FORM 10-Q/A

(Amendment No. 1)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

Commission File Number 0-23666

TRIPOS, INC.

(Exact Name of Registrant as Specified in its Charter)

Utah		43-1454986
(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification No.)

1699 South Hanley Road

St. Louis, Missouri 63144

(Address of Principal Executive Offices and Zip Code)

(314) 647-1099

(Registrant's Telephone Number, Including Area Code)

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 requirement for the past 90 days.

Yes X No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer ___

Accelerated filer ___

Non-accelerated filer _X

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No _X__

Number of shares outstanding of the issuer's Common Stock, par value $.01 per share, as of November 13, 2006: 10,281,712 shares.

TRIPOS, INC.

Amendment No. 1 to the Quarterly Report on Form 10-Q

For the Period Ended September 30, 2006

Explanatory Note

Tripos, Inc. (the "Company") is filing this Amendment No. 1 to its Quarterly Report on Form 10-Q for the period ended September 30, 2006 ("Form 10-Q/A) in order to include an impairment charge in the amount of $3.6 million which is equivalent to the loss on the sale of excess properties at the Company's Bude, England research facility. The sale of the properties was accomplished through a series of transactions that were in negotiation at the time the Company filed its original report on Form 8-K and were subsequently completed in the fourth quarter of 2006.

TRIPOS, INC.

	Page
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at September 30, 2006 (Unaudited) and December 31, 2005	4
Consolidated Statements of Operations for the Three- and Nine-Months Ended September 30, 2006 (Unaudited) and September 30, 2005 (Unaudited)	5
Consolidated Statements of Cash Flows for the Nine-Months Ended September 30, 2006 (Unaudited) and September 30, 2005 (Unaudited)	6-7
Notes to Consolidated Financial Statements (Unaudited)	8-31

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	32-45
Item 3. Quantitative and Qualitative Disclosures about Market Risk	45
Item 4. Controls and Procedures	45-46

PART II OTHER INFORMATION	46-47
SIGNATURES	47

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements.

TRIPOS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands)	09-30-2006	12-31-2005
	Restated
ASSETS	(Unaudited)
Current assets:
Cash and cash equivalents	$ 2,343	$ 6,241
Restricted cash	156	--
Marketable securities	127	--
Accounts receivable, less allowance for doubtful accounts of $191	3,638	11,219
Inventory	7,481	5,155
Prepaid expenses	3,807	4,386
Total current assets	17,552	27,001

Property and equipment, less accumulated depreciation	20,671	26,789
Capitalized development costs, less accumulated amortization	2,328	2,291
Goodwill	5,351	5,255
Intangible assets, less accumulated amortization	3,189	3,554
Investments recorded at cost	1,578	1,695
Deferred income taxes	250	231
Other assets	530	--
Total assets	$ 51,449	$ 66,816

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt	$ 7,964	$ 5,241
Current portion of capital leases	2,913	2,741
Accounts payable	1,337	1,219
Accrued expenses	3,566	4,970
Deferred revenue	10,394	15,898
Total current liabilities	26,174	30,069

Long-term portion of capital leases	2,527	1,343
Long-term debt	1,898	5,891
Common stock warrants	467	--
Total liabilities	31,066	37,303

Redeemable convertible preferred stock, $0.01 par value, authorized 1,833 shares, issued 1,833 shares as of September 30, 2006	3,716	--
Shareholders' equity :
Common stock, $0.01 par value; authorized 20,000 shares, issued 10,282 shares as of September 30, 2006 and 10,190 shares as of December 31, 2005.	103	102
Additional paid-in capital	43,362	41,846
Retained deficit	(25,659)	(12,377)
Accumulated other comprehensive loss	(1,139)	(58)
Total shareholders' equity	16,667	29,513

Total liabilities and shareholders' equity	$ 51,449	$ 66,816

See accompanying notes

Item 1. Financial Statements (continued)

TRIPOS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

	Three Months Ended		Nine Months Ended
	09-30-2006	09-30-2005	09-30-2006	09-30-2005
Net sales:	Restated		Restated
Discovery informatics products & support	$ 5,670	$ 6,618	$ 17,763	$ 18,730
Discovery informatics services	378	716	2,895	1,964
Discovery research products & services	1,605	5,821	4,347	20,842
Hardware	3	10	28	31
Total net sales	7,656	13,165	25,033	41,567

Cost of sales	4,121	6,067	11,082	20,860
Gross profit	3,535	7,098	13,951	20,707

Operating expenses:
Sales and marketing	2,367	2,556	8,153	8,186
Research and development	2,834	2,898	8,287	6,810
General and administrative	1,760	1,900	5,244	5,787
Restructuring charge	338	--	1,265	--
Impairment charge	3,607	--	3,607	--
Total operating expenses	10,906	7,354	26,556	20,783

Loss from operations	(7,371)	(256)	(12,605)	(76)

Interest expense	(569)	(478)	(1,597)	(1,259)
Other income (loss), net	353	311	1,525	(346)
Loss before income taxes	(7,587)	(423)	(12,677)	(1,681)

Income tax expense (benefit)	62	(583)	46	(2,633)
Net income (loss)	(7,649)	160	(12,723)	952

Preferred dividends	342	--	559	--

Net income (loss) available to common shareholders	$ (7,991)	$ 160	$ (13,282)	$ 952

Basic income (loss) per share	$ (0.78)	$ 0.02	$ (1.30)	$ 0.09
Basic weighted average number of shares	10,276	10,114	10,220	10,088
Diluted income (loss) per share	$ (0.78)	$ 0.02	$ (1.30)	$ 0.09
Diluted weighted average number of shares	10,276	10,143	10,220	10,132

See accompanying notes.

Item 1. Financial Statements (continued)

TRIPOS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)	Nine Months Ended
	09-30-2006	09-30-2005
Operating activities:	Restated
Net (loss) income	$ (12,723)	$ 952
Adjustments to reconcile net loss to net cash provided by operating activities:
Impairment charge	3,607	--
Depreciation of property and equipment	3,060	3,121
Amortization of capitalized development costs & intangibles	974	513
Amortization of debt discount	187	42
Amortization of deferred issuance costs	98	--
Gain on revaluation of common stock warrants	(572)	--
Deferred tax benefit	(6)	(1,288)
Gain from sale of marketable securities	--	(240)
Write-down of long-term investment	27	88
Loss on retirement of assets	28	--
Stock-based compensation expense	271	--
Non employee and director stock compensation expense	29	--
Change in operating assets and liabilities (excluding acquired business):
Restricted cash	(156)	--
Accounts receivable	8,408	559
Inventories	(1,823)	2,993
Prepaid expenses and other current assets	2,105	(690)
Accounts payable and accrued expenses	(3,224)	(3,641)
Deferred revenue	(6,519)	318
Net cash (used in) provided by operating activities	(6,229)	2,727
Investing activities:
Purchases of property and equipment	(409)	(880)
Capitalized development costs	(646)	(1,470)
Acquisition of business, net of cash received	--	(4,753)
Proceeds from the sale of marketable securities	--	426
Proceeds from the sale of equipment	3,799	1,995
Proceeds from distribution from investment in unconsolidated affiliates	36	--
Investment in unconsolidated affiliates	(88)	(133)
Net cash provided by (used in) investing activities	2,692	(4,815)
Financing activities:
Proceeds from stock issuance pursuant to stock purchase and option plans	172	39
Proceeds from issuance of common stock	--	500
Proceeds from issuance of preferred stock	4,851	--
Payments of cash dividends on preferred stock	(237)	--
Borrowings under revolving line of credit	6,710	14,380
Proceeds from issuance of long-term debt and capital leases	--	3,559
Payments on long-term debt and capital lease obligations	(11,134)	(17,189)
Net cash provided by financing activities	362	1,289

Effect of foreign exchange rate changes on cash and cash equivalents	(723)	194

Net decrease in cash and cash equivalents	(3,898)	(605)
Cash and cash equivalents at beginning of period	6,241	4,171
Cash and cash equivalents at end of period	$ 2,343	$ 3,566

See accompanying notes.

Item 1. Financial Statements (continued)

Supplemental Disclosure of Cash Flow Information (amounts in thousands)

Information about noncash investing activities not reflected in the Consolidated Statement of Cash Flows follows:

	Nine Months Ended
	09-30-2006	09-30-2005
Noncash investing activities
Increase (decrease) in fair value of marketable securities, net of tax effect	$ (9)	$ 53
Purchase of new equipment through capital lease financing	3,966	1,995
Issuance of common stock warrants with PIPE financing	1,069	--
Beneficial conversion feature of preferred stock and other
preferred stock discounts	(2,055)	--
Accretion of preferred stock discount	321	--

In January 2005, the Company acquired Optive Research, Inc. for $4,770 in cash, 600 shares of the Company's common stock valued at $3,200 and direct costs of the acquisition. The related assets and liabilities at the acquisition date were as follows:

Cash	$ 647
Accounts receivable	809
Prepaids & other	30
Equipment, net	40
Intangible assets	3,940
Goodwill	4,308
Total assets acquired	9,774

Accounts payable	(422)
Accrued expenses	(97)
Deferred revenue	(655)
Common stock issued to sellers	(3,200)

Cash paid	$ 5,400

Item 1. Financial Statements (continued)

TRIPOS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

(1) Summary of Significant Accounting Policies

Organization

Our discovery informatics and discovery research products and services enable life science companies to better perform their drug discovery. We combine our resources in computer-aided molecular design, cheminformatics, chemistry research and production, with the expertise of scientists on our staff to address the challenges facing pharmaceutical research organizations. We deliver products and services internationally recognized for their innovation and quality. By creating new chemical compounds and providing tools that aid our partners' design of new chemical compounds, we offer our customers advantages in terms of research cycle time, cost, and efficiency of research activities.

We have formed commercial relationships with most major pharmaceutical companies and with many emerging biotechnology companies based on their use of some or all of our products and services. Representative pharmaceutical clients include: Abbott, Bayer, Bristol-Myers Squibb, GlaxoSmithKline, Pfizer, Sanofi-Aventis, Schering AG, Schering-Plough, Servier and Wyeth. Representative biotechnology clients include: Biovitrum, BioTie, CeNeS, Chronogen and GeminX.

Tripos was formed in 1979 to commercialize software for molecular visualization, analysis and design. In building our discovery informatics solutions, we have focused on developing an integrated suite of offerings at the leading edge of scientific research. In addition to our discovery informatics product and service offerings, we engage in chemistry research enhanced by informatics capabilities to produce high-value products and services that directly impact our customers' discovery programs. In certain cases with customers, these capabilities have created opportunities for us to participate in research collaborations, in which we have the potential for milestones and/or royalty interests in early-stage new drug candidates.

Our business model is based primarily on deriving revenues from our discovery informatics and discovery research businesses as follows:

Discovery Informatics Products and Services. The SYBYL^® and UNITY^® software suites are the foundation of our discovery informatics product (software) offerings. These suites provide integrated tools for computer-aided molecular modeling and visualization, virtual screening, combinatorial library design, data storage and analysis, and structure-activity relationships to customers in pharmaceutical, biotechnology and related life science fields of research. We offer over fifty (50) software products for these research areas, some of which are in-licensed from third party scientific partners. Key components of these products are being packaged as web services as part of Tripos' Service-Oriented Informatics strategy, designed to make the company's valuable discovery tools adaptable to each scientist's workflow in the new rapidly evolving informatics environment. In 2005, we launched the Windows^®-based Benchware^TMsuite, used by laboratory researchers to support synthesis and testing decisions; digitally store, search and retrieve research information; and share experimental results with project team members, including computational scientists. These products and technologies are provided to our customers through a license arrangement, while certain of the enterprise-wide technologies also involve systems integration and other services to facilitate a smooth

• Item 1. Financial Statements (continued)

implementation. Customized software development projects can also be an avenue to assist customers to resolve specific research issues that require new scientific methods, techniques and analytical tools.

• Discovery Research Products and Services. Tripos Discovery Research Centre, based in the United Kingdom, offers compound design and synthesis, molecular analysis, a suite of lead discovery and lead optimization capabilities and newly introduced target-specific chemical libraries (LeadDiscovery libraries). Tripos offers off-the-shelf libraries of compounds sold for pharmaceutical screening purposes. We also participate with our customers in strategic chemistry research projects, primarily on a fee for service basis. In a few cases, the transfer of intellectual property rights for these therapeutic collaborations may include royalty or milestone payments associated with advancement of the compounds through various stages of drug development. In addition, Tripos' newly introduced target-specific libraries are intended to be a platform for our further collaborative development with clients.

We have a geographically diverse customer base, with approximately 51% of our 2006 year-to-date revenues derived from customers outside of North America. Our worldwide sales force operates from offices in the United States, Canada, England, France, and Germany. We also sell our products through representatives in Brazil and around the Pacific Rim. Our headquarters is in St. Louis, Missouri and our chemistry laboratory is in Bude, England.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all normal recurring adjustments necessary for a fair presentation of such financial statements have been included. For a further description of accounting policies, please refer to the "Description of Business and Summary of Significant Accounting Policies" section in the Company's annual report on Form 10-K for the year ended December 31, 2005. Operating results for the nine-month period ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006.

Revenue Recognition

Discovery Informatics Products and Support

We recognize revenues in accordance with the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, "Software Revenue Recognition," as amended. Revenues from software license agreements are recognized when all of the following criteria are met as set forth in paragraph 8 of SOP 97-2: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the fee is fixed or determinable, and (4) collectibility is probable.

