To increase productivity and reduce time and cost in developing new chemical entities, customers must make faster, more precise decisions. Our innovative MetaLayer^TM data integration software, implements a virtual data warehouse that integrates diverse cross-corporate data sources into a single repository of accessible information. The MetaLayer software allows any network-client access to all distributed data or application information.

Our consulting services are available to assist at all stages of an information technology project, including:

We strive for high levels of purity in order to make the screening process efficient and cost-effective. All compounds are subject to thorough analytical testing, and purity data is made available to customers. The design strategy behind the LeadQuest library exploits our proprietary and patented ChemSpace^TM technology, and improves the efficiency of the screening process by minimizing the number of compounds that need to be screened in order to find a lead compound. The compounds in the LeadQuest library represent chemistry space uniformly while minimizing overlap with an existing screening repository and avoid redundant sampling.

Our discovery research capabilities were acquired in late 1997 along with the initial staff of 8 and were expanded over the next two years. The laboratories are based in Bude, Cornwall, England and now have a staff that numbers over 140. An expansion in 1999 added 25,000 square feet to our research center. Our current expansion will add 48,000 square feet to our capacity by early 2004, bringing the total facility to 73,000 square feet.

We also resell computer systems to our customers upon request. We do not have an inventory of systems on-hand, but merely facilitate the customers' orders. We provide this service as a convenience to our customers and neither expect nor realize high margins on these products.

Our growth strategy is based on expanding relationships with large pharmaceutical companies to offer multiple Tripos products and services to enhance their drug discovery operations. Below are some of our major collaborations:

Accenture. In February, 2002 we entered into a marketing alliance agreement with Accenture LLP intended to market and sell a fully integrated solution to automate drug discovery operations of the largest global pharmaceutical and biotech companies. Our discovery and enterprise informatics software and our domain expertise in implementing software-based solutions for chemistry research activities is expected to form a substantial part of the integrated systems designed for implementation with Accenture. As part of this arrangement, we issued 32,520 shares of common stock valued at $1.0 million to Accenture upon entry into this arrangement. At this time, we do not expect any future fixed compensation to Accenture, however, we do expect that should certain collaborative engagements be successful, they may result in performance-based compensation to Accenture from Tripos.

Pfizer. In January, 2002, we entered into three key arrangements with Pfizer:

Schering AG. In September 2001, we entered into an agreement with Schering to build a global enhanced chemical information management system that integrates Schering's compound research and inventory data. The system will track research activities, such as synthesis and reactions, and will deploy our ChemCore^TM software, a comprehensive information-enriched chemical tracking system that incorporates our MetaLayer^TM software. These technologies are slated for deployment in 2003.

Novo-Nordisk A/S. In November 2000, we entered into a fifteen-month research collaboration with Novo Nordisk A/S to design and develop new software products for pharmaceutical research, focused on innovative ways to analyze the interactions between potential new drugs and their targets to accelerate the drug discovery process. This collaboration was extended in order to develop additional techniques and functionality. We expect that these new software tools will describe and compare the three-dimensional arrangement of key molecular elements of potential drugs and the receptor sites that they will attack. The new software builds on and extends methods for understanding receptor-ligand interactions that are used throughout the pharmaceutical industry.

Bayer AG. In October 2000, we entered into a three-party arrangement with Bayer and LION Bioscience to provide Bayer with an integrated cheminformatics technology to speed Bayer's identification of lead candidates for its drug and agricultural chemical programs. We are working with LION to develop and install a new platform combining bioinformatics and cheminformatics that will integrate our MetaLayer enterprise-wide cheminformatics portal.

Merck KgA - Lipha S.A. In June 2000 we entered into a one-year, multi-million dollar discovery research agreement with Lipha S.A., a subsidiary of Merck KgA, to utilize a wide range of Tripos technologies for the discovery of novel drug candidates for the treatment of metabolic and associated diseases. We used information from our LeadQuest^® general screening library and proprietary ChemSpace^TM library design technology, along with information generated from pharmacokinetic screens, to develop novel drug candidates.

