UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

o QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

ý TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from January 1, 2004 through March 31, 2004

Commission File Number: 0-27118

PHARMACOPEIA, INC.

(Exact name of registrant as specified in its charter)

Delaware		33-0557266
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

9685 Scranton Road, San Diego, CA		92121
(Address of principal executive offices)		(Zip code)

(858) 799-5000
(Registrant’s telephone number, including area code)

Former fiscal year end: December 31, 2003
Former address: PO Box 5350, Princeton, New Jersey 08543-5350
(Former name, former address and former fiscal year, if changed since last report)

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 such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Class		Outstanding at April 30, 2004
Common Stock, $.0001 par value		24,362,943 shares

PHARMACOPEIA, INC.

Form 10-Q

Table of Contents

Item

PART I. FINANCIAL INFORMATION

Item 1.	Unaudited Consolidated Financial Statements:

	Balance Sheets – March 31, 2004 and December 31, 2003

	Statements of Operations – Three Months Ended March 31, 2004 and 2003

	Statements of Cash Flows – Three Months Ended March 31, 2004 and 2003

	Notes to Unaudited Consolidated Financial Statements

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

Item 3.	Quantitative and Qualitative Disclosures about Market Risk

Item 4.	Controls and Procedures

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings

Item 2.	Changes in Securities and Use of Proceeds

Item 3.	Defaults upon Senior Securities

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

Item 5.	Other Information

Item 6.	Exhibits and Reports on Form 8-K

Signature

Index to Exhibits

PART I - FINANCIAL INFORMATION

Item 1. Unaudited Consolidated Financial Statements

Pharmacopeia, Inc.

Consolidated Balance Sheets

(Dollars in thousands)

	March 31, 2004			December 31, 2003
ASSETS
Current assets:
Cash and cash equivalents	$	40,072		$	27,509
Marketable securities	101,557			106,546
Trade receivables, net of allowance for doubtful accounts of $191 and $505, respectively	11,358			42,082
Prepaid expenses and other current assets	5,370			5,365
Total current assets	158,357			181,502

Property and equipment, net	19,327			15,398
Goodwill, net of accumulated amortization of $13,201	34,072			34,072
Software development costs, net of accumulated amortization of $27,443 and $26,555, respectively	7,748			7,634
Other assets	974			1,061
Total assets	$	220,478		$	239,667

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	5,483		$	4,659
Accrued liabilities	20,954			19,762
Deferred revenue, current portion	25,330			27,255
Leases payable, current portion	38			8
Total current liabilities	51,805			51,684

Restructuring reserve, long-term	2,655			—
Deferred revenue, long-term	5,767			5,249

Stockholders’ equity:
Preferred stock, $.0001 par value, 2,000 shares authorized, none issued and outstanding	—			—
Common stock, $.0001 par value, 40,000 shares authorized, 24,949 and 24,568 shares issued and outstanding, respectively	2			2
Additional paid-in capital	291,977			287,592
Unearned compensation	(862		)	(536		)
Treasury stock	(8,340		)	(8,340		)
Accumulated deficit	(124,088		)	(97,318		)
Accumulated comprehensive income	1,562			1,334
Total stockholders’ equity	160,251			182,734
Total liabilities and stockholders’ equity	$	220,478		$	239,667

See accompanying notes to these unaudited financial statements.

Pharmacopeia, Inc.
Consolidated Statements of Operations
(Dollars in thousands, except per share data)

	For the Three Months Ended March 31,
	2004			2003
Revenues:
Software license, service and other	$	11,135		$	17,219
Drug discovery	5,369			7,521
Total revenues	16,504			24,740

Cost of revenues:
Software license, service and other	4,107			5,169
Drug discovery	5,550			5,776
Total cost of revenues	9,657			10,945

Gross margin	6,847			13,795

Operating costs and expenses:
Research and development	5,654			5,733
Sales, general and administrative	15,288			14,658
Restructuring and other charges	11,147			(384		)
Total operating costs and expenses	32,089			20,007
Operating loss	(25,242		)	(6,212		)
Spin-off transaction costs	(2,321		)	—
Interest and other income, net	924			1,136
Loss before tax provision	(26,639		)	(5,076		)
Provision for income taxes	131			377
Net loss	$	(26,770	)	$	(5,453	)

Net loss per share:
- Basic and diluted	$	(1.11	)	$	(0.23	)

Weighted average number of common stock outstanding:
- Basic and diluted	24,090			23,617

See accompanying notes to these unaudited financial statements.

Pharmacopeia, Inc.

Consolidated Statements of Cash Flows

(Dollars in thousands)

	For the Three Months Ended March 31,
	2004			2003
OPERATING ACTIVITIES:
Net loss	$	(26,770	)	$	(5,453	)
Adjustments to reconcile net loss to net cash provided by operating activities
Depreciation	1,583			1,586
Amortization	882			1,882
Contribution of stock to 401(k) members	257			281
Amortization of unearned compensation	28			—
Non-cash compensation	8			10
Loss on disposal of capital assets	523			—
Changes in assets and liabilities:
Trade receivables	30,783			20,732
Prepaid expenses and other current assets	19			(704		)
Other assets	101			15
Accounts payable	805			(113		)
Accrued liabilities	3,825			(4,458		)
Deferred revenue	(1,477		)	(6,554		)
Net cash provided by operating activities	10,567			7,224
INVESTING ACTIVITIES:
Capital expenditures	(5,942		)	(800		)
Increase in capitalized software development costs	(956		)	(1,158		)
Purchases of marketable securities	(61,319		)	(18,552		)
Proceeds from sales of marketable securities	66,256			16,638
Net cash used in investing activities	(1,961		)	(3,872		)
FINANCING ACTIVITIES:
Proceeds from issuance of common stock	3,765			57
Principal payments on leases payable	(4		)	(3		)
Net cash provided by financing activities	3,761			54
Exchange rate effect on cash and equivalents	196			(63		)
Net increase in cash and equivalents	12,563			3,343
Cash and equivalents, beginning of period	27,509			28,236
Cash and equivalents, end of period	$	40,072		$	31,579

SUPPLEMENTAL INFORMATION:
Cash paid during the period for:
Interest expense	$	2		$	5
Income tax expense	$	163		$	141

See accompanying notes to these unaudited financial statements.

Pharmacopeia, Inc.

Notes to Unaudited Consolidated Financial Statements

1. Basis of Presentation

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these unaudited financial statements do not include all of the information and disclosures required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial statements have been included. Interim results are not necessarily indicative of the results that may be expected for the year. These financial statements should be read in conjunction with the audited financial statements and disclosures thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

On April 1, 2004 the Company changed its fiscal year end from December 31 to March 31. The consolidated financial statements and the accompanying notes include the “transition period” for the three months ended March 31, 2004.

On April 30, 2004 the Company completed the spin-off of the Company’s Drug Discovery segment, Pharmacopeia Drug Discovery, Inc. (“PDD”), see Note 6.

2. Net Loss Per Share

The Company computes net income (loss) per share in accordance with Statement of Financial Accounting Standard No. 128, “Earnings Per Share” (“SFAS 128”). Under the provisions of SFAS 128, basic net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted-average number of common and dilutive common equivalent shares outstanding during the period. Diluted earnings per share include the potentially dilutive effect of outstanding stock options, or other dilutive securities. The Company has a net loss for the periods presented; accordingly, the inclusion of common stock equivalents for outstanding stock options would be anti-dilutive and therefore the weighted-average shares used to calculate both basic and diluted loss per share are the same.

3. Segment Information

The Company operates in two industry segments. The Company’s Software segment, Accelrys Inc. (“Accelrys”), provides molecular modeling and simulation, bioinformatics and cheminformatics software, and related services that facilitate the discovery and development of new drug and chemical products and processes in the pharmaceutical, biotechnology, chemical, petrochemical and materials industries. PDD provides drug discovery services to pharmaceutical and biotechnology companies based on proprietary combinatorial chemistry, medicinal chemistry, high-throughput screening, and Accelrys technologies. The Company completed a spin-off of PDD on April 30, 2004, see Note 6. The accounting policies of the reportable segments are the same as those of the Company. Summarized financial information concerning industry segments is as follows (dollars in thousands):

	Three Months Ended March 31, 2004
	Accelrys			PDD			Total
Revenues:
Software licenses services and other	$	11,135		$	—		$	11,135
Drug discovery services	—			5,369			5,369
Total revenues	$	11,135		$	5,369		$	16,504
Operating loss	$	(15,306	)	$	(9,936	)	$	(25,242	)

	Three Months Ended March 31, 2003
	Accelrys			PDD			Total
Revenues:
Software licenses services and other	$	17,219		$	—		$	17,219
Drug discovery services	—			7,521			7,521
Total revenues	$	17,219		$	7,521		$	24,740
Operating loss	$	(5,372	)	$	(840	)	$	(6,212	)

4. Stock-Based Compensation

Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) encourages, but does not require, companies to record compensation cost for stock-based compensation plans at fair value. As permitted by SFAS 123, the Company has elected to continue following Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees,” (“APB 25”) and related interpretations, to account for stock-based compensation. Under APB 25, no compensation expense is recognized at the time of option grant because the exercise price of the Company’s employee stock option equals the fair market value of the underlying common stock on the date of grant.

