During 2001, we made a 30-month loan to a senior vice president in the amount of $175. As of September 30, 2002, $158 remained outstanding of which $35 (including accrued interest) was past due. We are taking actions to collect amounts that are currently in default. The loan is further described in our proxy statement for the 2002 Annual Meeting of Shareholders.

We have existing credit facilities provided by LaSalle Bank in the form of a revolving line of credit and a mortgage loan for our corporate headquarters building. As of September 30, 2002 there were no borrowings outstanding on the line of credit and a balance of $2,780 remaining on the mortgage. Our bank has waived our non-compliance with covenants as of September 30, 2002 concerning maximum capital expenditures and minimum cash flows (i.e. EBITDA) under our current credit facility.

Our bank has issued a commitment letter for a new credit facility that would replace the existing facility that matures in April 2003, make certain additional borrowings available, and revise certain covenants from those in effect in the current facility. We are currently negotiating definitive terms.

This report may contain certain statements that are forward-looking and involve risks and uncertainties. Words such as "expects", "anticipates", "projects", "estimates", "intends", "plans", "believes", variations of such words and similar expressions are intended to identify such forward looking statements. These statements are based on current expectations and projections made by management and are not guarantees of future performance. Therefore, actual events, outcomes and results may differ materially from what is expressed or forecast in such forward-looking statements. We have identified certain factors that could cause actual results to differ materially from the forward-looking statements under the caption "Cautionary Statements -- Additional Important Factors to be Considered" in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") in Tripos' Form 10-K for 2001. Except as required under federal securities laws and the rules and regulations of the SEC, we do not have any intention or obligation to update or revise any forward-looking statements in this Form 10-Q, whether as a result of new information, future events, changes in assumptions or otherwise.

The following discussion should be read in conjunction with the audited consolidated financial statements and notes thereto.

As a leader in our industry, we provide the pharmaceutical, biotechnology, agrochemical and other life sciences industries with state-of-the-art discovery chemistry, integrated discovery software products, software consulting services, and discovery research. We combine information technology and scientific research to optimize and accelerate molecular research for the discovery and progression of new products by our customers. Our products include proprietary discovery software tools to manage, analyze and share biological and chemical information; systems integration along with other software consulting services; diverse chemical libraries; and collaborative and contract research for the discovery, synthesis, characterization and optimization of new chemical compounds that are active in biological systems.

We license software and support in the form of one to three-year renewable contracts for any of our more than 50 software modules available for sale. The magnitude of these license fees is dependent on each customer's required usage levels, that is, the number of locations and individual users. Variations in licensing levels range from the low hundred-thousands up to several million dollars and therefore may be sufficient to impact the comparability of quarterly results.

Our integration of chemistry and biological data in the life sciences industries creates a revenue stream for enterprise software consulting services. To serve this market, we maintain a staff of specialists who use our proprietary data integration framework, MetaLayer^TM software, to configure customized solutions for data management. Revenue, depending on the contract, may be generated on a billable rate per day, or upon achievement of milestones or deliverables, and is recognized as services are performed. These contracts may also generate substantial license fee revenue for our proprietary software technologies such as our MetaLayer^TM and ChemCore^TM software. As with our discovery software products, licensing levels may range from the low hundred-thousands up to several million dollars and therefore may be sufficient to impact the comparability of quarterly results.

We develop and manufacture general screening compound libraries for sale to the life sciences industry. Revenue from the sale of these compound libraries is recognized upon shipment to the customer. Individual contracts for the sale of compound libraries may vary greatly in magnitude, from a few hundred dollars to over one million dollars, and thus may affect the comparability of quarterly results. The sale of compound libraries has created the opportunity to offer follow-up discovery research services to customers for design and synthesis of focused libraries for lead optimization. We also market a comprehensive research process to our life sciences customers for rapid and cost effective discovery. This process combines advanced informatics, chemistry and biology products and services, and proprietary discovery technologies for efficient lead development, refinement, and optimization resulting in a tightly integrated process to facilitate synergies in drug discovery. Revenue from these op timization or LeadFocus library design and synthesis contracts may include: technology access fees, billable time (full-time equivalents), milestone payments and royalties.

We also act as a reseller of computer hardware in conjunction with software sales. Hardware sales are generally made to facilitate integration of our software into customer research activities and are not a focus of our sales activities. We act merely as an authorized reseller and do not maintain any inventory. Accordingly, margins on these sales are relatively modest and are typically below 10%.

Over time we have invested in collaborative internal drug discovery programs with Arena Pharmaceuticals, Arrow Pharmaceuticals and Signase, Inc. These collaborations have generated patented lead compounds that are actively being validated and pursued by our respective partners. We are unable to predict when and if we will recognize any financial benefit from these collaborations. The costs of these program investments have been expensed in prior years.