Parke-Davis. In January 2000, we entered into a collaborative agreement with Parke-Davis, now a part of Pfizer Global Research and Development, for new informatics methods to enhance the effectiveness of high-throughput screening for drug discovery. We worked with Parke-Davis to design, develop and test a wide range of methodologies and software tools for the analysis, interpretation and follow-up of high-throughput screening data. This project concluded successfully in December 2002 and resulted in products currently being marketed by Tripos.

Arena Pharmaceuticals. In 1997, we invested in Arena to co-develop and obtain access to biological targets that demonstrated the value in our integrated offerings of informatics and chemistry. By teaming our expertise with Arena's novel biological technology, the joint effort resulted in identification of lead series drug candidates in less than nine months and at a considerable savings compared to industry averages. Today, we still retain a 30% ownership position in the lead series currently in development as well as shares of Arena's common stock.

Signase. In 1999 and again in 2002, we made an in-kind investment of products and services to this biotech start-up in exchange for an equity position and a royalty percentage of certain candidates in the cancer therapeutics area. As announced in 2002, Signase and Tripos are joint holders of a patent for a new compound.

We market our software products directly in the U.S., Australia, Canada and Europe, through an exclusive distributor arrangement in Japan, and through non-exclusive agency relationships in Brazil, Korea, China, Singapore, and India. On December 31, 2002, our sales force consisted of 53 management, technical, sales and administrative employees: 26 for the United States and Canada, 25 in Europe, and 2 for the Pacific Rim. Our domestic sales and support center is located at our headquarters in St. Louis, Missouri. We also maintain sales offices in California, New Jersey, Massachusetts, Virginia and near London, Paris and Munich.

The sales staff includes employees with Ph.D. degrees in chemistry, various advanced degrees in the sciences and work experience with various hardware and software suppliers as well as with the pharmaceutical and biotech industries we serve. Our sales representatives are compensated through a combination of base salary, commissions and bonuses based on quarterly and annual sales performance. In addition, our pre-sales scientists, all of whom have Ph.D. degrees in chemistry or a closely related field, receive total compensation determined in part by their success in supporting and generating sales in a particular territory.

Teams, which include scientists working in collaboration with our sales employees, have developed a consultative sales approach through which we have created relationships with our key customers. We believe these relationships enable us to understand and better serve the needs of our customers. Because our customers frequently have both domestic and international operations, our sales staff and scientists in foreign locations work closely with their counterparts in the United States to ensure that our customers' international needs are met in a coordinated and consistent fashion.

We market our workstation-based software products in a variety of ways, one of which is term licenses on the basis of a fixed number of simultaneous users per module. Network-based licensing is available, based on a count of the number of simultaneous users. We also have one, two and three year token license options that offer customers the ability to tailor their product selections to their specific research needs and that are renewable at the end of the selected terms. Our customer base has migrated to token and term license renewals based on the flexibility to access more of our software products. These arrangements provide a more predictable recurring revenue stream from the periodic renewals. Software packages consisting of modules typically purchased by customers in particular industry segments have been defined and have been specially priced to facilitate customer purchase of an optimal module set for their needs.

Consulting services are sold on a collaborative basis by salespeople and scientists directly to chemistry research management and information technology departments. Each contract is negotiated based on the custom software service needs of the customer. The term of the contract is highly variable but current examples range from two weeks up to three years. Tripos provides programming and scientific expertise on a cost plus margin basis. Services may include specification, gap and risk assessment, or full biological and chemical data integration. Our proprietary MetaLayer^TM software may be installed at a client site to integrate global information to the desktop. This technology has a license fee and annual maintenance fees.

Sales of the compound libraries are made through our sales teams and distributors. The LeadQuest® library now includes over 90,000 compounds available for purchase. The compounds are sold on a nonexclusive basis to all purchasers and we retain no trailing rights to the compounds once purchased by a customer. LeadQuest® high-throughput screening libraries are novel, diverse, high-quality, drug-like compounds that serve as a pathway to more extensive discovery research services.

Discovery research collaborations are offered through a team comprised of salespeople, scientists and members of the senior management staff. This approach is best suited for the long cycle required in developing meaningful partnerships with key customers for outsourcing or collaborating on discovery research projects.

