**UNITED STATES****SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **(Mark One)** |                                                                                               |
|----------------|----------------------------------------------------------------------------------------------------|
| **ý**     | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |

 

**For the quarterly period ended June 30, 2003**

 

**or**

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

 

**CommissionFile Number: 0-27118**

 

**PHARMACOPEIA,INC.**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**                                                                        |   | **33-0557266**                       |
|-------------------------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                     |   | (I.R.S. Employer Identification No.) |
|                                                                                |   |                                 |
| **PO Box 5350, Princeton, New Jersey**                                              |   | **08543-5350**                       |
| (Address of principal executive offices)                                            |   | (Zip code)                           |
|                                                                                |   |                                 |
| **(609) 452-3600**                                                                  |
| (Registrant’s telephone number, including  area code)                          |
|                                                                                |   |                                 |
| **Not Applicable**                                                                  |
| (Former name, former address and former  fiscal year, if changed since last report) |

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or such shorter periodthat the registrant was required to file such reports) and (2) has beensubject to such filing requirements for the past 90 days.  Yes ý Noo

 

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

 

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

 

| **Class**                      |   | **Outstanding at July 31, 2003** |
|--------------------------------|--------|----------------------------------|
| Common Stock, $.0001 par value |   | 23,810,201                       |

#### ** **

 

----

 

#### **PHARMACOPEIA,INC.**

 

**Form10-Q**

 

#### **Table of Contents**

 
| **Item**                             |                                                                                        |
|--------------------------------------|---------------------------------------------------------------------------------------------|
|                                 |
| PART  I.  FINANCIAL INFORMATION |
|                                 |
| Item 1.                         | Unaudited  Consolidated Financial Statements:                                               |
|                                 |                                                                                        |
|                                 | Balance Sheets – June 30, 2003 and December 31, 2002                              |
|                                 |                                                                                        |
|                                 | Statements of Operations – Three and Six  Months Ended June 30, 2003 and 2002          |
|                                 |                                                                                        |
|                                 | Statements of Cash Flows – Six Months Ended  June 30, 2003 and 2002                    |
|                                 |                                                                                        |
|                                 | Notes to Unaudited Consolidated Financial  Statements                                       |
|                                 |                                                                                        |
| Item 2.                         | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                                 |                                                                                        |
| Item 3.                              | Quantitative  and Qualitative Disclosures about Market Risk                                 |
|                                 |                                                                                        |
| Item 4.                              | Controls  and Procedures                                                                    |
|                                 |                                                                                        |
| PART  II.  OTHER INFORMATION    |
|                                 |                                                                                        |
| Item 1.                              | Legal  Proceedings                                                                          |
|                                 |                                                                                        |
| Item  2.                             | Changes  in Securities and Use of Proceeds                                                  |
|                                 |                                                                                        |
| Item  3.                             | Defaults  upon Senior Securities                                                            |
|                                 |                                                                                        |
| Item  4.                             | Submission  of Matters to a Vote of Security Holders                                        |
|                                 |                                                                                        |
| Item 5.                              | Other  Information                                                                          |
|                                 |                                                                                        |
| Item  6.                             | Exhibits  and Reports on Form 8-K                                                           |
|                                 |
| Signature                            |
|                                 |
| Index to Exhibits                    |
|                                      |                                                                                             |  |

 

2

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#### **PART I**- FINANCIAL INFORMATION

 

**Item 1.****  Unaudited Consolidated Financial Statements**

 

