  |              | 1,110,461 | 
|Possible future issuance under Employee Stock
    Purchase Plan |  |              | 851,129   | 
|Common stock warrants                                           |  |              | 223,253   | 
|                                                                |  |              |           | 
|Total shares reserved                                           |  |              | 6,012,190 | 
|                                                                |  |              |           | 



| |                      
| | ---------------------
| | Deferred Compensation

In accordance with APB 25, for stock options
and restricted stock grants granted at exercise prices below the
deemed fair value, we record deferred compensation expense for
the difference between the exercise price of the shares and the
deemed fair value. The amounts are amortized over the vesting
period of the individual options, generally 48 months.
Amortization of deferred compensation amounted to $26, $39 and
$89 during 2003, 2002 and 2001, respectively. We adjusted the
deferred compensation amount by $35 to reflect the cancellation
of options granted to terminated employees in 2002.



|   |                                                       
|-- | ------------------------------------------------------
|8. | Operations by Industry Segment and Geographic
    Area



| |                                                    
| | ---------------------------------------------------
| | Description of Products and Services by
    Segment

We currently operate in two business segments:
Commercial Operations and TriPath Oncology (see Note 1).



| |                                                             
| | ------------------------------------------------------------
| | Measurement of Segment Profit or Loss and
    Segment Assets

We evaluate performance and allocate resources
based on operating profit or loss. The accounting policies of
the reportable segments are the same as those described under
the summary of significant accounting policies (see Note 2
above). Inter-segment transfers are recorded at cost.



| |                                                                          
| | -------------------------------------------------------------------------
| | Factors Management Used to Identify the
    Companys Reportable Segments

Our reportable segments are business units that
offer or seek to develop different products and services. The
reportable segments are each managed separately because they do
or seek to develop and commercialize distinct products. The
segments operate as separate entities.



| |                   
| | ------------------
| | Results by Segment

The results, by segment, for 2003, 2002 and 2001
follow:

F-19



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)


|                        |                            |              |        |          |        |       |         |       |     |   |        |        |        | 
|----------------------- | -------------------------- | ------------ | ------ | -------- | ------ | ----- | ------- | ----- | --- | - | ------ | ------ | ------ | 
|                        |                            |             
|                        |                            | 2003        
|                        |                            |             
|                        |                            | Commercial   |        | TriPath  |        |      
|                        |                            | Operations   |        | Oncology |        | Total
|                        |                            |              |        |          |        |      
|Revenues                |                            | $            | 53,631 |          |        | $     | 133     |       |     | $ | 53,764 |       
|Cost of revenues        |                            |              | 18,361 |          |        |       | 16      |       |     |   | 18,377 |       
|                        |                            |              |        |          |        |       |         |       |     |   |        |       
|                        |                            | Gross profit |        |          | 35,270 |       |         |       | 117 |   |        |        | 35,387 | 
|Operating expenses:     |                            |              |        |          |        |       |         |       |     |   |        |       
|                        | Research and development   |              |        | 2,319    |        |       |         | 6,542 |     |   |        | 8,861  |       
|                        | Regulatory                 |              |        | 4,763    |        |       |         | 671   |     |   |        | 5,434  |       
|                        | Sales and marketing        |              |        | 17,318   |        |       |         | 1,006 |     |   |        | 18,324 |       
|                        | General and administrative |              |        | 7,264    |        |       |         | 4,423 |     |   |        | 11,687 |       
|                        |                            |              |        |          |        |       |         |       |     |   |        |       
|                        |                            |              | 31,664 |          |        |       | 12,642  |       |     |   | 44,306 |       
|                        |                            |              |        |          |        |       |         |       |     |   |        |       
|Operating income (loss) |                            | $            | 3,606  |          |        | $     | (12,525 | )     |     | $ | (8,919 | )     
|                        |                            |              |        |          |        |       |         |       |     |   |        |       