We exhibit our products and services at various scientific conferences and trade exhibitions, including national and regional conferences of the American Chemical Society, at the InfoTech Pharma Conference, a variety of IBC Drug Discovery Conferences, Society for Biomolecular Screening Conference and CHI High-throughput Screening for Drug Discovery Conference and others. Our scientists frequently publish and present results of original research at these and other conferences throughout the world.

We offer customer training in the use of our products through staff knowledgeable in both chemistry and computer science. We send technical newsletters, bulletins, and advance notification about future software releases to our customers to keep them informed and to help them with resource allocation and scheduling. We also sponsor seminars throughout the world for our customers, involving presentations both by our personnel and guest lecturers. These seminars are designed to enhance customer understanding of our products and their potential utilization as an aid to customer research requirements. We currently provide our customers with advice on computer system configuration management and frequently provide customers with consulting advice in addressing particular research questions as part of the normal pre- and post-sales process.

In 2002, revenue from Pfizer, Inc. represented 34% of our global revenue. During 2001, we obtained 14% of our global revenue from Pfizer and 10% from Bayer AG spanning most, if not all, of our products and services. No other individual customer accounted for over 10% of total revenue in either year.

We sell software and compound products through our wholly owned subsidiaries in Australia and Europe and through a network of distributors in the Pacific Rim and India. Net sales from our activities outside of North America represented approximately 62%, 47% and 57% of total net sales in 2002, 2001 and 2000, respectively, with Europe accounting for 55%, 40% and 47%, and the respective balances coming from customers in the Pacific Rim. We believe that revenues from foreign activities will continue to account for a significant percentage of our total net sales. See Note 10 to the consolidated financial statements, Geographic Segment Data, later in this Annual Report.

We believe our position as a leader in discovery products and services will depend in large part on our ability to enhance our current product line, develop new products, maintain technological competitiveness, integrate complimentary third-party products and meet a rapidly evolving range of customer requirements. We intend to continue to make substantial investments in product and technology development to meet our customers' demands.

We have previously experienced delays in developing new products ranging from a few days to approximately twelve months. The complexity of developing new and enhanced scientific information management software in a client/server environment is significant. Delays or unexpected difficulties in any segment of a development project can result in late or undeliverable product. In view of this complexity, there can be no certainty that we will be able to introduce our products on a timely basis in the future, or that our new products and product enhancements will adequately meet the requirements of the marketplace or achieve market acceptance.

Our research and development activities are undertaken by our discovery software group and our discovery research group. The discovery software group, composed of chemists and other scientists, works closely with customers to identify market needs for new products. Upon identification of a market need for a new product, the discovery software group collaborates with our software engineers to develop requirements and specifications, implement code and perform regression tests for the new product. Separate quality assurance, environment management and systems groups manage the final release, documentation and porting of the new product to all supported platforms. In addition, we fund research at certain academic institutions. We believe that this funding allows us to gain access to significant technology not otherwise available. Also, we enter into funded research and development arrangements with major pharmaceutical customers to develop software tools crucial to high throughput research en vironments and for other emerging issues in life science chemistry.

In September 1998, we opened our first laboratory facility (6,600 sq. ft.) suitable for complete chemical synthesis operations. We began production of newly designed screening libraries, started pilot projects for contract research and generated focused libraries in our internal therapeutic collaborative work with Arena Pharmaceuticals and the Wolfson Institute. In May 1999 we opened our second and larger laboratory facility (18,400 sq. ft.), providing us with the capacity to accommodate large library synthesis and contract research operations simultaneously. By the end of 1999, we had reached our targeted monthly synthesis and purification rate. The inventory of compounds of the LeadQuest® library has subsequently increased to over 90,000 highly pure compounds available for sale. In addition to LeadQuest® library synthesis, we have the facilities and staff to perform several contract research projects concurrently. Presently, these facilities serve customers' contract research nee ds and continue to add to the LeadQuest® library. We are undertaking a further expansion of our chemistry facilities by adding nearly 48,000 sq. ft. of laboratory space to accommodate increasing production under the Pfizer compound enrichment contract and other incremental business opportunities. The expanded facilities are expected to be fully operational by early 2004.