Had the Company followed the fair value measurement provisions of SFAS 123, the following table summarizes the pro forma net loss and pro forma net loss per share that would have been recorded (in thousands, except per share data):

	Three Months Ended March 31,
	2004			2003
Net loss:
As reported	$	(26,770	)	$	(5,453	)
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects	(1,876		)	(3,053		)
Pro forma	$	(28,646	)	$	(8,506	)
Basic and diluted net loss per common share:
As reported	$	(1.11	)	$	(0.23	)
Pro forma	(1.19		)	(0.36		)

The fair value of each option granted during 2004 and 2003 is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

	2004		2003
Dividend yield	0	%	0	%
Expected volatility	85.24	%	88.28	%
Risk-free interest rate	3.31	%	3.25	%
Expected life (years)	5.8		6.5

5. Restructuring

During the third quarter of 2002, the Company announced that it was undertaking various actions to restructure its Accelrys operations to improve its overall financial performance. As of March 31, 2004 the remaining obligation under this restructuring was related to the closure of certain facilities. The following table summarizes the activity and balance of the restructuring liability during the quarter ended March 31, 2004 (dollars in thousands):

	Costs to Exit Lease Obligations
Balance at December 31, 2003	$	1,161
Ultization of Reserves:
Cash	(65		)
Balance at March 31, 2004	$	1,096

During the quarter ended March 31, 2004, the Company executed a restructuring plan for the purpose of making Research and Development activities more efficient and eliminating unnecessary facilities. The restructuring effort included a reduction in force of 73 Accelrys employees, of which 67 had been terminated as of March 31, 2004. Additionally, an excess facility of the PDD business was abandoned and a reduction in force of 6 administrative PDD employees occurred during the quarter, of which 5 employees were terminated as of March 31, 2004. As a result, restructuring related charges of approximately $8.7 million were recognized as operating expense during the quarter ended March 31, 2004.

The following table summarizes the activity and balance of the restructuring reserve liability during the quarter ended March 31, 2004 (dollars in thousands):

	Accelrys Severance Cost for Involuntary Employee Terminations			PDD Severance Cost for Involuntary Employee Terminations			PDD Costs to Exit Lease Obligations			Total
Restructuring Charges	$	2,813		$	132		$	5,718		$	8,663
Utilization of Reserves:
Cash	(2,197		)	(44		)	—			(2,241		)
Write-off Leasehold Improvements	—			—			(458		)	(458		)
Balance at March 31, 2004	$	616		$	88		$	5,260		$	5,964

6. Subsequent Events – Spin-off of Pharmacopeia Drug Discovery, Inc.

On April 30, 2004 the Company completed the spin-off of PDD into an independent, separately traded, publicly held company through the distribution to its stockholders a dividend of one share of PDD common stock for every two shares of Pharmacopeia common stock. The Company has received an opinion of counsel that the transaction will qualify for treatment as a tax-free spin-off. As a result of this transaction, the Company made a capital contribution of $46.5 million to PDD.

Subsequent to April 30, 2004 the Company agreed to guarantee PDD’s lease obligation of approximately $33.2 million in conjunction with the assignment of the leases to PDD in event PDD does not perform under the terms of the lease.

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

The following discussion and analysis of financial condition and results of operations of Pharmacopeia, Inc. (“Pharmacopeia” or the “Company”) should be read in conjunction with the Unaudited Financial Statements and related notes included elsewhere in this Form 10-Q, and also in conjunction with the Consolidated Financial Statements and related notes included in the Company’s Form 10-K for the year ended December 31, 2003.

This report, including, without limitation, this section regarding Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements regarding the Company and its business, financial condition, results of operations, and prospects. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this Report. Additionally, statements concerning future matters such as the development of new products, enhancements of technologies, possible changes in legislation, and other statements regarding matters that are not historical are forward-looking statements.

Although forward-looking statements in this Report reflect the good faith judgment of the Company’s management, such statements can only be based on facts and factors currently known by the Company. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. The Company undertakes no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Report. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Report.

The Company’s registration statements on Form S-1 (Reg. No. 33-98246), most recent Form 10-K, and this Report, describe certain risk factors and uncertainties that may cause actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements. These risk factors and uncertainties should be considered in connection with any investment in the Company’s common stock.

BUSINESS OVERVIEW

Pharmacopeia is a leader in enabling science and technology that accelerates and improves the drug discovery and chemical development processes. The Company’s software subsidiary, Accelrys Inc., (“Accelrys”) develops and commercializes molecular modeling and simulation software for the life sciences and materials research markets, cheminformatics and decision support systems, and bioinformatics tools including gene sequence analysis. On April 30, 2004, the Company spun off its drug discovery subsidiary, Pharmacopeia Drug Discovery, Inc. (“PDD”), which integrated proprietary small molecule combinatorial and medicinal chemistry, high-throughput screening, in-vitro pharmacology, computational methods and informatics to discover and optimize lead compounds and drug candidates. The spin-off of PDD resulted in PDD becoming an independent, separately traded, publicly held company. This was accomplished through the distribution to its stockholders a dividend of one share of PDD common stock for every two shares of Pharmacopeia common stock.

As of March 31, 2004 the Company employed approximately 700 people and was headquartered in Princeton, NJ. Subsequent to the spin-off of PDD, the Company employed approximately 530 employees and is headquartered in San Diego, CA.

RESULTS OF OPERATIONS

THREE MONTHS ENDED MARCH 31, 2004 AND 2003

Total revenue decreased 33% to $16.5 million in the quarter ended March 31,2004 compared to $24.7 million in the quarter ended March 31, 2003.

	For the Three Months Ended March 31,
	2004		2003		% Change
Revenues:
Software license, service and other	$	11.1	$	17.2	-35	%
Drug discovery	5.4		7.5		-29	%
Total revenues	$	16.5	$	24.7	-33	%

Software license, service and other revenue decreased 35% to $11.1 million in the quarter ended March 31, 2004 compared to $17.2 million in the quarter ended March 31, 2003. The decrease in revenue was related to decreased orders, the discontinuance of delivering unprofitable one-off consulting work, finalization of our last consortium in 2003, and the effects of subscription revenue accounting as a result of our new licensing agreement.

In January 2004 we issued a new license offering at Accelrys, which will require subscription accounting. Under this new license, revenue will be recognized ratably over the license term. This contrasts with our typical annual license offering, in which we recognize 64% of the license revenue in the quarter in which the license is executed and amortize the other 36% of the revenue over the remaining term of the contract to reflect the value based on vendor-specific evidence. The revenue recognition for the new license is even more dramatic when compared to our traditional perpetual license offering, in which we recognize 85% of the license revenue in the quarter in which the contract is executed and amortize the remaining 15% of the revenue over the term of a one-year maintenance agreement. The unrecognized revenue, amortized over the remaining term of the agreement, will be accounted for as “deferred revenue” on the Accelrys balance sheet.

Drug discovery revenue decreased 29% to $5.4 million in the quarter ended March 31, 2004 compared to $7.5 million in the quarter ended March 31, 2003. The decrease was primarily due to a decrease in milestone and other one-time revenue transactions, as well as a decrease in lead optimization revenue, and reduced revenue from our collaboration with Schering Plough. Milestone and other one-time revenue transactions recorded in the quarters ended March 31, 2004 and 2003 was $1.0 million, and $1.9 million, respectively. Excluding the revenue from milestones and other one-time revenue transactions, revenue decreased 22% to $4.4 million in the quarter ended March 31, 2004 compared to $5.6 million in the quarter ended March 31, 2003.

Gross margin decreased 51% to $6.8 million (41% of related revenues) in the quarter ended March 31, 2004 compared to $13.8 million (56% of related revenues) in the quarter ended March 31, 2003.

