**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

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**FORM10-Q**

| **x**                                             |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------|
| ** **                                        |   | ** **                                                                                              |
| **For the  quarterly period ended June 30, 2007** |
| ** **                                        |
| **OR**                                            |
| ** **                                        |
| **o**                                             |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition periodfrom            to**

**Commission File Number: 0-27188**

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**ACCELRYS, INC.**

**(Exact name of registrant as specified in its charter)**

| **Delaware**                                               |   | **33-0557266**                        |
|------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of                           |   | (I.R.S. Employer  Identification No.) |
| incorporation or  organization)                            |   |                                  |
|                                                       |   |                                  |
| **10188  Telesis Court, Suite 100, San Diego, California** |   | **92121-4779**                        |
| (Address of  principal executive offices)                  |   | (Zip Code)                            |

 

**(858) 799-5000**

(Registrant’stelephone number, including area code)

Indicate by checkmark whether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes x   No o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large acceleratedfiler o   Acceleratedfiler x   Non-accelerated filer o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

Yeso   No x

The number of outstanding shares of the registrant’scommon stock, par value $0.0001 per share, as of July 20, 2007 was 26,669,631,net of treasury shares.

 

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**ACCELRYS, INC.**

**FORM 10-Q— QUARTERLY REPORT**

**For TheQuarterly Period Ended June 30, 2007**

**Tableof Contents**
| **PART I — FINANCIAL  INFORMATION** |
|------------------------------------------|
| Item 1.                                  | Condensed  Consolidated Financial Statements |   |
|                                     | Condensed  consolidated balance sheets as of June 30, 2007 (unaudited) and March 31,  2007 |   |
|                                     | Condensed  consolidated statements of operations (unaudited) for the three-month periods  ended June 30, 2007 and 2006 |   |
|                                     | Condensed  consolidated statements of cash flows (unaudited) for the three-month periods  ended   June 30, 2007 and 2006 |   |
|                                     | Notes to  condensed consolidated financial statements (unaudited) |   |
| Item 2.                                  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
| Item 3.                                  | Quantitative  and Qualitative Disclosures About Market Risk |   |
| Item 4.                                  | Controls and  Procedures |   |
| **PART II — OTHER  INFORMATION**    |   |
| Item  1A.                                | Risk  Factors |   |
| Item  6.                                 | Exhibits |   |
| **Signature**                            |   |   |

 

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**PARTI — FINANCIAL INFORMATION**

**Item 1.Condensed Consolidated Financial Statements**

**Accelrys, Inc.**

**CondensedConsolidated Balance Sheets**

**(Inthousands, except per share amounts)**
| ** **                                                                                                                                         | ** ** | **June 30,  2007** | ** ** | **March 31,  2007** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                         | ** ** | ** **              | ** ** | ** **               | ** ** |
| **Assets**                                                                                                                                         | ** ** | ** **              | ** ** | ** **               | ** ** |
| Current assets:                                                                                                                                    |       |                    |       |                     |       |
| Cash and cash  equivalents                                                                                                                         |       | $                       | 37,275     |                     | $          | 33,247 |   |
| Marketable  securities                                                                                                                             |       | 23,154                  |       | 29,322                   |       |
| Trade  receivables, net of allowance for doubtful accounts of $214 and $213 as of  June 30, 2007 and March 31, 2007, respectively             |       | 10,074                  |       | 18,617                   |       |
| Prepaid  expenses, deferred tax assets and other current assets                                                                                    |       | 4,304                   |       | 8,652                    |       |
| Total current assets                                                                                                                               |       | 74,807                  |       | 89,838                   |       |
| Restricted cash and  marketable securities                                                                                                         |       | 8,233                   |       | 8,188                    |       |
| Property and equipment,  net                                                                                                                       |       | 5,670                   |       | 6,049                    |       |
| Goodwill                                                                                                                                           |       | 42,663                  |       | 42,663                   |       |
| Purchased intangible  assets, net                                                                                                                  |       | 6,756                   |       | 7,138                    |       |
| Other assets                                                                                                                                       |       | 546                     |       | 725                      |       |
| Total assets                                                                                                                                       |       | $                       | 138,675    |                     | $          | 154,601 |   |
| **Liabilities and stockholders’  equity**                                                                                                     | ** ** | ** **              | ** ** | ** **               | ** ** |
| Current liabilities:                                                                                                                               |       |                    |       |                     |       |
| Accounts payable                                                                                                                                   |       | $                       | 810        |                     | $          | 1,199 |   |
| Accrued  liabilities                                                                                                                               |       | 3,852                   |       | 10,911                   |       |
| Accrued  compensation and benefits                                                                                                                 |       | 5,600                   |       | 8,353                    |       |
| Current portion  of accrued restructuring charges                                                                                                  |       | 527                     |       | 673                      |       |
| Current portion  of deferred revenue                                                                                                               |       | 45,002                  |       | 53,218                   |       |
| Total current  liabilities                                                                                                                         |       | 55,791                  |       | 74,354                   |       |
| Deferred revenue, net  of current portion                                                                                                          |       | 2,138                   |       | 2,915                    |       |
| Deferred tax liability                                                                                                                             |       | 633                     |       | 505                      |       |
| Accrued restructuring  charges, net of current portion                                                                                             |       | 1,468                   |       | 1,371                    |       |
| Lease-related  liabilities, net of current portion                                                                                                 |       | 6,356                   |       | 6,466                    |       |
| Stockholders’ equity:                                                                                                                         |       |                    |       |                     |       |
| Preferred stock,  $.0001 par value; 2,000 shares authorized; no shares issued and outstanding                                                 |       | —                  |       | —                   |       |
| Common stock,  $.0001 par value; 40,000 shares authorized; 27,314 and 27,155 shares issued  at June 30, 2007 and March 31, 2007, respectively |       | 3                       |       | 3                        |       |
| Additional  paid-in capital                                                                                                                        |       | 260,623                 |       | 259,435                  |       |
| Lease guarantee                                                                                                                                    |       | (556                    | )          | (572                     | )          |
| Treasury stock;  644 shares at each of June 30, 2007 and March 31, 2007                                                                       |       | (8,340                  | )          | (8,340                   | )          |
| Accumulated  deficit                                                                                                                               |       | (180,555                | )          | (182,681                 | )          |
| Accumulated  other comprehensive income                                                                                                            |       | 1,114                   |       | 1,145                    |       |
| Total stockholders’  equity                                                                                                                   |       | 72,289                  |       | 68,990                   |       |
| Total liabilities and stockholders’ equity                                                                                                    |       | $                       | 138,675    |                     | $          | 154,601 |   |

 

Seeaccompanying notes to these condensed consolidated financial statements.

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**Accelrys, Inc.**

**CondensedConsolidated Statements of Operations**

**(In thousands, except per shareamounts)**

**(Unaudited)**
| ** **                                                            | ** ** | **Three Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                            | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| ** **                                                            | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Revenue                                                               |       | $                                                   | 20,101     |   | $ | 20,150 |   |
| Cost of revenue                                                       |       | 3,507                                               |       | 3,656 |   |
| Gross margin                                                          |       | 16,594                                              |       | 16,494 |   |
|                                                                  |       |                                                |       |   |   |
| Operating  expenses:                                                  |       |                                                |       |   |   |
| Product development                                                   |       | 4,309                                               |       | 5,126 |   |
| Sales and marketing                                                   |       | 7,540                                               |       | 7,066 |   |
| General and administrative                                            |       | 3,915                                               |       | 4,718 |   |
| Total operating  expenses                                             |       | 15,764                                              |       | 16,910 |   |
| Operating income  (loss)                                              |       | 830                                                 |       | (416 | ) |
| Interest and  other income, net                                       |       | 992                                                 |       | 484 |   |
| Income before  taxes                                                  |       | 1,822                                               |       | 68 |   |
| Income tax  expense                                                   |       | 403                                                 |       | 397 |   |
| Net income  (loss)                                                    |       | $                                                   | 1,419      |   | $ | (329 | ) |
|                                                                  |       |                                                |       |   |   |
| Basic and diluted  net income (loss) per share amounts                |       | $                                                   | 0.05       |   | $ | (0.01 | ) |
| Weighted average  shares used to compute net income (loss) per share: |       |                                                |       |   |   |
| Basic                                                                 |       | 26,552                                              |       | 26,208 |   |
| Diluted                                                               |       | 26,884                                              |       | 26,208 |   |

 

See accompanying notes to these condensed consolidatedfinancial statements.

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**Accelrys, Inc.Condensed Consolidated Statements of Cash Flows**

**(In thousands)**

**(Unaudited)**
| ** **                                                                            | ** ** | **Three Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| ** **                                                                            | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| **Cash  flows from operating activities:**                                            | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net income (loss)                                                                     |       | $                                                   | 1,419      |   | $ | (329 | ) |
| Adjustments to reconcile net income (loss) to net  cash used in operating activities: |       |                                                |       |   |   |
| Depreciation                                                                          |       | 596                                                 |       | 820 |   |
| Amortization of purchased intangible assets                                           |       | 381                                                 |       | 384 |   |
| Non-cash stock-based compensation                                                     |       | 903                                                 |       | 1,009 |   |
| Deferred income taxes                                                                 |       | (384                                                | )          | 63 |   |
| Other                                                                                 |       | (86                                                 | )          | 406 |   |
| Changes in operating assets and liabilities:                                          |       |                                                |       |   |   |
| Trade receivables                                                                     |       | 8,412                                               |       | 4,855 |   |
| Prepaid expenses and other current assets                                             |       | (367                                                | )          | (619 | ) |
| Other assets                                                                          |       | 27                                                  |       | (937 | ) |
| Accounts payable                                                                      |       | (423                                                | )          | (588 | ) |
| Accrued liabilities                                                                   |       | (3,736                                              | )          | (2,178 | ) |
| Deferred revenue                                                                      |       | (8,679                                              | )          | (7,820 | ) |
| Net cash used in operating activities                                                 |       | (1,937                                              | )          | (4,934 | ) |
| **Cash  flows from investing activities:**                                            | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Purchases of property and equipment, net                                              |       | (183                                                | )          | (156 | ) |
| Purchases of marketable securities                                                    |       | (2,635                                              | )          | (16,757 | ) |
| Proceeds from maturities of marketable securities                                     |       | 8,850                                               |       | 13,800 |   |
| Net cash provided by (used in) investing activities                                   |       | 6,032                                               |       | (3,113 | ) |
| **Cash  flows from financing activities:**                                            | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Proceeds from issuance of common stock                                                |       | 325                                                 |       | 311 |   |
| Net cash provided by financing activities                                             |       | 325                                                 |       | 311 |   |
| Effect of changes in exchange rates on cash and cash  equivalents                     |       | (392                                                | )          | 917 |   |
| Increase (decrease) in cash and cash equivalents                                      |       | 4,028                                               |       | (6,819 | ) |
| Cash and cash equivalents at beginning of period                                      |       | 33,247                                              |       | 24,656 |   |
| Cash and cash  equivalents at end of period                                           |       | $                                                   | 37,275     |   | $ | 17,837 |   |

 

See accompanying notes to these condensed consolidatedfinancial statements.