**Pharmacopeia, Inc.**

**ConsolidatedBalance Sheets**

**(Dollarsin thousands)**

 
|                                                                                       |   | **June 30,  2003** |       | **December 31,  2002** |       |
|--------------------------------------------------------------------------------------------|--------|--------------------|------------|------------------------|------------|
|                                                                                       |   | **(Unaudited)**    |       |                   |       |
| **ASSETS**                                                                                 |   |               |       |                   |       |
| Current assets:                                                                            |   |               | ** ** |                   | ** ** |
| Cash and cash equivalents                                                                  |   | $                  | 24,486     |                   | $          | 28,236 |   |
| Marketable securities                                                                      |   | 118,468            |       | 112,835                |       |
| Trade receivables, net of allowance for doubtful  accounts of $556 and $1,634 respectively |   | 15,948             |       | 35,571                 |       |
| Prepaid expenses and other current assets                                                  |   | 5,978              |       | 5,505                  |       |
| Total current assets                                                                       |   | 164,880            |       | 182,147                |       |
|                                                                                       |   |               |       |                   |       |
| Property and equipment - net                                                               |   | 13,270             |       | 14,157                 |       |
| Goodwill - net                                                                             |   | 34,404             |       | 34,404                 |       |
| Capitalized software - net                                                                 |   | 7,611              |       | 8,656                  |       |
| Other intangibles - net                                                                    |   | —             |       | 116                    |       |
| Other assets                                                                               |   | 550                |       | 625                    |       |
| Total assets                                                                               |   | $                  | 220,715    |                   | $          | 240,105 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                             |   |               |       |                   |       |
| Current liabilities:                                                                       |   |               |       |                   |       |
| Accounts payable                                                                           |   | $                  | 2,619      |                   | $          | 2,497 |   |
| Accrued liabilities                                                                        |   | 16,682             |       | 20,429                 |       |
| Deferred revenue, current portion                                                          |   | 19,606             |       | 29,076                 |       |
| Total current liabilities                                                                  |   | 38,907             |       | 52,002                 |       |
|                                                                                       |   |               |       |                   |       |
| Deferred revenue, long-term                                                                |   | 5,224              |       | 4,766                  |       |
|                                                                                       |   |               |       |                   |       |
| Stockholders’ equity:                                                                 |   |               |       |                   |       |
| Capital stock                                                                              |   | 2                  |       | 2                      |       |
| Additional paid-in capital                                                                 |   | 286,335            |       | 284,733                |       |
| Treasury stock                                                                             |   | (8,340             | )          | (8,340                 | )          |
| Accumulated deficit                                                                        |   | (103,038           | )          | (93,821                | )          |
| Accumulated comprehensive income                                                           |   | 1,625              |       | 763                    |       |
| Total stockholders’ equity                                                            |   | 176,584            |       | 183,337                |       |
| Total liabilities and stockholders’ equity                                            |   | $                  | 220,715    |                   | $          | 240,105 |   |

 

See accompanying notes to these unauditedfinancial statements.

 

3

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**Pharmacopeia,Inc.**

#### **ConsolidatedStatements of Operations**

**(Dollarsin thousands, except per share data)**

 
|                                                 |   | **For the Three Months  Ended June 30,** |       | **For the Six Months  Ended June 30,** |       |
|------------------------------------------------------|--------|------------------------------------------|------------|----------------------------------------|------------|
|                                                 |   | **2003**                                 |       | **2002**                               |       | **2003** |   | **2002** |   |
| Revenue:                                             |   |                                     | ** ** |                                   | ** ** |   | ** ** |   | ** ** |
| Software license, service and other                  |   | $                                        | 19,090     |                                   | $          | 21,413 |   | $ | 36,309 |   | $ | 41,034 |   |
| Drug discovery                                       |   | 7,014                                    |       | 7,887                                  |       | 14,535 |   | 15,106 |   |
| Total revenue                                        |   | 26,104                                   |       | 29,300                                 |       | 50,844 |   | 56,140 |   |
|                                                 |   |                                     |       |                                   |       |   |   |   |   |
| Cost of revenue:                                     |   |                                     |       |                                   |       |   |   |   |   |
| Software license, service  and other            |   | 5,014                                    |       | 5,421                                  |       | 10,183 |   | 10,184 |   |
| Drug discovery                                       |   | 5,396                                    |       | 5,203                                  |       | 11,172 |   | 10,057 |   |
| Total cost of revenue                                |   | 10,410                                   |       | 10,624                                 |       | 21,355 |   | 20,241 |   |
|                                                 |   |                                     |       |                                   |       |   |   |   |   |
| Gross margin                                         |   | 15,694                                   |       | 18,676                                 |       | 29,489 |   | 35,899 |   |
|                                                 |   |                                     |       |                                   |       |   |   |   |   |
| Operating costs and expenses:                        |   |                                     |       |                                   |       |   |   |   |   |
| Research and development                             |   | 5,499                                    |       | 6,987                                  |       | 11,232 |   | 14,306 |   |
| Sales, general and administrative                    |   | 14,486                                   |       | 17,240                                 |       | 29,144 |   | 34,306 |   |
| Restructuring                                        |   | —                                   |       | —                                 |       | (384 | ) | — |   |
| Total operating costs and expenses                   |   | 19,985                                   |       | 24,227                                 |       | 39,992 |   | 48,612 |   |
| Operating loss                                       |   | (4,291                                   | )          | (5,551                                 | )          | (10,503 | ) | (12,713 | ) |
| Interest and other income, net                       |   | 903                                      |       | 663                                    |       | 2,039 |   | 1,943 |   |
| Loss before provision for income taxes               |   | (3,388                                   | )          | (4,888                                 | )          | (8,464 | ) | (10,770 | ) |
| Provision for income taxes                           |   | 376                                      |       | 192                                    |       | 753 |   | 313 |   |
| Net loss                                             |   | $                                        | (3,764     | )                                      | $          | (5,080 | ) | $ | (9,217 | ) | $ | (11,083 | ) |
|                                                 |   |                                     | ** ** |                                   | ** ** |   | ** ** |   | ** ** |
| Net loss per share                                   |   |                                     | ** ** |                                   | ** ** |   | ** ** |   | ** ** |
| Basic and Diluted                                    |   | $                                        | (0.16      | )                                      | $          | (0.22 | ) | $ | (0.39 | ) | $ | (0.47 | ) |
|                                                 |   |                                     |       |                                   |       |   |   |   |   |
| Weighted average number of common stock  outstanding |   |                                     |       |                                   |       |   |   |   |   |
| Basic and Diluted                                    |   | 23,707                                   |       | 23,373                                 |       | 23,662 |   | 23,527 |   |