|                    |                            |              |        |          |        |       |         |       |   |   |         |        |        | 
|------------------- | -------------------------- | ------------ | ------ | -------- | ------ | ----- | ------- | ----- | - | - | ------- | ------ | ------ | 
|                    |                            |             
|                    |                            | 2002        
|                    |                            |             
|                    |                            | Commercial   |        | TriPath  |        |      
|                    |                            | Operations   |        | Oncology |        | Total
|                    |                            |              |        |          |        |      
|Revenues            |                            | $            | 37,485 |          |        | $     |        |       |   | $ | 37,485  |       
|Cost of revenues    |                            |              | 14,922 |          |        |       |        |       |   |   | 14,922  |       
|                    |                            |              |        |          |        |       |         |       |   |   |         |       
|                    |                            | Gross profit |        |          | 22,563 |       |         |       |  |   |         |        | 22,563 | 
|Operating expenses: |                            |              |        |          |        |       |         |       |   |   |         |       
|                    | Research and development   |              |        | 1,764    |        |       |         | 5,770 |   |   |         | 7,534  |       
|                    | Regulatory                 |              |        | 2,206    |        |       |         | 519   |   |   |         | 2,725  |       
|                    | Sales and marketing        |              |        | 18,864   |        |       |         | 986   |   |   |         | 19,850 |       
|                    | General and administrative |              |        | 6,245    |        |       |         | 4,691 |   |   |         | 10,936 |       
|                    |                            |              |        |          |        |       |         |       |   |   |         |       
|                    |                            |              | 29,079 |          |        |       | 11,966  |       |   |   | 41,045  |       
|                    |                            |              |        |          |        |       |         |       |   |   |         |       
|Operating loss      |                            | $            | (6,516 | )        |        | $     | (11,966 | )     |   | $ | (18,482 | )     
|                    |                            |              |        |          |        |       |         |       |   |   |         |       

|                    |                            |              |         |                  |        |       |        |       |   |   |         |        |        | 
|------------------- | -------------------------- | ------------ | ------- | ---------------- | ------ | ----- | ------ | ----- | - | - | ------- | ------ | ------ | 
|                    |                            |             
|                    |                            | 2001        
|                    |                            |             
|                    |                            | Commercial   |         |                 
|                    |                            | Operations   |         | TriPath Oncology |        |      
|                    |                            | Full year    |         | July to December |        | Total
|                    |                            |              |         |                  |        |      
|Revenues            |                            | $            | 27,017  |                  |        | $     |       |       |   | $ | 27,017  |       
|Cost of revenues    |                            |              | 13,096  |                  |        |       |       |       |   |   | 13,096  |       
|                    |                            |              |         |                  |        |       |        |       |   |   |         |       
|                    |                            | Gross profit |         |                  | 13,921 |       |        |       |  |   |         |        | 13,921 | 
|Operating expenses: |                            |              |         |                  |        |       |        |       |   |   |         |       
|                    | Research and development   |              |         | 4,779            |        |       |        | 1,079 |   |   |         | 5,858  |       
|                    | Regulatory                 |              |         | 1,970            |        |       |        |      |   |   |         | 1,970  |       
|                    | Sales and marketing        |              |         | 18,464           |        |       |        | 221   |   |   |         | 18,685 |       
|                    | General and administrative |              |         | 10,092           |        |       |        |      |   |   |         | 10,092 |       
|                    |                            |              |         |                  |        |       |        |       |   |   |         |       
|                    |                            |              | 35,305  |                  |        |       | 1,300  |       |   |   | 36,605  |       
|                    |                            |              |         |                  |        |       |        |       |   |   |         |       
|Operating loss      |                            | $            | (21,384 | )                |        | $     | (1,300 | )     |   | $ | (22,684 | )     
|                    |                            |              |         |                  |        |       |        |       |   |   |         |       

All revenues were from external customers. There
were no inter-segment revenues. Sales to external customers in
the TriPath Oncology segment were $133 during 2003 and were
attributable to services sold.

