ACCELRYS, INC.

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2004

or

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

For the transition period from to

Commission File Number: 0-27118

ACCELRYS, 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, California		92121-1761
(Address of principal executive offices)		(Zip code)

(858) 799-5000

(Registrant’s telephone number, including area code)

Not applicable

(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 October 29, 2004
Common Stock, $.0001 par value		26,508,671 shares

PART I - FINANCIAL INFORMATION

Item 1. Unaudited Consolidated Financial Statements

Accelrys, Inc.

Consolidated Balance Sheets

(Dollars and share amounts in thousands)

	September 30, 2004			December 31, 2003
	(unaudited)			(note 1)
ASSETS
Current assets:
Cash and cash equivalents	$	19,935		$	26,985
Restricted cash	7,133			—
Marketable securities	39,584			106,546
Trade receivables, net of allowance for doubtful accounts of $219 and $505, respectively	11,804			39,780
Prepaid expenses and other current assets	6,182			4,197
Current assets of discontinued operations	—			3,994
Total current assets	84,638			181,502

Property and equipment, net	7,908			8,441
Goodwill	37,809			34,072
Intangible assets	16,300			—
Software development costs, net of accumulated amortization of $29,123 and $26,555, respectively	7,766			7,634
Other assets	852			960
Long-term assets of discontinued operations	—			7,058
Total assets	$	155,273		$	239,667

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,229		$	1,850
Accrued liabilities	16,984			18,819
Deferred revenue, current portion	25,978			24,595
Current liabilities of discontinued operations	—			6,420
Total current liabilities	44,191			51,684

Deferred revenue, long-term	3,541			4,924
Lease guarantee, long-term	682			—
Long-term liabilities of discontinued operations	—			325

Stockholders’ equity:
Preferred stock, $.0001 par value, 2,000 shares authorized, none issued and outstanding	—			—
Common stock, $.0001 par value, 40,000 shares authorized, 26,508 and 24,949 shares issued, respectively	2			2
Additional paid-in capital	252,640			287,592
Unearned compensation	(1,920		)	(536		)
Lease guarantee	(730		)	—
Treasury stock, 644 shares	(8,340		)	(8,340		)
Accumulated deficit	(135,344		)	(97,318		)
Accumulated comprehensive income	551			1,334
Total stockholders’ equity	106,859			182,734
Total liabilities and stockholders’ equity	$	155,273		$	239,667

See accompanying notes to these unaudited consolidated financial statements.

Accelrys, Inc.

Consolidated Statements of Operations

(Dollars in thousands, except per share data, unaudited)

	For the Three Months Ended September 30,						For the Six Months Ended September 30,
	2004			2003			2004			2003

Revenue	$	14,277		$	17,675		$	28,458		$	36,765
Cost of revenue	3,137			5,156			6,923			10,170
Gross margin	11,140			12,519			21,535			26,595

Research and development	4,382			4,222			8,505			8,808
Sales and marketing	7,471			7,170			15,240			16,127
General and administrative	3,680			4,214			7,689			8,689
Write-off of in-process research and development	700			—			700			—
Total operating costs and expenses	16,233			15,606			32,134			33,624
Operating loss from continuing operations	(5,093		)	(3,087		)	(10,599		)	(7,029		)
Interest and other income, net	489			1,194			1,074			2,093
Loss from continuing operations before provision for income taxes	(4,604		)	(1,893		)	(9,525		)	(4,936		)
Provision for income taxes	479			215			614			591
Loss from continuing operations	(5,083		)	(2,108		)	(10,139		)	(5,527		)
Discontinued operations:
Loss from discontinued operations	—			(27		)	(1,117		)	(370		)
Net loss	$	(5,083	)	$	(2,135	)	$	(11,256	)	$	(5,897	)

Loss from continuing operations per share:
- Basic and diluted	$	(0.21	)	$	(0.09	)	$	(0.42	)	$	(0.23	)

Loss from discontinued operations per share:
- Basic and diluted	$	—		$	(0.00	)	$	(0.05	)	$	(0.02	)

Net loss per share:
- Basic and diluted	$	(0.21	)	$	(0.09	)	$	(0.46	)	$	(0.25	)

Weighted average shares of common stock outstanding:
- Basic and diluted	24,463			23,813			24,393			23,760

See accompanying notes to these unaudited consolidated financial statements.

Accelrys, Inc.

Consolidated Statements of Cash Flows

(Dollars in thousands)

	For the Six Months Ended September 30,
	2004			2003
OPERATING ACTIVITIES:
Net loss	$	(11,256	)	$	(5,897	)
Adjustments to reconcile net loss to net cash provided by operating activities
Depreciation	2,221			2,216
Amortization	1,683			2,792
Write-off in-process research and development	700			—
Contribution of stock to 401(k) members	179			514
Amortization of unearned compensation	292			—
Non-cash compensation	—			20
Changes in assets and liabilities:
Trade receivables	(139		)	583
Prepaid expenses and other current assets	(1,730		)	2
Other assets	(14		)	(80		)
Accounts payable	(4,468		)	159
Accrued liabilities	(952		)	1,249
Deferred revenue	(214		)	(4,812		)
Net cash used by operating activities	(13,698		)	(3,254		)
INVESTING ACTIVITIES:
Capital expenditures	(1,818		)	(1,896		)
Increase in capitalized software development costs	(1,716		)	(2,168		)
Acquisition of business, net of cash acquired	(10,471		)	—
Purchases of marketable securities	(40,226		)	(41,466		)
Proceeds from sales of marketable securities	94,840			41,103
Net cash provided/(used) in investing activities	40,609			(4,427		)
FINANCING ACTIVITIES:
Proceeds from issuance of common stock	1,326			1,093
Principal payments on leases payable	—			(6		)
Net cash provided by financing activities	1,326			1,087
Exchange rate effect on cash and cash equivalents	(273		)	190
Net cash used in discontinued operations	(47,733		)	(787		)
Net decrease in cash and cash equivalents	(19,769		)	(7,191		)
Cash and cash equivalents, beginning of period	39,704			31,579
Cash and cash equivalents, end of period	$	19,935		$	24,388

SUPPLEMENTAL INFORMATION:
Cash paid during the period for:
Interest expense	$	3		$	—
Income tax expense	$	232		$	136

See accompanying notes to these unaudited consolidated financial statements.

Notes to Unaudited Consolidated Financial Statements

1. Basis of Presentation

The accompanying unaudited consolidated 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 (under our former name Pharmacopeia, Inc.) 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.