Our largest sources of software license revenue are from Term and Bundled licenses. These are time-based arrangements for one or multiple software products that are sold together with maintenance and support for the term of the license arrangement. We do not have Vendor Specific Objective Evidence ("VSOE") to determine fair value of the maintenance and support in term arrangements and therefore

Item 1. Financial Statements (continued)

recognize revenues from these bundled time-based licenses ratably over the license term, which typically range from 1 to 3 years.

We allocate revenues from perpetual software arrangements involving multiple elements to each element based on the relative fair values as determined by the VSOE for each element. We limit our assessment of VSOE for each element to the price charged when the same element is sold separately. We have analyzed all of the elements included in our multiple-element arrangements and determined that we have sufficient VSOE to allocate revenues to maintenance and support services, and training. We sell training separately and have established VSOE on this basis. VSOE for maintenance and support is determined based upon the renewal rates in contracts themselves, which is based on a fixed percentage of the current perpetual license list price. Accordingly, assuming all other revenue recognition criteria are met, revenues from perpetual licenses are recognized upon delivery of the software using the residual method in accordance with SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions."

Software maintenance agreements provide technical support and the right to unspecified enhancements and upgrades on a "when-and-if-available" basis. Post-contract support revenues on perpetual agreements are recognized ratably over the term of the support period (generally one year), and training and other service revenues are recognized as the related services are provided. Any unrecognized portion of amounts paid in advance for licenses and services is recorded as deferred revenue.

Discovery Informatics Services

Discovery Informatics Services (DIS) includes contracts for the development of packaged Tripos software and/or for the development and delivery of enterprise-wide customized software (such as laboratory information systems or database integration projects). Technological feasibility exists on these software arrangements as they normally leverage our existing products or techniques. These arrangements typically include installation at the customer's site. We account for these arrangements in accordance with SOP 81-1, as required by SOP 97-2 since the contract to deliver software and installation requires significant production, modification or customization of software.

In applying the provisions of SOP 81-1 the percentage of completion method of accounting for long-term contracts is utilized. Percentage of completion accounting provides for two methods to record long-term contract activity: 1) For contracts where customer approval of contractually required tasks must occur at each distinct milestone, and where amounts billable are indicative of progress-to-completion, we record revenues when a milestone has been met and accepted by the customer. 2) For contracts without distinct milestones, we measure progress using the cost-to-cost method (cumulative costs as a percentage of total expected costs to complete), which approximates progress towards completion. In addition, when current estimates of total contract revenue and contract cost indicate a loss, a provision for the entire loss on the contract is made in the period that the loss becomes evident.

DIS also includes software development ("SD") projects that are contractual arrangements with customers to leverage our expertise in developing a scientific software tool for use in drug discovery. Billings may be on a time and materials basis; accordingly, we record the related revenue when the time and costs are incurred at the stated contractual rates. Other contracts may be accounted for under milestone or completed contract basis depending on the negotiated terms. For these arrangements, cost and revenues are deferred until achievement of the milestone or completion of the contract.

Item 1. Financial Statements (continued)

Discovery Research Products and Services

Discovery research sales include: (1) sales of chemical compounds from inventory, (2) sales of compounds with associated exclusive intellectual property, (3) long-term contracts to design and produce chemical compounds to customer specifications, (4) contracts to perform high-throughput analytical and/or purification, (5) contracts to perform discovery research activities, or (6) contracts to provide biological screening services.

We recognize revenue from the sale of chemical compounds upon shipment of the products, FOB shipping point to the customer. This practice is consistent with the four criteria required for revenue recognition listed in paragraph 1 of Staff Accounting Bulletin ("SAB") 104 issued by the U.S. Securities and Exchange Commission ("SEC"). For chemical compound transactions, persuasive evidence of an agreement exists upon the receipt of a contract outlining the purchase and usage terms of the compounds. A purchase order may also be received as confirmation. As stated above, revenue is not recognized until the compounds have been shipped to the customer. The selling price for compounds is fixed according to the terms of the contract or customer's purchase order. Payment terms for chemical compound transactions are Net 30 days. We have experienced very few bad debts arising from these product transactions; as a result, collectibility is reasonably assured.

In accordance with SOP 81-1, sales derived from long-term contracts to design and produce chemical compounds to customer specifications are recorded using the percentage of completion method as the finished goods are delivered (under the units of delivery method). The contract costs related to delivered compounds are recorded to cost of sales as the compounds are delivered and revenue is recognized.

Discovery research activities involve lead compound optimization projects, custom synthesis, compound design and compound screening. These contracts generally call for non-refundable contractual fees tied to time and materials. Accordingly, revenues under contracts of this type are recorded on a time and material basis. When contracts to perform discovery research activities require a specific deliverable, the direct and incremental contract costs are deferred. Revenue and the contract costs are then recognized upon delivery and acceptance.

An access fee for our LeadDiscovery programs may in some cases be recognized upon completion of a materials transfer agreement and shipment of selected compounds to the customer for screening purposes. Customers deciding to retain exclusive rights to promising compounds in the selection are required to pay an additional fee. Certain customers may engage Tripos for follow-on discovery research services to further refine the lead compound at additional cost.

Hardware Sales

Hardware sales are recorded upon shipment of the product to the customer.

Stock-Based Compensation

Prior to January 1, 2006, we accounted for stock-based compensation plans under the intrinsic value method as permitted under Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees", and related Interpretations. Under APB 25, generally no compensation expense was recognized because the exercise price of the options equaled the fair value of the stock at the grant date.

Item 1. Financial Statements (continued)

Stock-Based Compensation (continued)

Effective January 1, 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards ("SFAS") No. 123R ("FAS 123R"), "Share-Based Payment," using the modified-prospective transition method. Under this transition method, compensation expense was recognized beginning January 1, 2006 and includes (a) compensation expense for all share-based employee compensation arrangements granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of FAS 123, and (b) compensation expense for all share-based employee compensation arrangements granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of FAS 123R. Results for prior periods have not been restated. See Note 15 of the Notes to Consolidated Financial Statements in this Form 10-Q for further discussion of stock-based compensation.

Income Taxes

We account for income taxes in accordance with SFAS No. 109 ("FAS 109"), Accounting for Income Taxes, which prescribes the use of the asset and liability method whereby deferred tax assets or liabilities are calculated at the balance sheet date using current tax laws and rates in effect. Valuation allowances are established when necessary to reduce deferred tax assets when it is more likely than not that a portion or all of the deferred tax assets will not be realized. In accordance with FAS 109, income tax expense includes 1) deferred tax expense, which generally represents the net change in the deferred tax asset or liability balance during the period plus any change in valuation allowances, and 2) current tax expense, which represents the amount of tax currently payable to or receivable from a taxing authority. The primary difference between financial statement income and taxable income results from the use of different methods of computing depreciation, capitalized development cost, certain revenue recognition activities, other timing differences and the valuation of net operating loss carryforwards. Deferred taxes do not reflect temporary differences relating to our investment in foreign subsidiaries as these amounts have been deemed to be permanently invested. Estimating the deferred tax position on these amounts is not practical.

The effective tax rate reflects management's current estimate of the distribution of earnings among the statutory jurisdictions in which we operate and the valuation of certain tax credits and net operating losses in the U.S. and U.K. from prior tax years (each ending December 31). Valuation allowances established for deferred tax assets related to net operating losses does not impair our ability to use those deferred tax assets upon achieving profitability in the related jurisdictions. Upon the recognition of income in future periods in the jurisdictions where the deferred tax assets were created, release of the corresponding valuation allowances may result in a lower effective tax rate.

Inventory

We account for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) as current-period charges and not included in overhead as required by SFAS No. 151 "Inventory Costs-an amendment of ARB No. 43, Chapter 4" ("FAS 151"). In addition, FAS 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. We have adopted FAS 151 effective January 1, 2006. The adoption of FAS 151 coincided with the completion of our four-year $90 million file enrichment project with Pfizer. As a result, there are more current period charges of approximately $247 and $719 in the third quarter and first nine months of 2006, respectively, and we are estimating a total of approximately $933 for fiscal year 2006, unless excess property is sold, based upon decreased production.

Item 1. Financial Statements (continued)

(2) Comprehensive Income (Loss)

The components of comprehensive income, net of related tax, for the three- and nine-month periods ended September 30, 2006 and 2005 were as follows:

	Three-month Period		Nine-month Period
	09-30-2006	09-30-2005	09-30-2006	09-30-2005
	Restated		Restated
Net income (loss) available to common shareholders	$ (7,991)	$ 160	$ (13,282)	$ 952
Unrealized gain (loss)on marketable securities	(9)	--	(9)	53
Less: reclassification for (gain) loss included in net income	--	--	--	(149)
Foreign currency translation adjustments	(163)	207	(1,072)	1,522
Comprehensive income (loss)	$ (8,163)	$ 367	$ (14,363)	$ 2,378

The components of accumulated other comprehensive income, net of related tax, at September 30, 2006 and December 31, 2005 were as follows:

	09-30-2006	12-31-2005
Foreign currency translation adjustments	$ (1,130)	$ (58)
Unrealized loss on marketable securities	(9)	--
Accumulated other comprehensive loss	$ (1,139)	$ (58)

(3) Contingent Liabilities

Securities Class Action Litigation

On or about July 24, 2003, the Company and two of its executive officers, Dr. John P. McAlister and Mr. B. James Rubin, were sued in federal district court in St. Louis, Missouri on behalf of purchasers of the Company's common stock during the first half of 2002. The consolidated class action complaint alleged that statements made by the Company in press releases and other public disclosures contained materially false and misleading information in violation of the federal securities laws. On or about May 5, 2004, plaintiffs filed a second amended complaint on behalf of a purported class of purchasers of the Company's common stock between February 9, 2000 and July 1, 2002 (the "Class Period"). The second amended complaint generally alleges that, during the Class Period, defendants made false or misleading statements of material fact about the Company's prospects and failed to follow generally accepted accounting principles in violation of the federal securities laws. The second amended complaint also named Ernst & Young LLP, the Company's former independent registered public accounting firm, as a co-defendant. In August 2004, the Company and the individual defendants and Ernst & Young filed motions to dismiss the second amended complaint. On September 30, 2005, the Company was informed that its motion to dismiss was denied; however, the motion to dismiss filed by Ernst & Young was granted.

On March 21, 2006, the parties reached a tentative agreement to settle the class action litigation. The total amount of the settlement is $3,150 which is to be paid by our insurers. The settlement was subject to court approval after notice and an opportunity to object was provided to the putative shareholder class. On August 4, 2006, the Court entered an order approving the settlement and dismissing with prejudice all claims against the defendants.

Item 1. Financial Statements (continued)

(3) Contingent Liabilities (continued)

Shareholder Derivative Litigation

On or about February 10, 2006, a shareholder derivative action was filed in the Circuit Court of the County of St. Louis. The complaint named certain of the Company's officers and directors as defendants and names the Company as a nominal defendant. The complaint alleged that certain of the Company's officers and directors breached their fiduciary duties to the Company by engaging in alleged wrongful conduct including conduct complained of in the securities class action litigation described above.

On March 21, 2006, the parties reached a tentative agreement to settle this litigation, subject to final documentation and court approval, involving the implementation of certain policies and procedures by the Company and the payment of attorneys' fees of $200 to plaintiffs' counsel. All fees are to be paid by our insurers. On September 8, 2006, the Court granted preliminary approval to the parties' settlement and scheduled a final approval hearing for November 17, 2006. There can be no assurance that the settlement will be approved, in which case we will continue to vigorously defend ourselves against these claims.

Grant Programs

In 2002, Tripos, Inc. and its U.K. subsidiary, Tripos Discovery Research Ltd. ("TDR") was awarded a GBP2400 grant by the U.K Department of Trade and Industry ("DTI") based on the creation of jobs in the region and capital investment. In 2002 and 2004 we met all criteria for the first and second installments and received GBP550 and GBP990, respectively. We may be obligated to repay portions or all of the grant money received for a period of up to five years after our first draw, which was January 2003, under the DTI grant programs if we eliminate jobs or exit the property. On January 24, 2006 we reduced headcount as described in Note 10 by seventy-six positions. We reduced headcount further on August 11, 2006 and the fourth quarter, 2006 by fourteen positions and twenty-seven positions, respectively. Calculation of any amounts repayable to the U.K. government will be based on employee staffing levels at December 31, 2006. Actual staffing levels at that date will be compared to staffing levels previously funded by the grant. Any shortfall in actual staffing could require repayment to the DTI calculated at a rate of GBP17 per employee up to a maximum amount of GBP1,540 (approximately $2,800). The Company has initiated discussions with the DTI with the goal of negotiating a reduced repayment obligation. The Company has yet to receive an indication from the DTI as to the amount to be repaid nor as to the timing of the repayments, if any, and is unable to estimate the potential liability at this time.

(4) Significant Customer

During the third quarter and nine months ended September 2006, we had no customer representing over 10% of net sales. During the third quarter and nine months ended September 2005, Pfizer, Inc. represented 43% and 46%, respectively, of total net sales. We provided products and services to Pfizer under three separate contracts: multi-year worldwide licenses to our discovery software products, multi-year collaborative software development project and a $90 million four-year discovery research project to design and synthesize exclusive compound libraries which was completed in the fourth quarter 2005. We continue to provide worldwide licenses to our discovery software products to Pfizer during 2006; however revenues from Pfizer have dropped below 10% of third quarter and nine months ended September 2006 total revenues.