We license discovery software tools to customers, provide ongoing support, including upgrades selected by customers, and provide consulting services to customers that enable the integration of our discovery tools to customers' discovery operations. We generally expense research and development costs associated with software enhancements and new software tools. Thus, a significant portion of the costs associated with development and enhancement of software is accounted for as research and development and not as a cost of software sales.

Quarterly expenses include the fixed costs of research and development for software development and new chemistry research along with related overheads. We believe that selling and marketing expenses will be higher in 2002 as a percent to net sales as we grow this organization to capitalize on market opportunities. We expect that 2002 administrative costs will be consistent with 2001 levels, however, these expenses may rise in future periods as our company grows. Variability in quarterly expenses primarily occurs in relation to the level of revenues for sales compensation, bonuses and for periodic marketing activities such as appearances at trade exhibitions.

Our revenues and expenses vary from quarter to quarter depending upon, among other things, the timing of customers' budget processes, the success of our sales efforts, the lengthy sales cycle and our ability to influence customers and prospective customers to make decisions to outsource portions of their discovery process, the size of the customers' capital expenditure budgets, the ability to produce compound libraries in a timely manner, market acceptance of new products and enhanced versions of existing products, the timing of new product introductions by us and other vendors, changes in pricing policies (ours, partners and other vendors), consolidation in customer base, client involvement in decision points in contracts related to project plans, and changes in general economic and competitive conditions. In addition, we may negotiate a long-term software license contract that may, subject to certain rules of SOP 97-2 and SOP 98-4, be required to be recognized ratably over the life o f the contract. See Note 8 of the Notes to Unaudited Consolidated Financial Statements of this Form 10-Q for a further discussion of revenue recognition policies. A substantial portion of product-based revenues for each quarter is attributable to a limited number of orders and tends to be realized toward the end of each quarter. The mix of revenue components can also affect our quarterly results. Variability in the timing, scope, and magnitude of milestone and other service-based payments under existing and future contracts along with our ability to obtain additional contracts can have a significant impact on quarterly and annual revenues.

Net sales for the third quarter of 2002 were $11,125 compared to $11,949 in 2001. Net sales for the nine-months year-to-date increased 7% and were $34,887 and $32,463 for 2002 and 2001, respectively.

Net sales for the Company's activities outside of North America represented approximately 72% for the three months ended September 30, 2002 and 62% for the first nine months of the year compared to 39% and 49%, respectively for the same period in 2001. Net sales in Europe increased 88% for the third quarter of 2002 compared to 2001 and accounted for 66% and 33% of net sales for the three-month periods, respectively. The increase in Europe for 2002 is principally related to the on-track performance to-date in the chemistry collaboration with Pfizer's European research location. Net sales in the Pacific Rim, principally Japan, decreased 15% compared to the third quarter of 2001 and accounted for 6% of net sales for the periods. Sales to existing customers represent 92% of total net sales for the nine-month period ending September 30, 2002.

Cost of sales for the nine-month period ending September 30, 2002 increased 36% to $11,849 compared to the same period in 2001. Cost of sales were $4,084 and $3,166 for the third quarter of 2002 and 2001, respectively, an increase of 29%. Higher discovery research and compound revenues, traditionally lower margin services, resulted in an increase in costs of sales. Cost of sales as a percent of total net sales was 37% and 26% for the three-month periods and 34% and 27% for the nine-month periods in 2002 and 2001, respectively.

Gross profit margin percentage for the third quarter 2002 decreased to 63% from 74% of total net sales in the third quarter of 2001. For the nine months year-to-date, gross margin percentage decreased to 66% in 2002 from 73% in 2001. The decrease in gross profit resulted from a shift in the mix of revenues from our product and service offerings.

Sales and marketing expenses increased 23% to $3,910 from $3,175 for the third quarter of 2002 compared to 2001 and by 46% to $12,281 from $8,413 for the nine-months year-to-date compared to 2001. Sales and marketing expenses as a percentage of net sales were 35% and 27% for the third quarter in 2002 and 2001, respectively. The increase in sales and marketing expenses is driven by additions to the sales and marketing organization and the amortization related to our contribution to the five-year joint marketing effort with Accenture to offer combined expertise in enterprise consulting and knowledge management services. Additionally, product advertisement increased over the prior year in an effort to increase public awareness and inform current and potential customers of Tripos products.