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. The operations, financial position and cash flows of PDD have been represented as discontinued operations in the accompanying financial statements.

On May 11, 2004, the Company’s shareholders approved the change of the Company’s name to Accelrys, Inc. from Pharmacopeia, Inc.

2. Business Combinations

On September 27, 2004, the Company acquired 100 percent of the outstanding common shares of SciTegic, Inc. (SciTegic). The results of SciTegic’s operations have been included in the consolidated financial statements since that date. SciTegic is a leading provider of workflow software solutions for the research science market. The primary reason for the acquisition was to complement the Company’s existing product offerings.

The aggregate purchase price was $20.4 million including $12.9 million of cash and common stock valued at $7.5 million. The value of the 1,166,218 common shares issued was determined based on the average market price of Accelrys’ common shares over the period including two days before and after the terms of the acquisition were agreed to and announced.

Pursuant to the terms of the merger agreement, $3.2 million in cash and $2.1 million in stock is held in escrow accounts. A portion of the cash escrow will be released to the former SciTegic stockholders subject to the settlement of an ongoing negotiation with a SciTegic distributor. The remaining cash escrow will be released September 27, 2005. The stock held in escrow will be released in four semi-annual installments to former SciTegic stockholders upon the condition that the two founders of SciTegic remain employees of Accelrys through the period.

The value of the shares held in escrow relates to the continued employment of the two founders of SciTegic and therefore resulted in deferred compensation of $1.3 million as of September 30, 2004. Additionally, the Company converted SciTegic employees’ unvested stock options into unvested options in the Company resulting in deferred compensation of $0.2 million as of September 30, 2004.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. Accelrys is in the process of obtaining the final third-party valuations of certain intangible assets; thus, the allocation of the purchase price is considered preliminary and subject to refinement.

At September 27, 2004 (in thousands)
Current assets		$		3,471
Property and equipment		163
Research and development assets		700
Other long-term assets		21
Intangible assets not subject to amortization -
Trademark/Tradename		3,800
Intangible assets subject to amortization -
Developed Technology (seven year useful life)	6,000
Customer Relationships (ten year useful life)	5,400
Backlog (two and one-half year useful life)	800
Contract based (seven year useful life)	300
		12,500
Goodwill		4,237
Total assets acquired		24,892

Current liabilities		(2,297			)
Deferred revenue		(2,172			)
Long-term liabilities		(15			)
Total liabilities acquired		(4,484			)

Net assets acquired		$	20,408

The $0.7 million assigned to research and development assets were written off at the date of acquisition in accordance with FASB Interpretation No.4, Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method. Those write-offs are included in the Statement of Operations as a separate line item.

Of the $4.2 million assigned to goodwill, there will be no deduction for tax purposes as this was a stock acquisition.

Assuming the acquisition had occurred on April 1 of the following respective years, the pro forma consolidated results of operations would be as follows (in thousands, except per share amounts):

	For the Three Months Ended September 30,						For the Six Months Ended September 30,
	2004			2003			2004			2003

Total revenue	$	16,221		$	19,160		$	32,272		$	39,675
Net loss	556		)	(2,145		)	(11,500		)	(6,081		)

Net loss per share:
Basic and diluted	$	(0.23	)	$	(0.09	)	$	(0.47	)	$	(0.26	)

3. 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.

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 September 30,								Six Months Ended September 30,
	2004				2003				2004			2003
Net loss:
As reported	$	(5,083		)	$	(2,135		)	$	(11,256	)	$		(5,897	)
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects	(1,736			)	(3,091			)	(4,032		)	(6,192			)
Pro forma	$	(6,819		)	$	(5,226		)	$	(15,288	)	$	(12,089		)
Basic and diluted net loss per common share:
As reported	$		(0.21	)	$		(0.09	)	$	(0.46	)	$	(0.25		)
Pro forma	$		(0.28	)	$		(0.22	)	$	(0.63	)	$	(0.51		)

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	69.76	%	86.49	%
Risk-free interest rate	3.35	%	3.74	%
Expected life (years)	3.8		6.5

5. Restructuring

During the third quarter of 2002, the Company announced that it was undertaking various

actions to restructure its operations to improve its overall financial performance. As of September 30, 2004 the remaining obligation under this restructuring was related to a closure of a facility. The following table summarizes the activity and balance of the restructuring liability during the quarter ended September 30, 2004 (dollars in thousands):

	Costs to Exit Lease Obligations
Balance at June 30, 2004	$	1,040
Utilization of Reserves:
Cash	(59		)
Balance at September 30, 2004	$	981

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 reducing general and administrative costs. The restructuring effort included a reduction in force of 73 Accelrys employees, of which all had been communicated to by March 31, 2004 and terminated as of June 28, 2004. As a result, restructuring related charges of approximately $2.8 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 September 30, 2004 (dollars in thousands):

	Severance Cost for Involuntary Employee Terminations
Balance at June 30, 2004	$	89
Ultization of Reserves:
Cash	(76		)
Balance at September 30, 2004	$	13

6. 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 the Company’s stockholders of a dividend of one share of PDD common stock for every two shares of Accelrys common stock. The Company has received an opinion of counsel that the transaction qualified 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 and incurred costs of approximately $2.3 million which were accrued at March 31, 2004, and the majority of which were paid during the six months ended September 30, 2004. For the one-month period ended April 30, 2004, the discontinued PDD operations had revenue of $1.3 million and a pretax loss of $(1.1) million.

7. Guarantee

On April 30, 2004, the landlords of the New Jersey facilities related to the PDD operations consented to the assignment of the leases to PDD. Despite the assignment, the landlords required Accelrys to guarantee the remaining lease obligations representing approximately $32.2 million in future payments through April 2016. The probability weighted fair market value of this guarantee was calculated in accordance with Financial Accounting Standard Board Interpretation No. 46 (FIN 46) “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” and resulted in a remaining liability of $0.7 million in short- and long-term liabilities as of September 30, 2004.

8. Restricted Cash

At September 30, 2004, the Company has a restricted cash balance of $7.1 million consisting of two separate accounts. During the June 2004 quarter, the Company signed a nine-year sublease agreement for corporate facilities in San Diego. Under the terms of the sublease, the Company was required to place $6.6 million in a restricted cash account to ensure performance under the sublease agreement. The cash restriction decreases over the term of the sublease agreement.

Additionally, $0.5 million of cash is restricted under the transition services agreement with PDD in which the Company agreed to provide certain infrastructure to PDD over a one-year term. At the end of the term, any remaining cash will be released back to Accelrys.