Item 1. Financial Statements (continued)

(5) Earnings (Loss) Per Share

The following table sets forth the computation of basic and diluted earnings per share for the three- and nine-month periods ended September 30, 2006 and 2005.

	Three-months Ended		Nine-months Ended
	09-30-2006	09-30-2005	09-30-2006	09-30-2005
Numerator:	Restated		Restated
Numerator for basic earnings per share-- net income (loss) allocable to common shareholders	$ (7,991)	$160	$ (13,282)	$ 952
dividends accruing to preferred shareholders (Note C)	--	--	--	--
Numerator for diluted earnings per share	$ (7,991)	$160	$ (13,282)	$ 952
Denominator:
Denominator for basic earnings per share-- Weighted average shares	10,276	10,114	10,220	10,088
Effect of dilutive securities:
Warrants (Note A)	--	--	--	--
Employee stock options (Note B)	--	29	--	44
Assumed conversion of Series C preferred Shares (Note C)	--	--	--	--
Denominator for diluted earnings per share-- Adjusted weighted average shares	10,276	10,143	10,220	10,132

Basic and diluted earnings (loss) per share	$ (0.78)	$ 0.02	$ (1.30)	$ 0.09

Note A: For the three and nine-months periods in 2006 and 2005, the dilutive effect of the 156 outstanding warrants to purchase shares of common stock

issued to Horizon has been excluded as the average market price of Tripos common stock was below the price of the warrants and therefore the warrants could

not be deemed to have been converted into common stock. The 550 warrants and 16 warrants issued to Midwood Capital and Seven Hills, respectively, have

also been excluded for the three and nine-months periods in 2006 as the average market price of Tripos common stock was below the price of the warrants

and therefore the warrants could not be deemed to have been converted into common stock.

Note B: For the three and nine-months periods in 2006, weighted average shares outstanding did not include shares related to the effect of employee stock

options as none were exercisable due to the market price of the Company's common stock during the periods.

Note C: For the three and nine-months periods ending September 30, 2006, weighted average shares outstanding were not adjusted for the conversion of the

Series C Preferred Stock as their inclusion would have been anti-dilutive. Accordingly, the related preferred dividends were not added back to the numerator

for diluted earnings per share.

For additional disclosures regarding earnings per share, see the notes to the Company's 2005 consolidated financial statements in its Form 10-K.

Item 1. Financial Statements (continued)

(6) Inventory

We maintain a physical inventory of chemical compound libraries in various states of completion for LeadQuest, LeadDiscovery and customer-specific chemistry research projects. Costs associated with the manufacture of compounds are calculated using the standard cost method and are carried at the lower of cost (standard cost method approximating FIFO) or market. In calculating the reserve for obsolescence, collections of compounds are reviewed for their age, possible chemical degradation and cumulative sales trends, and if necessary, a reserve provision is made so that the carrying value is at or below the respective net realizable values. If there is, in our opinion, a significant adverse deviation in sales trends for a specific compound collection or library, an additional reserve provision is taken. A portion of the LeadQuest inventory is used in discovery research projects. Amortization of this inventory is recorded in the reserve for obsolescence over its 10-year expected useful life. Similarly, LeadDiscovery libraries containing patented compound series are amortized over the anticipated patent life. The remaining LeadDiscovery libraries are amortized over a 10-year period. Amortization related to these inventory components was $135 during the third quarter and $255 for the nine-month period of 2006. In all cases, customers may purchase any or all remaining quantities of LeadQuest or LeadDiscovery libraries. Work in process and finished goods inventory includes the accumulated cost of compounds in production or awaiting shipment to customers under discovery research or custom synthesis contracts. The increase in finished goods inventory at September 30, 2006 is due to the movement of LeadQuest libraries from work in process at December 31, 2005 to finished goods in 2006 and the production of approximately $2,500 of new LeadDiscovery compounds in 2006.

Inventory balances at September 30, 2006 and December 31, 2005 were:

	09-30-2006	12-31-2005
Raw materials	$ 1,953	$ 1,763
Work in process	1,847	3,339
Finished goods	7,376	3,217
Reserve for obsolescence	(3,695)	(3,164)
Total inventory	$ 7,481	$ 5,155
Costs of discovery research customer projects included in Work in Process and Finished Goods above	$ 986	$ 534

(7) Time-based Software License Arrangements

Certain time-based software license arrangements are covered by non-cancelable agreements whose terms generally range from one to five years. The typical term of the contracts is three years. Revenue from these time-based software license arrangements is recognized ratably over the agreed term. The following table shows the amount of revenues to be recognized from these non-cancelable arrangements after September 30, 2006:

	Revenues to be recognized in:	Amount
	2006 (remaining 4^th quarter)	$ 4,891
	2007	8,052
	2008	1,669
	2009 and later	247
	Total	$ 14,859

Item 1. Financial Statements (continued)

(7) Time-based Software License Arrangements (continued)

Tripos is typically paid annually under these contracts. Shown below are the amounts to be billed under these contracts subsequent to September 30, 2006 (amounts not included in the accompanying balance sheets at September 30, 2006).

	Amounts to be billed in:	Amount
	2006	$ 2,067
	2007	3,249
	2008	472
	Total	$ 5,788

(8) Debt Facilities

As of September 30, 2006 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, due to expire on January 1, 2007 and April 18, 2008, respectively. The credit facilities are collateralized by substantially all of our U.S. assets and stock pledges for each of the U.S. and U.K. subsidiaries.

The revolving line of credit borrowing capacity is $6,000 and has a borrowing base of 80% of domestic and insured foreign accounts receivable plus an allowance of $1,800 against excess equity in U.S. real estate. Covenants under the credit facility include a minimum shareholders' equity covenant tested quarterly and a minimum consolidated cash balance covenant tested monthly. There is no annual clean-down requirement. Borrowings under the revolving line of credit bear interest at variable rates tied to LIBOR or the bank's prime rate. The line of credit carries a commitment fee of 3/8% of the unused portion of the line. Due to the short term commitment of the amended credit facility, draws on the line of credit are classified as short-term debt. Borrowing base availability was $3,310 and we had borrowings outstanding of $3,310 at September 30, 2006. The mortgage note calls for even quarterly principal payments based on a twenty-year amortization schedule. Interest on the mortgage loan is based on LIBOR plus 3.0%. Interest rates paid by the Company on the mortgage averaged 8.5% and 7.5% during the third quarter of 2006 and first nine months of 2006, respectively. As of September 30, 2006, $3,534 was remaining on the mortgage. We were in violation of the Minimum Net Worth covenant on September 30, 2006 and therefore have reflected all amounts outstanding on the revolving line of credit and mortgage loan as current on the balance sheet. We have requested a waiver of this covenant violation for the period ended September 30, 2006; however, there are no assurances that the bank will grant a waiver or that the bank will not impose additional terms as a condition to granting a waiver. In addition, the LaSalle Bank facility matures January 1, 2007, and LaSalle Bank has advised Tripos that it does not intend to renew or extend revolving credit to Tripos beyond January 1, 2007. Nevertheless, Tripos plans to request an extension from LaSalle Bank to enable it to complete certain strategic transactions that are currently under negotiation. Tripos' ability to fund the anticipated capital and operating needs of its business following maturity of the LaSalle Bank facility and absent completion of certain strategic transactions is dependent, among other things, on the replacement of this facility of the ability to secure alternative bank or other debt financing and/or equity funding. See "Management's Discussion and Analysis-Liquidity" for further information concerning our liquidity and financial position.

Item 1. Financial Statements (continued)

(8) Debt Facilities (continued)

In connection with the Optive acquisition, the Company issued a subordinated promissory note to Horizon Technology Finance with a face value of $3,500 and a stated interest rate of 11.42%. The repayment terms of the promissory note require monthly interest only payments of $33 for the first 18 months, followed by 30 monthly principal and interest payments of $135 beginning on August 1, 2006. Each payment of principal will be accompanied by payment of accrued but unpaid interest to the date of the payment. The subordinated promissory note contains prepayment penalties. The balance outstanding at September 30, 2006 was $3,296. In addition, as part of the financing transaction, 112 shares of common stock were issued to Horizon and Sand Hill Capital at a discounted price of $4.48 per share. Warrants to purchase 156 common shares were issued to Horizon at a negotiated price of $4.48. These transactions resulted in original issuance debt discount of $89 related to the common stock issued at a discount and $432 related to the warrants, calculated based upon relative fair values. The debt discounts are being amortized to interest expense over the life of the loan using the effective interest rate method. As a result of the default under the LaSalle Bank credit facility described above, we are required to notify Horizon of the existence of the default and of the ability to accelerate this indebtedness if the default is not cured within 30 days.

(9) Goodwill and Other Intangible Assets

At September 30, 2006 and December 31, 2005, the Company had the following intangible asset balances:

	September 30, 2006		December 31, 2005
	Gross		Gross
	Carrying	Accumulated	Carrying	Accumulated
	Amount	Amortization	Amount	Amortization
Acquired software	$ 3,590	$ 668	$ 3,590	$ 382
Noncompete agreements	350	162	350	92
Patents and trademarks	192	113	192	104
Total	$ 4,132	$ 943	$ 4,132	$ 578

Amortized intangible assets have the following weighted average useful lives as of September 30, 2006: acquired software -- 14.4 years; non-compete agreements -- 3.9 years; patents and trademarks -- 16.7 years; and intangible assets in total -- 13.6 years.

Amortization expense was approximately $122 and $121 for the three-month periods ended September 30, 2006 and 2005, and $365 and $364 for the nine-month periods respectively. Estimated annual amortization expense for the next 5 years is: 2006 - $486; 2007 - $476; 2008 - $475; 2009 - $391 and 2010 - $9.

The changes in the carrying amount of goodwill for the nine months ended September 30, 2006 are as follows:

	Discovery	Discovery
	Informatics	Research	Total
Balance at December 31, 2005	$ 4,308	$ 947	$ 5,255
Foreign currency translation adjustments	--	96	96
Balance at September 30, 2006	$ 4,308	$ 1,043	$ 5,351

The goodwill related to Discovery Informatics is not tax deductible.

Item 1. Financial Statements (continued)

(10) Restructuring Charge

On January 24, 2006 we completed a reduction in force for our Discovery Research business based in Bude, England which was previously announced on December 19, 2005. This action coincided with the conclusion of the 30-day consultation period with employees mandated by U.K. law. We reduced the number of employees by 76 positions to streamline and refine our Discovery Research business and associated cost structure as a result of our fourth quarter 2005 completion of the four-year $90 million file enrichment project with Pfizer Inc. More than half of the employees affected left the Company under a voluntary separation plan. In addition, a restructuring of our US based employees resulted in a staff reduction of 9 employees. As a result of these actions, the Company recorded a pre-tax restructuring charge in the first quarter 2006 of approximately $807 and $120 related to our Discovery Research and Discovery Informatics divisions, respectively, for one-time termination benefits and outplacement costs. These costs are recorded in the consolidated statement of operations in the restructuring charge line item. All costs associated with these restructurings were paid by the end of the second quarter.

The following table summarizes the activity related to the January 24, 2006 restructuring:

	Discovery Informatics	Discovery Research	Total
Restructuring charge first quarter 2006	$ 120	$ 807	$927
Cash payments first quarter 2006	(114)	(803)	(917)
Accrual balance at March 31, 2006	$ 6	$ 4	$10
Cash payments second quarter 2006	(6)	(4)	(10)
Remaining accrual balance	$ --	$ --	$ --

On August 11, 2006 we completed an additional 14-position reduction in force for our Discovery Research business, resulting in a pre-tax restructuring charge of

$338. We solicited and obtained voluntary terminations for all positions affected in exchange for one-time termination benefits and outplacement costs.

All costs associated with this restructuring not paid during the third quarter are expected to be paid in the fourth quarter of this year.

The following table summarizes the activity related to the August 11, 2006 restructuring:

	Discovery Informatics	Discovery Research	Total
Restructuring charge third quarter 2006	$ --	$ 338	$338
Cash payments third quarter 2006	--	(295)	(295)
Accrual balance at September 30, 2006	$ --	$ 43	$43

In the fourth quarter of 2006 we performed a third reduction in force for an additional 27 positions, reducing our headcount in this business segment to 43

positions. These actions were necessary in order to further streamline the Discovery Research unit. See Note 16 "Subsequent Event" for further discussion.

Item 1. Financial Statements (continued)

(11) Long-term Investments

Since 2001, we have invested in the Life Science Ventures II fund administered by A.M. Pappas. This fund invests in new and developing companies in the life science sector. Our investment commitment of $2,500 represents approximately 2.0% of the total capital of the fund. During the third quarter of 2006, we invested an additional $88, increasing the total amount invested to $2,163 or 87% of our total commitment. The fund's managers record investment impairments when identified, for which we recognize our pro-rata share of such impairments. We received a distribution from the fund in August 2006, reducing our investment by $29 and recognizing a $6 gain. Our net investment balance in the A.M. Pappas Life Science Ventures II Fund at September 30, 2006 totals $1,578, and is reflected in investments recorded at cost on the balance sheet.

During the third quarter 2005, we received shares of common stock of Infinity Pharmaceuticals, a private cancer drug discovery and development company, valued at $191 as part of an early termination agreement for a software license contract. Compensation for the early termination agreement consisted of cash plus shares and represented the full value of our software license agreement. In April 2006, Infinity Pharmaceuticals announced its intent to merge with Discovery Partners International, Inc. to become a public company. This merger was completed on September 12, 2006. The value of our shares on the date of merger was $141, resulting in a loss on our investment of $50. At the date of merger, our $141 investment in the combined company was moved from investments recorded at cost to marketable securities and marked to market at September 30, 2006.