	For the Three Months Ended March 31,
	2004					2003
	$			% of Revenue		$		% of Revenue		% Change
Gross margin:
Software license, service and other	$	7.1		63	%	$	12.1	70	%	-42	%
Drug discovery	(0.2		)	-3	%	1.7		23	%	-110	%
Total gross margin	$	6.8		41	%	$	13.8	56	%	-51	%

Software license, service and other gross margin decreased 42% to $7.1 million (63% of related revenue) in the quarter ended March 31, 2004 compared to $12.1 million (70% of related revenue) in the quarter ended March 31, 2003. The $5.0 million decrease in gross margin resulted from the 35% decrease in revenue, offset by decreased direct costs for distribution and royalties.

Drug discovery gross margin decreased 110% to ($.02) million ((3%) of related revenue) in the quarter ended March 31, 2004 compared to $1.7 million (23% of related revenue) in the quarter ended March 31, 2003. The gross margin decreased substantially due to the decrease in revenue resulting in the under absorption of fixed costs allocated to collaborative partnerships.

Research and development expenses remained consistent at $5.7 million in the quarter ended March 31, 2004 and 2003.

Software research and development expense consists primarily of the employment-related costs of personnel associated with developing new products, enhancing existing products, testing software products and developing product documentation. PDD research and development expense includes the employment-related costs of scientific staff working on unfunded internal drug discovery projects focused on the creation of new small molecule therapeutics.

Software research and development expense is capitalized in accordance with Statement of Financial Accounting Standards No. 86, “Accounting for the Cost of Computer Software to be Sold, Leased or Otherwise Marketed” (SFAS 86). Capitalized software development costs consist primarily of the employment-related costs and consulting fees paid to consultants in relation to the development of Accelrys’ products that have not yet been released.

The following table shows the breakout of research and development costs by division and the amount of capitalized software development for the periods indicated:

	For the Three Months Ended March 31,
	2004			2003			% Change
Research and development:
Gross software development costs	$	5.3		$	5.9		-10	%
Capitalized software development costs	(1.0		)	(1.2		)	-16	%
Internal drug discovery	1.4			1.0			33	%
Total research and development costs	$	5.7		$	5.7		-1	%

The decrease in software research and development expenses was primarily attributable to a restructuring at Accelrys in January 2004, offset by lower capitalization of software development activities. The increase in drug discovery research and development is primarily due to the increased investment in internal drug discovery programs.

Sales, general and administrative expenses increased by 4% to $15.3 million in the quarter ended March 31, 2004 compared to $14.7 million in the quarter ended March 31, 2003. The increase in sales, general and administrative expenses is primarily attributable to moving costs incurred in the

Company’s New Jersey and Tokyo facilities of $0.7 million and $0.2 million, respectively. Excluding the moving costs of $0.9 million, Sales, general and administrative expenses decreased by 2%.

During the quarter ended March 31, 2004, the Company undertook a restructuring and certain other actions. Accordingly restructuring and other charges of $11.1 million were incurred. The charge included several bonuses and severance payments, including the retirement of the Chief Executive Officer, the cost to exit certain lease obligations, and the acceleration of a deferred compensation charge. The Company was able to reverse an excess portion of the 2002 restructuring liability during the quarter ended March 31, 2003.

The Company incurred $2.3 million for professional fees related to the spin-off of PDD during the quarter ended March 31, 2004.

Net interest and other income decreased 19% to $0.9 million in the quarter ended March 31, 2004 compared to $1.1 million in the quarter ended March 31, 2003. The decrease is due to lower average investment balances and decreases in market interest rates, and the effect of foreign exchange.

The Company recorded an income tax provision of $0.1 million for the quarter ended March 31, 2004 compared to $0.4 million for quarter ended March 31, 2003. The decrease is due to the increased loss.

As a result of the lower revenues and lower costs described above, the Company generated a net loss of $26.8 million ($1.11 per diluted share) in the quarter ended March 31, 2004 compared to a net loss of $5.5 million ($0.23 per diluted share) in the quarter ended March 31, 2003.

LIQUIDITY AND CAPITAL RESOURCES

The Company has funded its activities to date primarily through the sale of equity securities, software licenses, software maintenance services, and drug discovery services. As of March 31, 2004, the Company had cash, cash equivalents, and marketable securities of $141.6 million compared to $134.1 million as of December 31, 2003. On April 30, 2004, the Company made a capital contribution to PDD of $46.5 million in cash and marketable securities.

Cash provided by operations increased by $3.3 million in the quarter ended March 31, 2004 compared to the quarter ended March 31, 2003. The increase is primarily attributable to the collection of high dollar accounts receivable balances generated during the fourth quarter of 2003. Cash used in investing activities decreased by $1.9 million in the quarter ended March 31, 2004 compared to the quarter ended March 31, 2003 due to the timing of investments and offset by increased capital purchases, substantially all of which were related to the build-out of new facilities at PDD. Cash used in financing activities increased by $3.7 million in the quarter ended March 31, 2004 compared to the quarter ended March 31, 2003 due to option exercises.

The Company anticipates that its capital requirements may increase in future periods as a result of seasonal sales trends, additional research and development activities, and the acquisition of additional equipment. The Company’s capital requirements may also increase in future periods as the Company seeks to expand its technology platform through investments, licensing arrangements, technology alliances, or acquisitions.

The Company anticipates that its existing capital resources will be adequate to fund the Company’s operations at least through the next twelve months. However, there can be no assurance that changes will not occur that would consume available capital resources before then.

The Company’s capital requirements depend on numerous factors, including the ability of the Company to continue to generate software sales, the ability of the Company to extend existing Drug Discovery agreements and to enter into additional arrangements, competing technological and market developments, changes in the Company’s existing collaborative relationships, the cost of filing, prosecuting, defending, and enforcing patent claims and other intellectual property rights and the outcome of related litigation, the purchase of additional capital equipment, acquisitions of other businesses or technologies, and the progress of the Company’s customers’ milestone and royalty producing activities. There can be no assurance that additional funding, if necessary, will be available on favorable terms, if at all. The Company’s forecasts of the period of time through which its financial resources will be adequate to support its operations are forward looking information, and actual results could vary. The factors described earlier in this paragraph will impact the Company’s future capital requirements and the adequacy of its available funds.

RISK FACTORS

You should carefully consider the risks described below before investing in our publicly-traded securities. The risks described below are not the only ones facing us. Our business is also subject to the risks that affect many other companies, such as competition, technological obsolescence, labor relations, general economic conditions, geopolitical changes and international operations. Additional risks not currently known to us or that we currently believe are immaterial also may impair our business operations and our liquidity.

CERTAIN RISKS RELATED TO THE SPIN-OFF OF PDD

There can be no assurance that neither PDD nor Accelrys will be successful on a stand-alone basis. Our Board of Directors approved the plan to separate our Accelrys and PDD businesses through the spin-off to our stockholders of 100% of the outstanding shares of common stock of PDD which transaction was completed on April 30, 2004. The transaction has resulted in PDD being an independent, publicly-traded company owning and operating our Drug Discovery business; we retain ownership of and operate the Accelrys software business.

We believe that separating PDD from Pharmacopeia will resolve difficulties we have encountered regarding the effective operation and development of our two businesses within a single publicly-traded corporation. We further believe the spin-off will enhance the performance of Pharmacopeia and PDD by providing each company with greater focus on its respective business, with a publicly traded equity security for use in compensation programs and as “currency” in strategic transactions, and with a clearer story to enable investors to better evaluate each company and assign each entity an appropriate market valuation. There can be no assurance that PDD and Pharmacopeia, as stand-alone entities, will be able to benefit from these items.

PDD and Accelrys have not been independent companies, and will no longer be able to rely on the financial and other resources and the cash flows generated from each other’s operations. Currently, we operate our businesses as part of a broader corporate organization rather than as separate stand-alone companies. Historically, certain corporate functions have been centralized for PDD and Accelrys; after a transition period following the distribution, each company will be responsible for fulfilling these functions independently. Our estimates concerning the costs for independent corporate administrative functions (such as overhead functions, corporate governance, securities compliance, exchange listing and investor relations services) may be substantially lower than the actual costs incurred. As a result, it will be difficult for anyone to accurately forecast future operating performance for either company. Further, either company may need to obtain financing on a stand-alone basis after the spin-off, which may be difficult because financial and other resources may not be as strong as the Company’s prior to the distribution. Any future financing

will have to be raised without reference to or reliance on the financial condition of the consolidated company. There can be no assurance that either company will be able to obtain financing after the distribution on acceptable terms, or at all.