9. Income Taxes

The Company accounts for income taxes using the liability method. Under the liability method, deferred income taxes are recognized for the tax consequences of “temporary differences” by applying enacted statutory tax rates applicable to future years to differences between the financial carrying amounts and the tax basis of existing assets and liabilities. The provision for income taxes is based on the Company’s estimates for taxable income of the various legal entities and jurisdictions used in which it operates.

10. Variable Interest Entity

In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (FIN 46). In December 2003, the FASB modified FIN 46 to make certain technical corrections and address certain implementation issues that had arisen. FIN 46 provides a new framework for identifying variable interest entities (VIEs) and determining when a company should include the assets, liabilities, noncontrolling interest and results of activities of a VIE in its consolidated financial statements.

In general, a VIE is a corporation, partnership, limited-liability corporation, trust, or any other legal structure used to conduct activities or hold assets that either (1) has an insufficient amount of equity to carry out its principal activities without additional subordinated financial support, (2) has a group of equity owners that are unable to make significant decisions about its activities, or (3) has a group of equity owners that do not have the obligation to absorb losses or the right to receive returns generated by its operations.

FIN 46 requires a VIE to be consolidated if a party with an ownership, contractual or other financial interest in the VIE (a variable interest holder) is obligated to absorb a majority of the risk of loss from the VIE’s activities, is entitled to receive a majority of the VIE’s residual returns (if no party absorbs a majority of the VIE’s losses), or both. A variable interest holder that consolidates the VIE is called the primary beneficiary. Upon consolidation, the primary beneficiary generally must initially record all of the VIE’s assets, liabilities and noncontrolling interest at fair value and subsequently account for the VIE as if it were consolidated based on majority voting interest. FIN 46 also requires disclosures about VIE’s that the variable interest holder is not required to consolidate but in which it has a significant variable interest.

FIN 46 was effective immediately for VIE’s created after January 31, 2003. The provisions of FIN 46, as revised, were adopted as of December 31, 2003, for the Company’s interest in all VIE’s. In October 2004, the FASB revised FIN 46 to include rabbi trusts as a VIE since the

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

The following discussion and analysis of our financial condition and results of operations 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 our 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 us and our 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. Examples of forward-looking statements herein include statements regarding the launch of our Nanotechnology Consortium, our capital requirements, and capital resources. 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 our management, such statements can only be based on facts and factors currently known by us. 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. We undertake 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 Report describes 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.

BUSINESS OVERVIEW

We are a leading provider of software for computation, simulation, and the management and mining of scientific data used by biologists, chemists and materials scientists, including nanotechnology researchers, for product design as well as drug discovery and development. Our technology and services are designed to meet the needs of today’s leading research organizations.

On April 30, 2004, we spun off our drug discovery subsidiary, Pharmacopeia Drug Discovery, Inc. (“PDD”), which integrates 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 our stockholders of a dividend of one share of PDD common stock for every two shares of Accelrys common stock.

software solutions for the research science market. The primary reason for the acquisition was to complement the Company’s existing product offerings.

As of September 30, 2004, we employed approximately 570 employees. We are headquartered in San Diego, California.

RESULTS OF OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003

	For the Three Months Ended September 30,
	2004			**		2003			**		Percent Change
Revenue	$	14,277		100	%	$	17,675		100	%	-19	%
Cost of revenue	3,137			22	%	5,156			29	%	-39	%
Gross Margin	11,140			78	%	12,519			71	%	-11	%

Research and development	4,382			31	%	4,222			24	%	4	%
Sales and marketing	7,471			52	%	7,170			41	%	4	%
General and administrative	3,680			26	%	4,214			24	%	-13	%
Write-off of in-process research and development	700			5	%	—			0	%	100	%
Total operating costs and expenses	16,233			114	%	15,606			88	%	4	%
Operating loss from continuing operations	(5,093		)	-36	%	(3,087		)	-17	%	65	%
Interest and other income, net	489			3	%	1,194			7	%	-59	%
Loss from continuing operations before provision for income taxes	(4,604		)	-32	%	(1,893		)	-11	%	143	%
Provision for income taxes	479			3	%	215			1	%	123	%
Loss from continuing operations	(5,083		)	-36	%	(2,108		)	-12	%	141	%
Discontinued operations:
Loss from Discontinued Operations	—			0	%	(27		)	0	%	-100	%
Net Loss	$	(5,083	)	-36	%	$	(2,135	)	-12	%	138	%

** Line items expressed as a percent of revenue in the respective periods.

Revenue decreased 19% to $14.3 million in the quarter ended September 30, 2004 compared to $17.7 million reported in the quarter ended September 30, 2003. The decrease in revenue was attributed principally to the transition to subscription accounting for annual and multi-year licenses. In January 2004 we began offering a new license to our customers which requires subscription accounting. Under this new license, revenue is recognized ratably over the license term. This contrasts with our previous annual license offering, whereby we recognized 64% of the license revenue in the quarter in which the license was executed and amortized the other 36% of the revenue over the remaining term of the contract to reflect the costs of post-sales support. Under this new license, the unrecognized revenue, amortized over the remaining term of the agreement, will be accounted for as “deferred revenue” on the balance sheet. The Company also licenses its software on perpetual licenses whereby we recognize 85% of the license revenue in the quarter in which the license is executed and amortize the remaining 15% of the revenue over the term of the maintenance agreement.

Cost of revenue was 39% lower at $3.1 million in the quarter ended September 30, 2004 compared to $5.2 million in the quarter ended September 30, 2003. Lower royalties, client service costs and documentation and shipping costs were offset by higher amortization of previously capitalized software development costs. In addition, $0.7 million of amortization expense related to purchased technology was recorded in the 2003 quarter.

Research and development expenses were 4% higher in the September 2004 quarter at $4.4 million when compared to the $4.2 million recorded in the quarter ended September 30, 2003. Lower personnel-related costs were offset by lower capitalization of software development costs. Additionally, in the quarter ended September 30, 2003 about $0.6 million of expenses were allocated from research and development to client service costs in cost of revenue as developers were involved in revenue generating activities. In the September 2004 quarter the amount allocated was minor. We have now staffed the pre- and post- sales support department to reduce the need of requiring developers in the fulfillment of revenue generating service opportunities.

Research and development expense consists primarily of the employment-related costs of personnel associated with developing new software products, enhancing existing products, testing and developing product documentation. 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 products that have not yet been released.