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**Accelrys, Inc.**

**Notes to Condensed ConsolidatedFinancial Statements**

**1.****                       Basisof Presentation and Significant Accounting Policies**

*FinancialStatement Preparation*

Thecondensed consolidated financial statements of Accelrys, Inc. (“we”, “our”, or “us”)as of June 30, 2007, and for thethree months ended June 30, 2007and 2006 are unaudited. We have condensed or omitted certain information anddisclosures normally included in financial statements presented in accordancewith accounting principles generally accepted in the United States. We believethe disclosures made are adequate to make the information presented notmisleading. However, you should read these condensed consolidated financialstatements in conjunction with the consolidated financial statements and notesthereto included in our Annual Report on Form 10-K for the fiscal year endedMarch 31, 2007.

Inthe opinion of management, these condensed consolidated financial statementsinclude all adjustments, consisting of normal recurring adjustments, necessaryfor a fair presentation of results for the interim periods presented.

Ourbusiness is subject to seasonal variations. Historically, we have received approximately two-thirds of our annualcustomer orders in the second half of our fiscal year. In accordance with ourrevenue recognition policies, the revenue associated with these orders isgenerally recognized over the contractual license term. Therefore, because weaccrue sales commissions and royalties upon the invoicing of customer orders,we have historically experienced an increase in operating costs and expensesduring the second half of our fiscal year. Additionally, our cash flows fromoperations have historically been positive in the fiscal quarter ended March 31as we collect the accounts receivable generated from these customer orders,while we have historically experienced negative cash flows from operations inthe other three fiscal quarters. As a result of these and other seasonalvariations, we believe that quarter-to-quarter comparisons of our operatingresults are not a good indication of our future performance and that theinterim financial results for the periods presented in this quarterly reportare not necessarily indicative of results for a full year or for any subsequentinterim period.

*Principlesof Consolidation*

Theaccompanying unaudited condensed consolidated financial statements include theaccounts of our wholly-owned subsidiaries. All material intercompany accountsand transactions have been eliminated in consolidation.

*Reclassifications*

Certain amounts in thepreviously reported financial statements have been reclassified to conform tothe current period presentation.

*Use ofEstimates*

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires us to make estimates andassumptions that affect the amounts reported in the financial statements andaccompanying notes. On an on-going basis, we evaluate our estimates, includingthose related to revenue recognition, stock-based compensation, income taxesand the valuation of goodwill, intangibles and other long-lived assets. We baseour estimates on historical experience and on various other assumptions that webelieve to be reasonable under the circumstances. Actual future results coulddiffer from those estimates.

*RevenueRecognition*

We recognizerevenues in accordance with the American Institute of Certified PublicAccountants (“AICPA”) Statement of Position (“SOP”) 97-2, *Software Revenue Recognition*, as amended, Securities andExchange Commission (the “SEC”) Staff Accounting Bulletin (“SAB”) No. 104,*Revenue Recognition* and Emerging IssuesTask Force (“EITF”) Issue No. 00-21, *RevenueArrangements with Multiple Deliverables*.

We generate revenue from the following primarysources:

·       software licenses,

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·       provision of post-contractcustomer support and maintenance services on licensed software, collectivelyreferred to as PCS, and

·       professional services.

Customer billingsgenerated in connection with our revenue-generating activities are initiallyrecorded as deferred revenue. We then recognize the revenue from these customerbillings as set forth below and when all of the following criteria are met:

·       a fully executed writtencontract and/or purchase order has been obtained from the customer (i.e.,persuasive evidence of an arrangement exists),

·       the contractual price ofthe product or services has been defined and agreed to in the contract (i.e.,price is fixed or determinable),

·       delivery of the product orservice has occurred and no material uncertainties regarding customeracceptance of the delivered product or service exist, and

·       collection of the purchaseprice from the customer is deemed probable.

*SoftwareLicenses.*We license software either perpetually or on a termbasis. Our standard perpetual software licensing arrangements include twelvemonths of bundled PCS, while our standard term-based software licensingarrangements typically include PCS for the full duration of the term license.Because we do not have vendor specific objective evidence (“VSOE”) of the fairvalue of these elements, we recognize as revenue the entire fee for suchperpetual and term-based licenses ratably over the term of the bundled PCS.Certain of our term-based licenses also allow the customer to substitutepurchased products for other products of equal value throughout the term. Weaccount for these arrangements as in-substance subscriptions and, accordingly,we recognize as revenue the entire fee for such licenses ratably over the contractualterm of the arrangement, which is typically the same as the term of the bundledPCS.

*Renewalof PCS under Perpetual Software Licenses.*     Our PCS includes the right to receiveunspecified upgrades or enhancements and technical support. Fees from customerrenewals of PCS related to previously purchased perpetual licenses arerecognized ratably over the term of the PCS.

*ProfessionalServices.*  We providecertain services to our customers, including non-complex product training,installation, implementation and other professional services which arenon-essential to the operation of the software. We also perform professional services for our customers designed toenhance the value of our software products by creating extensions tofunctionality to address a client’s specific business needs.  When sold separately, revenue from theseservices is recorded under the proportional performance or completedperformance method.

*Multi-ElementArrangements.*For multi-element arrangements which includesoftware licenses, PCS and non-complex training, installation andimplementation services which are non-essential to the operation of thesoftware, the entire fee for such arrangements is recognized as revenue ratablyover the term of the PCS or delivery of the services, whichever is longer.  For multi-element arrangements which includedsoftware licenses, PCS, non-essential services and services that are essentialto the operation of the software, the fee for such arrangements is generallydeferred until the services essential to the operation of the software havebeen performed and the modified software has been delivered, at which point theentire fee for such arrangements is recognized as revenue ratably over the termof the PCS or the delivery of the non-essential services, whichever is longer.

# *Software Development Costs*

We account for costsincurred to develop our software products in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 86, *Accountingfor the Cost of Computer Software to be Sold, Leased or Otherwise Marketed*.Accordingly, costs incurred in the research and development of new softwareproducts and significant enhancements to existing software products areexpensed as incurred until the technological feasibility of the product hasbeen established. Technological feasibility occurs shortly before our softwareproducts are available for general release, and we have determined that costseligible for capitalization are not material. Accordingly, there were nosoftware development costs capitalized as of June 30, 2007 or March 31, 2007.

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*ShareBased Compensation*

Weadopted SFAS No. 123 (revised 2004), *Share-Based Payments*(“SFASNo. 123R”), effective April 1, 2006, using the modified prospective transitionmethod. Accordingly, beginning in the first quarter of fiscal year 2007, werecognized as a charge against income the estimated grant date fair value ofshare-based awards granted to employees and directors. We estimate the fairvalue of our share-based stock awards on the date of grant using theBlack-Scholes option-pricing model. The Black-Scholes option-pricing modelrequires the use of certain input variables, as follows:

*Expected Volatility.* Volatility is ameasure of the amount the stock price will fluctuate during the expected lifeof an award. We determine volatility based on our historical stock pricevolatility over the most recent period equivalent to the expected life of theaward and the historical stock price volatilities of comparable publicly tradedcompanies, giving consideration to company-specific events impacting historicalvolatility that are unlikely to occur in the future, such as the April 30, 2004spin-off of PDD, as well as anticipated future events that may impactvolatility.

*Risk-Free Interest Rate.*Our assumption ofthe risk-free interest rate is based on the interest rates on U.S. constantrate treasury securities with contractual terms approximately equal to theexpected life of the award.

*Expected Dividend Yield.*Because we havenot paid any cash dividends since our inception and do not anticipate payingdividends in the foreseeable future, we assume a dividend yield of zero.

*Expected Award Life.*We determine theexpected life of an award by considering various relevant factors, includingthe vesting period and contractual term of the award, our employees’ historicalexercise patterns and length of service, the expected future volatility of ourstock price, tax implications of exercising an award and employeecharacteristics. We also consider the expected award lives of comparablepublicly traded companies. For stock purchase plan purchase rights, theexpected life is equal to the current offering period under the stock purchaseplan.

UnderSFAS No. 123R, we are also required to estimate at grant the likelihood thatthe award will ultimately vest (the “pre-vesting forfeiture rate”), and revisethe estimate, if necessary, in future periods if the actual forfeiture ratediffers. We determine the pre-vesting forfeiture rate of an award based on ourhistorical pre-vesting award forfeiture experience, giving consideration tocompany-specific events impacting historical pre-vesting award forfeitureexperience that are unlikely to occur in the future as well as anticipatedfuture events that may impact forfeiture rates.

*Income Taxes*

We account forincome taxes in accordance with SFAS No. 109, *Accountingfor Income Taxes*. Accordingly, deferred tax assets and liabilities are recognized for thetax consequences of temporary differences between the financial carryingamounts and the tax basis of existing assets and liabilities by applyingenacted statutory tax rates applicable to future years. The provision forincome taxes is based on our estimates for taxable income of the various legalentities and jurisdictions in which we operate. As such, income tax expense mayvary from the customary relationship between income tax expense and pre-taxaccounting income. We establish a valuation allowance against our netdeferred tax assets to reduce deferred tax assets to the amount expected to berealized.

We adoptedFinancial Accounting Standards Board (“FASB”) Interpretation No. 48, *Accounting for Uncertainty in Income Taxes*(“FIN No. 48”),effective April 1, 2007.  FIN No. 48prescribes a recognition threshold and measurement standard for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. FIN No. 48 requires that we determine whether thebenefits of our tax positions are more likely than not of being sustained uponaudit based on the technical merits of the tax position. We recognize theimpact of an uncertain income tax position taken on our income tax return atthe largest amount that is more-likely-than-not to be sustained upon audit bythe relevant taxing authority.  An uncertainincome tax position is not recognized if it has less than a 50% likelihood ofbeing sustained.  See Note 4 foradditional information on our adoption of the provisions of FIN No. 48.