Research and development expenses include all costs of software development and maintenance and any non-capitalizable research associated with the validation of compound libraries or discovery research projects. In accordance with Statement of Financial Accounting Standards No. 86 and AICPA Statement Of Position 98-1, Tripos capitalizes software development costs for both external and internal use. Net capitalized software development costs were $1,402,000 at December 31, 2002 and $295,000 at December 31, 2001.

Tripos has entered into consulting contracts with certain customers that provide for collaboration in customizing chemical compound libraries for drug discovery in specific therapeutic areas. We recognize revenue related to such agreements as contractual milestones are achieved and delivered or, absent such contractual milestones, on a completed contract basis.

Our software production operations consist of assembling, packaging, shipping of software and database products along with documentation needed to fulfill orders. Outside vendors provide printing of documentation and manufacturing of packaging materials. We typically ship our software products promptly after the acceptance of a customer purchase order and the execution of a software license agreement. Accordingly, we do not generally have any significant software backlog, and we believe that a backlog at any particular time, or fluctuations in backlog, are not indicative of sales for any succeeding period.

Enterprise consulting service contracts may be structured under a variety of terms including billing for hours worked, successful delivery of milestones or fixed-price contracts. Staff assigned to these contracts have been located in the U.S., U.K. and at the customer's location. These contracts may contain provisions for license fees on the core technologies delivered at the inception of the project or for the system software activated upon completion of the contract. Quarterly revenues and costs from software consulting will vary due to the mix of contracts being serviced in any particular quarter and the timing of the recognition of any applicable license fees.

Discovery research services and LeadQuest® chemical compound production are performed and carried out at Tripos Receptor Research in Bude, England. With respect to discovery research projects, they vary in size, scope and length of time to complete. Discovery research agreements may include technology access fees, full-time equivalent billing rates, trailing rights in the form of milestone payments or royalties. Certain projects include management of biology screening processes performed by third parties. The unpredictability of chemistry reactions may impact the rate of progress on research contracts and lead to fluctuations in revenue recognition.

LeadQuest® compound sales are shipped shortly after the execution of a sales contract between the customer and Tripos. The potential for backlog exists in the delivery of compounds due to the nature of the materials to be accumulated, packaged and shipped along with the sometimes-lengthy compound selection process of the customer. Backlogs will fluctuate based on the number, size and timing of orders received, and availability of product.

We rely upon a combination of patent, copyright, trademark and trade secret laws to protect our intellectual property. License and non-disclosure agreements are used to establish and protect the proprietary rights in our products. We hold four key patents in the area of analysis of the relationship of chemical structure to activity; one issued in the early 1990's on our SYBYL CoMFA product, another issued in 1998 on our Hologram QSAR, and two on our ChemSpace technology issued in 2001. From 1996 to early 2002, we applied for ten (10) other software patents and, jointly with collaborators, for an additional three (3) composition-of-matter or related use patents. The source code for our products is protected both as trade secrets and as unpublished, copyrighted work. In addition, our core software products are developed and manufactured only at our St. Louis facility. We do not disclose the source code for our products to any of our distributors. We supply our source code under special, restrictive license provisions to a very limited number of customers only on special request, none of which has been received in the last five years. Also, upon request, Tripos has placed source code in escrow for the benefit of a minimal number of designated customers for limited support purposes on a contingency basis. All major software products are shipped from our St. Louis facility under a technical license management system that governs access. Despite these precautions, it may be possible for a third party to gain use of our products or technology without prior authorization, or to develop similar technology independently. Effective copyright and trade secret protection may be unavailable or limited in certain foreign countries where we do business. The markets in which we compete are characterized by rapid technological change. While we believe that legal protection of our technology is an important competitive factor, we are aware that such factors as the technological and creative skills of our pe rsonnel, new product development, frequent product enhancements, name recognition and reliable product support are important in maintaining a sustained technology leadership position.

We license our workstation software through the execution of license agreements. We license our personal computer software products by use of a "shrinkwrap" license. A "shrinkwrap" license agreement is a printed license agreement included within packaged software that sets forth the terms and conditions under which the purchaser can use the product and is intended to bind the purchaser, by the purchaser's acceptance of the software, to such terms and conditions.