F-20



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)


Sales to external customers in the Commercial
Operations segment for the years ended December 31, 2003,
2002 and 2001, include the following:

|                      |                |      |        |        |  |      |        |        |  |   |        |        | 
|--------------------- | -------------- | ---- | ------ | ------ |  | ---- | ------ | ------ |  | - | ------ | ------ | 
|                      |                | 2003 |        | 2002   |  | 2001
|                      |                |      |        |        |  |     
|Instruments           |                | $    | 7,528  |        |  | $    | 6,495  |        |  | $ | 10,236 |       
|Reagents              |                |      | 39,013 |        |  |      | 24,730 |        |  |   | 10,914 |       
|Fee-per-use and other |                |      | 7,090  |        |  |      | 6,260  |        |  |   | 5,867  |       
|                      |                |      |        |        |  |      |        |        |  |   |        |       
|                      | Total revenues |      | $      | 53,631 |  |      | $      | 37,485 |  |   | $      | 27,017 | 
|                      |                |      |        |        |  |      |        |        |  |   |        |       

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

The Commercial Operations segment had
depreciation and amortization expense of $4,128, $3,735 and
$3,888 for the 2003, 2002 and 2001 financial years,
respectively. The TriPath Oncology segment had depreciation
expense of $228 and $126 for the 2003 and 2002 financial years
respectively. During 2001 our TriPath Oncology segment also
received $6,198 in deferred R&D funding from BD, which is
being amortized against such expenses over thirty months on a
straight-line basis. In 2003, 2002 and 2001, respectively,
$2,479, $2,479 and $1,033 of amortization was recorded against
R&D expense. Purchases of property and equipment by the
Commercial Operations segment for 2003, 2002 and 2001 were $61,
$1,430 and $775, respectively. For TriPath Oncology, purchases
of property and equipment for 2003, 2002 and 2001 were $85, $821
and $161, respectively. The TriPath Oncology segment had total
assets of $1,849 as of December 31, 2003 and the Commercial
Operations segment total assets of $64,079.



| |                     
| | --------------------
| | Geographic Area Data

Our Commercial Operations domestic revenues
are generated primarily by direct sales activities. Beginning in
October 2000, the segment began a planned expansion of its field
sales forces, which included the building of a physician
directed sales force. International revenues continue to be
derived primarily through distributors and were most predominant
in Canada, various European countries, including Belgium,
Denmark, Germany, Switzerland and the United Kingdom, and China,
Hong Kong and Japan in the Far East. International revenues
accounted for 27%, 32% and 23% of total revenues during 2003,
2002 and 2001, respectively. Our largest customer accounted for
6% of total revenue in 2003. In 2002 and 2001, the respective
largest customers accounted for 8% and 11% of total revenue.



|   |                           
|-- | --------------------------
|9. | Related Party Transactions

We have a temporary arrangement with BD, a
shareholder, for leasing a portion of BDs facility in
Research Triangle Park, North Carolina (RTP). Total
rent paid to BD amounted to $46, $130 and $5 during 2003, 2002
and 2001, respectively. This arrangement continued, primarily
for use of BDs animal laboratory facilities, though on a
much-reduced scale after TriPath Oncology occupied its new space
in the RTP area of North Carolina in July of 2002. We also
recovered certain R&D expenses from BD, which were incurred
by TriPath Oncology on behalf of BD in terms of our arrangement
with BD. These recoveries were

F-21



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)


set-off against R&D expenses in our TriPath
Oncology segment and amounted to $3,156 and $1,480 in the 2003
and 2002 financial years, respectively.

A loan of $27 made to an Officer of the Company
and included in Notes Receivable at December 31, 2002 was
repaid in full during the 2003 financial year.



|    |                  
|--- | -----------------
|10. | Employee Benefits

We maintain qualified 401(k) Retirement Plans
covering substantially all employees that provide for voluntary
salary deferral contributions. Total expense for the plans,
including employer contributions, amounted to $435, $336 and
$263 during 2003, 2002 and 2001, respectively.