Interest andpenalties related to income tax matters are recognized in income taxexpense.  During the three months endedJune 30, 2007 and 2006 we did not incur any expense related to interest orpenalties for income tax matters, and no such amounts were accrued as of June30, 2007.

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**2.****                       NetIncome (Loss) Per Share**

We compute net income(loss) per share pursuant to SFAS No. 128, *Earnings PerShare*. Accordingly, basic net income (loss) per share and dilutednet loss per share are computed by dividing the net income (loss) for theperiod by the weighted average number of common shares outstanding during theperiod, without consideration for common stock equivalents.  Diluted net income per share is computed bydividing the net income for the period by the weighted average number of commonstock and common stock equivalents outstanding during the period.  Potentially dilutive common share equivalentsconsist of vested in-the-money common stock options and unvested restrictedstock units (“RSUs”).
|                                                               | ** ** | **Three Months Ended June 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                    | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
|                                                          |       |                                                |       |   |   |
| Numerator:                                                    |       |                                                |       |   |   |
| Net income (loss)                                             |       | $                                                   | 1,419      |   | $ | (329 | ) |
|                                                          |       |                                                |       |   |   |
| Denominator:                                                  |       |                                                |       |   |   |
| Weighted average common shares outstanding                    |       | 26,552                                              |       | 26,208 |   |
| Dilutive potential common stock equivalents                   |       | 332                                                 |       | — |   |
| Weighted average shares and dilutive potential  common shares |       | 26,884                                              |       | 26,208 |   |
|                                                          |       |                                                |       |   |   |
| Basic and diluted net  income (loss) per share:               |       | $                                                   | 0.05       |   | $ | (0.01 | ) |

 

Potentiallydilutive common share equivalents that were excluded from the diluted netincome (loss) per share calculations as their effect would be anti-dilutive totaledapproximately 3.4 million shares and 2.1 million shares for the three monthsended June 30, 2007 and 2006, respectively.

**3.****                       Share-BasedPayments**

*Share-BasedCompensation Plans*

On August 2,2005, our stockholders approved the Amended and Restated 2004 Stock IncentivePlan (the “2004 Plan”). The 2004 Plan authorizes the grant of equity awards topurchase the number of shares of our common stock equal to the sum of(i) 1,900,000 shares and (ii) the number of shares of common stockunderlying any stock awards granted under certain prior share-basedcompensation plans that expire or are cancelled or forfeited without havingbeen exercised in full or that are repurchased by us. Potential types of equityawards that may be granted under the 2004 Plan to our officers, directors,employees and consultants include stock options, restricted stock awards,common stock awards, stock appreciation rights, performance awards and deferredstock units. Pursuant to the 2004 Plan, any shares of common stock that are awardedunder the 2004 Plan as restricted stock awards, common stock awards,performance awards or deferred stock units (but not as stock options or stockappreciation rights) are counted against the maximum number of shares of commonstock available for issuance under the 2004 Plan based on a 1.15-to-1ratio. The terms and conditions of specific awards are set at the discretion ofour board of directors although generally awards vest over not more than fiveyears, expire no later than ten years from the date of grant and do not haveexercise prices less than the fair market value of the underlying common stockon the date of grant. At June 30, 2007, approximately 1,714,000 shares of ourcommon stock remain available for issuance pursuant to awards granted under the2004 Plan.

OnAugust 2, 2005, our stockholders also approved the 2005 Employee StockPurchase Plan (the “ESPP”), under which we have reserved 1,000,000 shares ofour common stock for issuance. Under the ESPP, employees may defer up to 10% oftheir base salary to purchase shares of our common stock, up to a maximum of1,000 shares. The purchase price of the common stock is equal to 85% of thelower of the fair market value per share of our common stock on thecommencement date of the applicable offering period or the applicable purchasedate. To date, we have issued 138,000 shares under the ESPP and 862,000 sharesremain available for future issuance under the ESPP as of June 30, 2007.

We also maintaincertain other share-based compensation plans, under which we did not grantawards during fiscal year 2007 and do not intend to grant any further awards inthe future.

Our share-basedcompensation plans contain a provision that allows eligible participants tocontinue to vest in their stock options upon their retirement, as that term isdefined in the plans. To be eligible for continued vesting, participants mustbe at least 55 years of age and have 5 years of service at the time of theirretirement.  Awards granted under the2004 Plan beginning in fiscal year 2008 do not contain this retirement benefit.

During the second quarter of fiscal year 2007, weoffered eligible employees the one-time opportunity to surrender any 

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and all stockoptions granted pursuant to any of our stock plans with an exercise price greaterthan $9.00 per share in exchange for RSUs (the “Exchange Offer”) based on anexchange ratio determined by our board of directors. The RSUs vest in threeequal annual installments commencing on the date of grant and are subject tothe terms and conditions set forth in the 2004 Plan. The offer period commencedon July 28, 2006 and expired on August 25, 2006.  On August 26, 2006, all eligible stockoptions tendered by eligible employees in accordance with the terms of theExchange Offer were cancelled and RSUs were issued to such eligible employeesin accordance with the exchange ratios established by the board ofdirectors.  In total, stock options forthe purchase of approximately 410,000 shares of our common stock were tenderedand cancelled, and RSUs for approximately 105,000 shares of our common stockwere granted.  Any eligible stock optionsnot tendered remain issued and outstanding in accordance with their originalterms and conditions.

Pursuant to SFASNo. 123R, we accounted for the cancellation of the tendered stock options andconcurrent grant of RSUs as a modification of the cancelled stock options.Accordingly, we measured the excess of the grant-date fair value of the RSUsover the fair value of the cancelled stock options at cancellation (the “incrementalvalue”) and are recognizing the aggregate of the incremental value and theremaining unamortized grant-date fair value of the cancelled stock options ofapproximately $0.3 million as share-based compensation expense over therequisite service period of the RSUs.

*Share-BasedAward Activity*

Ourstock options generally vest over four years and have a contractual term of 10years.  A summary of stock optionactivity under our share-based compensation plans is as follows:
| ** **                    | ** ** | **Number of  Shares**                                                                | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Aggregate   Intrinsic   Value** | ** ** | **Weighted  Average  Remaining  Contractual   Life** | ** ** |
|-------------------------------|------------|-------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                    | ** ** | **(In thousands, except per share amounts and years)** | ** ** |
| Outstanding at  April 1, 2007 |       | 3,730                                                                                     |       | $                                      | 7.67       |                                        |       |                                                      |       |   |
| Granted                       |       | 40                                                                                        |       | 6.24                                   |       |                                        |       |                                                      |       |
| Exercised                     |       | (7                                                                                        | )          | 4.55                                   |       |                                        |       |                                                      |       |
| Expired/Forfeited             |       | (301                                                                                      | )          | 10.67                                  |       |                                        |       |                                                      |       |
| Outstanding at June 30, 2007  |       | 3,462                                                                                     |       | $                                      | 7.40       |                                        | $          | 786                                                       |       | 7.0 |   |
| Exercisable at June 30, 2007  |       | 2,217                                                                                     |       | $                                      | 8.20       |                                        | $          | 561                                                       |       | 5.8 |   |

 

RSUs granted underthe 2004 Plan vest annually over three years and, once vested, do not expire.Upon vesting of an RSU, employees are generally issued an equivalent number ofshares of our common stock. A summary of RSU activity under our share-basedcompensation plans is as follows:
| ** **                 | ** ** | **Number of  Shares**                                            | ** ** | **Weighted  Average  Grant Date   Fair Value** | ** ** |
|----------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                 | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Unvested at  April 1, 2007 |       | 439                                                                   |       | $                                                             | 6.73       |   |
| Granted                    |       | 375                                                                   |       | 6.34                                                          |       |
| Vested                     |       | (97                                                                   | )          | 7.19                                                          |       |
| Forfeited                  |       | (3                                                                    | )          | 6.86                                                          |       |
| Unvested at June 30,  2007 |       | 714                                                                   |       | $                                                             | 6.46       |   |

 

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*Share-BasedCompensation Expense*

The estimated fairvalue of our share-based awards is recognized as a charge against income on astraight-line basis over the requisite service period, which is the generallythe vesting period of the award. Total stock-based compensation expenserecognized in our condensed consolidated statements of operations for the threemonths ended June 30, 2007 and 2006 was as follows:
|                                         | ** ** | **Three Months Ended June 30,** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                              | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
|                                    |       |                                                |       |   |   |
| Cost of revenue                         |       | $                                                   | 81         |   | $ | 71 |   |
| Product  development                    |       | 230                                                 |       | 345 |   |
| Sales and  marketing                    |       | 201                                                 |       | 159 |   |
| General and  administrative             |       | 391                                                 |       | 434 |   |
| Total stock-based  compensation expense |       | $                                                   | 903        |   | $ | 1,009 |   |

 

No stock-basedcompensation expense was capitalized in the periods presented. At June 30,2007, the gross amount of unrecognized stock-based compensation expenserelating to unvested share-based awards was approximately $8.8 million, whichwe anticipate recognizing as a charge against income over a weighted averageperiod of 1.26 years.

**4.****                       IncomeTaxes**

As a result of ouradoption of FIN No. 48 on April 1, 2007, we reversed a previously recordedincome tax reserve with a corresponding adjustment to beginning retainedearnings of $0.7 million.

Due touncertainties surrounding our ability to generate future taxable income, avaluation allowance of $71.6 million has been established to offset our grossdeferred tax asset as of April 1, 2007, which primarily consists of federal andstate net operating loss carryforwards (“NOLs”).  The future utilization of our NOLs to offsetfuture taxable income may be subject to a substantial annual limitation as aresult of ownership changes that may have occurred previously or that couldoccur in the future.  We plan to completean assessment of such ownership changes under Sections 382 and 383 of theInternal Revenue Code in fiscal year 2008. As a result of this assessment, our future utilization of NOLs could bematerially impacted; however, we are unable to estimate the range of possibleoutcomes at this time.  Until such anassessment is completed and any limitation on future utilization of NOLs known,no amounts are being presented as an uncertain tax position under FIN No.48.  Accordingly, we had no unrecognizedtax benefits upon our adoption of FIN No. 48 on April 1, 2007.  Additionally, if as a result of thisassessment we determine that we do have an uncertain tax position, futurechanges in our unrecognized tax benefits will not impact our effective tax rateas we have a full valuation allowance against our NOLs.  Any NOLs that expire prior to utilization asa result of such limitations will be removed from deferred tax assets with acorresponding reduction of the valuation allowance.