The combined market value of our shares and those of PDD after the spin-off may not be equal to or greater than the market value of our shares prior to the distribution. There is no assurance that an active public market for PDD’s or our common stock will develop or be sustained. In addition, the smaller size of the market capitalization of each company after the distribution compared to our market capitalization prior to the distribution may result in our loss of, and PDD’s failure to obtain, stock research analyst coverage, which could adversely impact each entity’s stock market following. Consequently, there can be no assurance that the combined market value of our shares and those of PDD after the spin-off will be equal to or greater than the market value of our shares prior to the distribution. Further, the market price of PDD’s and our stock may fluctuate substantially, as in recent years the stock market has experienced significant price and volume changes and the Company’s stock price has been volatile. In addition, following the distribution, our current stockholders will now own separate securities in PDD and the Company. It is possible that some stockholders will sell shares of PDD or our common stock for various reasons, including the fact that the business profile or market capitalization of that entity as a stand-alone company does not fit their investment objectives. Given the large concentration of our stockholdings among our top seven stockholders, substantial sales of shares by one or more of these stockholders could depress the market price for PDD’s or our shares. We cannot predict whether substantial amounts of PDD’s or our stock will be sold in the open market following the spin-off.

If the distribution is taxable, stockholders could be required to pay tax on the fair market value of the shares of PDD common stock you receive, and we could incur a corporate tax liability. If the spin-off fails to qualify as a tax-free distribution for U.S. federal income tax purposes, our stockholders who receive PDD shares would be treated as if they had received a taxable distribution in an amount equal to the fair market value of the PDD common stock received. In such event, a corporate income tax could also be payable by us on the excess of the fair market value of the PDD stock over our adjusted tax basis in the stock. Further, even if the distribution is tax-free to our stockholders, we could be subject to corporate income tax on any gain inherent in PDD’s stock if one or more persons acquire a 50% or greater interest in PDD as part of a plan or series of related transactions that included the spin-off.

We may be required to indemnify PDD, or may not be able to collect on indemnification rights from PDD. As part of the spin-off, we and PDD have agreed to indemnify one another after the distribution with respect to the indebtedness, liabilities and obligations that will be retained by our respective companies. One such obligation is a guarantee by us of PDD’s obligations under the existing New Jersey laboratory and headquarters leases, with respect to which PDD will indemnify us should we be required to make any payment under the guarantee. These indemnification obligations could be significant. PDD’s ability to satisfy any such indemnification obligations (including, without limitation, PDD’s commitment to indemnify us in the event of our payment under our guarantee of its leases) will depend upon PDD’s future financial strength. We cannot assure you that, if PDD becomes obligated to indemnify us for any substantial obligations, PDD will have the ability to do so. There also can be no assurance that we will be able to satisfy any indemnification obligations to PDD. Any required payment by PDD or us could have a material adverse effect on its or our business, and any failure by PDD or us to satisfy its obligations could have a material adverse effect on the other company’s business.

CERTAIN RISKS RELATED TO OUR BUSINESS AS A WHOLE

Our PDD revenue is highly concentrated in its largest collaborators; the termination of the collaboration with PDD’s largest collaborator would have a material adverse effect on our business, financial condition and results of operations. During the year ended December 31, 2003, we earned approximately 47% of PDD’s revenue, and 12% of our consolidated revenue, under PDD’s research collaboration agreements with Schering-Plough Corporation. In the third quarter of 2003, PDD entered into new multiyear drug discovery collaboration agreements with Schering-Plough, which continue certain existing programs and implement a number of new activities. The new agreements continue PDD’s collaboration with this partner through at least August 2006 and, under their terms, may be extended by the parties for up to three additional years based upon progress made in the programs governed by the agreements. The agreements may be terminated at the end of the third year, and Schering-Plough’s funding obligations may be reduced significantly before that time, under the circumstances summarized previously. There can be no assurance that the results of PDD’s collaboration with Schering-Plough would be sufficient to cause Schering-Plough not to exercise its rights to terminate the agreements. In light of the significance to us of the Schering-Plough relationship, the termination of PDD’s collaboration agreements would have a material adverse effect on PDD and our business as a whole.

Pharmaceutical and biotechnology companies may discontinue or decrease their use of our services and products. We are dependent on pharmaceutical and biotechnology companies continuing to collaborate with outside companies to obtain drug discovery expertise. Our capabilities include aspects of the drug discovery process that pharmaceutical companies have traditionally performed internally. Further, these companies (together with diversified chemical and other industrial companies) comprise the principal market for our Accelrys modeling, simulation, data analysis and related software products and services. Although there is a history among pharmaceutical and biotechnology companies of outsourcing drug research and development functions, this practice may not continue. Similarly, these companies have frequently utilized outside software vendors for key tools used in drug discovery and chemical development, rather than developing needed information and analysis tools internally. Our revenue depends to a large extent on research and development expenditures by the pharmaceutical, biotechnology, and chemical industries, particularly companies in these industries outsourcing research and development projects and adding new and improved technologies to accelerate their drug discovery and chemical development initiatives. The willingness of these companies to expand or continue drug discovery collaborations or outsourcing of services to enhance their research and development activities is based on certain factors that are beyond our control. Examples of relevant factors include customers’ and collaborators’ spending priorities among various types of research activities, their ability to hire and retain qualified scientists, their approach regarding expenditures during recessionary periods, their policies regarding the balance of research expenditures versus cost containment and the benefits of new software tools versus their costs of licensure. Since a large proportion of our software customers license our products on an annual basis or buy maintenance contracts from us annually, if their spending priorities shift, our revenue may be impacted. Also, general economic downturns in our customers’ industries or any decrease in research and development expenditures could harm our operations, as could increased popularity of management theories which counsel against outsourcing of critical business functions. In addition, the popularity of scientific thinking that disfavors expensive products such as large diversity libraries could negatively impact our revenue or our sales mix. Any decrease in drug discovery spending by pharmaceutical and biotechnology companies, or in chemical or materials spending by chemical and industrial companies, could cause our revenue to decline and adversely impact our profitability.

Our ability to increase revenue and grow our business is dependent upon our success in adding new customers and expanding our existing customer relationships. In order to generate

the additional revenue needed to grow, we must add new customers and retain, and expand upon, our existing customer relationships. These efforts depend significantly upon, among other factors:

• our successful development of new products;

• the success of our business development, sales and marketing efforts;

• biotechnology and pharmaceutical company spending for the outsourcing of chemistry and other drug discovery services; and

• the willingness of current and potential biotechnology, pharmaceutical, chemical, petrochemical and diversified technology customers to invest in new modeling, simulation and informatics solutions.

If we are unable to add revenue from additional or expanded customer relationships, we may not be able to grow our business.

Our future profitability is uncertain. We generated losses in 2002, 2003 and the three months ended March 31, 2004. Continuing net losses may limit our ability to fund our operations and we may not generate income from operations in the future. Our future profitability depends upon many factors, including several that are beyond our control. These factors include:

• changes in the demand for our products and services, or for collaborative relationships with PDD;

• the introduction of competitive drug discovery services and software;

• our ability to license desirable technologies;

• changes in the research and development budgets of our customers and potential customers; and

• our ability to successfully, cost effectively and timely develop, introduce and market new collaborative arrangements, products, services and product enhancements.

On a quarterly basis, our future profitability is likely to be highly volatile because, among other reasons, it is impacted by our receipt of milestone payments from our collaborators. We may not receive milestone payments on a regular basis, or at all.

We operate in business lines that change rapidly and in unexpected ways. Rapid technological change and uncertainty due to new and emerging technologies characterize the software, drug discovery and chemical development industries. We may be unable to develop, integrate and market, on a timely basis, the new and enhanced products and services necessary to keep pace with competitors. Our products and services may be rendered obsolete by the offerings of our competitors. Failure to anticipate or to respond to changing technologies, or significant delays in the development or introduction of products or services, could cause customers to delay or decide against purchases of our products or services.

Failure to attract and retain skilled personnel could have a material adverse effect on us. Our success depends in part on the continued service of key scientific, software, sales, business development, engineering and management personnel and our ability to identify, hire and retain additional personnel. There is intense competition for qualified personnel. In particular, we believe that there is a shortage of scientists qualified to work for PDD. The competition among drug discovery and development companies to hire such scientists is particularly intense. Immigration laws may further restrict our ability to attract or hire qualified personnel. We may not be able to continue to attract and retain the personnel necessary for the development of our business. Failure to attract and retain key personnel could have a material adverse effect on our business, financial condition and results of operations. Further, we are highly dependent on the principal members of our scientific and management staff. One or more of these key employees could retire or otherwise leave our employ within the foreseeable future, and the loss of any of

these people could have a material adverse effect on our business, financial condition and results of operations. We are currently conducting a search to hire a chief executive officer of PDD. Dr. Joseph A. Mollica, Ph.D., the former Chairman of the Board, President and Chief Executive Officer of Pharmacopeia, is expected to serve as PDD’s President and Chief Executive Officer until a successor is appointed. We do not, and do not intend to, maintain key person life insurance on the life of any employee.