(12) Series C Preferred Stock

On May 4, 2006, Tripos completed the sale of 1,833 shares of Redeemable Convertible Preferred Stock ("Preferred Stock") at a price of $3.00 per share and issued 550 five-year common stock warrants exercisable at $3.50 per share to Midwood Capital, a private equity firm, for gross proceeds of $5,500. Net proceeds from this transaction, after the placement agent's fee and estimated legal and other costs incurred by the Company, were approximately $4,851. Proceeds were utilized to reduce the borrowings under the revolving line of credit and to fund working capital requirements. The warrants to purchase common stock were exercisable upon issuance. The shares of Preferred Stock represent approximately 18 percent of Tripos' outstanding common stock on an as-converted basis (1 preferred share is convertible into 1 share of common stock). Each outstanding share of Preferred Stock is entitled to voting rights equal to the number of full shares of Common Stock into which such shares are convertible on the date of issuance. The Preferred Stock also has preferential distribution rights in the event of a liquidation, dissolution or winding-up of the Company or a deemed liquidation. The Preferred Stock bears a dividend at an annual rate of 10.5% and is redeemable in two years at the option of the holders. If certain events occur prior to January 26, 2007, which events relate primarily to a sale or acquisition of Tripos, the dividends will be accelerated such that the holders of the Preferred Stock will receive dividends in the aggregate amount of $958 (or dividends in the aggregate amount of $1,155 if the event occurs on or after January 26, 2007) inclusive of any dividends received to date. This financing strengthened the Company's balance sheet, enhancing its ability to explore strategic alternatives and support current and potential business initiatives.

Upon issuance, the fair value of the warrants was determined based on the Black-Scholes option-pricing model and recorded on the balance sheet as a liability in the amount of $1,040. The warrants were determined to be a liability, as under Emerging Issues Task Force ("EITF) 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock", they

Item 1. Financial Statements (continued)

(12) Series C Preferred Stock (continued)

could not be recorded in equity due to registration rights obligations and cash penalty requirements that were not capped in the event of an unsuccessful registration. The maximum penalty for failure to register or maintain effectiveness of a registration was determined to exceed the spread between the fair value of a registered and unregistered share and, as such, cash settlement was assumed for this determination. The weighted-average assumptions utilized in determining the Black-Scholes values were as follows: stock price-$2.96; strike price-$3.50; dividend yield-0%; risk-free interest rate-5.0%; volatility factor-0.79 and expected life-5 years. The Company will reassess the fair value of the warrants on a quarterly basis until exercise or expiration and record any resulting gain or loss through "other income" in the statement of operations. The Company evaluated the conversion feature of the preferred stock under FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" and determined that it was clearly and closely related to the host contract (preferred stock) and was more akin to equity. The conversion feature therefore was not separated from the host contract. The equity features of the preferred stock are voting rights similar to common stock, participation in distributions to common shareholders, the holder has a residual interest in the Company, and the preferred shares are not mandatorily redeemable. The Company therefore determined that the conversion feature should be evaluated under EITF No. 98-5, " Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Rations" and EITF No. 00-27, "Application of Issue No. 98-5 to Certain Convertible Instruments." After taking into account the allocation of the proceeds to the warrants, the Company determined that the Preferred Stock contained a beneficial conversion feature valued at $1,015 based upon the intrinsic value of the shares at the closing stock price versus the value assigned to the preferred stock. Together, the value assigned to the warrants and the beneficial conversion feature created a preferred stock discount in the amount of $2,055, which is being accreted through preferred dividend expense over a two-year period using the effective interest rate methodology.

In addition the transaction costs of $629 were recorded as a deferred issuance cost on the balance sheet and are being amortized to interest expense over a two-year period also using the effective interest rate methodology. Included in the transaction costs are 16 warrants valued at $29 to purchase common stock issued to the placement agent. These warrants were issued with the same terms as the warrants issued to the holders of Preferred Stock. Accretion of the preferred stock discount and amortization of the deferred issuance cost during the third quarter 2006 totaled $197 and $62, respectively, while year-to-date accretion and amortization amounts are $321 and $98, respectively. The Company adjusted the warrant valuation at September 30, 2006 to the fair value at that date of $467 indicated by Black-Scholes, reducing the liability for the quarter by $215 and recording a gain through "other income" in the statement of operations. For the year, the cumulative adjustment to the warrant value as indicated by Black-Scholes is a reduction of $572. The Black-Scholes assumptions utilized at September 30 were the same as the assumption utilized upon issuance with the exception of the stock price reduced to $1.71, the risk-free interest rate adjusted to 4.59% and the expected life reduced to 4.58 years.

Upon issuance, cash in the amount of $388 was deposited into a separate account at LaSalle Bank to cover dividends payable up to December 31, 2006. On June 30, 2006 and September 30, 2006, dividends of $93 and $144, respectively, were paid from this account to Midwood Capital. The remaining balance and accrued interest of $156 are shown as "Restricted cash" on the Consolidated Balance Sheets.

Item 1. Financial Statements (continued)

(13) New Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109." This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Interpretation is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the requirements of this Interpretation, but do not expect that the adoption will have a material effect on our financial statements or tax returns.

In September 2006, the FASB issued SFAS No. 157 "Fair Value Measurements" ("FAS 157"). FAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of FAS 157 are effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the provisions of FAS 157.

In September 2006, the SEC staff issued Staff Accounting Bulletin 108 "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements" ("SAB 108"). SAB 108 requires that public companies utilize a "dual-approach" to assessing the quantitative effects of financial misstatements. This dual approach includes both an income statement focused assessment and a balance sheet focused assessment. The guidance in SAB 108 must be applied to annual financial statements for fiscal years ending after November 15, 2006. We are currently assessing the impact of adopting SAB 108 but do not expect that it will have a material effect on our consolidated financial position or results of operations.

Item 1. Financial Statements (continued)

(14) Segments

The Company operates in two reporting segments, Discovery Informatics and Discovery Research. The Company's Discovery Informatics segment designs and produces, or in-licenses, and sells licenses to software suites that provide computer-aided molecular modeling and visualization, virtual screening, combinatorial library design, data storage and analysis, and structure-activity relationships to customers in pharmaceutical, biotechnology and related life science fields of research. The Company's Discovery Research segment provides drug discovery services to pharmaceutical and biotechnology companies. High-end services offered are based on application by Tripos of its proprietary high-throughput combinatorial chemistry, high-throughput analytical and purification methods, medicinal chemistry, and our ChemSpace database searching and selection technologies, including the Lead Hopping method for quick identification of alternative chemistries for customer's needs.

Summarized financial information concerning the industry segments follows:

DI = Discovery Informatics

DR = Discovery Research

	Three-Months End September 30,
	2006			2005
	DI	DR	Total	DI	DR	Total
		Restated
Revenues:
DI products (including hardware)	$ 5,673	$ --	$ 5,673	$ 6,628	$ --	$ 6,628
DI services	378	--	378	716	--	716
DR products & services	--	1,605	1,605	--	5,821	5,821
Total revenues	$ 6,051	$ 1,605	$ 7,656	$ 7,344	$ 5,821	$ 13,165

Depreciation & amortization	$ 586	$ 741	$ 1,327	$ 372	$ 884	$ 1,256
Corporate non-allocated			37			71
Depreciation & amortization on statement of operations			$ 1,364			$ 1,327

Operating income (loss)	$ (477)	$ (5,653)	$ (6,130)	$ 1,523	$ (143)	$ 1,380
Non-allocated corporate department expense			(1,241)			(1,636)
Operating loss on statement of operations			$ (7,371)			$ (256)

Long-lived assets	$ 15,274	$ 16,265	$ 31,539	$ 17,633	$ 23,210	$ 40,843

Total assets (1)	$ 23,245	$ 25,578	$ 48,823	$ 30,025	$ 35,092	$ 65,117
Consolidated cash and marketable securities			2,626			3,566
Total assets on balance sheet			$ 51,449			$ 68,683

(1) Excludes cash and cash equivalents, restricted cash and marketable securities of $2,626 and $3,566 in 2006 and 2005, respectively as cash and cash equivalents are monitored on a consolidated basis.

Item 1. Financial Statements (continued)

(14) Segments (continued)


	Nine-Months End September 30,
	2006			2005
	DI	DR	Total	DI	DR	Total
		Restated
Revenues:
DI products (including hardware)	$ 17,791	$ --	$ 17,791	$ 18,761	$ --	$ 18,761
DI services	2,895	--	2,895	1,964	--	1,964
DR products & services	--	4,347	4,347	--	20,842	20,842
Total revenues	$ 20,686	$ 4,347	$ 25,033	$ 20,725	$ 20,842	$ 41,567

Depreciation & amortization	$ 1,710	$ 2,199	$ 3,909	$ 1,065	$ 2,317	$ 3,382
Corporate non-allocated			125			252
Depreciation & amortization on statement of operations			$ 4,034			$ 3,634

Operating income (loss)	$ 449	$ (9,093)	$ (8,644)	$ 3,551	$ 1,037	$ 4,588
Non-allocated corporate department expense			(3,961)			(4,664)
Operating income (loss) on statement of operations			$ (12,605)			$ (76)

Long-lived assets	$ 15,274	$ 16,265	$ 31,539	$ 17,633	$ 23,210	$ 40,843

Total assets (2)	$ 23,245	$ 25,578	$ 48,823	$ 30,025	$ 35,092	$ 65,117
Consolidated cash and marketable securities			2,626			3,566
Total assets on balance sheet			$ 51,449			$ 68,683

(2) Excludes cash and cash equivalents, restricted cash and marketable securities of $2,626 and $3,566 in 2006 and 2005, respectively as cash and cash equivalents are monitored on a consolidated basis.

Item 1. Financial Statements (continued)

(15) Stock-based Compensation

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123R ("FAS 123R"), "Share-Based Payment," using the modified-prospective transition method. Under this transition method, compensation expense was recognized beginning January 1, 2006 and includes (a) compensation expense for all share-based employee compensation arrangements granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of FAS 123, and (b) compensation expense for all share-based employee compensation arrangements granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of FAS 123R. Under the modified-prospective transition method of FAS 123R, results for prior periods are not restated.

As a result of adopting FAS 123R on January 1, 2006, earnings before income taxes and net income for the three- and nine-months ended September 30, 2006 were both $53 and $271 lower, respectively, than if we had continued to account for share-based compensation under APB No. 25. Basic earnings per share for the three- and nine-months ended September 30, 2006 was reduced by $0.01 and $0.03 per share, respectively, as a result of the adoption of this statement. The majority of options granted by the Company qualify as Incentive Stock Options (ISO) for which no tax benefit is available to be recognized until the options are exercised and sold by the grantee within one year of exercise. Typically, Non-Qualifying (NQ) options provide a deferred tax benefit to the Company at the time of grant and normally a tax benefit in the year of exercise. However, due to the Company's present net deferred tax asset position, a valuation allowance was recorded to offset the projected tax benefit from the compensation expense recorded in the third quarter and year to date. The Company will only realize the tax benefits when and if they result in an actual reduction in taxes payable.

Prior to the adoption of FAS 123R, we presented tax benefits for which we received deductions resulting from the exercise of stock options as operating cash flows in the Consolidated Condensed Statements of Cash Flows. FAS 123R requires the cash flows from the tax benefits resulting from tax deductions in excess of the compensation expense recognized for those options (excess tax benefits) to be classified as financing cash flows. There were no exercises of stock options in the first nine months of 2006, therefore no tax benefits were recorded as financing proceeds in the cash flow statement. The effect of FAS 123R on our year-to-date consolidated statement of cash flows was to add back the $271 of non-cash compensation expense to the cash flows from operating activities.

The following table illustrates the effect on the third quarter and nine-months of 2005 net earnings and earnings per basic and diluted common share if we had applied the fair value recognition provisions of FAS 123 to options granted under our stock-based employee compensation plans. For purposes of this pro forma disclosure, the value of the options was estimated using a Black-Scholes option-pricing valuation model and amortized to expense over the options' vesting periods.

Item 1. Financial Statements (continued)

(15) Stock-based Compensation (continued)

	Three-month Period	Nine-month Period
	09-30-2005	09-30-2005
Net income as reported	$ 160	$ 952
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects	242	302
Pro forma net income (loss)	$ (82)	$ 407

Pro forma income (loss) per share:
Basic and diluted- as reported	$ 0.02	$ 0.09
Basic and diluted- pro forma	$ (0.01)	$ 0.04

Equity Incentive Plans. In 2005, we adopted the 2005 Equity Incentive Plan ("2005 Plan") that provides for incentive and/or non-statutory stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares and units, deferred stock units and dividend equivalents to be granted to our employees, consultants and directors. A total of 800,000 shares are available for issuance under the 2005 Plan plus any outstanding options under the Company's 1994 Employee Stock Option Plan that subsequently expire unexercised, up to a maximum of 300,000 shares. As of September 30, 2006, only stock options have been granted. Stock options may be granted under the 2005 Plan at an exercise price not less than 100% of the fair market value on the date of grant. Options become exercisable and expire at the times and terms established by the administrator, but generally vest over four years and expire five to ten years after the grant date. The Company satisfies the exercise of stock options by issuing new shares. Options for 25 shares were granted during the nine months ended September 30, 2006. No options have been exercised in 2006.