We are subject totaxation in the U.S., various state jurisdictions, the United Kingdom, France,Germany, and Japan.  Our tax years from1993 forward are subject to examination by the U.S. and various other statejurisdictions due to the carryforward of unutilized net operating losses andresearch and development credits.  Ourtax years from fiscal year 2006 forward are subject to examination by theUnited Kingdom taxing authorities and from fiscal year 2003 forward are subjectto examination by the Japanese taxing authorities.

At March 31, 2007, our wholly-ownedJapanese subsidiary, Accelrys, K.K., recognized an income tax payableand associated deferred tax asset of $4.8 million for revenue recognized forJapanese income tax purposes in advance of being recognized for book purposesas a result of the change in our revenue recognition policy in connection withthe restatement of our previously issued consolidated financial statements. Inthe first quarter of fiscal year 2008, we pursued alternative tax returnpositions that were consistent with Japanese tax law and filed Accelrys K.K.’sfiscal year 2007 income tax return.  As aresult, Accelrys K.K.’s income tax obligation was reduced to $0.6 million,which was paid during the first quarter of fiscal year 2008.  The associated deferred tax asset wasreversed in the same period.

**4.****                       ComprehensiveIncome**

For the threemonths ended June 30, 2007 and 2006, comprehensive income consists of thefollowing:

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|                                           | ** ** | **Three Months Ended June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| ** **                                | ** ** | **(In thousands)**                             | ** ** |
| Net income  (loss)                        |       | $                                                   | 1,419      |   | $ | (329 | ) |
| Foreign currency  translation adjustment  |       | (86                                                 | )          | 654 |   |
| Unrealized gain  on marketable securities |       | 55                                                  |       | 60 |   |
| Total comprehensive  income               |       | $                                                   | 1,388      |   | $ | 385 |   |

 

**5.****                       SegmentInformation**

In accordance withSFAS No. 131, *Disclosures aboutSegments of an Enterprise and Related Information*, our operationshave been aggregated into one reportable segment given the similarities ofeconomic characteristics between the operations and the common nature of theproducts, services and customers.

**6.****                       Guarantees**

*Guaranteeof Lease Obligation of Others*

On April 30, 2004,we spun-off our drug discovery subsidiary, Pharmacopeia Drug Discovery, Inc. (“PDD”),into an independent, separately traded, publicly held company through thedistribution to our stockholders of a dividend of one share of PDD common stockfor every two shares of our common stock. The landlords of our New Jerseyfacilities, which were used by our PDD operations, consented to the assignmentof the leases to PDD. Despite the assignment, the landlords required us toguarantee the remaining lease obligations, which totaled approximately $21 millionas of June 30, 2007. In the event that PDD defaults on their lease commitment,we are permitted under the guarantee to sublease the facility in order tomitigate our lease obligation.  Inaccordance with FIN No. 45, *Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others,* we recognized a liability andcorresponding charge to stockholders’ equity for the probability-weighted fairmarket value of the guarantee. Changes to the fair market value of theliability are recognized in stockholders’ equity. The liability for ourguarantee of the lease obligation was $0.6 million at each of June 30, 2007 andMarch 31, 2007.

*OtherGuarantees and Indemnifications*

We provideindemnifications of varying scope and size to certain customers against claimsof intellectual property infringement made by third parties arising from theuse of our products. We have also entered into indemnification agreements withour officers and directors. Although the maximum potential amount of futurepayments we could be required to make under these indemnifications isunlimited, to date we have not incurred material costs to defend lawsuits orsettle claims related to these indemnification provisions. Additionally, we haveinsurance policies that, in most cases, would limit our exposure and enable usto recover a portion of any amounts paid. Therefore, we believe the estimatedfair value of these agreements is minimal and likelihood of incurring anobligation is remote. Accordingly, we have not accrued any liabilities inconnection with these indemnification obligations as of June 30, 2007.

**7.****                       RestructuringActivities**

The followingsummarizes the changes in our accrued restructuring charges liability:
|                                                    | ** ** | **Severance and   Related Costs** | ** ** | **Lease  Obligation Exit   and Facility   Closure Costs** | ** ** | **Total**  | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|------------|------------|
| ** **                                         | ** ** | ** **                                       | ** ** | ** **                                                                         | ** ** | ** ** | ** ** |
| Balance at  March 31, 2006                    |       | $                                                | 1,065      |                                                                               | $          | 3,209      |       | $ | 4,274 |   |
| Additional severance and lease abandonment charges |       | 611                                              |       | 355                                                                                |       | 966        |       |
| Adjustments to liability                           |       | —                                           |       | 237                                                                                |       | 237        |       |
| Cash payments                                      |       | (1,591                                           | )          | (2,230                                                                             | )          | (3,821     | )          |
| Effect of foreign exchange                         |       | 79                                               |       | 309                                                                                |       | 388        |       |
| Balance at  March 31, 2007                    |       | 164                                              |       | 1,880                                                                              |       | 2,044      |       |
| Additional severance and lease abandonment charges |       | 55                                               |       | —                                                                             |       | 55         |       |
| Adjustments to liability                           |       | —                                           |       | 16                                                                                 |       | 16         |       |
| Cash payments                                      |       | (55                                              | )          | (101                                                                               | )          | (156       | )          |
| Effect of foreign exchange                         |       | 1                                                |       | 35                                                                                 |       | 36         |       |
| Balance at June 30,  2007                          |       | $                                                | 165        |                                                                               | $          | 1,830      |       | $ | 1,995 |   |

 

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Prior to fiscal year 2005, we implemented variousactions designed to improve our operations and overall financial performancethrough workforce reductions and the abandonment of leased facilities.  All severance benefits related to theworkforce reductions in these periods have been fully paid.  Our remaining obligations under the leaseobligations terminate in fiscal year 2008.

During fiscal year 2005, we implemented variousactions designed to improve the efficiency of our sales department andeliminate duplicative general and administrative personnel through workforcereductions and the abandonment of a leased facility in Germany. As a result ofthe implementation of these actions, we recognized a charge of $1.7 million,consisting of $1.4 million in severance benefits from the termination of 42employees and $0.3 million related to the abandonment of the leased facility.The severance benefits were paid in full in fiscal year 2006. In the secondquarter of fiscal year 2007, we made a $0.1 million lease buy-out payment tothe landlord of the abandoned facility that terminates our obligations underthe lease. As a result of the termination of the lease, we reduced theremaining liability for the abandoned facility to a negligible amount.

In March 2006, we implemented various actions designedto realign our resources with our portfolio of products and services, eliminateredundancies in our workforce and streamline our operations through workforcereductions and abandoning two leased facilities in the United Kingdom. As aresult of the implementation of these actions, we recognized a charge of $3.2million, consisting of $1.8 million in severance benefits from the terminationof approximately 50 employees and $1.4 million for our future lease obligationsrelated to the abandoned facility, net of estimated future sublease income. Infiscal year 2007, we recognized a charge of $0.3 million for estimatedadditional severance benefits to be paid to certain employees terminated underthe original restructuring plan and associated legal expenses.  We anticipate completing the payment ofseverance benefits in the second quarter of fiscal year 2008. Additionally, infiscal year 2007 we recorded an additional lease abandonment charge of $0.3million.  The lease obligations for theabandoned facilities terminate in fiscal years 2013 and 2022.

As a result of the substantial completion of ourproduct modernization and integration efforts, in December 2006, we implementeda restructuring plan which resulted in the closure of our research anddevelopment facility in Bangalore, India, and the termination of approximately60 research and development employees.  As a result of the implementation of therestructuring plan, we recognized a charge of $0.8 million, consisting of $0.3million of severance benefits and $0.5 million of asset impairment charges andother facility closure costs during fiscal year 2007. The severance benefitsand facility closure costs were fully paid in the fourth quarter of fiscal year2007.

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

When used anywhere inthis Quarterly Report on Form 10-Q (this “Report”), the words “expect”, “believe”,“anticipate”, “estimate”, “intend”, “plan” and similar expressions are intendedto identify forward-looking statements. These forward-looking statements mayinclude statements addressing our future financial and operating results. Wehave based these forward-looking statements on our current expectations about futureevents. Such statements are subject to certain risks and uncertaintiesincluding those related to execution upon our strategic plans, the successfulrelease and**acceptance of newproducts, the demand for new and existing products, additional competition,changes in economic conditions and those described in documents we have filedwith the Securities and Exchange Commission, including this Report in “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” and “RiskFactors,” and in our subsequent reports on Form 10-Q and Form 10-K. Allforward-looking statements in this Report are qualified entirely by thecautionary statements included in this Report and such other filings. Theserisks and uncertainties could cause actual results to differ materially fromresults expressed or implied by forward-looking statements contained in thisReport. These forward-looking statements speak only as of the date of thisReport. We disclaim any undertaking to publicly update or revise anyforward-looking statements contained herein to reflect any change in ourexpectations with regard thereto or any change in events, conditions orcircumstances on which any such statement is based.

The following discussionand analysis of our financial condition and results of operations should beread in conjunction with our condensed consolidated financial statements andrelated notes thereto included elsewhere in this Report.

**Overview**

***Our Business***

We develop and commercialize scientific businessintelligence software for the aggregation, mining, integration, analysis,simulation, management and interactive reporting of scientific data used bybiologists, chemists, materials scientists including nanotechnologyresearchers, and information technology professionals for product design anddrug discovery and development. Our technology and services are designed tomeet the needs of today’s leading research and development organizations. Ourcustomers include leading commercial, government and academic organizations.Many of the largest pharmaceutical, biotechnology, chemical, and petroleumcompanies worldwide use our products. We market our products and servicesworldwide, principally through our direct sales force, augmented by the use ofthird-party distributors.