We are dependent upon some of our suppliers. We currently rely on two suppliers to provide plastic filter bottom microtiter plates that are used in the assay plate preparation process. We have, over the past year, developed a process such that we are not entirely dependent upon these suppliers. Should we be unable, in some instances, to obtain an adequate supply of these or comparable filter bottom plates at commercially reasonable rates, our ability to continue to prepare assay plates could be adversely affected, which in turn could harm our business.

We may be unable to develop strategic relationships with large pharmaceutical, biotechnology, chemical and technology companies. A component of our business strategy is to develop strategic relationships with larger pharmaceutical, biotechnology, chemical and technology companies. We believe that through such relationships we can add revenue, expand our distribution channels, maximize our research and development resources, improve our competitive position and increase market awareness and acceptance of Drug Discovery and scientific software products. To date, we have entered into significant strategic relationships with such companies as Schering-Plough, N.V. Organon, IBM, Oracle and HP. There can be no assurance that any such relationship will continue, that relationships with similar large organizations can be developed, or that any such existing or new alliances will produce substantial revenue or profit opportunities.

We are subject to risks associated with the operation of an international business. In 2003, approximately 53% of the Company’s consolidated revenue was derived from customers outside the United States, both through international subsidiaries and on an export basis. Approximately 36% of our revenue was derived from customers in Europe and approximately 17% was derived from customers in the Asia/Pacific region. We anticipate that international revenue will continue to account for a significant percentage of future overall revenue. Our international operations, particularly at Accelrys, continue to expand, with functions such as software development, sales and customer support increasingly being performed outside the United States. In this connection, we intend to continue the expansion of our development center in Bangalore, India.

Our non-U.S. operations are subject to risks inherent in the conduct of international business, including:

• unexpected changes in regulatory requirements;

• longer payment cycles;

• currency exchange rate fluctuations;

• import and export license requirements;

• tariffs and other barriers;

• political unrest, terrorism and economic instability;

• disruption of our operations due to local labor conditions;

• limited intellectual property protection;

• difficulties in collecting trade receivables;

• difficulties in managing distributors or representatives;

• difficulties in managing an organization spread over various countries;

• difficulties in staffing foreign subsidiary or joint venture operations; and

• potentially adverse tax consequences.

Our success depends, in part, on our ability to anticipate and address these risks. There can be no assurance that these or other factors will not adversely affect our business or operating results.

We may not be able to sustain or increase international revenue. Any of the foregoing factors may have a material adverse effect on our international operations and, therefore, our business, financial condition and results of operations. Our direct international sales generally are denominated in local currencies. Fluctuations in the value of currencies in which we conduct business relative to the United States dollar result in currency transaction gains and losses, and the impact of future exchange rate fluctuations cannot be accurately predicted. Future fluctuations in currency exchange rates may have a material adverse impact on revenue from international sales, and thus on our business, financial condition and results of operations. When deemed appropriate, we may engage in currency exchange rate hedging transactions in an attempt to mitigate the impact of adverse exchange rate fluctuations. However, currency hedging policies may not be successful, and they may increase the negative impact of exchange rate fluctuations.

Investments in Sales and Business Development Efforts. Both Accelrys and PDD products and services involve lengthy sales and business development cycles, often requiring us to expend considerable financial and personnel resources without any assurance that revenue will be recognized. These sales and business development cycles typically are long for a number of reasons. In drug discovery, factors include the strategic nature of drug discovery partnerships, the size of many such transactions, the confidential and proprietary nature of the biological targets against which we screen our chemical compound libraries, and the unique terms typically found in each collaborative transaction. With respect to software sales, sales cycles are impacted by the time and resources required to educate potential customer organizations as to the value and comparative advantages of our products. As a result, we may expend substantial funds and effort to negotiate agreements for collaborative relationships, services and products in both of our business segments, but may ultimately be unable to consummate the related transaction. In these circumstances, our results of operations and ability to achieve profitability are adversely affected.

Consolidation within the pharmaceutical and biotechnology industries may lead to fewer potential customers for our products and services. A significant portion of our customer base consists of pharmaceutical and biotechnology companies. Mergers between large multinational pharmaceutical companies have accelerated in recent years. Continued consolidation within the pharmaceutical and biotechnology industries may result in fewer customers for our products and services. If one of the parties to a consolidation uses the products or services of our competitors, we may lose existing customers as a result of such consolidation.

Our operations may be interrupted by the occurrence of a natural disaster or other catastrophic event at our primary facilities. We depend on our laboratories and equipment for the continued operation of our business. Our research and development operations and administrative functions are primarily conducted at our facilities in the Princeton, New Jersey area, San Diego, California, Cambridge, United Kingdom, and Bangalore, India. Although we have contingency plans in effect for natural disasters or other catastrophic events, catastrophic events could still disrupt our operations. Even though we carry business interruption insurance policies, we may suffer losses as a result of business interruptions that exceed the coverage available under our insurance policies. Any natural disaster or catastrophic event in our facilities or the areas in which they are located could have a significant negative impact on our operations.

Because our stock price may be volatile, our stock price could experience substantial declines. The market price of our common stock has historically experienced and may continue to experience volatility. Our quarterly operating results, changes in general conditions in the economy or the financial markets and other developments affecting us or our competitors could

cause the market price of our common stock to fluctuate substantially. In addition, in recent years, the stock market has experienced significant price and volume fluctuations and, during the past two years, the stock market (and in particular technology companies) has experienced significant decreases in market value. This volatility and the recent market decline has affected the market prices of securities issued by many companies, often for reasons unrelated to their operating performance, and may adversely affect the price of our common stock.

As institutions hold the majority of our Common Stock in large blocks, substantial sales by these stockholders could depress the market price for our shares. As of April 30, 2004, our company’s seven largest stockholders held approximately 58% of our outstanding common stock. As a result, if one or more of these major stockholders were to sell all or a portion of their holdings, or if the market were to perceive that such sale or sales may occur, the market price of our common stock may fall significantly.

Because we do not intend to pay dividends, you will benefit from an investment in our common stock only if it appreciates in value. We have never declared or paid any cash dividends on our common stock. We currently intend to retain our future earnings, if any, to finance the expansion of our business and do not expect to pay any cash dividends in the foreseeable future. As a result, the success of your investment in our common stock will depend entirely upon any future appreciation in its value. There is no guarantee that our common stock will appreciate in value or even maintain the price at which you purchased your shares.

Anti-takeover provisions under the Delaware general corporation law, provisions in our certificate of incorporation and bylaws, and our adoption of a stockholder rights plan may render more difficult the accomplishment of mergers or the assumption of control by a principal stockholder, making more difficult the removal of management. Certain provisions of the Delaware General Corporation Law may delay or deter attempts to secure control of our company without the consent of our management. Also, our governing documents provide for a staggered board of directors, which will make it more difficult for a potential acquirer to gain control of our Board of Directors. In 2002, we adopted a stockholder rights plan, which is triggered upon commencement or announcement of a hostile tender offer or when any one person or group acquires 15% or more of our common stock. The rights plan, once triggered, enables stockholders to purchase our common stock, and the stock of the entity acquiring us, at reduced prices. These provisions of our governing documents and stockholder rights plan, and of Delaware law, could have the effect of delaying, deferring or preventing a change of control including without limitation a proxy contest, making more difficult the acquisition of a substantial block of our common stock. The provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock. Further, the existence of these anti-takeover measures may cause potential bidders to look elsewhere, rather than initiating acquisition discussions with us.

If we consume cash more quickly than expected, we may be unable to raise additional capital and we may be forced to curtail operations. We anticipate that our existing capital resources will be adequate to fund our operations at least through 2005. However, changes may occur that would consume available capital resources before that time. Our capital requirements will depend on numerous factors, including:

• costs associated with software sales;

• costs associated with drug discovery services;

• our internal proprietary drug discovery activities;

• competing technological and market developments;

• changes in our existing collaborative relationships;

• the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights and the outcome of related litigation;

• the purchase of additional capital equipment;

• acquisitions of other businesses or technologies; and

• the progress of our milestone and royalty producing activities.

If we determine that we must raise additional capital, we may attempt to do so through public or private financings involving debt or equity. However, additional capital may not be available on favorable terms, or at all. If adequate funds are not available, we may be required to curtail operations significantly or to obtain funds by entering into arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies, products or potential markets that we would not otherwise relinquish.