The fair value of each option award is estimated on the date of grant using the Black-Scholes valuation model based on assumptions for volatility, interest rates, dividend rates, expected time outstanding until exercised (expected term) and expected forfeitures made at the time of the grant. The requisite service life equals the vesting term, primarily four years. Expected volatilities are based on daily observations of the historical volatility of our common stock over comparable length periods and other factors. No adjustment was made in contemplation of the affect of future events. We estimate option exercises and employee terminations based on historical data for groups of employees that have similar exercise and termination behavior (the groups identified are: a. employees, b. officers, and c. directors). The expected term of options granted is derived by considering actual historical exercise data and represents the period of time that options granted are expected to be outstanding. The risk-free interest rate is based on the U.S Treasury yield curve in effect at the time of the grant.

Item 1. Financial Statements (continued)

(15) Stock-based Compensation (continued)

A summary of option activity under the plans for the nine months ended September 30, 2006 is as follows:

Directors	Shares	Weighted Average Exercise Price	Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding, January 1, 2006	417	$8.64
Granted	--	--
Exercised	--	--
Forfeited	--	--
Expired	(15)	$4.25
Outstanding, September 30, 2006	402	$8.80	4.4 years	$0
Options Exercisable	345	$9.22	4.0 years	$0

Officers	Shares	Weighted Average Exercise Price	Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding, January 1, 2006	867	$7.62
Granted	--	--
Exercised	--	--
Forfeited	--	--
Expired	(64)	$3.62
Outstanding, September 30, 2006	803	$7.95	4.1 years	$0
Options Exercisable	676	$8.71	3.9 years	$0

Employees	Shares	Weighted Average Exercise Price	Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding, January 1, 2006	671	$5.83
Granted	25	$2.99
Exercised	--	--
Forfeited	(20)	$3.76
Expired	(32)	$5.07
Outstanding, September 30, 2006	644	$5.82	4.1 years	$0
Options Exercisable	452	$6.71	3.7 years	$0

A summary of the status of the Company's Nonvested shares as of September 30, 2006 and changes during the nine months then ended is as follows:

Nonvested Shares		Shares
Nonvested at January 1, 2006		492
Granted		25
Vested		(110)
Forfeited		(31)
Nonvested at September 30, 2006		376

Item 1. Financial Statements (continued)

(15) Stock-based Compensation (continued)

As of September 30, 2006, there was approximately $400 of total unrecognized compensation expense related to nonvested stock options. This expense is expected to be recognized in the remainder of 2006, 2007, 2008 and 2009 in the amounts of $176, $155, $51, and $18, respectively. The total fair value of shares vested during the three and nine-month periods ended September 30, 2006 was $39 and $228, respectively plus the value of the ESPP shares vesting in the same periods of $14 and $43, respectively.

Employee Stock Purchase Plan. In 2002, we adopted the 2002 Employee Stock Purchase Plan that allows eligible employees to purchased stock at the lower of 85% of the fair market value of the stock on the enrollment date or exercise date as defined by the plan. Issuances of shares under the Employee Stock Purchase Plan occur each six months on June 30 and December 31. Pursuant to the plan, employee purchases are limited to 10% of annual compensation. The plan originally had 250 shares reserved for issuance. In 2004 the shareholders approved an increase in the reserve of 450 shares. The plan is in effect for ten years unless terminated or amended sooner by the Board of Directors. At September 30, 2006, 418 shares have been purchased under this plan leaving 282 shares available for future issuance. 79 shares were issued on June 30, 2006. The value of the 15% discount and a pro-rata share of the fair value of the implied six-month options is included in the cost of stock-based compensation expense for the three and nine-months ending September 30, 2006.

1996 Director Stock Plan. The Director Stock Plan provides for automatic and discretionary issuances of the Company's common stock to non-employee directors. The principle purpose of the Plan is to compensate the non-employee Directors for their service on the Board. Compensation is paid quarterly in the form of 50% cash and 50% in common stock issued from the Plan's reserve based on the closing market value on the last trading day of each fiscal quarter. Compensation expense for the Board of Directors is reflected in General and Administrative expense for all periods presented. The total expense is the combination of the cash portion and market value of the stock component on the date of issue.

An initial reserve of 160 shares was approved by the shareholders in 1996 with an expiration date of May 2006. Shareholders approved a five-year extension of the Plan at the Annual Meeting of Shareholders held on May 17, 2006. As of September 30, 2006, approximately 93 shares remain available for issuance. Further details on the 1996 Director Stock Plan can be found in the Company's Proxy Statement for its 2006 Annual Meeting of Shareholders.

(16) Subsequent Event

In the fourth quarter of 2006, the Company conducted a further reduction of staff levels at its laboratory facility in Bude, England, eliminating 27 positions in our continued effort to streamline this business. Of the 27 positions, 21 were voluntary, 5 involuntary and another was reassigned to our Discovery Informatics division. Costs associated with this effort are estimated at $500 and, when finalized, will be reflected in the Company's fourth quarter 2006 financial results.

(17) Restatement for Impairment Charge

At the time of filing its Quarterly Report on Form 10-Q, the Company was in negotiations to sell certain excess real properties at its Bude, England location. The property sale subsequently closed in the fourth quarter of 2006 and management has determined that it should amend its Form 10-Q to reflect the asset value as being impaired in the amount of the loss that would ultimately be recognized upon consummation of the transaction. The loss on the sale of these excess properties was $3,607. The following financial statements reflect the "as reported" figures from the Form 10-Q filed on November 14, 2006 and the effect of the impairment charge on the value of the property.

TRIPOS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands)	09-30-2006		09-30-2006
ASSETS	As Reported	Adjust	Restated
Current assets:
Cash and cash equivalents	$ 2,343		$ 2,343
Restricted cash	156		156
Marketable securities	127		127
Accounts receivable, less allowance for doubtful accounts of $191	3,638		3,638
Inventory	7,481		7,481
Prepaid expenses	3,807		3,807
Total current assets	17,552		17,552

Property and equipment, less accumulated depreciation	24,278	(3,607)	20,671
Capitalized development costs, less accumulated amortization	2,328		2,328
Goodwill	5,351		5,351
Intangible assets, less accumulated amortization	3,189		3,189
Investments recorded at cost	1,578		1,578
Deferred income taxes	250		250
Other assets	530		530
Total assets	$ 55,056	$ (3,607)	$ 51,449

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt	$ 7,964			$ 7,964
Current portion of capital leases	2,913			2,913
Accounts payable	1,337			1,337
Accrued expenses	3,566			3,566
Deferred revenue	10,394			10,394
Total current liabilities	26,174			26,174

Long-term portion of capital leases	2,527			2,527
Long-term debt	1,898			1,898
Common stock warrants	467			467
Total liabilities	31,066			31,066

Redeemable convertible preferred stock, $0.01 par value, authorized 1,833 shares, issued 1,833 shares as of September 30, 2006	3,716			3,716
Shareholders' equity :
Common stock, $0.01 par value; authorized 20,000 shares, issued 10,282 shares as of September 30, 2006	103			103
Additional paid-in capital	43,362			43,362
Retained deficit	(22,052)	(3,607)		(25,659)
Accumulated other comprehensive loss	(1,139)			(1,139)
Total shareholders' equity	20,274	(3,607)		16,667

Total liabilities and shareholders' equity	$ 55,056	$ (3,607)		$ 51,449

(17) Restatement for Impairment Charge (continued)

TRIPOS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

	Three Months Ended			Nine Months Ended
	09-30-2006		09-30-2006	09-30-2006		09-30-2006
	As Reported	Adjust	Restated	As Reported	Adjust	Restated
Net sales:
Discovery informatics products & support	$ 5,670		$ 5,670	$ 17,763		$ 17,763
Discovery informatics services	378		378	2,895		2,895
Discovery research products & services	1,605		1,605	4,347		4,347
Hardware	3		3	28		28
Total net sales	7,656		7,656	25,033		25,033

Cost of sales	4,121		4,121	11,082		11,082
Gross profit	3,535		3,535	13,951		13,951

Operating expenses:
Sales and marketing	2,367		2,367	8,153		8,153
Research and development	2,834		2,834	8,287		8,287
General and administrative	1,760		1,760	5,244		5,244
Restructuring charge	338		338	1,265		1,265
Impairment charge	--	3,607	3,607	--	3,607	3,607
Total operating expenses	7,299	3,607	10,906	22,949	3,607	26,556

Loss from operations	(3,764)	(3,607)	(7,371)	(8,998)	(3,607)	(12,605)

Interest expense	(569)		(569)	(1,597)		(1,597)
Other income (loss), net	353		353	1,525		1,525
Loss before income taxes	(3,980)	(3,607)	(7,587)	(9,070)	(3,607)	(12,677)

Income tax expense (benefit)	62		62	46		46
Net income (loss)	(4,042)	(3,607)	(7,649)	(9,116)	(3,607)	(12,723)

Preferred dividends	342		342	559		559

Net income (loss) available to common shareholder	$ (4,384)	$ (3,607)	$ (7,991)	$ (9,675)	$ (3,607)	$ (13,282)

Basic & diluted income (loss) per share	$ (0.43)		$ (0.78)	$ (0.95)		$ (1.30)
Basic & diluted weighted average number of shares	10,276		10,276	10,220		10,220

(17) Restatement for Impairment Charges (continued)

TRIPOS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)	Nine Months Ended
	09-30-2006 As Reported	Adjust	09-30-2006 Restated
Operating activities:
Net (loss) income	$ (9,116)	$ (3,607)	$ (12,723)
Adjustments to reconcile net loss to net cash provided by operating activities:
Impairment charges	--	3,607	3,607
Depreciation of property and equipment	3,060		3,060
Amortization of capitalized development costs & intangibles	974		974
Amortization of debt discount	187		187
Amortization of deferred issuance costs	98		98
Gain on revaluation of common stock warrants	(572)		(572)
Deferred tax benefit	(6)		(6)
Gain from sale of marketable securities	--		--
Write-down of long-term investment	27		27
Loss on retirement of assets	28		28
Stock-based compensation expense	271		271
Non employee and director stock compensation expense	29		29
Change in operating assets and liabilities (excluding acquired business):
Restricted cash	(156)		(156)
Accounts receivable	8,408		8,408
Inventories	(1,823)		(1,823)
Prepaid expenses and other current assets	2,105		2,105
Accounts payable and accrued expenses	(3,224)		(3,224)
Deferred revenue	(6,519)		(6,519)
Net cash (used in) provided by operating activities	(6,229)	--	(6,229)
Investing activities:
Purchases of property and equipment	(409)		(409)
Capitalized development costs	(646)		(646)
Acquisition of business, net of cash received	--		--
Proceeds from the sale of marketable securities	--		--
Proceeds from the sale of equipment	3,799		3,799
Proceeds from distribution from investment in unconsolidated affiliates	36		36
Investment in unconsolidated affiliates	(88)		(88)
Net cash provided by (used in) investing activities	2,692	--	2,692
Financing activities:
Proceeds from stock issuance pursuant to stock purchase and option plans	172		172
Proceeds from issuance of common stock	--		--
Proceeds from issuance of preferred stock	4,851		4,851
Payments of cash dividends on preferred stock	(237)		(237)
Borrowings under revolving line of credit	6,710		6,710
Proceeds from issuance of long-term debt and capital leases	--		--
Payments on long-term debt and capital lease obligations	(11,134)		(11,134)
Net cash provided by financing activities	362	--	362

Effect of foreign exchange rate changes on cash and cash equivalents	(723)	--	(723)

Net decrease in cash and cash equivalents	(3,898)	--	(3,898)
Cash and cash equivalents at beginning of period	6,241		6,241
Cash and cash equivalents at end of period	$ 2,343	--	$ 2,343

See accompanying notes.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-looking Statements

The remainder of 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. Among the factors that could cause actual results to differ materially from the forward-looking statements are set forth under the caption "Risk Factors" in Part 1A of Tripos' Form 10-K for 2005. Tripos undertakes no obligation to update any forward-looking statements in this Form 10-Q.

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

Update on Strategic Alternatives

Tripos has been engaged in exploring strategic options for most of 2006. Tripos has determined to exit the discovery research business. Tripos will proceed as a stand-alone public Discovery Informatics business unless it is able to negotiate and conclude a transaction to sell the Discovery Informatics business.

With respect to Tripos' Discovery Research business, Tripos:

• Has completed further staffing reductions at Tripos Discovery Research. The business now has 43 research and sales professionals dedicated to this business;

• Is currently engaged in advanced discussions for the sale of the UK-based Discovery Research business. The buyer would assume substantially all of the assets and liabilities of that business;

• Is in negotiations to sell certain surplus real estate in the UK.

With respect to Tripos' Discovery Informatics business, Tripos:

• Is working to restructure the Discovery Informatics business as a public company to continue to provide software and enterprise solutions to the pharmaceutical and biotechnology industry;

• As part of the restructuring, the Company is seeking funding for the near-term capital needs of the Discovery Informatics business, either through replacement of its bank credit facility (which matures January 1, 2007) or through the proceeds of other debt or equity financings, any of which may be dilutive to the interests of current stockholders;

• Continues to evaluate possible sale transactions, and is currently in advanced discussions with a potential buyer for the Discovery Informatics business.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

We cannot provide any assurance that we will be able to complete the transactions described in the preceding paragraphs or whether the proposed terms of such transactions would be acceptable to our Board of Directors or our stockholders.

Overview

We provide products and services to the pharmaceutical, biotechnology, and life science industries to support early stage research activities. Our products are used by research chemists to make decisions about the most productive new compounds to make and test as potential therapeutics. Through our own chemistry laboratories, we also manufacture those compounds for our clients. Through strategic partnerships, we can also participate more directly with our clients in the development and testing of new therapeutic compounds for our clients.