***Our Marketplace***

Historically, we have primarily sold molecularmodeling and simulation software. The market for molecular modeling andsimulation products in the pharmaceutical and biotechnology industries ischallenging due to the maturity of the market, industry consolidation,reduction in the level of discovery research activity, and increasedcompetition, including competition from open source software. We also sellmodeling and simulation products to the chemical, petrochemical and materialsindustries. We believe these industries are in the early stages of adoption ofthese technologies. Thus we believe the market for our products within theseindustries is nascent and has experienced modest growth over the past severalyears. Following the acquisition of SciTegic, Inc. (“SciTegic”), we began tooffer data-pipelining and workflow software. This technology is widelyapplicable within our target industries and represents a significant growthopportunity. There is currently limited competition in our targeted industriesto this technology, which is experiencing growth within our customer base.

***Our Strategy***

Our objective is to be the leader in scientificbusiness intelligence solutions and scientific innovation. We plan toaccomplish this objective by providing a comprehensive set of integratedsolutions, built on our industry leading scientific operating platform, thatare central to the enterprise-wide research and development activities of ourcustomers. By doing this we will make it easier for research and developmentorganizations to manage data, information, knowledge, and collaborativeprocesses.

Our strategy for growth is to expand usage of ourproducts and services by marketing and distributing our solutions to a broadergroup of users, including scientists, engineers and information technologyprofessionals, within our existing customers, as well as to new customers inother industries.

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A key enabler of this strategy is the scientificoperating platform we acquired through our SciTegic acquisition. We areutilizing this technology to enable our customers to build solutions whichallow them to integrate scientific software and content from across theresearch and development spectrum. Selling solutions is fundamentally differentthan our traditional sale of stand-alone modeling and simulation products. Weare focused on enhancing our sales processes to emphasize solutions-selling andstrategic account management. We are also expanding our professional servicescapabilities to enable our customers to deploy these solutions.

In addition to the activities underway in our salesand service functions, we continue to focus on the componentization of ourentire suite of products on our Discovery Studio and Materials Studioplatforms. In fiscal year 2008, we expect to substantially complete themigration of our life sciences applications to the Discovery Studio platformwith the expected launch of a new version of Discovery Studio by the end of thefiscal year.  The development, release,and timing of any new or upgraded features or functionality for our productsremains at our sole discretion.

Finally, in addition to our focus on revenue growth,we continuously evaluate our personnel requirements and cost structure. Overthe past several years we have significantly reduced our operating coststhrough workforce reductions and other cost-savings measures. We will continueour focus on cost control, as well as working capital management as we striveto improve our financial performance.

**CriticalAccounting Policies**

The critical accountingpolicies and estimates used in the preparation of our consolidated financialstatements are described in Item 6, “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations,” of our Annual Report on Form10-K for the fiscal year ended March 31, 2007. There have been no significantchanges in our critical accounting policies and estimates from March 31, 2007,other than as described below.

We adopted FASBInterpretation No. 48, *Accounting for Uncertaintyin Income Taxes*(“FIN No. 48”), effective April 1, 2007. FIN No. 48prescribes a recognition threshold and measurement standard for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. FIN No. 48 requires that we determine whether thebenefits of our tax positions are more likely than not of being sustained uponaudit based on the technical merits of the tax position. We recognize theimpact of an uncertain income tax position taken on our income tax return atthe largest amount that is more-likely-than-not to be sustained upon audit bythe relevant taxing authority.  Anuncertain income tax position is not recognized if it has less than a 50%likelihood of being sustained.

**Resultsof Operations**

Historically, we havereceived approximately two-thirds of our annual customer orders in the secondhalf of our fiscal year. In accordance with our revenue recognition policies,the revenue associated with these orders is generally recognized over the contractuallicense term. Therefore, because we accrue sales commissions and royalties uponthe invoicing of customer orders, we have historically experienced an increasein operating costs and expenses during the second half of our fiscal year. As aresult of these and other seasonal variations, we believe thatquarter-to-quarter comparisons of our operating results are not a goodindication of our future performance and that the interim financial results forthe periods presented in this Report are not necessarily indicative of resultsfor a full year or for any subsequent interim period.

**Comparisonof the Three Months Ended June 30, 2007 and 2006**

The following tablesummarizes our results of operations as a percentage of revenue for therespective periods:

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| ** **                         | ** ** | **Three Months Ended  June 30,** | ** ** |
|------------------------------------|------------|-------------------------------------------------|------------|
| ** **                         | ** ** | **   2007   **    | ** ** | **   2006   ** | ** ** |
| ** **                         | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| Revenue                            |       | 100                                             | %          | 100 | % |
| Cost of revenue                    |       | 17                                              | %          | 18 | % |
| Gross margin                       |       | 83                                              | %          | 82 | % |
|                               |       |                                            |       |   |   |
| Operating  expenses:               |       |                                            |       |   |   |
| Product development                |       | 21                                              | %          | 25 | % |
| Sales and marketing                |       | 38                                              | %          | 35 | % |
| General and administrative         |       | 20                                              | %          | 23 | % |
| Total operating  expenses          |       | 79                                              | %          | 84 | % |
| Operating income  (loss)           |       | 4                                               | %          | (2 | )% |
| Interest and  other income, net    |       | 5                                               | %          | 2 | % |
| Income (loss)  before income taxes |       | 9                                               | %          | — | % |
| Income tax  expense                |       | 2                                               | %          | 2 | % |
| Net income (loss)                  |       | 7                                               | %          | (2 | )% |

 

***Revenue***

Revenue decreasedslightly to $20.1 million for the three months ended June 30, 2007, as comparedto $20.2 million for the three months ended June 30, 2006. The decrease wasprimarily attributable to reduced revenues in our legacy modeling andsimulation products, partially offset by continued growth in our scientificoperating platform product line.

***Cost of Revenue***

Cost of revenuedecreased 4% to $3.5 million for the three months ended June 30, 2007, ascompared to $3.7 million for the three months ended June 30, 2006. As apercentage of revenue, cost of revenue decreased to 17% for the three monthsended June 30, 2007, as compared to 18% for the three months ended June 30,2006.  The decrease in cost of revenue was primarily attributable to a decreasein fulfillment costs of $0.1 million driven by increased electronic softwaredistribution to our customers.  We alsoincurred approximately $0.1 million less in royalty costs, primarily due to amore favorable product mix, as well as a slight decrease in sales volume in thecurrent quarter.

***Operating Expenses***

*Product Development Expenses.*Product development expenses decreased16% to $4.3 million for the three months ended June 30, 2007, as comparedto $5.1 million for the three months ended June 30, 2007. As a percentageof revenue, product development decreased to 21% for the three months endedJune 30, 2007, as compared to 25% for the three months ended June 30, 2006. The decrease in product development expenses wasprimarily attributable to savings of approximately $0.7 million resulting fromthe closure of our research and development facility in Bangalore, India in thefourth quarter of fiscal year 2007.

*Sales and Marketing Expenses.*Sales and marketing expenses increased7% to $7.5 million for the three months ended June 30, 2007, as comparedto $7.1 million for the three months ended June 30, 2006. As a percentageof revenue, sales and marketing expenses increased to 38% for the three monthsended June 30, 2007, as compared to 35% for the three months ended June 30,2006. The increase in sales and marketingexpense is primarily attributable to an increase in personnel related costs of$0.3 million associated with our expanded sales and sales support organization.

*General and AdministrativeExpenses.*General andadministrative expenses decreased 17% to $3.9 million for the threemonths ended June 30, 2007, as compared to $4.7 million for the threemonths ended June 30, 2006. As a percentage of revenue, general andadministrative expenses decreased to 20% for the three months ended June 30,2007, as compared to 23% for the three months ended June 30, 2006. The decreasewas primarily attributable to outside consulting and accounting fees incurredduring the first quarter of fiscal year 2007 in connection with the restatementof our previously issued consolidated financial statements which were notincurred in the current quarter.

***Net Interest and Other Income***

Net interest and otherincome was $1.0 million for the three months ended June 30, 2007,as compared to $0.5 million 

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forthe three months ended June 30, 2006. The increase in net interest and otherincome was primarily attributable to favorable fluctuations in foreigncurrencies resulting from the cash settlement of certain intercompanytransactions and higher interest rates obtained on our cash and marketablesecurities balances during the current quarter.

***Income Tax Expense***

Income tax expensewas $0.4 million for each of the three months ended June 30, 2007 and 2006.

**Liquidityand Capital Resources**

We had cash, cash equivalents, marketable securities,and restricted cash and marketable securities of $68.7 million as of June 30,2007, as compared to $70.8 million as of March 31, 2007, a decrease of $2.1million. The decrease in cash, cash equivalents, marketable securities andrestricted cash and marketable securities during the three months ended June30, 2007 was primarily attributable to cash used in operations of $1.9 million,$0.2 million in net property and equipment purchases and a $0.4 million effecton cash and cash equivalents of changes in foreign currency rates.  These were offset by proceeds of $0.3 millionfrom the issuance of our common stock under employee stock plans. Our operatingcash flows on a quarterly basis are significantly impacted by changes inaccounts receivable balances. Due to the seasonality of our business, accountsreceivable balances have historically increased significantly in the thirdquarter of each fiscal year as a result of higher order intake. The collectionof these accounts receivable balances has generally resulted in positive cashflows from operations in the fourth quarter of each fiscal year, while we havehistorically experienced negative cash flows from operations in the other threefiscal quarters.

Net cash used in operating activities was $1.9 millionfor the three months ended June 30, 2007, as compared to $4.9 million for thethree months ended June 30, 2006. The decrease in cash used in operatingactivities was primarily attributable to reduced operating expenditures.

Net cash providedby investing activities was $6.0 million for the three months ended June 30,2007, as compared to net cash used in investing activities of $3.1 million forthe three months ended June 30, 2006. Significant components of cash flows frominvesting activities for the three months ended June 30, 2007 included netpurchases of property and equipment of $0.2 million and a net decrease in ourmarketable securities portfolio of $6.2 million. Significant components of cashflows used in investing activities for the three months ended June 30, 2006included $0.2 million of net purchases of property and equipment and a netincrease in our marketable securities portfolio of $3.0 million.

Net cash providedby financing activities was $0.3 million for each of the three months endedJune 30, 2007 and 2006.  Cash flows fromfinancing activities for both periods consisted solely of proceeds from theissuance of our common stock under employee stock plans.

At March 31, 2007, ourAccelrys, K.K. subsidiary recognized an income tax payable and associateddeferred tax asset of $4.8 million for revenue recognized for Japanese incometax purposes in advance of being recognized for book purposes as a result ofthe change in our revenue recognition policy in connection with the restatementof our previously issued consolidated financial statements.  In the first quarter of fiscal year 2008 wepursued alternative tax return positions that were consistent with Japanese taxlaw and filed Accelrys K.K.’s fiscal year 2007 income tax return.  As a result, Accelrys K.K.’s income taxobligation was reduced to $0.6 million, which was paid during the first quarterof fiscal year 2008.  The associateddeferred tax asset was reversed in the same period.