If we choose to acquire new and complementary businesses, products or technologies instead of developing them ourselves, we may be unable to complete these acquisitions or to successfully integrate an acquired business or technology in a cost-effective and non-disruptive manner. From time to time, we may choose to acquire complementary businesses, products or technologies instead of developing them ourselves. We do not know if we will be able to complete any acquisitions, or whether we will be able to successfully integrate any acquired businesses, operate them profitably or retain their key employees. Integrating any business, product or technology we acquire could be expensive and time-consuming, disrupt our ongoing business and distract company management. In addition, in order to finance any acquisition, we might need to raise additional funds through public or private equity or debt financings. In that event, we could be forced to obtain financing on less than favorable terms and, in the case of equity financing, that may result in dilution to our stockholders. If we are unable to integrate any acquired entities, products or technologies effectively, our business will suffer. In addition, under certain circumstances, amortization of assets or charges resulting from the costs of acquisitions could harm our business and operating results.

CERTAIN RISKS RELATED TO INTELLECTUAL PROPERTY

Positions taken by the U.S. patent and trademark office or non-U.S. patent and trademark officials may preclude us from obtaining sufficient or timely protection for our intellectual property. The patent positions of pharmaceutical and biotechnology companies are uncertain and involve complex legal and factual questions. The coverage claimed in a patent application can be significantly reduced before the patent is issued. There is a significant risk that the scope of a patent may not be sufficient to prevent third parties from marketing other products or technologies with the same functionality of our products and technologies. Consequently, some or all of our patent applications may not issue into patents, and any issued patents may provide ineffective remedies or be challenged or circumvented.

Third parties may have filed patent applications of which we may or may not have knowledge, and which may adversely affect our business. Patent applications in the U.S. are maintained in secrecy for 18 months from filing or until a patent issues. Under certain circumstances, patent applications are never published but remain in secrecy until issuance. As a result, others may have filed patent applications for products or technology covered by one or more pending patent applications upon which we are relying. There may be third-party patents, patent applications and other intellectual property or information relevant to our software, chemical compositions and other technologies which are not known to us and that block or compete with our software, chemical compositions or other technologies, or limit the scope of patent protection available to us. Moreover, from time to time, patents may issue which block or compete with our software, chemical compositions or other technologies, or limit the scope of patent protection available to us. Litigation may be necessary to enforce patents issued to us or to determine the scope and validity of the intellectual property rights of third parties.

We may not be able to protect adequately the trade secrets and confidential information that we disclose to our employees. We rely upon trade secrets, technical know-how and continuing technological innovation to develop and maintain our competitive position. Competitors through their independent discovery (or improper means, such as unauthorized disclosure or industrial espionage) may come to know our proprietary information. We generally require employees and consultants to execute confidentiality and assignment-of-inventions agreements. These agreements typically provide that all materials and confidential information developed by or made known to the employee or consultant during his, her or its relationship with us are to be kept confidential, and that all inventions arising out of the employee’s or consultant’s relationship with us are our exclusive property. Our employees and consultants may breach these agreements, and in some instances we may not have an adequate remedy. Additionally, in some instances, we may have failed to require that employees and consultants execute confidentiality and assignment-of-inventions agreements.

Foreign laws may not afford us sufficient protections for our intellectual property, and we may not seek patent protection outside the United States. We believe that our success depends, in part, upon our ability to obtain international protection for our intellectual property. However, the laws of some foreign countries may not be as comprehensive as those of the U.S. and may not be sufficient to protect our proprietary rights abroad. In addition, we may decide not to pursue patent protection outside the United States, because of cost and confidentiality concerns. Accordingly, our international competitors could obtain foreign patent protection for, and market overseas, products and technologies for which we are seeking U.S. patent protection.

We may not be able to adequately defend our intellectual property from third party infringement, and third party challenges to our intellectual property may adversely affect our rights and be costly and time consuming. Some of our competitors have, or are affiliated with companies having, substantially greater resources than we have, and those competitors may be able to sustain the costs of complex patent litigation to a greater degree and for longer periods of time than us. Uncertainties resulting from the initiation and continuation of any patent or related litigation could have a material adverse effect on our ability to compete in the marketplace pending resolution of the disputed matters. If our competitors prepare and file patent applications in the United States that claim technology also claimed by us, we may have to participate in interference proceedings declared by the U.S. Patent and Trademark Office to determine the priority of invention, which could result in substantial costs to us, even if the outcome is favorable to us. Similarly, opposition proceedings may occur overseas, which may result in the loss or narrowing of the scope of claims or legal rights. Such proceedings will at least result in delay in the issuance of enforceable claims. An adverse outcome could subject us to significant liabilities to third parties and require us to license disputed rights from third parties or cease using the technology. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In limited instances, we have licensed source codes of certain products to customers or collaborators. For these reasons, policing unauthorized use of our software products may be difficult.

A patent issued to us may not be sufficiently broad to protect adequately our rights in intellectual property to which the patent relates. Even if patents are issued to us, these patents may not sufficiently protect our interest in our software, chemical compositions or other technologies because the scope of protection provided by any patents issued to or licensed by us are subject to the uncertainty inherent in patent law. Third parties may be able to design around these patents or develop unique products providing effects similar to our products. In addition, others may discover uses for our software, chemical compositions or technologies other than those uses covered in our patents, and these other uses may be separately patentable. A number of pharmaceutical and biotechnology companies, software organizations and research and academic

institutions, have developed technologies, filed patent applications or received patents on various technologies that may be related to our business. Some of these technologies, patent applications or patents may conflict with our technologies, patent applications or patents. These conflicts could also limit the scope of patents, if any, that we may be able to obtain, or result in the denial of our patent applications.

We may be subject to claims of infringement by third parties. Third parties may claim infringement by us of their intellectual property rights. In addition, to the extent our employees are involved in research areas similar to those areas in which they were involved at their former employers, we may be subject to claims that one of our employees, or we, have inadvertently or otherwise used or disclosed the alleged trade secrets or other proprietary information of a former employer. From time to time, we have received letters claiming or suggesting that our products or activities may infringe third party patents or other intellectual property rights. Our products may infringe patent or other intellectual property rights of third parties. A number of patents may have been issued or may be issued in the future that could cover certain aspects of our technology and that could prevent us from using technology that we use or expect to use. We may be required to seek licenses for, or otherwise acquire rights to, technology as a result of claims of infringement. We may not possess proper ownership or access rights to the intellectual property we use. Third parties or other companies may bring infringement suits against us. We expect, in general, that software product developers will be subject to more infringement claims as the number of products and competitors in our industry segments grows and the functionality of products in different industry segments overlaps. Any claims, with or without merit, could be time consuming to defend, result in costly litigation, divert management’s attention and resources, cause product shipment delays or require us to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on terms acceptable to us, if at all. In the event of a successful claim of product infringement against us, our failure or inability to license or design around the infringed technology could have a material adverse effect on our business, financial condition and results of operations.

CERTAIN RISKS RELATED TO ACCELRYS

Our ability to increase Accelrys software revenue may depend upon increased market acceptance of our products and services. Accelrys products are currently used primarily by molecular modeling and simulation and gene sequence analyses specialists. Our strategy is to expand usage of our products and services by marketing and distributing our software, in part through our desktop-based products, client-server solutions, and related services to a broader, more diversified group of biologists, chemists, and engineers. If we cannot expand our customer base by selling our desktop-based products, client-server solutions, and related services, we may not be able to increase our software revenue, or such revenue may decline. In general, increased market acceptance and greater market penetration of our software products depend upon several factors, including:

• overall product performance;

• ease of implementation and use;

• accuracy of simulation;

• breadth and integration of product offerings;

• the extent to which users achieve the intended research and development benefits from their use of the products and services; and

• willingness of customers to pay for such use.

Our software products and services may not achieve market acceptance or penetration in their target industries or other industries. Failure to increase market acceptance or penetration may

restrict substantially the future growth of our software business and may have a material adverse effect on our company as a whole.

We may be unable to develop and market new Accelrys products that are necessary to increase revenue. The success of our software business plan depends heavily upon increases in revenue. Our strategy is to increase software revenue in a number of ways, including:

• adding more computational modeling, simulation, and analyses tools to our current portfolio of tools for chemists and biologists;

• offering more informatics solutions that capture and manage the data created by customers’ drug discovery and chemical development activities, including the data created by the use of computational modeling, simulation, and analysis software;

• creating and marketing genomic, biological and/or chemical data content for use in conjunction with the software offered to support customers’ drug discovery activities; and

• developing more knowledge management workflow software to automate the flow of genomic, biological and chemical data and information and project status between and among workgroups and the enterprise.

• Developing enhanced modeling and informatics tools to address the needs of companies engaged in nanotechnology research.

We do not have sufficient historical or comparative sales data to rely upon to indicate that our new products or data content services will achieve the desired level of commercial success.