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

	Three Months Ended September 30,
	2004			2003			% Change
Research and development:
Gross software development costs	$	5.1		$	5.2		-2	%
Capitalized software development costs	(0.7		)	(1.0		)	-27	%
Total research and development costs	$	4.4		$	4.2		4	%

Sales and marketing expenses increased by 4% to $7.5 million in the quarter ended September 30, 2004 compared to $7.2 million in the quarter ended September 30, 2003. Lower marketing expenses were offset by higher sales commissions and the expenses related to our New Business Development Group which was established during calendar 2004.

General and administrative expenses decreased 13% to $3.7 million in the quarter ended September 30, 2004 compared to $4.2 million recorded in the quarter ended September 30, 2003. The decrease in general and administrative is due to lower head-count and lower corporate charges as a result of the spin-off of PDD.

Write-off of in-process research and development costs. As a result of the valuation of the assets acquired in the acquisition of SciTegic on September 27, 2004, we recorded a write-off of $0.7 million related to the portion of the purchase price allocated to in-process research and development.

Net interest and other income was $489 thousand in the quarter ended September 30, 2004 compared to $1.2 million in the quarter ended September 30, 2003. The decrease is due to lower average investment balances as the Company made a capital contribution to PDD under the terms of the spin-off agreement at April 30, 2004.

The provision for income tax expense was $0.5 million in the quarter ended September 30, 2004 compared to $0.2 million recorded in the quarter ended September 30, 2003. The increase resulted from relatively higher income recognized in foreign jurisdictions.

A loss from discontinued operations of ($0.3) million was recorded in the quarter ended September 30, 2003 representing the net of revenues and expenses at PDD for such period. Since the spin-off was consummated on April 30, 2004, no amount of discontinued operations was realized in the quarter ended September 30, 2004.

A net loss of ($5.1) million or ($.21) per share was reported for the quarter ended September 30, 2004 compared to a net loss of ($2.1) million or ($.09) per share reported in the quarter ended September 30, 2003. The results for the quarter ended June 30, 2003 included a net loss from discontinued operations at PDD operations of $(0.3) million or ($.00) per share.

SIX MONTHS ENDED SEPTEMBER 30, 2004 AND 2003

	For the Six Months Ended September 30,
	2004				**		2003			**		Percent Change

Revenue	$		28,458		100	%	$	36,765		100	%	-23	%
Cost of revenue	6,923				24	%	10,170			28	%	-32	%
Gross Margin	21,535				76	%	26,595			72	%	-19	%

Research and development	8,505				30	%	8,808			24	%	-3	%
Sales and marketing	15,240				54	%	16,127			44	%	-6	%
General and administrative	7,689				27	%	8,689			24	%	-12	%
Write-off of in-process research and development	700				2	%	—			0	%	100	%
Total operating costs and expenses	32,134				113	%	33,624			91	%	-4	%
Operating loss from continuing operations	(10,599			)	-37	%	(7,029		)	-19	%	51	%
Interest and other income, net	1,074				4	%	2,093			6	%	-49	%
Loss from continuing operations before provision for income taxes	(9,525			)	-33	%	(4,936		)	-13	%	93	%
Provision for income taxes	614				2	%	591			2	%	4	%
Loss from continuing operations	(10,139			)	-36	%	(5,527		)	-15	%	83	%
Discontinued operations:
Loss from Discontinued Operations	(1,117			)	-4	%	(370		)	-1	%	202	%
Net Loss	$	(11,256		)	-40	%	$	(5,897	)	-16	%	91	%

** Line items expressed as a percent of revenue in the respective periods.

Revenue for the six months ended September 30, 2004 was 23% lower at $28.5 million compared to revenue of $36.8 million reported in the six months ended September 30, 2003. The decrease in revenue was attributed principally to the effects of transitioning from up-front revenue recognition to subscription revenue accounting as a result of contractual changes made to our licensing agreement and to lower orders. In addition about $0.7 million of revenue from consortia was recognized in the 2003 period while no comparable revenue was recognized in 2004 although we launched the Nanotechnology Consortium on July 1, 2004. Revenue from this new consortium is expected to be realized in future periods. Revenue from consulting was lower if the six months ended September 30, 2004 when compared to the six months ended September 30, 2003.

. In January 2004 we began offering a new license to our customers which requires subscription accounting. Under this new license, revenue is recognized ratably over the license term. This contrasts with our previous annual license offering, whereby we recognized 64% of the license revenue in the quarter in which the license was executed and amortized the other 36% of the revenue over the remaining term of the contract to reflect the costs of post-sales support. Under this new license, the unrecognized revenue, amortized over the remaining term of the agreement, will be accounted for as “deferred revenue” on the balance sheet. The Company also

licenses its software on perpetual licenses whereby we recognize 85% of the license revenue in the quarter in which the license is executed and amortize the remaining 15% of the revenue over the term of the maintenance agreement.

Cost of revenue was 32% lower at $6.9 million for the six months ended September 30, 2004 compared to $10.2 million in the six months ended September 30, 2003. Lower royalties, client service costs and documentation and shipping costs were offset by higher amortization of previously capitalized software development costs. In addition, $1.6 million of amortization expense related to purchased technology was recorded in the 2003 while none was recorded in 2004.

Research and development expenses were 3% lower in the six months ended September, 30 2004 at $8.5 million compared to the $8.8 million recorded in the six months ended September 30, 2003. Lower personnel-related costs were offset by lower capitalization of software development costs. Additionally, in the quarter ended September 30, 2003 about $1.1 million of expenses was allocated from research and development to client service costs in cost of revenue as developers were involved in revenue generating activities. During the six months ended September 30, 2004 the amount allocated was about $0.1 million. We have now staffed the pre- and post- sales support department to reduce the need of requiring developers in the fulfillment of revenue generating service opportunities.

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

	Six Months Ended June 30, 2004
	2004			2003			% Change
Research and development:
Gross software development costs	$	10.2		$	10.9		-7	%
Capitalized software development costs	(1.7		)	(2.1		)	-20	%
Total research and development costs	$	8.5		$	8.8		-3	%

Sales and marketing expenses decreased by 6% to $15.2 million in the six months ended September 30, 2004 compared to $16.2 million in the six months ended September 30, 2003. Lower sales and marketing expenses were slightly offset by the expenses related to our New Business Development Group which was established during calendar 2004.

General and administrative expenses decreased 12% to $7.7 million in the six months ended September 30, 2004 compared to $8.7 million recorded in the six months ended September 30, 2003. The decrease in general and administrative is due to lower head-count and lower corporate charges as a result of the spin-off of PDD.