We have funded ouractivities to date primarily through the sales of software licenses and relatedservices and the issuance of equity securities.

We anticipate thatour capital requirements may increase in future periods as a result of seasonalsales trends, additional product development activities, and the acquisition ofadditional equipment. Our capital requirements may also increase in futureperiods as we seek to expand our technology platform through investments,licensing arrangements, technology alliances, or acquisitions.

We anticipate thatour existing capital resources will be adequate to fund our operations for atleast the next 12 months. However, there can be no assurance that changes willnot occur that would consume available capital resources before then. Our capitalrequirements depend on numerous factors, including our ability to continue togenerate software sales, the purchase of additional capital equipment andacquisitions of other businesses or technologies. There can be no assurancethat additional funding, if necessary, will be available to us on favorableterms, if at all. Our forecast for the period of time 

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through which ourfinancial resources will be adequate to support our operations is forwardlooking information, and actual results could vary.

**Item3. Quantitative and Qualitative Disclosures About Market Risk**

The information called for by this item is provided inItem 7A, “Quantitative and Qualitative Disclosures About Market Risk,” of ourAnnual Report on Form 10-K for the fiscal year ended March 31, 2007. Ourexposures to market risk have not changed materially since March 31, 2007.

**Item 4. Controls and Procedures**

**ConclusionRegarding the Effectiveness of Disclosure Controls and Procedures**

We maintaindisclosure controls and procedures, as such term is defined in Rules 13a-15(e)and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”), that are designed to provide reasonable assurance that informationrequired to be disclosed by us in the reports that we file or submit under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the SEC rules and forms, and that such information isaccumulated and communicated to our management, including our principalexecutive officer and principal financial officer, as appropriate, to allowtimely decisions regarding required financial disclosures. Because of inherentlimitations, our disclosure controls and procedures, no matter how welldesigned and operated, can provide only reasonable, and not absolute, assurancethat the objectives of such disclosure controls and procedures are met.

As of the end ofthe period covered by this Report, we conducted an evaluation, under thesupervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures pursuant to Exchange Act Rules 13a-15(b) and 15d-15(b). Based onthis evaluation, our principal executive officer and principal financialofficer concluded that our disclosure controls and procedures were effective asof June 30, 2007.

**Changesin Internal Control Over Financial Reporting**

There were nochanges in our internal control over financial reporting during the threemonths ended June 30, 2007 that materially affected, or are reasonably likelyto materially affect, those controls.

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**PART II — OTHER INFORMATION**

**Item1A. Risk Factors**

*Youshould carefully consider the risks described below before investing in ourpublicly-traded securities. The risks described below are not the only onesfacing us. Our business is also subject to the risks that affect many othercompanies, 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 areimmaterial also may impair our business operations and our liquidity. The risksdescribed below could cause our actual results to differ materially from thosecontained in forward-looking statements we have made in this Report, theinformation incorporated herein by reference and those we may make from time totime.*

**CertainRisks Related to Our Marketplace and Environment**

***Our revenue fromthe sale of modeling and simulation software to the life science discoveryresearch marketplace, which has historically constituted a significant portionof our overall revenue, has been declining over the past several years and may continueto decline in future years.***   Historically wehave derived a significant portion of our revenue from the sale of modeling andsimulation software to the discovery research departments in pharmaceutical andbiotechnology companies. Such revenues have been declining over the past severalyears. We believe this decline is due to several factors, including increasedcompetition, including competition from open source software, industryconsolidation, a general reduction in the level of discovery research activityby our customers, and reductions in profit and related information technologyspending by our customers. If such declines continue and we do not increase therevenue we derive from our other product and service offerings, our businesscould be adversely impacted.

***Our ability to sustainor increase revenues will depend upon our success in entering new markets andin deriving additional revenues from our existing customers.***   Ourproducts are currently used primarily by molecular modeling and simulationspecialists in discovery research organizations. Our strategy is to expandusage of our products and services by utilizing our scientific operatingplatform and our tools and components to leverage vast amounts of informationstored in both corporate databases and public data sources in order to makeinformed scientific and business decisions during the research and developmentprocess.  This strategy would allowincreased usage of our software and services by biologists, chemists, engineersand informaticians within our existing pharmaceutical and biotechnologycustomers, as well as to new customers in other industries. However, ourproducts and services may not achieve market acceptance or penetration intargeted new departments within our customers or in new industries. As aresult, we may not be able to sustain or increase revenue.

***Our focus onoffering scientific business intelligence solutions to both existing and newcustomers and markets may make it more difficult for us to sustain our revenuefrom the sale of modeling and simulation products to the life science discoveryresearch marketplace.***   Our strategy involvestransforming our product and service offerings by utilizing our scientificoperating platform and our tools and components in order to enable ourcustomers to more effectively utilize the vast amounts of information stored inboth their databases and public data sources in order to make informedscientific and business decisions during the research and developmentprocess.  This strategy is intended tolead us to new and different markets and customers, as well as increase theusage of our offerings by existing customers. Executing this strategy will require significant management focus andutilization of resources.  Though weintend to continue to dedicate sufficient resources and management focus to ourlife science modeling and simulation products, it is possible that the strategywill result in loss of management focus and resources relating to theseexisting products and markets, thereby resulting in decreasing revenues fromthese markets.  If these revenues are notoffset by increasing revenues from new markets and/or customers, our overallrevenues will suffer.

***We may be unableto develop strategic relationships with our customers.******  ***Our strategy is to expandusage of our products and services by marketing and distributing our solutionsto a broader, more diversified group of biologists, chemists, engineers andinformaticians throughout our customers’ research and development organizations.A key component of our business strategy is to become a preferred provider ofscientific software and solutions. Becoming a preferred vendor will requiresubstantial re-training and new skills development within our sales and servicepersonnel and deployment of a successful account-management sales model. Webelieve that developing strategic relationships with our customers may lead toadditional revenue opportunities. However, there can be no assurance that anysuch relationships will develop or that such relationships will produceadditional revenue or profit opportunities.

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***Consolidationwithin the pharmaceutical and biotechnology industries may continue to lead tofewer potential customers for our products and services.***   Asignificant portion of our customer base consists of pharmaceutical andbiotechnology companies. Continued consolidation within the pharmaceutical andbiotechnology industries may result in fewer customers for our products andservices. If one of the parties to a consolidation uses the products orservices of our competitors, we may lose existing customers as a result of suchconsolidation.

***Increasingcompetition and increasing costs within the pharmaceutical and biotechnologyindustries may affect the demand for our products and services, which mayaffect our results of operations and financial condition.***   Ourpharmaceutical and biotechnology customers’ demand for our products is impactedby continued demand for their products and by our customers’ research anddevelopment costs.  Demand for ourcustomers’ products could decline, and prices charged by our customers fortheir products may decline, as a result of increasing competition, includingcompetition from companies manufacturing generic drugs.  In addition, our customers’ expenses couldcontinue to increase as a result of increasing costs of complying withgovernment regulations and otherwise.  Adecrease in demand for our customers’ products, pricing pressures associatedwith the sales of these products, and additional costs associated with productdevelopment could cause our customers to reduce research and developmentexpenditures. Because our products and services depend on such research anddevelopment expenditures, our revenues may be significantly reduced.

***Health care reformand restrictions on reimbursement may affect the pharmaceutical, biotechnologyand industrial chemical companies that purchase or license our products orservices, which may affect our results of operations and financial condition.***   Thecontinuing efforts of government and third-party payers in the markets we serveto contain or reduce the cost of health care may reduce the profitability ofpharmaceutical, biotechnology and industrial chemical companies causing them toreduce research and development expenditures. Because our products and servicesdepend on such research and development expenditures, our revenues may besignificantly reduced. We cannot predict what actions federal, state or privatepayers for health care goods and services may take in response to any healthcare reform proposals or legislation.

***We face strongcompetition in the scientific software sector.***   Themarket for our products is intensely competitive. We currently face competitionfrom other scientific software providers, larger technology and solutionscompanies, in-house development by our customers, as well as academic andgovernment institutions and the open source community.

Some of our competitors and potential competitors inthis sector have longer operating histories than us and have greater financial,technical, marketing, research and development and other resources. Many of ourcompetitors offer products and services directed at more specific markets thanthose we target, enabling these competitors to focus a greater proportion oftheir efforts and resources on these markets. Some offerings that compete withour products are developed and made available at lower cost by governmentorganizations and academic institutions, and these entities may be able todevote substantial resources to product development and also offer theirproducts to users for little or no charge. We also face competition from opensource software initiatives, in which developers provide software andintellectual property free over the Internet. In addition, many of ourcustomers spend significant internal resources in order to develop their ownsoftware.  Moreover, we intend toleverage our scientific operating platform in order to enable our customers tomore effectively utilize the vast amounts of information stored in both theirdatabases and public data sources in order to make informed scientific andbusiness decisions during the research and development process.  This strategy could lead to competition frommuch larger companies which provide general data storage and managementsoftware.

There can be no assurance that our current orpotential competitors will not develop products, services or technologies thatare comparable to, superior to, or render obsolete, the products, services andtechnologies we offer. There can be no assurance that our competitors will notadapt more quickly than us to technological advances and customer demands,thereby increasing such competitors’ market share relative to ours. Anymaterial decrease in demand for our technologies or services may have amaterial adverse effect on our business, financial condition and results ofoperations.

***We are subject topricing pressures in the markets we serve.******  ***We operate in an intenselycompetitive marketplace which has led to significant pricing pressure anddeclines in average selling price over the past several years. In response tocompetition and general adverse economic conditions in the markets we serve, wemay be required to modify our pricing practices. Changes in our pricing modelcould lead to a decline or delay in revenue as our sales force and customersadjust to the new pricing policies. This development may adversely affect ourrevenue and earnings.

***Our operations maybe interrupted by the occurrence of a natural disaster or other catastrophicevent at our primary facilities.***   Ourresearch and development operations and administrative functions are primarilyconducted at our 

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facilities in San Diego,California, and Cambridge, United Kingdom. We also conduct sales and customersupport activities at our facilities in Burlington, Massachusetts, Paris,France, and Tokyo, Japan. Although we have contingency plans in effect fornatural disasters or other catastrophic events, catastrophic events could stilldisrupt our operations. For example, our San Diego and Tokyo facilities are locatedin areas that are particularly susceptible to earthquakes. Any natural disasteror catastrophic event in our facilities or the areas in which they are locatedcould have a significant negative impact on our operations.