We face strong competition in the scientific software sector. The market for our software products is intensely competitive, subject to rapid change and significantly affected by new product introductions, pricing strategies and other market activities of industry participants. Competition currently comes from the following principal sources:

• other molecular simulation software packages and software for analysis of chemical and biological data;

• desktop software applications, including chemical drawing, molecular modeling and analytical data simulation applications;

• consulting and outsourcing services;

• other types of simulation software provided to engineers;

• firms supplying databases, such as chemical or genomic information databases, database management systems and information technology; and

• academic and government sponsored institutes focused on nanotechnology.

In addition, some of our software licenses grant the right to sublicense our software. As a result, our software customers and third-party licensees could develop specific simulation applications using our software developer’s kit and compete with us by distributing these programs to our potential customers. Customers or licensees could also develop their own simulation technology or informatics software and cease using our software products and services. Some of our competitors and potential competitors in this sector have longer operating histories than us and have greater financial, technical, marketing, research and development and other resources. Many of our software competitors offer products and services directed at more specific markets than those we target, enabling these competitors to focus a greater proportion of their efforts on these markets. Some offerings that compete with our software products are developed and made available at lower cost by governmental organizations and academic institutions, and these entities may be able to devote substantial resources to product development and also offer their products to users for little or no charge.

Finally, we also face competition from open source software initiatives, in which developers provide software and intellectual property free over the internet.

If we are unable to license software to, or collect receivables from, our early stage biotechnology customers, it may have a material adverse effect on our operating results. We license our modeling, simulation, data analysis and informatics software to smaller, development stage biotechnology customers. Often these customers have limited or no operating history, and require considerable funding to launch their businesses. As we have experienced in recent quarters, they often significantly scale back, or altogether cease, operations. Therefore, there is considerable risk in counting on these types of entities for revenue growth. For entities that remain in business, transactions with these customers carry a higher degree of financial risk. Our customers, particularly our development stage customers, are vulnerable to, and may be impacted by, the current tightening of available credit and capital, and general economic slowdown occurring in the United States and our other key markets. As a result of these conditions, our customers may be unable to license or, if under a license, may be unable to pay for, Accelrys software products. If we are not able to collect such amounts, we may be required to write-off significant accounts receivable and recognize bad debt expense. As a result of the exposures above and other potential exposures, we recorded a provision for doubtful accounts of $1.3 million and $0.4 million in 2002 and 2003, respectively. Failure of these businesses, write-offs and difficulties associated with collection of receivables from these customers, could materially adversely affect our operating results.

Defects or malfunctions in our software products, or in the products of our software technology partners, could hurt our reputation among software customers and expose us to liability. Our software business and the level of customer acceptance of our products depend upon the continuous, effective and reliable operation of our computer software and related tools and functions. Defects could occur in current or future Accelrys products. To the extent that our software malfunctions and our customers’ use of our products is interrupted, our software reputation and business could suffer. We may also be subject to liability for the defects and malfunctions of third party technology partners and others with whom our software products and services are integrated.

Our quarterly operating results in the software business could vary significantly. We have historically experienced stronger financial performance in the third and fourth calendar quarters of each year followed by a comparative decline in the first and second quarters. Quarterly operating results may continue to fluctuate as a result of a number of factors, including lengthy sales cycles, market acceptance of new products and upgrades, timing of new product introductions, changes in pricing policies, changes in general economic and competitive conditions, seasonal slowdowns, and the timing and integration of acquisitions. Additionally, changes in the timing of revenue recognition may result if subscription sales increase. We also expect to continue to experience fluctuations in quarterly operating results due to general and industry specific economic conditions that may affect the research and development expenditures of pharmaceutical and biotechnology companies. Due to the possibility of fluctuations in our revenue and expenses, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance.

CERTAIN RISKS RELATED TO PDD

Our PDD revenue is highly concentrated in its largest collaborators; the termination of the collaborations with certain of PDD’s large collaborators would have a material adverse effect on PDD’s business, financial condition and results of operations. During the year ended December 31, 2003, we earned approximately $5.5 million, or 18.5% of our PDD revenue, and 4.8% of our consolidated revenue, under PDD’s research collaboration agreements with N.V. Organon, its

second largest customer. The principal agreement with Organon, entered into in February 2002, has a stated term of five years; however, Organon has the right to terminate the agreement in 2005 if PDD is unable to deliver compounds meeting the criteria specified in the agreement. We have timely delivered the first compound required under this agreement for inspection and verification by Organon. However, there can be no assurance that these compounds will be compliant, or that future compliant compounds will be delivered before the enumerated dates. The termination of this agreement would have a material adverse effect on PDD, and may have a material adverse effect on our business as a whole.

The development of our products is at an early stage and is uncertain. Drug development is a highly uncertain process. Our approach and technology may never result in a commercial drug. None of our compounds are contained in products that have received regulatory approval for commercial sale, and currently we have only four candidates with respect to which clinical trials (i.e., human testing) have been commenced. All of our therapeutic candidates, including these clinical candidates, are in development, and face the substantial risks of failure inherent in the drug development process. Any potential pharmaceutical product emanating from one of our internal or collaborative programs must satisfy rigorous standards of safety and efficacy before the FDA and foreign regulatory authorities will approve them for commercial use. To satisfy these standards, significant additional research, preclinical studies (i.e., animal testing) and clinical trials will be required. Preclinical and clinical development of drug candidates is a long, expensive and uncertain process. Failure can occur at any stage of testing. Success in preclinical testing does not ensure that clinical trials will be successful. Based on results at any stage of product development, we or our development collaborators may decide to discontinue development of our product candidates.

Our product candidates and research programs are in the early stages of development and require significant, time-consuming and costly research and development, testing and regulatory approvals. We do not expect that our product candidates will be commercially available for many years, if ever. In addition, we pursue the discovery and initial development of product candidates using our integrated technology platform in both our internal and collaborative programs to implement our strategy of reducing the cost and time incurred by the pharmaceutical industry in developing drug candidates. To date, we have not identified a therapeutic candidate that has been developed into a commercial drug using our platform. It is uncertain whether our technology platform will achieve these goals at all or whether it will be competitive with platforms used by our competitors.

We and our collaborators may not be able to successfully develop our existing clinical candidates. Our collaborators, Bristol-Myers Squibb Company, Daiichi Pharmaceutical Co. and Schering-Plough Corporation, currently are performing clinical trials of prospective pharmaceutical products containing our proprietary compounds. In each case, the collaborator is responsible for the development of these potential products as well as the decision as to when, or whether, such development should cease. Numerous additional studies are necessary to support the further development of these product candidates. Results from preclinical studies conducted to date on these product candidates are not necessarily indicative of the results that may be obtained in clinical studies. Results from additional studies could cause our collaborators to discontinue or limit development of these product candidates. There can be no assurance that Bristol-Myers Squibb, Daiichi or Schering-Plough will continue to develop these programs. In addition, our collaborators may pursue alternative technologies or drug candidates, either on their own or in collaboration with others, that compete with our clinical candidates. If our collaborators do not continue their development efforts, we will not receive additional milestone and royalty payments from those efforts.

Disputes may arise between our collaborative partners and us as to royalties and milestones to which we are entitled. The compound basis for drugs developed by a customer may be a derivative or optimized version of the compound screened or optimized by us. While our existing collaborative agreements provide that we will receive milestone payments and royalties with respect to certain products developed from certain derivative compounds, there can be no assurance that disputes will not arise over the application of payment provisions to such products. There can be no assurance that current or future collaborative partners will not pursue alternative technologies, or develop alternative products either on their own or in collaboration with others, including our competitors, as a means for developing treatments based on the targets which are the subject of the collaborative arrangements with us.

Our collaborations and internal programs may not result in the discovery of potential drug candidates that will be safe or effective. Although we have received license and milestone fees to date, we may never receive any royalty payments, or any additional license and milestone fees, under our current or any future collaborations. Our receipt of any future milestone, royalty or license payments depends on many factors, including whether our collaborators desire to or are able to continue to pursue a potential drug candidate and the ultimate commercial success of the drug. Development and commercialization of potential drug candidates depend not only on the achievement of research objectives by us and our collaborators, but also on each collaborator’s financial, competitive, marketing and strategic considerations and regulation in the United States and other countries. If these or unforeseen complications arise in the development or commercialization of the potential drug candidates by our collaborators, we may not realize milestone, royalty or license payments.

The drug research and development industry is highly competitive and subject to technological change, and we may not have the resources necessary to compete successfully. Many of our competitors have access to greater financial, technical, research, marketing, sales, distribution, service and other resources than we do. Moreover, the pharmaceutical and biotechnology industries are characterized by continuous technological innovation. We anticipate that we will face increased competition in the future as new companies enter the market and our competitors make advanced technologies available. Technological advances or entirely different approaches that we or one or more of our competitors develop may render our products, services and expertise obsolete or uneconomical. Additionally, the existing approaches of our competitors or new approaches or technologies that our competitors develop may be more effective than those we develop. We may not be able to compete successfully with existing or future competitors.