Write-off of in-process research and development costs. As a result of the valuation of the assets acquired in the acquisition of SciTegic in September 2004, we recorded a write-off of $0.7

million related to the portion of the purchase price allocated to in-process research and development.

Net interest and other income was $1.1 million in the six month period ended September 30, 2004 compared to $2.1 million in the six months ended September 30, 2003. The decrease is due to lower average investment balances as we made a capital contribution to PDD under the terms of the spin-off agreement at April 30, 2004.

The provision for income tax expense was virtually flat at $0.6 million in the six months ended September 30, 2004 compared to $0.6 million in the six months ended September 30, 2003.

A loss from discontinued operations of ($1.1) million was recorded in the six months ended September 30, 2004 representing the net of revenues and expenses at PDD for such period. For the six months ended September 30, 2003 the loss was ($0.4) million.

A net loss of ($11.3) million or ($.46) per share was reported for the six months ended September 30, 2004 compared to a net loss of ($5.9) million or ($.25) per share reported in the same period ended September 30, 2003. In 2004 and 2003 the net loss included the losses from discontinued operations discussed above representing ($0.05) and ($0.02) per share, respectively.

LIQUIDITY AND CAPITAL RESOURCES

We have funded our activities to date primarily through the sale of equity securities, software licenses, software maintenance and related services and interest income. Also, prior to the spin-off of PDD, funding was provided through the sale of drug discovery services. As of September 30, 2004, we had cash, restricted cash, cash equivalents, and marketable securities of $66.7 million compared to $141.6 million as of March 31, 2004. On April 30, 2004, we made a capital contribution to PDD of $46.5 million in cash and securities and incurred costs of approximately $2.3 million which were accrued at March 31, 2004 and the majority of which were paid during the six months ended June 30, 2004. On September 27, 2004, we paid $10.5 million in cash as part of the total purchase price of $20.4 million for the acquisition of SciTegic.

Cash used in operations increased by $10.4 million in the six months ended September 30, 2004 compared to the six months ended September 30, 2003. The increase is primarily attributable to an increased loss, payments made under the January 2004 restructuring plan and payments made pursuant to the spin-off of PDD, as referred to above. Cash provided by investing activities increased by $45.0 million in the six months ended September 30, 2004 compared to the six months ended September 30, 2003 due to the sale of marketable securities to fund the capital contribution to the PDD business under the contractual agreements of the spin-off and cash paid for the acquisition of SciTegic. Cash provided by financing activities increased by $0.2 million in the six months ended June 30, 2004 compared to the six months ended June 30, 2003 due to option exercises.

The following summarizes our long-term contractual obligations as of March 31, 2004 (in thousands). This table has been updated from our most recently filed Report on Form 10-Q to include the effects of the assignment of the PDD leases to PDD, the guarantee of the PDD leases and the corporate facility lease in San Diego.

	Payments Due by Period
Contractual Obligations	Total		Less than 1 Year		1 to 3 Years		4 to 5 Years		After 5 Years

Operating leases	$	47,579	$	3,909	$	7,979	$	7,580	$	28,111

Total	$	47,579	$	3,909	$	7,979	$	7,580	$	28,111

We anticipate that our 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. Our capital requirements may also increase in future periods as we seek to expand our technology platform through investments, licensing arrangements, technology alliances, or acquisitions.

We anticipate that our existing capital resources will be adequate to fund our operations at least through the next twelve months. However, there can be no assurance that changes will not occur that might consume available capital resources before then. Our capital requirements depend on numerous factors, including our ability to continue to generate software sales, competing technological and market developments, 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, and acquisitions of other businesses or technologies. There can be no assurance that additional funding, if necessary, will be available on favorable terms, if at all. Our forecast of the period of time through which our financial resources will be adequate to support our operations are forward looking information, and actual results could vary. The factors described earlier in this paragraph will impact our future capital requirements and the adequacy of our 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 OUR BUSINESS

Our future profitability is uncertain. We generated losses in the twelve months ended 2001, 2002, 2003, the three months ended March 31, 2004 and the six months ended September 30, 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 without limitation:

• changes in the demand for our products and services,;

• the introduction of competitive 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 products, services and product enhancements.

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. We currently face competition 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 and resources 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.

We are subject to pricing pressures in the markets we serve. In response to competition and general adverse economic conditions in the markets we serve, we may be required to modify our pricing practices. This development may adversely affect our revenue and earnings. We generally license our software products and services on a “right to use” basis pursuant to licenses over a specified period of time or in perpetuity. Changes in our pricing model or any other future broadly-based changes to our prices and pricing policies could lead to a decline or delay in revenue as our sales force and customers adjust to the new pricing policies.

Our investments in sales and business development efforts may not result in additional sales of our products and services. Our 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. Software 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, but may ultimately be unable to consummate the related transaction. Under such circumstances, our results of operations and ability to achieve profitability will be adversely affected.

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 for at least the next twelve months. 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;

• 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; and

• acquisitions of other businesses or technologies.

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.

Our quarterly operating results 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.

Our ability to increase our software revenue may depend upon increased market acceptance of our products and services. Our products are currently used primarily by molecular modeling and simulation 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 of our products and services 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 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 scientists, including chemists, biologists, and materials scientists

• 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; 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; and

• 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. As a result, we may not be able to increase revenue.

Delays in release of new or enhanced software products or services or undetected errors in our software products or services may result in increased cost to us, delayed market acceptance of our products and delayed or lost revenue. To achieve market acceptance, new or enhanced software products or services can require long development and testing periods, which may result in delays in scheduled introduction. Any delays in the release schedule for new or enhanced software products or services may delay market acceptance of these products or services and may result in delays in new customer orders for these new or enhanced software products or services or the loss of customer orders. In addition, new or enhanced software products or services may contain a number of undetected errors or “bugs” when they are first released. As a result, in the months following the introduction of certain releases, we generally devote significant resources to correct these errors. There can be no assurance, however, that all of these errors can be corrected. Although we test each new or enhanced software product or service before being released to the market, there can be no assurance that significant errors will not be found in existing or future releases.

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 adversely impacted by, the tightening of available credit and capital during periods of contraction affecting 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 payments, we may be required to write-off significant accounts receivable and recognize bad debt expense. As a result of these types of exposures 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 and adversely affect our operating results.