***Our insurancecoverage may not be sufficient to avoid material impact on our financialposition or results of operations resulting from claims or liabilities againstus, and we may not be able to obtain insurance coverage in the future.***   Wemaintain insurance coverage for protection against many risks of liability. Theextent of our insurance coverage is under continuous review and is modified aswe deem it necessary. Despite this insurance, it is possible that claims orliabilities against us may have a material adverse impact on our financialposition or results of operations. In addition, we may not be able to obtainany insurance coverage, or adequate insurance coverage, when our existinginsurance coverage expires. For example, we do not carry earthquake insurancefor our facilities in Tokyo, Japan or San Diego, California, because we do notbelieve the costs of such insurance are reasonable in relation to the potentialrisk.

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**CertainRisks Related to Our Operations**

***Defects ormalfunctions in our products could hurt our reputation among our customers,result in delayed or lost revenue and expose us to liability.***   Ourbusiness and the level of customer acceptance of our products depend upon thecontinuous, effective and reliable operation of our software and related toolsand functions. To the extent that defects cause our software to malfunction andour customers’ use of our products is interrupted, our reputation could sufferand our revenue could decline or be delayed while such defects are remedied. Wemay also be subject to liability for the defects and malfunctions ofthird-party technology partners and others with whom our products and servicesare integrated.

***Delays in the releaseof new or enhanced products or services or undetected errors in our products orservices may result in increased cost to us, delayed market acceptance of ourproducts and delayed or lost revenue.***   Toachieve market acceptance, new or enhanced products or services can requirelong development and testing periods, which may result in delays in scheduledintroduction. Any delays in the release schedule for new or enhanced productsor services may delay market acceptance of these products or services and mayresult in delays in new customer orders for these new or enhanced products orservices or the loss of customer orders. In addition, new or enhanced productsor services may contain a number of undetected errors or “bugs” when they arefirst released. Although we test each new or enhanced software product orservice before being released to the market, there can be no assurance thatsignificant errors will not be found in existing or future releases. As aresult, in the months following the introduction of certain releases, we mayneed to devote significant resources to correct these errors. There can be noassurance, however, that all of these errors can be corrected.

***We are subject torisks associated with the operation of a global business.****  *Our non-U.S. operations are subject to risks inherentin the conduct of international business, including:

·       unexpected changes inregulatory requirements;

·       longer payment cycles;

·       currency exchange ratefluctuations;

·       import and export licenserequirements;

·       tariffs and other barriers;

·       political unrest, terrorismand economic instability;

·       disruption of ouroperations due to local labor conditions;

·       limited intellectualproperty protection;

·       difficulties in collectingtrade receivables;

·       difficulties in managingdistributors or representatives;

·       difficulties in managing anorganization spread over various countries;

·       difficulties in staffingforeign subsidiary or joint venture operations; and

·       potentially adverse taxconsequences.

Our success depends,in part, on our ability to anticipate and address these risks. There can be noassurance that we will do so effectively, or that these or other factorsrelating to our international operations will not adversely affect our businessor operating results.

***In order toimprove our financial position, we have reduced our headcount, which couldnegatively impact our business.******  ***We have undergone severalreductions-in-force over the past several years, and our workforce hasdeclined. While we believe we have sufficient staff to operate our business, wedo not have duplicative or redundant resources in many 

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of our functions or operations.As a result, there can be no assurance that further attrition will not impactour ability to operate our business, or adversely impact our revenues.

***Failure to attractand retain skilled personnel could have a material adverse effect on us.***   Oursuccess depends in part on the continued service of key scientific, sales,business development, marketing, engineering, management and accountingpersonnel and our ability to identify, hire and retain additional personnel.There is intense competition for qualified personnel. Immigration laws mayfurther restrict our ability to attract or hire qualified personnel. We may notbe able to continue to attract and retain the personnel necessary for thedevelopment of our business. Failure to attract and retain key personnel couldhave a material adverse effect on our business, financial condition and resultsof operations. Further, we are highly dependent on the principal members of ourtechnical, scientific and management staff. One or more of these key employeescould retire or otherwise leave our employ within the foreseeable future, andthe loss of any of these people could have a material adverse effect on ourbusiness, financial condition or results of operations. We do not intend tomaintain key person life insurance on the life of any employee.

***If we choose toacquire businesses, products or technologies instead of developing themourselves, we may be unable to complete these acquisitions or to successfullyintegrate an acquired business or technology in a cost-effective andnon-disruptive manner.***   From time to time, wemay choose to acquire businesses, products or technologies instead ofdeveloping them ourselves. We do not know if we will be able to complete anyacquisitions, or whether we will be able to successfully integrate any acquiredbusinesses, operate them profitably or retain their key employees. Integratingany business, product or technology we acquire could be expensive andtime-consuming, disrupt our ongoing business and distract company management.In addition, in order to finance any acquisition, we may utilize our existingfunds, thereby lowering the amount of funds we currently have, or might need toraise additional funds through public or private equity or debt financings. Inthat event, we could be forced to obtain financing on less than favorable termsand, in the case of equity financing, that may result in dilution to ourstockholders. If we are unable to integrate any acquired entities, products ortechnologies effectively, our business could suffer. In addition, under certaincircumstances, amortization of assets or charges resulting from the costs ofacquisitions could harm our business, financial condition, or operatingresults.

**CertainRisks Related To Our Financial Performance**

***We have a history of losses and our future profitability isuncertain.*****Wegenerated net losses for the years ended March 31, 2007, 2006 and 2005.Continuing net losses may limit our ability to fund our operations and we maynot generate income from operations in the future. Our future profitability dependsupon many factors, including several that are beyond our control. These factorsinclude without limitation:

·       changesin the demand for our products and services;

·       the introduction ofcompetitive software;

·       our ability to licensedesirable technologies;

·       changes in the research anddevelopment budgets of our customers and potential customers;

·       our ability tosuccessfully, cost effectively and timely develop, introduce and market newproducts, services and product enhancements; and

·  the acquisition of any new entities orbusinesses which may have a dilutive effect upon our earnings.

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

***If we are unableto license software to, or collect receivables from our customers our operatingresults may be adversely affected.***   While themajority of our current customers are well-established, large pharmaceuticalcustomers and 

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universities, we alsoprovide products and services to smaller biotechnology companies. We have notexperienced significant customer defaults during the past three fiscal years.Our financial success depends upon the creditworthiness and ultimate collectionof amounts due from our customers, including our smaller customers with fewerfinancial resources. If we are not able to collect from our customers, we maybe required to write-off significant accounts receivable and recognize bad debtexpenses which could materially and adversely affect our operating results.

***Our quarterlyoperating results, particularly our quarterly cash flows, may fluctuate.******  ***Quarterly operating resultsmay fluctuate as a result of a number of factors, including lengthy salescycles, market acceptance of new products and upgrades, timing of new productintroductions, changes in pricing policies, changes in general economic andcompetitive conditions, and the timing and integration of acquisitions. We mayalso experience fluctuations in quarterly operating results due to general andindustry specific economic conditions that may affect the research anddevelopment expenditures of pharmaceutical and biotechnology companies. Inparticular, historically we have received approximately two-thirds of ourannual customer orders in the second half of our fiscal year. In accordancewith our revenue recognition policies, the revenue associated with these ordersis generally recognized over the contractual license term. Therefore, becausewe accrue sales commissions and royalties upon the receipt of customer orders,we generally experience an increase in operating costs and expenses during thesecond half of our fiscal year with only a minimal corresponding incrementalincrease in revenue. Additionally, our cash flows from operations havehistorically been positive in the fiscal quarter ended March 31 as we collectthe accounts receivable generated from these customer orders, while we havehistorically experienced negative cash flows from operations in the other threefiscal quarters. As a result of these seasonal variations, we believe thatquarter-to-quarter comparisons of our operating results are not a goodindication of our future performance and that our interim financial results arenot necessarily indicative of results for a full year or for any subsequentinterim period.

***We may be requiredto indemnify Pharmacopeia Drug Discovery, Inc. (“PDD”), or may not be ableto collect on indemnification rights from PDD.***   On April 30, 2004, we spun-offour drug discovery subsidiary, PDD, into an independent, separately traded,publicly held company through the distribution to our stockholders of adividend of one share of PDD common stock for every two shares of our commonstock. As part of the spin-off, we agreed to indemnify the indebtedness,liabilities and obligations of PDD. One such obligation includes a guarantee byus to the landlord of PDD’s obligations under certain facility leases, withrespect to which PDD will indemnify us should we be required to make anypayment under the guarantee. These indemnification obligations could be assignificant as the remaining future minimum lease payments, which totaledapproximately $21 million as of June 30, 2007. PDD’s ability to satisfy anysuch indemnification obligations (including, without limitation, PDD’scommitment to indemnify us in the event of our payment under our guarantee ofits leases) will depend upon PDD’s future financial strength. We cannot assureyou that, if PDD becomes obligated to indemnify us for any substantialobligations, PDD will have the ability to do so. There also can be no assurancethat we will be able to satisfy any indemnification obligations to PDD. Anyfailure by PDD to satisfy its obligations and any required payment by us couldhave a material adverse effect on our business.

***Enacted andproposed changes in securities laws and regulations have increased our costsand may continue to increase our costs in the future.***   TheSarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) required changes in some of ourcorporate governance and securities disclosure and compliance practices. UnderSarbanes-Oxley, publicly held companies, including us, are required to, amongother things, furnish independent annual audit reports regarding the existenceand reliability of their internal control over financial reporting and havetheir chief executive officer and chief financial officer certify as to theaccuracy and completeness of their financial reports.

We expect continued compliance with Sarbanes-Oxley toremain costly. Further, Sarbanes-Oxley and the related SEC and NASDAQcompliance rules may make it more difficult and expensive for us to obtaindirector and officer liability insurance, and we may be required to acceptreduced coverage or incur substantially higher costs to obtain coverage. Theselaws and regulations could also make it more difficult for us to attract andretain qualified members of our board of directors, or qualified executiveofficers. We continually evaluate and monitor regulatory developments andcannot estimate the timing or magnitude of additional costs we may incur as aresult.