In addition, due to improvements in global communications, combined with the supply of lower cost Ph.D. level scientific talent in offshore locations such as China, India and Eastern Europe, we face the growing threat of competition for our services.

If we cannot manage the multiple relationships and interests involved in our collaborative arrangements and drug discovery programs, our business, financial condition and results of operations may be materially adversely affected. We may need to successfully structure and manage multiple drug discovery programs and collaborative relationships, including maintaining confidentiality of the research being performed for multiple customers. We may be unable to manage successfully conflicts between competing drug development programs of third parties to which we offer services. Conflicts also may arise between customers as to proprietary rights to particular compounds in our libraries or as to proprietary rights to biological targets such as receptors or enzymes against which we screen compounds in our libraries. The occurrence of conflicts could have a material adverse effect on our business, financial condition and results of operations.

If we use hazardous materials in a manner that causes injury or violates laws, we may be liable for damages. PDD’s activities involve the use of potentially harmful hazardous materials, chemicals and various radioactive compounds. These materials are utilized in the performance of PDD’s assay development, high throughput screening and chemistry optimization services, and include common organic solvents, such as acetone, hexane, methylene chloride, acetonitrile, and isopropyl and methyl alcohol as well as common acids and bases. The waste from utilization of these solvents and other materials is disposed of through licensed third party contractors. Further, PDD utilizes an extremely wide variety of chemicals in the performance of its assay development, screening and optimization services. These chemicals, such as reagents, buffers and inorganic salts, typically are employed in extremely small amounts in connection with the work performed in its laboratories. We cannot completely eliminate the risk of accidental contamination or injury from the use, storage, handling or disposal of these materials. In the event of contamination or injury, we could be held liable for damages that result. We maintain insurance coverage against environmental hazards arising from the storage and disposal of the materials utilized in our business. Although our management believes that such insurance has terms, including coverage limits, which are appropriate for our business, liabilities arising from the use, storage, handling or disposal of these materials could exceed our insurance coverage as well as our resources. We are subject to federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products. The cost of compliance with these laws and regulations could be significant. To our knowledge, we have not been, and currently are not, the subject of any governmental investigation concerning the violation of these federal, state and local laws and regulations. There can be no assurance that we will not be the subject of future investigations by governmental authorities.

We may not successfully enter into additional collaborations or services agreements that allow us to participate in the future success of our product candidates through milestone, royalty and/or license payments, and we may never receive any milestone royalty and/or license payments under our current or any future collaborations. One of our business strategies is to expand our proprietary pipeline of drug candidates and to then enter into collaborations for the development of these drug candidates that will allow us to earn milestone, royalty and/or license payments. Our proprietary drug discovery program is in its early stage of development and is unproven. Although we have expended, and continue to expend, time and money on internal research and development programs, we may be unsuccessful in creating valuable proprietary drug candidates that would enable us to form additional collaborations and receive milestone, royalty and/or license payments.

Some of the development and marketing activities of PDD are, or will be, conducted by third parties. If these third parties fail to perform their functions satisfactorily, our revenue and earnings from PDD could be delayed, reduced or eliminated. The ultimate success of our business plan for PDD heavily depends upon the successful discovery, development and commercialization of pharmaceutical products. Our drug discovery endeavors will result in commercialized pharmaceutical products, if at all, only after significant preclinical and clinical development, requisite regulatory approvals, establishment of manufacturing capabilities and successful marketing. We do not currently have the technology, facilities, personnel or experience to accomplish all of these tasks on our own, and we will likely not have all the necessary resources in the foreseeable future. Therefore, we continue to depend heavily upon the expertise and dedication of sufficient resources by collaborative partners to develop and commercialize products primarily based on lead compounds discovered by us. If a collaborative partner fails to develop or commercialize a compound or product with respect to which it has rights from us, we may not receive any future milestone payments or royalties associated with that compound or product. Similarly, because we rely heavily on our strategic collaborators, our revenue could be adversely affected if our collaborators:

• fail to select a target or product candidate we have identified for subsequent development;

• fail to gain the requisite regulatory approvals of product candidates;

• do not successfully commercialize products based on the compounds that we originate;

• do not conduct their collaborative activities in a timely manner;

• do not devote sufficient time or resources to our partnered programs or potential products;

• terminate their alliances or arrangements with us;

• develop, either alone or with others, products that may compete with our product candidates;

• dispute our respective allocations of rights to any products or technology developed during our collaborations; or

• merge with or are acquired by a third party that may wish to terminate our collaboration.

There may be only a limited market for PDD’s drug discovery services. The pricing and nature of PDD’s drug discovery services are such that there may only be a limited number of potential customers for these services. The acceptance by potential customers of our services is important in determining revenue. Historically, pharmaceutical companies have conducted lead compound identification and optimization within their own research departments due to the highly proprietary nature of the activities being conducted, the central importance of these activities to their drug discovery and development efforts, and the desire to obtain maximum patent and other proprietary protection on the results of their internal programs. In order to achieve our business objectives for PDD, we must convince these companies that our technology and expertise justify the outsourcing of these programs to us. There can be no assurance that we will be able to attract customers on acceptable terms for our products and services or to develop a sustainable profitable business. Moreover, the pricing and nature of our combinatorial libraries is such that there may only be a limited number of pharmaceutical companies that are potential customers for such libraries. There can be no assurance that we will be able to establish additional collaborative or licensing arrangements, that any such arrangements or licenses will be on terms favorable to us, or that current or future collaborative or licensing arrangements will ultimately be successful.

SHOULD ONE OR MORE OF THE ABOVE-DESCRIBED RISKS OR UNCERTAINTIES MATERIALIZE, OR SHOULD THE UNDERLYING ASSUMPTIONS PROVE INCORRECT, OUR ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE ANTICIPATED.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company is exposed to various market risks consisting primarily of changes in foreign currency exchange rates. The Company’s international sales generally are denominated in local currencies. In the quarter ended March 31, 2004, approximately 54% of the Company’s consolidated revenue was derived from customers outside the United States (including 36% from customers in Europe and 18% from customers in the Asia/Pacific region). As such, the Company’s exchange rate risk is greatest for Dollar/Euro and Dollar/Yen fluctuations. When deemed appropriate, the Company engages in exchange rate-hedging transactions in an attempt to mitigate the impact of adverse exchange rate fluctuations. At March 31, 2004, the Company had no hedging transactions in effect.

The Company does not use derivative financial instruments for trading or speculative purposes. However, the Company regularly invests excess cash in overnight repurchase agreements that are subject to changes in short-term interest rates. The Company believes that the market risk arising from holding these financial instruments is minimal.

The Company’s exposure to market risks associated with changes in interest rates relates primarily to the increase or decrease in the amount of interest income earned on its investment portfolio since the Company has minimal debt. The Company ensures the safety and preservation of invested funds by limiting default risks, market risk, and reinvestment risk. The Company mitigates default risk by investing in investment grade securities. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of the Company’s interest sensitive financial instruments at March 31, 2004.

Item 4. Controls and Procedures

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of March 31, 2004. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2004. There were no material changes in the Company’s internal control over financial reporting during the transition period from January 1, 2004 through March 31, 2004.

PART II - OTHER INFORMATION

Item 1.		Legal Proceedings

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

Item 2.		Changes in Securities and Use of Proceeds - None

Item 3.		Defaults upon Senior Securities – None

Item 4.		Submission of Matters to a Vote of Security Holders - None

Item 5.		Other Information – None

Item 6.		Exhibits and Reports on Form 8-K

		(a) Exhibits – See Exhibit Index

		(b) Reports on Form 8-K

(i) Current report on Form 8-K filed February 9, 2004 reporting that a press release was issued and a conference call was held regarding the Company’s financial results for 2003.

(ii) Current report on Form 8-K filed February 27, 2004 reporting a change to the Company’s ticker symbol.

SIGNATURE

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, thereunto duly authorized.

	ACCELRYS, INC.

	By:	/s/John J. Hanlon

		John J. Hanlon
		Executive Vice President and
		Chief Financial Officer (Duly Authorized Officer and Chief Financial Officer)

		Date: May 10, 2004

PHARMACOPEIA, INC.

INDEX TO EXHIBITS

No.		EXHIBIT

31.1		Section 302 Certification of the Principal Executive Officer

31.2		Section 302 Certification of the Principal Financial Officer

32.1		Section 906 Certification of the Chief Executive Officer

32.2		Section 906 Certification of the Chief Financial Officer