We will need to achieve commercial acceptance of our products and services in the nanotechnology industry to obtain significant product revenue from that industry. We intend to develop and sell our products and services to companies in the nanotechnology industry. We do not know when a market for nanotechnology-enabled products will develop, if at all, and we cannot reasonably estimate the projected size of any market that may develop. In addition, nanotechnology-enabled products may achieve some degree of market acceptance in one industry but may not achieve market acceptance in other industries for which we are developing products. If the markets we are targeting fail to accept nanotechnology-enabled products or to determine that other products were superior, we may not be able to achieve commercial acceptance of our products and services. Even if our potential products achieve commercial acceptance, if the size of the potential markets for our products is not sufficient, we will be unable to generate significant revenue from the nanotechnology industry.

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 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.

Pharmaceutical, biotechnology and industrial chemical companies may discontinue or decrease their use of our services and products. We are dependent on pharmaceutical and biotechnology companies. 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. In addition, 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 adding new and improved technologies to accelerate their drug discovery and chemical development initiatives. The willingness of these companies to expand or continue is dependent on 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 customers’ research and development expenditures could harm our operations.

Health care reform and restrictions on reimbursement may affect the ability of pharmaceutical, biotechnology and industrial chemical companies to purchase or license our software products or services, which may affect our results of operations and financial condition. The continuing efforts of government and third party payers in our markets to contain or reduce the cost of health care may reduce the profitability of pharmaceutical, biotechnology and industrial chemical companies causing them to reduce research and development expenditures upon which we depend to see our products and services, and potentially significantly reducing our revenues. We cannot predict what actions federal, state or private

payers for health care goods and services may take in response to any health care reform proposals or legislation.

Our sales forecast and/or revenue projections may not be accurate. We use a “pipeline” system, a common industry practice, to forecast sales and trends in our business. Our sales personnel monitor the status of proposals, including the date when they estimate a customer will make a purchase decision and the potential size of the order. We aggregate these estimates on a quarterly basis in order to generate a sales pipeline. While the pipeline process provides us with some guidance in business planning and forecasting, it is based on estimates only and is therefore subject to risks and uncertainties. Any variation in the conversion of the pipeline into revenue or the pipeline itself could cause us to improperly plan or budget and thereby adversely affect our business, results of operations and financial condition.

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. 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 do not intend to maintain key person life insurance on the life of any employee.

We may be unable to develop strategic relationships with large technology companies. A component of our business strategy is to develop strategic relationships with larger 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 scientific software products. To date, we have entered into significant strategic relationships with such companies as 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.

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.

There can be no assurance as to the effect of the Scitegic acquisition or future acquisitions on our business or operating results. From time to time, we may acquire other companies that would be complementary to our business. Acquisitions may result in potentially dilutive issuances of equity securities, incurrence of debt and contingent liabilities, amortization expenses related to intangible assets and the possible impairment of goodwill, which could harm our profitability. In addition, acquisitions involve numerous risks, including, among other things: higher than estimated acquisition expenses; difficulties in successfully assimilating the operations, technologies and personnel of the acquired company; diversion of management’s attention from other business concerns; risks of entering markets in which we have no or limited direct prior experience; and the potential loss of key employees and customers as a result of the acquisition. In this regard, in September 2004, we acquired Scitegic, Inc., a privately held company providing workflow software solutions for the research science market. Pursuant to this transaction, Scitegic shareholders received approximately $12.9 million of cash and up to 1,166,218 shares of Accelrys common stock in exchange for their Scitegic shares, and up to 334,324 additional Accelrys common shares over the next two years subject to certain conditions. There can be no assurance as to the effect of the Scitegic acquisition or future acquisitions on our business or operating results.

Recently enacted and proposed changes in securities laws and regulations are likely to increase our costs. The Sarbanes-Oxley Act of 2002 (“SOX”) requires changes in some of our corporate governance and securities disclosure or compliance practices. The Securities and Exchange Commission (the “SEC”) has promulgated new rules on a variety of subjects and Nasdaq has issued revisions to its requirements for companies that are Nasdaq-listed. In June 2003 the SEC adopted certain rules as directed by Section 404 of SOX. These rules require that publicly held companies, including us, include in their annual report to shareholders a report of management on our internal controls over financial reporting. Our independent auditors will be required to attest to management’s assessment of internal controls over financial reporting. We will be required to comply with this new requirement in our annual report for the year ending March 31, 2005. If our financial reporting controls are not deemed effective, there will be an adverse impact on our reputation that could negatively impact our stock price.

We also expect compliance with SOX to increase our corporate governance, legal and accounting costs. We also expect SOX and the related SEC and Nasdaq compliance rules to make it more difficult and expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These laws and regulations could make it more difficult for us to attract and retain qualified members of our board of directors, or qualified executive officers. We continually evaluate and monitor regulatory developments and cannot estimate the timing or magnitude of additional costs we may incur as a result.

We are subject to risks associated with the operation of an international business. For the six months ended September 30, 2004, approximately 54% of the Company’s consolidated revenue was derived from customers outside the United States, both through international subsidiaries and on an export basis. Approximately 27% of our revenue was derived from customers in Europe and approximately 27% 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 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 we would do so effectively, or 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.

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. 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.

We expect that our stock price will fluctuate significantly, and you may not be able to resell your shares at or above your investment price. The stock market, particularly in recent years, has experienced significant volatility and in particular with technology company stocks. The volatility of technology company stocks often does not relate to the operating performance of the companies represented by the stock. Factors that could cause this volatility in the market price of our common stock include without limitation:

• market conditions in the technology and software sectors and issuance of new or changed securities analysts’ reports or recommendations;

• actual and anticipated fluctuations in our quarterly financial and operating results;

• developments or disputes concerning our intellectual property or other proprietary rights;

• introduction of technological innovations or new commercial products by us or our competitors;

• market acceptance of our products and services; and

• additions or departures of key personnel.

These and other external factors may cause the market price and demand for our common stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of common stock and may otherwise negatively affect the liquidity of our common stock. In addition, in the past, when the market price of a stock has been volatile, holders of that stock have instituted securities class action litigation against the company that issued the stock. If any of our stockholders brought a lawsuit against us, we could incur substantial costs defending the lawsuit. Such a lawsuit could also divert the time and attention of our management.

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 October 2004, the top ten institutional holders of our common stock held approximately 70% 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, our stockholders will benefit from an investment in our common stock only if our stock price 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.

Our operations may be interrupted by the occurrence of a natural disaster or other catastrophic event at our primary facilities. Our research and development operations and administrative functions are primarily conducted at our facilities in 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.