Research and development expenses increased to $2,966 from $2,671 and represented 27% and 22% of net sales for the third three-month periods in 2002 and 2001, respectively. Nine month year-to-date R&D expenses were $9,261 in 2002 compared to $7,577 in 2001, 27% and 23% of net sales, respectively. The increases in expense dollars and percentage of net sales reflect preparation and startup costs for the previously announced strategic design and synthesis discovery research project with Pfizer along with collaborative software development agreements whose costs are included in R&D reflecting the uncertain outcome from this type of research.

General and administrative expenses decreased 4% for the third quarter of 2002 to $1,783 from $1,861 in 2001, and represent 16% of net sales. For the nine-month period ending September 30, 2002, G&A expense was $4,952 compared to $4,841 in 2001, a 2% increase. The increase in G&A for the year-to-date period is principally related to miscellaneous corporate matters.

Other income increased from a net loss of $33 for the third quarter in 2001 to net income of $633 for the comparable period in 2002. During the nine-month periods in 2001 we realized a net gain of $2,387 on the sale of one hundred thousand shares of Arena Pharmaceuticals at $27 per share during Arena's secondary public offering. During the third quarter of 2002, we continued selling shares of Arena under a program initiated earlier in 2002 and realized gains from the sale of one hundred thirty thousand shares at an average price of $6.30 per share. For the nine-month period in 2002, we sold an aggregate of three hundred eighty thousand shares of Arena at an average price of approximately $8 per share, resulting in a gain of $2,400.

Income tax benefit was $207 for the third three-month period in 2002, which represents an effective tax rate of 21%. For the same period in 2001, income tax expense was $87, resulting in a 30% year-to-date effective rate. The rate reduction for 2002 reflects management's estimated usage of net operating losses in the U.K. during the current tax year ending December 31, 2002.

Pharmaceuticals common stock, our bank facilities and, if necessary, equipment lease financing that we expect to be available for these purposes.

For the nine-month period ending September 30, 2002, net cash used in operations was $466 primarily due to a net loss of $471, decreases in trade accounts receivable of $7,506, a decrease in notes receivable of $195, an increase in deferred revenue of $876 and depreciation and amortization of $1,160 and $553 respectively, which were offset by a decrease in accounts payable and accrued expenses of $6,093, an increase in prepaid expenses of $999 less the gain from the sale of shares of Arena, $2,409. For the nine-month period ending September 30, 2001, net cash provided by operations was $1,325 primarily due to net income of $3,971, a decrease in trade accounts receivable of $293 and prepaid expenses of $295, an increase in accounts payable and accrued expenses of $2,596 along with depreciation and amortization of $1,166 and $165 respectively, which were offset by increases in inventories of $307, notes receivables of $1,733 and a decrease in deferred revenue of $2,396.

Cash provided by financing activities for 2002 included the payment of accrued dividends upon the conversion of the Series B Preferred Stock by LION Bioscience ($892) and the reduction of outstanding debt ($1,035) offset by proceeds from the exercise of employee stock options of $1,782. For the same nine-month period in 2001, the net cash provided by financing activities of $700 resulted from proceeds from stock option exercises reduced by debt repayments.

We anticipate that working capital of $19,670, at September 30, 2002, together with continued cash flow from operations, payments to be received under current and contemplated strategic partnership contracts, the U.K. grant assistance for our previously announced chemistry laboratory expansion, our bank facilities (when amended and expanded), and equipment lease financing, will be sufficient to fund our operations and commitments for at least the next twelve months. For a description of certain factors that could adversely affect the Company's future capital requirements and the adequacy of its available funds, including factors that are beyond the Company's control, see the discussion under the caption "Cautionary Statements-Additional Important Factors to be Considered" in the Company's Annual Report on Form 10-K for the year ended December 31, 2001.

Within 90 days prior to the date of this report, we carried out, under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer, an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information which is required to be included in the periodic reports that Tripos must file with the Securities and Exchange Commission.

There have been no significant changes in our internal controls or in other factors that could significantly affect the internal controls subsequent to the date we completed our evaluation.

Item 1.     Legal Proceedings

          The Company is not a party to any material litigation and is not aware of any threatened material litigation.

Item 2.     Changes in Securities

          None

Item 3.     Defaults upon Senior Securities

          None

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

          None

Item 5.     Other Information

          None

Item 6.     Exhibits and Reports on Form 8-K

          (a) List of Exhibits

None

          (b) No reports on Form 8-K were required to be filed during the period from July 1, 2002 to September 30, 2002.

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

1. I have reviewed this quarterly report on Form 10-Q of Tripos, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other signing officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function); (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of their most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 13, 2002

/s/ B. James Rubin

B. James Rubin
Chief Financial Officer

1. I have reviewed this quarterly report on Form 10-Q of Tripos, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5. The registrant's other signing officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function); (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of their most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 13, 2002

/s/ John P. McAlister

John P. McAlister

Chief Executive Officer