The industries that we serve are highly research driven. Mature pharmaceutical companies typically spend up to 20% of their annual revenues on research to find new blockbuster drugs. This research process consists of several phases from early discovery of compounds of interest, through testing of the promising ones for activity and safety in animals, to final testing of these compounds in humans. The investment in research activity increases dramatically in the second and third phases. Tripos' offerings are most relevant to the initial phase of this activity, namely discovery of compounds. Our products and services are designed and intended to provide our pharmaceutical and biotechnology customers with improved ways to identify and select the most promising drug candidates to take forward into the more expensive and time consuming stages of the drug development process. Depending on the number of compounds that a particular company has in different stages of their new therapeutic pipeline, they may reduce or increase investment in the other phases of research. Further, decisions by the pharmaceutical industry concerning their research investments are strongly influenced by decisions by the various governments of the world regarding drug pricing and regulation.

Tripos' software products are primarily sold on a renewable license basis, typically with terms of one to three years. This business has been generally predictable, as we have experienced high renewal rates in the past for licenses. Tripos management closely monitors license expirations and deploys sales staff to ensure the highest probability of renewals. Tripos' service businesses, both informatics and chemistry, are much less predictable. The sales cycles for these offerings are typically long -- from six to eighteen months -- and are highly influenced by factors in the macro-economic environment, including the general state of the pharmaceutical industry and the extent to which governments regulate local pharmaceutical pricing. To forecast potential business in these areas, Tripos management strives to closely interact with the management of our customers and is closely involved in business development activities for material service project opportunities.

Large service contracts for pharmaceutical research, both informatics and chemistry, are complex and, because they are deployed in research applications where outcomes are uncertain, have a large risk component. Risk management in these projects begins with the definition of project requirements and continues through performance metrics and customer acceptance milestones. Due to the complexity of the projects and changing priorities within client organizations, it is typical that many decision points will arise that require management attention both at Tripos and at the client. To mitigate the project difficulties, Tripos has developed a focused process in which management monitors milestones in the project plan according to the process workflow. Despite best efforts, however, some projects are of sufficient complexity that they present challenges that require revisions to the project plan and scope.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

Having been a public company spinout in 1994 with limited capital, we have focused on profitability and cashflow. That said, we have not always been profitable, but have achieved profitability in certain years. Major investments, such as the recent expansion of our chemistry research laboratories in England, have been funded by other successful investments (e.g. Arena Pharmaceuticals), cash from operations, temporary use of debt capacity, and grant funding.

We license our Discovery Informatics products and post-contract support ("PCS") as either perpetual licenses or time-based licenses, typically one to three-year renewable contracts. 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 tens of thousands up to several million dollars. The following are descriptions of our current sales models for discovery software:

Perpetual licenses:

Software pricing is taken from our price list based on the quantity of individual modules and number of users. Customers are billed upon delivery. Revenue for software is recognized upon delivery of product and issuance of perpetual keys. PCS is optional for each customer and is priced as a fixed percentage of the total current list price of the software purchased. Where applicable, PCS is typically billed annually.

The Company has analyzed the other elements included in its multiple element arrangements involving perpetual licenses, and has determined it has sufficient Vendor Specific Objective Evidence ("VSOE") to allocate revenues to PCS and/or training. VSOE for PCS and training is established based on the price charged when those elements are sold separately. For PCS, this allocation amount is established based on the renewal rate specified in the arrangement, which is consistently priced at a percentage of the list price of the purchased licenses. Training is charged consistently from the Company's price list.

Bundled licenses:

Time-based bundled licenses are an alternative to perpetual licenses. This type of license allows our customers to obtain multiple software products bundled with PCS that is coterminus with the period of the arrangement. A bundled license includes specific software modules and specified numbers of users of each module with all product and access keys delivered on or before the effective date of the contract. Tripos software is sold to professional users on an "off the shelf" basis in which the customer is responsible for installation. These non-cancelable, non-refundable contracts are normally three years in duration although certain customers request shorter or longer contract periods. At the end of the contract term, the customer must renew the license, or the software will cease to operate. PCS, which includes unspecified updates, upgrades, and "help desk" services, is included in the total price of the contract. The PCS provided under bundled arrangements is the same as that provided to customers under perpetual agreements. Bundled contract pricing is taken from our established price list (includes package pricing and a-la-cart pricing) that is based on the number of users and length of term. All contracted products are delivered at inception. If the customer should want additional modules, users, or license to any new software products, the customer must enter a new contract (or addendum) and pay the incremental fees to purchase these items. Software revenue and PCS revenues under bundled license agreements are recognized ratably over the contract period.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

Term licenses:

Term Licenses represent one-year arrangements for a software product and one-year of PCS. The price is taken from the Company's price list by product. The support renewal fee is a fixed percentage of the software price (similar to perpetual model). The PCS provided for under term arrangements is the same as that provided to customers under perpetual agreements. Software and support pricing are separately stated and billed upon delivery of product. To continue to operate the software, the customer must pay their annual renewal fee. Software revenue and PCS revenues under term license agreements are recognized ratably over the contract period.

Our integration of chemistry and biological data in the life sciences industries creates a revenue opportunity for discovery informatics services (software consulting). To serve this market, we maintain a staff of specialists who use our proprietary data integration framework, such as FormsBuilder, Discovery-360 (formerly "SMART-IDEA"), Benchware Notebook, ChemCoreRIO and AUSPYX^TM to configure customized solutions for data management. Revenue may be generated on a billable rate per day, or upon achievement of milestones or deliverables and is recognized as production activities are performed. These contracts may also generate license fee revenue for our proprietary software technologies. Similarly to our discovery informatics products, licensing levels are dependent on the number of users and sites and may range from the low hundred-thousands up to million dollar levels.

We develop and manufacture general screening compound libraries for sale to the life sciences industry for a fee per compound delivered. In addition we offer our LeadDiscovery libraries which include higher value intellectual property rights (such as patent applications). These compounds and libraries have created the opportunity to offer follow-up discovery research methods 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, with proprietary discovery technologies for efficient lead development, refinement, and optimization resulting in a tightly integrated process to facilitate synergies in drug discovery.

In the past we have acted as a reseller of computer hardware. Hardware sales are generally made to facilitate our software customers' access to hardware components and not a primary focus of our sales activities. We act as an authorized reseller and only order hardware products on an "as needed" basis, and thus do not maintain any inventory.

We license discovery informatics tools to customers, provide ongoing support (including upgrades selected by customers) and provide informatics services to customers that enable integration of our existing and newly developed discovery tools into our 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 upon achievement of technological feasibility and/or a working model according to the Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 86.

Quarterly expenses include the fixed costs of research and development for software development and new chemistry research. We believe that core selling and administrative costs will remain generally consistent on an annual basis. Variability in quarterly expenses primarily occurs in relation to the level

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

of revenues. This is due to sales compensation, bonuses, staffing for selling, general and administrative functions and for periodic marketing activities such as appearances at trade exhibitions. The relationship between the quarterly amounts presented for cost of sales or research and development expense may fluctuate based on the utilization of our employees on either billable contracts or research projects.

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 and achieve product release schedules (including by Tripos' third party software providers and collaborators) in a timely manner, the rate of market acceptance of new products and enhanced versions of existing products, the timing of new product introductions by us and other vendors, changes in licensing and pricing policies (ours, our partners and that of other vendors), consolidation in the customer base, client involvement in decision points in contracts related to project plans, our ability to accurately match contract costs to milestone or contract performance requirements on our larger collaborative arrangements, and changes in general economic, regulatory, and competitive conditions. See Note 1 of the Notes to Consolidated Financial Statements for a discussion of revenue recognition policies. Because much of our software license and PCS revenue along with our contracted discovery research revenue is recognized ratably over multiple periods, fluctuations in our quarterly revenues and earnings are caused principally by sales of compounds or by achievement of milestones on specific projects. Our management team monitors quarterly business activity with the aid of sales pipeline reports and monthly financial reports.

Results of Operations (Amounts in thousands, except per share amounts)

Net sales for the third quarter of 2006 were $7,656 compared to $13,165 in 2005, a decrease of 42%. Discovery informatics products and support sales decreased 14% to $5,670 in the third quarter 2006 from $6,618 for the same period in 2005. This decrease is attributable to several factors. One is lower product sales in the Pacific Rim while we replace distributors in India and China. A second impact is lower current sales during a promotional period offering a free evaluation of a replacement product. Discovery informatics revenues in 2005 included approximately $373 related to an early termination agreement with a customer. The prior year quarter also included the recording of revenues that were delayed due to a patent infringement case in Japan relating to a software product that we in-licensed from a third party. The third party introduced what we believed to be a non-infringing version of the software in the second quarter 2005 and our distributor in Japan was able to close approximately $200 of previously delayed transactions. Discovery informatics services revenues for the third quarter of 2006 decreased 47% to $378 from $716 in the third quarter of 2005. Much of the revenue recorded in the third quarter of 2005 was related to the Schering project that was completed later in that year. In the third quarter of 2006 we were unable to recognize revenue on the project with Wyeth Pharmaceuticals that the Company announced on January 11, 2006. Late in the third quarter we determined that changes to the plan would be required on this "Next-Generation Discovery IT" project resulting in incremental costs to complete the assignment. As a result of the addition of incremental costs, the cumulative percentage of revenue to be recognized was held at the same level as that at the end of the second quarter of 2006 based upon the percentage of completion methodology, thus not recognizing approximately $1,450 of revenues in the third quarter that otherwise would have been recognized had the estimated costs to complete the project not changed. The timing of revenue recognition from discovery informatics services may fluctuate during any period based on achievement of contractual milestones or changes in overall costs estimates for "percentage completion" contracts. A collection of smaller projects was comparable for the two

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

quarterly periods in 2006 and 2005. Discovery research sales accounted for $1,605 in the third quarter of 2006 and $5,821 in the same period in 2005, a decrease of $4,216 or 72%. This decrease in discovery research business was attributable to the completion of our four-year $90 million strategic compound file enrichment and hit follow-up contract with Pfizer, Inc. in the fourth quarter of 2005. Revenues from Pfizer in the third quarter 2005 were approximately $5,100. This decrease was partially offset by an increase in the number of smaller projects in the current year. Hardware sales for the third quarter 2006 were $3 compared to $10 in 2005. We do not actively market hardware products, but rather facilitate customer demand as necessary.

For the nine-month period in 2006, total net sales decreased 40% to $25,033 from $41,567 for the same period in 2005. Discovery software and support sales decreased by $967 or 5% from $18,730 in the nine-month period ending September 30, 2005 to $17,763 in the nine-month period ending September 30, 2006. This decrease was primarily due to lower support revenues in the Pacific Rim and decreased new product sales in 2006, partially attributable to the promotional period offering a free evaluation of a replacement product and the non-renewal by several customers due to mergers with other Companies. The 2005 revenues also included approximately $373 from the early termination agreement with a customer. Revenues from discovery informatics services increased by 47% to $2,895 for the nine-month period in 2006 from $1,964 in 2005. The increase in discovery informatics service revenues is principally attributable to progress of work being performed on the project for Wyeth Pharmaceuticals for the implementation of our Benchware Discovery 360 technologies. Discovery research revenues decreased by 79% for the first nine months in 2006 to $4,347 from $20,842. The decrease in discovery research revenues was from the completion of the Pfizer compound file enrichment project in 2005. Revenues from discovery research projects for other customers are higher than 2005 by 52%.

Net sales for the Company's activities outside of North America represented approximately 58% and 73% for the three-month periods and 51% and 76% for the nine-month periods ending September 30, 2006 and 2005, respectively. North American net sales accounted for 42% of 2006 and 27% of 2005 total third quarter sales. For the respective nine-month periods, North American sales were 49% in 2006 and 24% in 2005. Net sales in Europe decreased $4,821 or 55% to $3,947 for the third quarter of 2006 compared to 2005, and accounted for 52% and 67%, respectively, of total sales. Year-to-date net sales in Europe declined to $10,932 in 2006 from $29,647 in 2005, a decline of 63%. The decrease in Europe is principally related to revenues included in 2005 related to progress on the Pfizer strategic compound design and synthesis project that was contracted through our U.K. office and completed in the fourth quarter 2005. Net sales in the Pacific Rim decreased by 35% and 14% for the third quarter of 2006 and the nine months ended, respectively, compared to the same periods in 2005. The decrease in Pacific Rim revenues was from discovery informatics support, and lower discovery research compound sales. The Pacific Rim accounted for 6% of net sales for the three-month periods in 2006 and 2005, and 7% and 5% for the nine-month periods.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

Cost of sales for the three-month period ending September 30, 2006 decreased by $1,946 or 32% to $4,121 compared to $6,067 for the same period in 2005, primarily related to lower costs in discovery research due to the completion of the four-year discovery research contract with Pfizer at the end of 2005, partially offset by increased costs on discovery informatics services projects. Cost of sales as a percent of net sales was 54% and 46% for the three-month periods in 2006 and 2005, respectively. Included in the 2005 cost of sales was approximately $3,600 related to the Pfizer discovery research contract. The increased costs in discovery informatics services for the quarter was $679, primarily attributable to work being performed on the project for Wyeth Pharmaceuticals for the development and implementation of our Benchware Discovery 360 product. The third quarter 2006 cost of sales for discovery informatics products and support included approximately $107 of incremental amortization expense related to capitalized software development costs for products that were released to the market in the third quarter of 2005 and $60 of new amortization related to new Benchware products launched in June 2006. Nine-month year-to-date cost of sales declined 47% to $11,082 in 2006 from $20,860 in 2005. Cost of sales was 44% and 50% of total net sales for 2006 and 2005, respectively. The 2005 year-to-date cost of sales included approximately $12,800 incurred in discovery research activities for the Pfizer compound file enrichment project. The increased incremental amortization expense for the year related to capitalized software development products released to the market is $522. In addition, cost of sales year to date for discovery informatics services increased by $1,460, primarily related to the Wyeth Next-Generation Discovery IT project.