Our insurance coverage may not be sufficient to avoid impacts on our financial position or results of operations resulting from claims or liabilities against us, and we may not be able to obtain insurance coverage in the future. We maintain insurance coverage for protection against many risks of liability. The extent of our insurance coverage is under continuous review and is modified as we deem it necessary. Despite this insurance, it is possible that claims or liabilities against us may have a material adverse impact on our financial position or results of operations. We may not be able to obtain any insurance coverage, or adequate insurance coverage, when our existing insurance coverage expires.

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 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 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 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 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 THE SPIN-OFF OF PDD

There can be no assurance that Accelrys will be successful on a stand-alone basis. Our Board of Directors approved the plan to separate the Accelrys and PDD businesses through the spin-off to our stockholders of 100% of the outstanding shares of common stock of PDD which was completed on April 30, 2004. The transaction resulted in PDD being an independent, publicly-traded company. Following the spin-off, we not been able to rely on the financial and other resources and the cash flows generated from the combined Accelrys and PDD operations. Previously, we operated our businesses as part of a broader corporate organization rather than as a stand-alone company. Historically, certain corporate functions had been centralized for PDD and Accelrys. As a result of disengaging the PDD operations from our business, it has been difficult for us to accurately forecast our future operating performance

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 with respect to the indebtedness, liabilities and obligations that will be retained by our respective companies. One such obligation includes 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.

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

We are exposed to various market risks including changes in foreign currency exchange rates. The Company’s international sales generally are denominated in local currencies. For the six months ended September 30, 2004, approximately 54% of our consolidated revenue was derived from customers outside the United States (including 27% from customers in Europe and 27% from customers in the Asia/Pacific region). As such, our exchange rate risk is greatest for Dollar/Euro and Dollar/Yen fluctuations. When deemed appropriate, we engage in exchange rate-hedging transactions in an attempt to mitigate the impact of adverse exchange rate fluctuations. At September 30, 2004, we had no such hedging transactions in effect.

We do not use derivative financial instruments for trading or speculative purposes. However, we regularly invest excess cash in money markets and time deposits that are subject to changes in short-term interest rates. We believe that the market risk arising from holding these financial instruments is minimal.

Because we have minimal debt, our exposure to market risks associated with changes in interest rates arise from increases or decreases in interest income earned on our investment portfolio. We ensure the safety and preservation of invested funds by limiting default risks, market risk, and reinvestment risk. We mitigate default risk by investing in investment grade securities. A hypothetical 100 basis point decrease 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 September 30, 2004.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2004. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

We are currently undergoing a comprehensive effort to comply with Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX”). Compliance is required as of March 31, 2005. The compliance process has included the following:

1. Define project scope,

2. Perform entity level assessment,

3. Identify significant accounts and related processes,

4. Document processes, transactions and controls,

5. Test and evaluate design and operating effectiveness of controls, and

6. Identify control deficiencies and implement improvements.

As of September 30, 2004, we have completed the first three items and we are in the process of completing the fourth item. As of September 30, 2004, we have not discovered any internal control deficiencies that we would consider a material weakness. There is no assurance that internal control problems will not emerge from future testing or that we will be able to comply with the requirements of Section 404 by the March 31, 2005 deadline.

Changes in Internal Control over Financial Reporting. There were no material changes in our internal controls over financial reporting during the quarter ended September 30, 2004.

Accelrys, Inc. and Subsidiaries

Exhibit Index

3.1		Restated Certificate of Incorporation of the Registrant (incorporated by Reference to Exhibit 3.1 to the Company’s Report on Form 10-K for the year ended December 31, 1996).
3.3		Bylaws of the Registrant, as amended (incorporated by Reference to Exhibit 3.3 to the Company’s Report on Form 10-K for the year ended December 31, 1996).
3.3(a)		Amendment to Bylaws of the Registrant dated July 31, 1997 (incorporated by Reference to Exhibit 3.3(a) to the Company’s Report on Form 10-Q for the quarter ended September 30, 1997).
3.3(b)		Amendment to Bylaws of the Registrant dated January 17, 2002 (incorporated by Reference to Exhibit 3.3(b) to the Company’s Report on Form 10-K for the year ended December 31, 2001).
4.1		Rights Agreement, dated as of September 6, 2002, between Pharmacopeia, Inc. and American Stock Transfer & Trust Company, as Rights Agent, which includes as Exhibit A thereto the Certificate of Designations, Preferences and Rights of Series A Junior Participating Preferred Stock and Exhibit B thereto the Form of Right Certificate (incorporated by Reference to Exhibit 4.1 to the Company’s Report on Form 8-K dated September 4, 2002).
10.1#		Amended 1994 Incentive Stock Plan (incorporated by Reference to Exhibit 10.5 to the Company’s Report on Form 10-K for the year ended December 31, 1995 (File Number 000-27188)).
10.1(a)#		Amendment No. 1 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.1(a) to the Company’s Report on Form 10-K for the year ended December 31, 2000).
10.1(b)#		Amendment No. 2 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.1(b) to the Company’s Report on Form 10-K for the year ended December 31, 2000).
10.1(c)#		Amendment No. 3 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.5(a) to the Company’s Report on Form 10-Q for the quarter ended June 30, 1997).
10.1(d)#		Amendment No. 4 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.1(d) to the Company’s Report on Form 10-K for the year ended December 31, 2000).
10.1(e)#		Amendment No. 5 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.1(e) to the Company’s Report on Form 10-K for the year ended December 31, 2000).
10.1(f)#		Amendment No. 6 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.1(f) to the Company’s Report on Form 10-K for the year ended December 31, 2000).
10.1(g)#		Amendment No. 7 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.1(g) to the Company’s Report on Form 10-K for the year ended December 31, 2000).
10.1(h)#		Amendment No. 8 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.54 to the Company’s Report on Form 10-Q for the quarter ended June 30, 2000).
10.1(i)#		Amendment No. 9 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.1(i) to the Company’s Report on Form 10-Q for the quarter ended March 31, 2002).
10.2#		1995 Employee Stock Purchase Plan (incorporated by Reference to Exhibit 10.6 to the Company’s Registration Statement on Form S-1 (Reg. No. 33-98246)).
10.2(a)#		Amendment No. 1 to the Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.2(a) to the Company’s Report on Form 10-Q for the quarter ended March 31, 2001).
10.3#		1995 Director Option Plan (incorporated by reference to Exhibit 10.7 to the Company’s Registration Statement on Form S-1 (Reg. No. 33-98246)).
10.3(a)#		Amendment No. 1 to 1995 Director Option Plan (incorporated by reference to Exhibit 10.3(a) to the Company’s report on form 10-K for the year ended December 31, 2000).
10.3(b)#		Amendment No. 2 to the 1995 Director Option Plan (incorporated by reference to Exhibit 10.3(b) to the Company’s report on Form 10-Q for the quarter ended March 31, 2001).

