This study seeks to define the morphological pathogenesis of a form of cystic transformation of lobules referred to as atypical cystic lobule or low-grade clinging carcinoma of flat type. We collected 25 examples that seem to represent the early stages in the formation of atypical cystic lobules and made a careful study of their morphology. Our observations indicate that this lesion arises from pre-existing, structurally normal terminal duct-lobular units and that it seems to develop by the direct transformation of indigenous luminal cells. The transformed cells first become evident in the small duct or terminal ductule, where they appear as slightly enlarged columnar cells containing atypical nuclei. In more advanced examples, these alterations affect all luminal cells of the terminal duct-lobular unit, but the cells of the terminal ductule continue to show more pronounced changes than the cells lining the acini. The atypical cells within the lobule do not seem to displace the normal acinar cells. Instead, the cells form a continuum, making it impossible to define the point at which atypical cells and normal cells meet. Within the small duct, however, the atypical epithelium comes to an abrupt halt as the duct courses towards the nipple. Considering these observations, we ascribe the formation of atypical cystic lobules to the accumulation of atypical cells in pre-existing terminal duct-lobular units.