***Our business,financial condition and results of operations may be adversely impacted by fluctuationsin foreign currency exchange rates.***   Ourinternational sales generally are denominated in local currencies. Fluctuationsin the value of currencies in which we conduct business relative to the UnitedStates dollar result in currency transaction gains and losses, and the impactof future exchange rate fluctuations cannot be accurately predicted. Futurefluctuations in currency exchange rates may have a material adverse impact onrevenue from international sales, and thus on our business, financial conditionand results of operations. When deemed appropriate, we may engage in currencyexchange rate hedging transactions in an 

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attempt to mitigate theimpact of adverse exchange rate fluctuations. However, currency hedgingpolicies may not be successful, and they may increase the negative impact ofexchange rate fluctuations.

***If we consume cashmore quickly than expected, we may be unable to raise additional capital and wemay be forced to curtail operations.***   Weanticipate that our existing capital resources will be adequate to fund ouroperations for at least the next twelve months. However, our capitalrequirements will depend on many factors, including the potential acquisitionof other businesses or technologies.  Ifwe determine that we must raise additional capital, we may attempt to do sothrough public or private financings involving debt or equity. However,additional capital may not be available on favorable terms, or at all. Ifadequate funds are not available, we may be required to curtail operationssignificantly or to obtain funds by entering into arrangements withcollaborative partners or others that may require us to relinquish rights tocertain of our technologies, products or potential markets that we would nototherwise relinquish.

**CertainRisks Related to Owning Our Stock**

***We expect that ourstock price will fluctuate significantly, and our stockholders may not be ableto resell their shares at or above their original investment price.***   The stock market, historicallyand in recent years, has experienced significant volatility particularly withtechnology company stocks. The volatility of technology company stock pricesoften does not relate to the operating performance of the companies representedby the stock. Factors that could cause volatility in the price of our commonstock include without limitation:

·       actual and anticipatedfluctuations in our quarterly financial and operating results;

·       market conditions in thetechnology and software sectors;

·       issuance of new or changedsecurities analysts’ reports or recommendations;

·       developments or disputesconcerning our intellectual property or other proprietary rights or other legalclaims;

·       introduction oftechnological innovations or new commercial products by us or our competitors;

·       market acceptance of ourproducts and services;

·       additions or departures ofkey personnel; and

·       the acquisition of newbusinesses or technologies;

These and other external factors may cause the marketprice and demand for our common stock to fluctuate substantially, which maylimit or prevent investors from readily selling their shares of common stockand may otherwise negatively affect the liquidity of our common stock.

***As institutionshold the majority of our common stock in large blocks, substantial sales bythese stockholders could depress the market price for our shares.***   Asof July 20, 2007, the top ten institutional holders of our common stock heldapproximately 60% of our outstanding common stock. As a result, if one or moreof these major stockholders were to sell all or a portion of their holdings, orif the market were to perceive that such sale or sales may occur, the marketprice of our common stock may fall significantly.

***Because we do notintend to pay dividends, our stockholders will benefit from an investment inour common stock only if our stock price appreciates in value.***   Wehave never declared or paid any cash dividends on our common stock. Wecurrently intend to retain our future earnings, if any, to finance theexpansion of our business and do not expect to pay any cash dividends in theforeseeable future. As a result, the success of an investment in our commonstock will depend entirely upon any future appreciation in its value. There isno guarantee that our common stock will appreciate in value or even maintainthe price at which it was purchased.

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***Anti-takeoverprovisions under the Delaware General Corporation Law, provisions in ourcertificate of incorporation and bylaws, and our adoption of a stockholderrights plan may render more difficult the accomplishment of mergers or theassumption of control by a principal stockholder, making more difficult theremoval of management.***   

Certain provisions of theDelaware General Corporation Law may delay or deter attempts to secure controlof our company without the consent of our management. Also, our governingdocuments provide for a staggered board of directors, which will make it moredifficult for a potential acquirer to gain control of our board of directors.In 2002, we adopted a stockholder rights plan, which is triggered uponcommencement or announcement of a hostile tender offer or when any one personor group acquires 15% or more of our common stock. The rights plan, oncetriggered, enables our stockholders (other than the stockholder responsible fortriggering the rights plan) to purchase our common stock at reduced prices.These provisions of our governing documents and stockholder rights plan, and ofDelaware law, could have the effect of delaying, deferring or preventing achange of control, including without limitation a proxy contest, making moredifficult the acquisition of a substantial block of our common stock. Theprovisions could also limit the price that investors might be willing to pay inthe future for shares of our common stock. Further, the existence of theseanti-takeover measures may cause potential bidders to look elsewhere, ratherthan initiating acquisition discussions with us.

**CertainRisks Related to Intellectual Property**

***We may not be ableto protect adequately the trade secrets and confidential information that wedisclose to our employees.******  ***Werely upon trade secrets, technical know-how and continuing technologicalinnovation to develop and maintain our competitive position. Competitorsthrough their independent discovery (or improper means, such as unauthorizeddisclosure or industrial espionage) may come to know our proprietaryinformation. We generally require employees and consultants to executeconfidentiality and assignment-of-inventions agreements. These agreementstypically provide that all materials and confidential information developed byor made known to the employee or consultant during his, her or its relationshipwith us are to be kept confidential, and that all inventions arising out of theemployee’s or consultant’s relationship with us are our exclusive property. Ouremployees and consultants may breach these agreements, and in some instances wemay not have an adequate remedy. Additionally, in some instances, we may havefailed to require that employees and consultants execute confidentiality andassignment-of-inventions agreements.

***Foreign laws maynot afford us sufficient protections for our intellectual property, and we maynot seek patent protection outside the United States.***   Webelieve that our success depends, in part, upon our ability to obtaininternational protection for our intellectual property. However, the laws ofsome foreign countries may not be as comprehensive as those of the UnitedStates and may not be sufficient to protect our proprietary rights abroad. Inaddition, we generally do not pursue patent protection outside the UnitedStates because of cost and confidentiality concerns. Accordingly, ourinternational competitors could obtain foreign patent protection for, andmarket overseas, products and technologies for which we are seeking patentprotection in the United States.

***A patent issued tous may not be sufficiently broad to protect adequately our rights inintellectual property to which the patent relates.***   Dueto cost and other considerations, we generally do not rely on patent protectionto enforce our intellectual property rights, and have filed only a limitednumber of patent applications. Even if patents are issued to us, these patentsmay not sufficiently protect our interest in our software or other technologiesbecause the scope of protection provided by any patents issued to or licensedby us are subject to the uncertainty inherent in patent law. Third parties maybe able to design around these patents or develop unique products providingeffects similar to our products. In addition, others may discover uses for oursoftware or technologies other than those uses covered in our patents, andthese other uses may be separately patentable. A number of pharmaceutical andbiotechnology companies, software organizations and research and academicinstitutions, have developed technologies, filed patent applications orreceived patents on various technologies that may be related to our business.Some of these technologies, patent applications or patents may conflict withour technologies, patent applications or patents. These conflicts could alsolimit the scope of patents, if any, that we may be able to obtain, or result inthe denial of our patent applications.

***We may be subjectto claims of infringement by third parties.****  *A number of patents may have been issued or may beissued in the future that could cover certain aspects of our technology orfunctionality of our products and could prevent us from using technology thatwe use or expect to use, or making or selling certain of our products. Inaddition, to the extent our employees are involved in research areas similar tothose areas in which they were involved at their former employers, we mayinadvertently use or disclose alleged trade secrets or other proprietaryinformation of their former employer. Thus, our products may infringe patent orother intellectual property rights of third parties, and we may be subject toinfringement claims by third parties. Any such claims, with or without merit,could be time consuming to defend, result in costly litigation, divertmanagement’s attention and resources, cause product shipment delays or requireus to enter into royalty or licensing agreements. Such licenses may not beavailable on terms acceptable to us, if at all. In the event of a successfulclaim of product infringement against us, our failure or inability to licenseor design around the infringed technology could have a material adverse effecton our business, financial condition and results of operations.

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***Third-partysoftware codes incorporated into our products could subject us to liability orlimit our ability to sell such products.***   Someof our products include software codes licensed from third parties, includingthe open source community. Some of these licenses impose certain obligationsupon us, including royalty and indemnification obligations. In the case ofcodes licensed from the open source community, the licenses may also limit ourability to sell products containing such code. Though we generally review theapplicable licenses prior to incorporating third party code into our softwareproducts, there can be no assurance that such third party codes incorporatedinto our products would not subject us to liability or limit our ability tosell the products containing such code, thereby having a material adverseaffect upon our business.

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**Item 6. Exhibits**
| Exhibit Number | ** ** | **Description**                                                                                                                                                                                                                        |
|----------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1            |       | Restated Certificate of Incorporation of  Pharmacopeia, Inc. (incorporated by reference to Exhibit 3.1 to Accelrys,  Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31,  1996).                             |
| 3.2            |       | Certificate of Amendment of the Restated Certificate  of Incorporation of Pharmacopeia, Inc. (incorporated by reference to Exhibit  3.1 to Accelrys, Inc.’s Annual Report on Form 10-K for the fiscal year ended  March 31, 2005. |
| 3.3            |       | Amended and Restated Bylaws of Accelrys, Inc. as  amended on June 9, 2005. (incorporated by reference to Exhibit 3.2 to  Accelrys, Inc.’s Annual Report on Form 10-K for the fiscal year ended March  31, 2005)              |
| 31.1*          |       | Section 302 Certification of the Principal Executive  Officer                                                                                                                                                                          |
| 31.2*          |       | Section 302 Certification of the Principal Financial  Officer                                                                                                                                                                          |
| 32.1*          |       | Section 906 Certification of the Chief Executive  Officer and Chief Financial Officer                                                                                                                                                  |

 

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*                    Filedherewith

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**SIGNATURE**

Pursuant to therequirements of section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.
|        |   |   | ACCELRYS, INC. |
|--------|--------|--------|----------------|
|   |   |   |           |   |
|   |   |   | By:            | /s/ RICK E. RUSSO |
|   |   |   |           | Rick E. Russo |
|   |   |   |           | Senior Vice President and Chief Financial  |
|   |   |   |           | Officer (Duly Authorized Officer and Chief |
|   |   |   |           | Financial Officer) |
|   |   |   |           |   |
|   |   |   |           | Date: August 2, 2007 |

 

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