Gross profit margin for the third quarter 2006 decreased to 46% of total net sales versus 54% in the third quarter of 2005 primarily due to lower margins in discovery informatics products and support, discovery informatics services and discovery research services, offset by an overall increase in gross profit margin due to shift in business mix. Relatively higher margin discovery informatics now represents a larger percentage of business compared to the third quarter of 2005. This shift is a result of our completion of the four-year $90 million discovery research contract with Pfizer, Inc. in the fourth quarter of 2005. Gross profit margin in the third quarter related to discovery informatics products and support declined to 72% in 2006 versus 77% in 2005 due to increased amortization expense related to capitalized software costs for new products released in latter-2005 and June 2006. Gross profit margin in the third quarter of 2006 was (178%) in discovery informatics services compared to 48% the prior year due to a cumulative adjustment on the Wyeth informatics project to reflect the anticipated incremental costs to complete the project and their impact on the calculation of percentage of completion as of September 30, 2006. Based on current estimates, we still anticipated positive gross margins for the project as a whole. Discovery Research gross profit margin decreased from 24% to (6%) for the third quarter and were negatively impacted by cost overruns on one contract and initial stages on another that included pass-through costs from a third-party vendor at no margin. The gross profit margin on compounds also decreased due to promotional pricing on new compound libraries.

Nine-month year-to-date gross profit margin improved to 56% in 2006 from 50% in the 2005 nine-month year-to-date period. The increase in year-to-date gross margin was primarily due to a shift in business mix with Discovery Informatics representing a larger portion of business at relatively higher gross margins than Discovery Research. This shift is a result of our completion of the four-year $90 million Discovery Research contract with Pfizer, Inc. in the fourth quarter of 2005. This increase was partially offset by a decrease in gross margin related to discovery informatics products and services as well as decreases in gross margin for discovery research products and services. Gross profit margin decreased in discovery informatics products and support due to the additional amortization expense associated with new products released to the market.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

Gross profit margin in discovery informatics services declined to 5% for the first nine months of 2006 versus 34% in the first nine months of 2005 due to a cumulative adjustment on the Wyeth project to reflect the impact of the anticipated incremental costs and the revised percentage of completion as discussed above. Gross profit margin in discovery research decreased from 23% to 4% for year-to-date periods due to the previously mentioned cost overruns on one contract and initial stages on another that included pass-through costs from a third party vendor at no margin. These events plus inventory provisions combined with lower revenues in the business unit resulted in the lower margins for the first nine months of the year.

Sales and marketing expenses decreased 7% to $2,367 for the third quarter of 2006 from $2,556 in the same period in 2005. Sales and marketing expenses as a percentage of net sales were 31% and 19% for the three-month periods in 2006 and 2005, respectively. For the nine-month period in 2006, sales and marketing expenses were flat at $8,153 compared to $8,186. Sales and marketing was 33% of total net sales for the first nine months of 2006 and 20% in 2005. The decreases in sales and marketing spending in the third quarter 2006 compared to the third quarter 2005 were attributable to lower advertising and promotional expenditures and reduced travel and commission expenses. These decreases were partially offset by an increase in salary and consulting costs as a result of additional employees in the current year, including the addition of a VP Marketing position in the fourth quarter 2005. The increase as a percentage of total revenues is primarily due to overall lower sales after completion of the Pfizer discovery research contract at the end of 2005.

Research and development expenses for the quarter decreased by $64 or 2% to $2,834 from $2,898 and represented 37% and 22% of net sales in 2006 and 2005, respectively. Nine-month year-to-date R&D expense was $8,287 in 2006 compared to $6,810 in 2005, an increase of 22%. Year-to-date R&D expense as a percent to total sales was 33% and 16% in 2006 and 2005, respectively. The increase in R&D expense year-over-year was partially attributable to reduced levels of capitalization of new development costs related to discovery informatics products. In 2006 we capitalized $191 and $646 for the three and nine-month periods, respectively, while in 2005 we capitalized $313 and $1,470 for the quarter and year-to-date periods. We have been developing one enterprise-wide product in 2006 compared to six computational chemistry software products in 2005. R&D expense also increased in the third quarter of 2006 at our laboratory facility in England to $1,079 from $649 in the third quarter of 2005 due to higher utility costs and less efficient operations arising from managing multiple smaller contracts. With the conclusion of the large Pfizer discovery research contract in 2005, our chemistry operations have changed from servicing primarily one large contract to servicing several smaller contracts. This change, coupled with a substantial increase in utility costs, has resulted in more costs expensed as R&D rather than being charged to cost of sales or absorbed into inventory for the third quarter of 2006.

The nine-month year-to-date results in 2006 were adversely affected by inefficiencies and redundant staff at our discovery research facility during a statutory consultation period in the first quarter leading up to a reduction in force as well as lower amounts capitalized related to discovery informatics products mentioned above. In December 2005 we announced that we had initiated a 30 day consultation period as mandated by UK law to complete a reduction in force for our Discovery Research business based in Bude, England. We initiated this action to streamline our Discovery Research business and associated cost structure as a result of our successful completion of the four-year $90 million file enrichment project with Pfizer in the fourth quarter of 2005. We completed this process in January 2006, reducing our workforce by 76 positions. Reorganization and reassignment of chemistry staff were finalized during February. A further reduction of 15 positions was made in August 2006 and subsequently another 27

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

positions in the fourth quarter. In addition, due to the lower staffing levels and increased facility costs, we estimate that we will pass approximately $933 of charges through our income statement in fiscal 2006 as a result of the adoption of Statement of Financial Accounting Standards No. 151 "Inventory Costs-an amendment of ARB No. 43, Chapter 4" ("FAS 151"). FAS 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) to require that these items be included as current-period charges and not included in inventory.

General and administrative expenses decreased $140 or 7% to $1,760 in 2006 from $1,900 for the third quarter of 2005, and represented 21% and 14% of net sales for the corresponding periods. G&A expense for the nine-month period in 2006 was $5,244, a 9% decrease from $5,787 in 2005. The reduced G&A expense for 2006 is a result of reduced staff, lower public company costs and lower legal defense costs as a result of meeting our insurance deductible in the first quarter 2006 related to the class action lawsuit. See Note 3 for further details on the class action lawsuit.

Stock-Based Compensation expense is included in each area of expense (Selling and Marketing, Research and Development, and General and Administrative) in the third quarter and year-to-date periods of 2006. The totals of $53 and $271 for the quarter and year-to-date periods, respectively, are now required under FAS 123R. Prior year amounts were reflected on a pro-forma basis in the footnotes to the financial statements. See Note 15 for a further discussion of the prior year amounts and stock-based compensation accounting treatment.

Restructuring charge represents a reduction in force primarily related to our Discovery Research division. On January 24, 2006 we completed a reduction in force for our Discovery Research business based in Bude, England that was initiated in December 2005 following completion of the four-year $90 million file enrichment project for Pfizer. This action coincided with the conclusion of the 30-day consultation period with employees mandated by U.K. law. We reduced the number of employees at the laboratory by 76 positions. More than half of the employees affected left the Company under a voluntary separation plan. In addition, a restructuring of our US based employees resulted in a reduction of 9 positions. As a result of these actions, the Company recorded pre-tax restructuring charges of approximately $807 and $120 in the first quarter 2006 related to our Discovery Research and Discovery Informatics divisions, respectively, for one-time termination benefits and outplacement costs. The annualized effect of the downsizing is estimated to result in a cash savings from payroll and related benefits of $2,400. This amount would have been distributed as follows: $250 in Selling and Marketing; $1,790 in Research and Development; and $360 in General and Administrative. Certain departments within R&D would have qualified for absorption into inventory and ultimately been reflected through reduced cost of sales. Other variable costs related to production are not estimable at this time.

The Company further reduced staffing levels on August 11, 2006 by 14 positions, resulting in a pre-tax restructuring charge of $338 and projected annualized savings from payroll and related benefits of $1,076. The distribution of the projected annualized savings would have been $858 in Research and Development and $218 in General and Administrative. We solicited and obtained voluntary terminations for all positions affected in exchange for one-time termination benefits and outplacement costs. All costs were incurred and paid in the third quarter and are reflected in the restructuring line item on the consolidated statement of operations. This action was necessary in order to further streamline this business.

In the fourth quarter of 2006 we had a further reduction in force of 27 positions with an estimated cost of $500. See Note 16 "Subsequent Event" for further discussion. Costs of this additional restructuring, when finalized, will be reflected in the fourth quarter 2006 financial statements.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

Impairment Charge We have determined to restate our quarterly financial statements to reflect an impairment charge for the amount of the loss on the sale of excess properties at our Bude, England research facility of $3,607. The sale of the property was accomplished through a series of transactions that were completed in the fourth quarter of 2006. The impairment charge represents the loss on the sale of those properties that had a net book value of $4,873. The final terms of the transaction were substantially the same as those under negotiation at the time of our original quarterly filing. Management has determined that it should amend its quarterly filing for the period ended September 30, 2006 to show the effect of the impairment to the carrying value of the property being sold.

Interest expense increased to $569 in the third quarter of 2006 from $478 in the same period in 2005. For the nine-month periods, interest expense increased to $1,597 in 2006 from $1,259 in 2005. The increases were primarily due to higher interest rates on our revolving line of credit and mortgage note, along with additional amortization of the debt discount that arose from the funding of the Optive Research acquisition in early 2005 and the amortization of the deferred issuance costs related to the Convertible Preferred Stock transaction beginning in the second quarter of 2006. The interest expense related to the deferred issuance costs was $62 and $98 for the third quarter and nine months of 2006, respectively. Incremental interest expense related to the debt discount represents $46 in the third quarter and $144 year-to-date. Capital lease interest expense decreased in the third quarter of 2006 by $47 compared to the third quarter of 2005 but was comparable for the nine month periods.

Other income was $353 for the third quarter of 2006 versus $311 in 2005. Included in 2006 is $153 related to currency gains, $215 non-cash gain on the revaluation of common stock warrants and $58 of interest income and miscellaneous income, offset by a writedown of investments of $50 and $23 loss on disposal of equipment. The 2005 third quarter gain resulted from a distribution from A.M. Pappas of $305 and interest income of $22, offset by a currency loss of $16. In the nine-month year-to-date period for 2006, other income totaled $1,525 that included currency gains of $876, the non-cash gain on the revaluation of common stock warrants of $572, interest income and miscellaneous income of $131 and gains on A.M. Pappas of $22 , offset by a writedown of investments of $50 and a $26 loss on disposal of equipment. For the same year-to-date period in 2005, we had a loss from other items netting to $346. This total included currency losses of $890 that were partially offset by interest income of $85 and net gains from unconsolidated investments of $457. The net gains from investments arose from sales of NuVasive and losses on our holdings in the A.M. Pappas Life Science II fund.

Income tax expense was $46 for the first nine-months of 2006 compared to a benefit of $2,633 for the same period in 2005, which represent effective tax rates of 0% and (157%), respectively. The 0% effective tax rate for 2006 reflects management's current estimate of the distribution of earnings among the statutory jurisdictions in which we operate, realization of R&D tax credits in the U.K. and the valuation of certain net operating loss carry forwards. The rate for 2005 included recording of R&D tax credits in the U.K. for a prior period when it became more likely than not that they would be realized.

Liquidity, Capital Resources and Capital Commitments

Net cash used in operations in 2006 was $6,229. The primary uses of cash were from a net loss of $12,723, increases in inventories of $1,823, reductions in accounts payable and accrued expenses of $3,224 along with lower deferred revenues of $6,519, the noncash gain on revaluation of commons stock warrants of $572 and a noncash impairment charge of $3,607. These uses of cash were partially offset by collections of accounts receivable of $8,408, reduction of prepaid expenses and other current assets of

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

$2,105, plus the add-back of non-cash depreciation and amortization, including the amortization of debt discount, totaling $4,221, along with the add-back of non-cash stock-based compensation expense of $300 and accretion of the deferred issuance costs of $98. The increase in inventory is primarily related to on-going customer contracts and development of our next generation of compounds for our LeadQuest and LeadDiscovery libraries. The drop in accounts receivable reflects the normal seasonal collection of balances. Reductions in deferred revenue reflect the ratable recognition of revenue in the year and the cyclicality of software contract renewals. Payments on accounts payable and accrued expenses also reflect the seasonality of the balances. The reduction in prepaid expenses and other current assets reflects the ratable recognition of prepaid royalties and distributor commissions consistent with the recognition of deferred revenues. Net cash provided by operations in the first nine-months of 2005 was $2,727. The primary sources of cash were from net income of $952, reductions in accounts receivable of $559, reductions in inventory of $2,993, increases in deferred revenue of $318 plus the add-back of non-cash depreciation and amortization, including the amortization of debt discount of $3,676 combined and the write-down on long-term investment of $88. These increases of cash were partially offset by payments of accounts payable and accrued expenses of $3,641, additions to prepaid expenses of $690 and a change in deferred tax benefit of $1,288 less the pre-tax gain of $240 from the sale of shares of NuVasive common stock. The change in deferred tax benefit is a result of recording the R&D tax credits in the U.K. The timing of collections of accounts receivable and reductions of deferred revenues both continue regular annual cyclical patterns. Reductions in inventory levels principally reflect the status of the deliveries of finished goods to Pfizer.