10.4		Lease Agreement between Pharmacopeia and Eastpark at 8A (incorporated by Reference to Exhibit 10.13 to the Company’s Registration Statement on Form S-1 (Reg. No. 33-98246)).
10.4(a)		Amendment dated as of January 22, 1996 to Lease Agreement between Pharmacopeia and Eastpark at 8A (incorporated by reference to Exhibit 10.13(a) to the Company’s Report on Form 10-K for the year ended December 31, 1995 (File Number 000-27188)).
10.4(b)		Third Amendment to Lease Agreement dated March 31, 1996 between Pharmacopeia and Eastpark at 8A (incorporated by reference to Exhibit 10.13(b) to the Company’s Report on Form 10-Q for the quarter ended June 30, 1996).
10.5#		Employment Agreement dated as of February 26, 2001 between the Company and Joseph A. Mollica, Ph.D. (incorporated by reference to the Company’s Report on form 10-K for the year ended December 31, 2000).
10.5(a)#		Amendment, effective as of May 1, 2003, to employment agreement between
		the Company and Joseph A. Mollica, Ph.D. (incorporated by reference to exhibit 10.9(a) to the Company’s report on Form 10-Q for the quarter ended March 31, 2003.)
10.6		Lease dated November 12, 1998 between Molecular Simulations Inc. and San Diego Tech Center, LLC (incorporated by reference to Exhibit 10.47 to the Company’s Report on Form 10-K for the year ended December 31, 1998).
10.7#		Form of Indemnity Agreement for Directors and Executive Officers (incorporated by reference to Exhibit 10.48 to the Company’s Report on Form 10-K for the year ended December 31, 1998).
10.8		Lease Agreement, dated May 1, 1999, between Pharmacopeia and South Brunswick Rental I, LTD (incorporated by reference to Exhibit 10.49 to the Company’s Report on Form 10-Q for the quarter ended June 30, 1999).
10.9#		Pharmacopeia, Inc. 2000 Stock Option Plan (incorporated by reference to the Company’s Report on form 10-K for the year ended December 31, 2000).
10.10#		Pharmacopeia, Inc. Executive Non-Qualified Deferred Compensation Plan (incorporated by reference to Exhibit 10.52 to the Company’s Report on Form 10-Q for the quarter ended March 31, 2000).
10.11		Form of Stock Purchase Agreement, dated as of March 8, 2000, among the company and the investors set forth therein (incorporated by reference to Exhibit 10.53 to the Company’s Report on Form 10-Q for the quarter ended March 31, 2000.)
10.12		Employment Agreement dated May 1, 2001 between the Company and Michael R. Stapleton. (incorporated by reference to the Company’s Report on form 10-Q for the quarter ended September 30, 2001).
10.12(a)#		Separation Agreement and Release of Claims dated September 30, 2002, by and between Pharmacopeia, Inc. and Michael R. Stapleton (incorporated by reference to Exhibit 10.28 to the Company’s Report on Form 10-K for the year ended December 31, 2003).
10.13		Lease Agreement dated July 29, 2001 among the Masters, Fellows and Scholars of Trinity College, Cambridge, Accelrys Limited, and Accelrys Inc. and Trinity College (CJP) Limited (incorporated by reference to the Company’s Report on form 10-Q for the quarter ended September 30, 2001).
10.14#		Employment Agreement dated December 3, 2002 by and between Pharmacopeia, Inc. and Mark J. Emkjer (incorporated by reference to Exhibit 10.28 to the Company’s Report on Form 10-K for the year ended December 31, 2003).
10.15		Lease, dated August 20, 2003, between Pharmacopeia, Inc. and Eastpark at 8A (Building 1000) (incorporated by reference to the Company’s report on form 10-Q for the quarter ended September 30, 2003)
10.16		Lease, dated August 20, 2003, between Pharmacopeia, Inc. and Eastpark at 8A (Building 3000) (incorporated by reference to the Company’s report on form 10-Q for the quarter ended September 30, 2003)
10.17*		Accelrys, Inc. 2004 New-Hire Equity Incentive Plan
31.1*		Section 302 Certification of the Principal Executive Officer
31.2*		Section 302 Certification of the Principal Financial Officer
32*		Section 906 Certification of the Chief Executive Officer and Chief Financial Officer

+ Confidential treatment granted.

++ Confidential treatment requested.

# Represents a management contract or compensatory plan or arrangement.

* Filed herewith

Item 1.	Legal Proceedings –
	We are not currently subject to any material pending legal proceedings. However, we may become subject to other lawsuits from time to time in the ordinary course of our business, and any such lawsuit could harm our business.

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds –
	In connection with the closing of our acquisition of SciTegic, Inc. on September 27, 2004, 1,040,119 shares of common stock were issued by us to SciTegic shareholders and up to an additional 334,324 shares of common stock may be issued by us to SciTegic shareholders, subject to the continued employment of two of SciTegic’s key employees in accordance with the terms of their employment agreements with us. The shares of common stock were issued pursuant to Regulation D and Regulation S under the Securities Act of 1933, as amended.

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- see Exibit Index attached

	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: November 9, 2004

Item		Page

PART I. FINANCIAL INFORMATION

Item 1.	Unaudited Consolidated Financial Statements:

	Balance Sheets – September 30, 2004 and December 31, 2003	3

	Statements of Operations – Three and Six Months Ended September 30, 2004 and 2003; Six Months Ended September 30, 2004 and 2003	4

	Statements of Cash Flows – Six Months Ended September 30, 2004 and 2003	5

	Notes to Unaudited Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	30

Item 4.	Controls and Procedures	30

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	31

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	31

Item 3.	Defaults Upon Senior Securities	31

Item 4.	Submission of Matters to a Vote of Security Holders	31

Item 5.	Other Information	31

Item 6.	Exhibits	31

Signature		32

Exhibit Index		33

For the transition period from to

ACCELRYS, INC.

Table of Contents

PART I - FINANCIAL INFORMATION

Consolidated Statements of Operations

Accelrys, Inc.

RESULTS OF OPERATIONS