Since January 1, 2002, we began offering to
employees a qualified Employee Stock Purchase Plan covering
substantially all employees that provide for voluntary salary
deferral contributions for the purchase of our stock subject to
the provisions of the Plan. There was no expense associated with
this plan recorded in 2003 or 2002.



|    |              
|--- | -------------
|11. | Contingencies

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

On June 16, 2003, Cytyc filed an action in
the United States District Court for the District of
Massachusetts seeking a declaration that our patents are invalid
and that its ThinPrep Imaging System does not infringe our
patents. Cytyc is not claiming in either of its actions that our
FocalPoint or any of our other products infringe any of its
patents. On October 30, 2003, our motion to dismiss
Cytycs complaint on jurisdictional grounds was denied
without any findings on the merits of the case. Accordingly, on
November 10, 2003, we filed our answer to Cytycs
complaint, which included a counterclaim for infringement of our
patents by Cytycs ThinPrep Imaging System.

On January 5, 2004, the district court in
Massachusetts entered an order consolidating the North Carolina
and Massachusetts lawsuits into a single action. The
consolidated case is currently in the discovery phase and no
trial date has been set. We anticipate that a trial will be
scheduled sometime in 2005 based on the current case schedule.
At this time, because of the early stage of the case, we are
unable to predict its ultimate outcome. Similarly, we are unable
to predict the potential effect on our business and results of
operations that any outcome may ultimately have.

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

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

F-22



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##### Table of Contents



TRIPATH IMAGING, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(In thousands, except share and per share amounts)




|    |                                                
|--- | -----------------------------------------------
|12. | Quarterly Results of Operations
    (Unaudited)

|                                                   |              |          |        |         |   |              |        |             |   |   |        |        |   |   |        |        |  
|-------------------------------------------------- | ------------ | -------- | ------ | ------- | - | ------------ | ------ | ----------- | - | - | ------ | ------ | - | - | ------ | ------ | -
|2003                                               |              | March 31 |        | June 30 |   | September 30 |        | December 31
|                                                   |              |          |        |         |   |              |        |            
|Revenues                                           |              | $        | 11,147 |         |   | $            | 13,252 |             |   | $ | 14,113 |        |   | $ | 15,252 |       
|                                                   | Gross profit |          |        | 7,269   |   |              |        | 8,621       |   |   |        | 9,308  |   |   |        | 10,189 |  
|                                                   | Net loss     |          |        | (2,350  | ) |              |        | (2,655      | ) |   |        | (1,609 | ) |   |        | (1,924 | )
|Net loss per common share (basic &
    diluted)(1) |              | $        | (0.06  | )       |   | $            | (0.07  | )           |   | $ | (0.04  | )      |   | $ | (0.05  | )     

|                                                   |              |          |       |         |   |              |       |             |   |   |       |        |   |   |        |        |  
|-------------------------------------------------- | ------------ | -------- | ----- | ------- | - | ------------ | ----- | ----------- | - | - | ----- | ------ | - | - | ------ | ------ | -
|2002                                               |              | March 31 |       | June 30 |   | September 30 |       | December 31
|                                                   |              |          |       |         |   |              |       |            
|Revenues                                           |              | $        | 7,563 |         |   | $            | 9,132 |             |   | $ | 9,826 |        |   | $ | 10,964 |       
|                                                   | Gross profit |          |       | 4,316   |   |              |       | 5,340       |   |   |       | 5,940  |   |   |        | 6,967  |  
|                                                   | Net loss     |          |       | (5,301  | ) |              |       | (5,418      | ) |   |       | (4,280 | ) |   |        | (3,065 | )
|Net loss per common share (basic &
    diluted)(1) |              | $        | (0.14 | )       |   | $            | (0.14 | )           |   | $ | (0.11 | )      |   | $ | (0.08  | )     



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|    |                                                                                                                                                                                                               
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The sum of per share earnings by quarter may not
    equal earnings per share for the year due to changes in average
    share calculations. This is in accordance with prescribed
    reporting requirements.

F-23