Cash provided by investing activities during 2006 totaled $2,692, consisting of proceeds from the sale of equipment of $3,799 and distribution from A.M. Pappas Life Science Fund of $36, partially offset by property and equipment acquisitions of $409, capitalized development costs for our discovery informatics software products of $646 and additional investments in the A.M. Pappas Life Science Fund of $88. Cash used in investing activities during the first nine months of 2005 totaled $4,815 and were for property and equipment acquisitions of $880, capitalized development costs for our discovery informatics software products of $1,470, cash used in the acquisition of Optive Research, Inc. of $4,753 and additional investments in the A. M. Pappas Life Science Fund totaling $133. These were partially offset by $1,995 of proceeds from the sale of equipment and $426 of gross proceeds from the sale of NuVasive shares. Over the next 12 to 18 months of 2006-2007, we may be asked to fund the remainder of our investment commitment ($338) to the A.M. Pappas Life Science II Fund.

For the first nine months of 2006, cash provided by financing activities was $362, consisting of borrowings under our revolving line of credit of $6,710, net proceeds from the issuance of convertible preferred stock of $4,851 and proceeds from stock issuance pursuant to stock purchase and option plans of $172. This was partially offset by cash payments on long-term debt and capital lease obligations totaling $11,134 along with dividend payments on the preferred stock amounting to $237. For the first nine months of 2005, $1,289 of cash was generated through financing activities from the issuance of common stock of $500, the issuance of subordinated debt in the amount of $3,500 to fund part of the acquisition of Optive Research, the issuance of new capital leases of $59 and the issuance of shares under our employee stock plans of $39. We had borrowings on our line of credit with LaSalle Bank of $14,380, while payments on our line of credit, mortgage and capital leases during the period totaled $17,189.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

On April 18, 2006, the Company and LaSalle Bank completed an amendment to the existing credit facility and mortgage loan. The term of the revolving line of credit was extended to January 1, 2007 and the line of credit was amended to $6,000. The amended line of credit has a borrowing base equal to 80%

of domestic and insured foreign accounts receivable plus $1,800 allowance for the excess equity in U.S. real estate, a revised minimum shareholders' equity covenant tested quarterly and a minimum consolidated cash balance covenant tested monthly. The annual clean-down requirement was eliminated. Interest on the mortgage loan was modified to LIBOR plus 3.0%. All other terms of the revolving line of credit remain the same.

On May 4, 2006, the Company completed the sale of 1.8 million shares of Convertible Preferred Stock at a price of $3.00 per share and issued 550 thousand five-year common stock warrants exercisable at $3.50 per share to Midwood Capital, a Boston-based investment partnership, for gross proceeds of $5,500. The shares of Convertible Preferred Stock represented approximately 18% of Tripos' outstanding common stock on an as-converted basis at the time of the transaction. The Convertible Preferred Stock bears a dividend at an annual rate of 10.5% and is redeemable in two years. If certain events occur prior to January 26, 2007, which events related primarily to a sale or acquisition of Tripos, the dividends will be accelerated such that the holders of the Convertible Preferred Stock will receive dividends in the aggregate amount of $958 (or dividends in the aggregate amount of $1,155 if the event occurs on or after January 26, 2007) inclusive of any dividends received to date. Net proceeds from this transaction, after the placement agent's fee and estimated legal and other costs, were $4,851. This financing strengthened the Company's balance sheet, enhancing its ability to explore strategic alternatives and support current and potential business initiatives.

Due to the financial performance in the third quarter of 2006, we were not in compliance with the minimum shareholders' equity covenant of our revolving credit

facility with LaSalle Bank N.A.  We requested a waiver of this covenant violation for the period ended September 30, 2006.  On December 5, 2006, we and

LaSalle Bank entered into the Sixth Amendment and Waiver to Amended and Restated Loan Agreement, effective December 1, 2006.  Under the terms of the

amendment, LaSalle Bank waived the default in the minimum shareholders' equity covenant and extended the revolving loan maturity date from January 1, 2007 to

February 28, 2007.  The term loan maturity date was also amended from April 18, 2008 to February 28, 2007.  In addition, the amendment reduced the maximum

amount available under our existing borrowing base by $500,000, imposed a $50,000 amendment fee and additional fees of up to $100,000 through February 28,

2007, and eliminated the minimum net worth and minimum liquidity covenants and removed a restriction on selling mortgaged real estate securing the term loan.  In

so doing, LaSalle indicated that it would not grant further extensions of the credit facility.

Tripos' ability to fund the anticipated capital and operating needs of its business following maturity of the LaSalle Bank facility and absent completion of certain

strategic transactions is dependent on the replacement of this facility or the ability to secure alternative bank or other debt financing and/or equity funding.  In the

event that the Company is unable to extend and amend its credit facility on acceptable terms or arrange alternate financing, the Company's capital resources and

liquidity would be materially adversely affected.

We
  are exploring the sale of our headquarters building and the lease-back of a
  portion of the facility.  If completed, the transaction would eliminate the
  existing

mortgage balance on the property and generate additional cash.  We
  anticipate that this transaction could provide prospective savings to the
  Company by

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

reducing the ongoing cost of occupancy. In addition, we are seeking to sell certain excess real properties at the Bude, England location. We are also pursuing the sale of our Investment in the A.M. Pappas Life Science Ventures II Fund.

Our continuing financial viability is dependent upon our ability to take further steps to control costs and/or increase revenues and our ability to obtain financing to

replace the LaSalle Bank facility and meet our working capital needs. We will seek to obtain this funding from our current bank, from an alternative lending source,

or from other providers of debt or equity funding.  We cannot predict whether such financing will be available or what the terms of financing might be.  Any financing

may have an equity feature that could be dilutive to common stockholders.

Critical Accounting Policies

For further discussion of the Company's critical accounting policies, please see the section entitled "Critical Accounting Policies" in Management's Discussion and Analysis of Financial Condition and Results of Operations in Form 10-K for the year ending December 31, 2005. With the adoption of FAS 123R at the beginning of fiscal 2006, we have determined that "Stock-Based Compensation" should be included as one of the Company's identified critical accounting policies. We account for stock-based compensation in accordance with the provisions of FAS 123R. We use the Black-Scholes option-pricing model, which requires the input of highly subjective assumptions. These assumptions include estimating the length of time employees will retain their stock options before exercising them ("expected term"), the estimated volatility of the Company's common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements ("forfeitures"). Changes in the subjective assumptions can materially affect the estimated fair value of stock-based compensation and consequently, the related amount recognized on the consolidated statements of operations. See Note 15 of the Notes to Consolidated Financial Statements in this Form 10-Q for further discussion of stock-based compensation. There have been no material changes to the other critical accounting policies previously reported in our Annual Report on Form 10-K for the fiscal year ended December31, 2005.

New Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109." This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Interpretation is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the requirements of this Interpretation, but do not expect that the adoption will have a material effect on our financial statements or tax returns.

In September 2006, the FASB issued SFAS No. 157 "Fair Value Measurements" ("FAS 157"). FAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of FAS 157 are effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the provisions of FAS 157.

In September 2006, the Securities and Exchange Commission ("SEC") staff issued Staff Accounting Bulletin 108 "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements" ("SAB 108"). SAB 108 requires that public companies utilize a "dual-approach" to assessing the quantitative effects of financial misstatements. This dual approach includes both an income statement focused assessment and a balance sheet focused assessment. The guidance in SAB 108 must be applied to annual financial statements for fiscal years ending after November 15, 2006. We are currently assessing the impact of adopting SAB 108 but do not expect that it will have a material effect on our consolidated financial position or results of operations.

Periodic reports on Form 10-Q, Form 10-K and other filings with the Securities and Exchange Commission on Form 8-K and S-8, can be found on the Tripos web site at www.tripos.com under the heading Investor Relations - SEC Filings.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our exposure to market risks is limited to foreign exchange variances and fluctuations in interest rates. To date, interest rate exposure has not resulted in a material impact. During 2003, 2004 and 2005, the Company did experience a significant impact from foreign exchange. The costs to perform the custom design and synthesis contract with Pfizer were incurred in British pounds sterling while we were compensated in U.S. dollars for much of the work. As a result, our gross profit was adversely affected by the decline in the U.S. dollar against the pound. Part of this effect was offset through foreign currency forward contracts whose gains were recorded in "Other Income".

Our foreign exchange risk is presently limited to currencies that historically have exhibited only minor fluctuations although from 2003 through 2005, these currencies have shown more significant variation. Assets outside the United States subject to currency fluctuation are located in England, Germany and France. Our investments in foreign subsidiaries with a functional currency other than the U.S. dollar are not hedged. The assets in foreign subsidiaries most susceptible to exchange rate variances were as follows: US dollar/UK pound balances 2005 $13.0 million, and US dollar/Euro balances 2005 $3.0 million. The potential reduction in fair value resulting from a hypothetical 10% adverse change in US dollar/UK pound currency exchange rates would be approximately $1.3 million at December 31, 2005, while the same 10% adverse movement in the US dollar/Euro rates would be approximately, $300,000 for 2005. Any loss in fair value of permanently invested funds would be reflected in Other Comprehensive Income and would not impact our net income.

Our interest rate risk is attributable to borrowings under the line-of-credit and mortgage loan. We monitor our exposure to floating interest rate risk on line-of-credit borrowings along with the outstanding balance on the mortgage loan and may, at times, endeavor to mitigate this risk through the use of appropriate hedging instruments.

Item 4. Controls and Procedures

We have established and maintain disclosure controls and procedures that are designed to ensure that material information relating to the Company and our

subsidiaries required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including

our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the

disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only a

Item 4. Controls and Procedures (continued)

reasonable assurance of achieving the desired control objectives, and management was necessarily required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

The Company's Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based upon that evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures were effective at the reasonable assurance level as of the date of such evaluation.

On October 12, 2006, B. James Rubin resigned as the Company's Chief Financial Officer and John D. Yingling was appointed to this position. Mr. Rubin remains with the Company as a Senior Vice

President and will continue to work with other members of the Company's senior management team on key corporate initiatives.

During the quarterly period covered by this report, there were no other changes in the Company's internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

PART II

OTHER INFORMATION

Item 1. Legal Proceedings

On August 4, 2006, the federal district court in St. Louis, Missouri approved the tentative agreement reached on March 21, 2006 to settle a class action litigation suit against the Company. The total amount of the settlement is $3,150 which is to be paid by our insurers. A court date has been set for November 17, 2006 to review the terms of the March 21, 2006 tentative settlement in the shareholder derivative suit. See "Contingent Liabilities" in the Notes to Unaudited Financial Statements above for a general description of legal proceedings. Reference is made to the "Legal Proceedings" section of our Form 10-K for the year ending December 31, 2005 for a detailed description of legal proceedings.

Item 1A. Risk Factors

A description of the risk factors associated with our business is contained in Item 1A, "Risk Factors," of our 2005 Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 11, 2006 and incorporated herein by reference. These cautionary statements are to be used as a reference in connection with any forward-looking statements. The factors, risks and uncertainties identified in these cautionary statements are in addition to those contained in any other cautionary statements, written or oral, which may be made or otherwise addressed in connection with a forward-looking statement or contained in any of our subsequent filings with the Securities and Exchange Commission.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults upon Senior Securities

None

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

None

PART II

OTHER INFORMATION (continued)

Item 5. Other Information

Pursuant to the terms of the Company's revolving loan facility with LaSalle Bank N.A., the Company is obligated to maintain a minimum net worth calculated pursuant to the terms of the agreement. On November 13, 2006, LaSalle Bank notified the Company that it was in default under the minimum net worth covenant under its revolving loan facility. This facility provides for borrowing capacity of $6 million, based on a borrowing base and matures January 1, 2007. See Note 8 to the Financial Statements contained herein. LaSalle Bank also notified the Company that it does not intend to extend or renew the revolving loan facility. LaSalle Bank also holds a security interest in certain property of the Company including a mortgage on the Company's principal offices which matures April 18, 2008. The total amount currently outstanding under the revolving loan maturing January 1, 2007 is approximately $5.1 million.

Under the revolving loan agreement, while the event of default exists, LaSalle Bank is entitled to cancel all its commitments under the facility and declare all loan obligations immediately due and payable. Furthermore, if the default is not cured within 30 days, Horizon will have the right to accelerate all loan obligations under its credit agreement with the Company. If LaSalle Bank and Horizon elect to exercise these rights, approximately $6.6 of additional indebtedness of the Company would be accelerated.

Item 6. Exhibits

31.1 Section 302 Certification of the Chief Executive Officer

31.2 Section 302 Certification of the Chief Financial Officer

32.1 Written Statement of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

TRIPOS, INC.

SIGNATURES

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.

TRIPOS, INC.

Date:	February 5, 2007	/s/ John P. McAlister
		President and
		Chief Executive Officer

Date:	February 5, 2007	/s/ John D. Yingling
		Vice President,
		Chief Financial Officer and
		Assistant Secretary

FORM 10-Q/A

SECURITIES AND EXCHANGE COMMISSION

For the quarterly period ended September 30, 2006

Commission File Number 0-23666

TABLE OF CONTENTS

FINANCIAL INFORMATION

Organization

TRIPOS INC 10-Q/A