We have a number of contracts with academic institutions and individuals providing us the right to license, market and use technology developed outside the company. These products enhance our ability to offer an enriched product line and represent a material percentage of our annual revenue.

Our general screening and targeted compound libraries, which are manufactured and shipped by Tripos Receptor Research from their Bude, England facilities, and the related synthesis methods and approaches, are protected as trade secrets by non-disclosure agreements and other means. Compound, consulting, discovery research and collaborative agreements we enter require specific documentation regarding defined proprietary rights, responsibilities of the parties, and/or allowed use of any related compounds or libraries of compounds.

We operate in a highly competitive industry characterized by rapidly changing technology, frequent new product introductions and enhancements, and evolving industry standards. We compete with other vendors of software products designed for applications in analytical chemistry, computational chemistry, chemical information management, and combinatorial chemistry; the four principal areas in the chemical and pharmaceutical research market. Our discovery services group competes with other vendors for the sale of contract research, focused compound libraries and diverse compound screening libraries. The competition in our industry is fragmented and populated with a wide spectrum of organizations ranging from small start-up companies to large multi-national firms along with academic research institutions.

Competition is likely to intensify as current competitors expand their product offerings and as new companies enter the market. The competition we experience in our existing and targeted markets could result in price reductions, reduced margins and loss of market share, all of which could have a material adverse effect on us. A number of our existing competitors have significantly greater financial, technical and marketing resources than we do. We believe that the principal factors affecting competition in our markets are product quality, performance, reliability, ease of use, technical service, support, and price. We expect that these factors will remain major competitive issues in the future, but additional factors will become increasingly important, including contribution to the overall efficiency of the research effort through enhanced integration, communication and analysis. Although we believe that we currently compete favorably with respect to these factors, there can be no assuranc e that we will be able to compete successfully against current and future competitors or that the competitive pressures we face will not have a material effect on our business, operating results or financial condition.

The information required by this item is included in the Proxy Statement in connection with our Annual Meeting of Shareholders to be held on May 7, 2003 under the caption "Management", and is incorporated herein by reference.

Our principal administrative, sales, marketing and product development facilities are located in St. Louis, Missouri. We own these facilities, which are financed by a mortgage note. Tripos also owns laboratory facilities located in Bude, England. We lease two domestic sales and service offices in Shrewsbury, New Jersey and South San Francisco, California. Our European subsidiaries lease sales and service offices in the United Kingdom, France and Germany. We believe that our existing facilities are adequate for our current needs and that additional space will be available as needed.

The Company is not currently a party to any material litigation and are not aware of any pending or threatened litigation that could have any material adverse effect upon its business, operating results or financial condition.

No matters were submitted to a vote of Tripos' shareholders during the fourth quarter of its fiscal year ended December 31, 2002.

Tripos' common stock trades on The NASDAQ National Market System under the symbol "TRPS". The following table sets forth the range of the high and low sales prices per share of the common stock for the fiscal quarters indicated, as reported by NASDAQ. Quotations represent actual transactions in NASDAQ's quotation system but do not include retail markup, markdown, or commission.

Note: values represent an adjustment for the 2-for-1 stock split effective on February 5, 2001 for holders of record on January 12, 2001.

We had approximately 1,000 shareholders of record and 2,600 street name holders as of December 31, 2002. We have not declared or paid any dividends on our common stock. We currently intend to retain earnings for use in our business, therefore, we do not anticipate paying cash dividends to common shareholders in the foreseeable future. In February 2000, we sold 409,091 shares of Series B Convertible Preferred Stock in a private placement transaction to LION bioscience AG ("LION"). On January 29, 2002, LION converted the preferred shares into 818,182 shares of Common Stock and was paid accrued dividends of $892,600 in cash. On February 7, 2002, LION sold all of its shares through a broker in a series of block trades.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

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

We license discovery software tools to customers, provide ongoing support (including upgrades selected by customers) and provide consulting services to customers that enable integration of our existing and newly developed discovery tools to customers' discovery operations. We generally expense research and development costs associated with software enhancements and new functionality. 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. Certain software development projects require substantial commitments of time and resources. Costs of these projects are capitalized according to Statement of Financial Accounting Standards ("SFAS") No. 86.