 

See accompanying notes to these unauditedfinancial statements.

 

4

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**Pharmacopeia, Inc.**

**Consolidated Statements of Cash Flows**

**(Dollars in thousands)**

 
|                                                                  |   | **For the Six Months  Ended June 30,** |   |
|-----------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                  |   | **2003**                               |   | **2002** |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                 |   |                                   |   |   |   |
| Net loss                                                              |   | $                                      | (9,217 | ) | $ | (11,083 | ) |
| Adjustments to reconcile net loss to net cash  provided by operations |   |                                   |   |   |   |
| Depreciation                                                          |   | 3,091                                  |   | 2,911 |   |
| Amortization                                                          |   | 3,464                                  |   | 3,857 |   |
| Contribution of stock to 401(k) members                               |   | 541                                    |   | 612 |   |
| Non-cash compensation                                                 |   | 20                                     |   | 35 |   |
| Changes in assets and liabilities:                                    |   |                                   |   |   |   |
| Accounts receivable                                                   |   | 19,620                                 |   | 15,856 |   |
| Prepaid and other current assets                                      |   | (473                                   | )      | 154 |   |
| Other assets                                                          |   | (15                                    | )      | 529 |   |
| Accounts payable                                                      |   | 120                                    |   | (2,188 | ) |
| Accrued liabilities                                                   |   | (3,744                                 | )      | (4,110 | ) |
| Deferred revenue                                                      |   | (9,008                                 | )      | (5,100 | ) |
| Net cash provided by operating activities                             |   | 4,399                                  |   | 1,473 |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                 |   |                                   |   |   |   |
| Capital expenditures                                                  |   | (1,957                                 | )      | (6,345 | ) |
| Purchases of marketable securities                                    |   | (35,579                                | )      | (71,083 | ) |
| Proceeds from sales of marketable securities                          |   | 30,279                                 |   | 31,902 |   |
| Increase in capitalized software development costs                    |   | (2,303                                 | )      | (1,250 | ) |
| Net cash used in investing activities                                 |   | (9,560                                 | )      | (46,776 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                 |   |                                   |   |   |   |
| Proceeds from issuance of common stock                                |   | 1,043                                  |   | 1,251 |   |
| Purchases of treasury stock                                           |   | —                                 |   | (7,024 | ) |
| Principal payments under capital lease obligations                    |   | (6                                     | )      | (47 | ) |
| Net cash provided by (used in) financing  activities                  |   | 1,037                                  |   | (5,820 | ) |
| Exchange rate effect on cash and equivalents                          |   | 374                                    |   | 102 |   |
| Net decrease in cash and equivalents                                  |   | (3,750                                 | )      | (51,021 | ) |
| Cash and equivalents, beginning of period                             |   | 28,236                                 |   | 68,891 |   |
| Cash and equivalents, end of period                                   |   | $                                      | 24,486 |   | $ | 17,870 |   |
|                                                                  |   |                                   |   |   |   |
| SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:                       |   |                                   |   |   |   |
| Cash paid during the period for:                                      |   |                                   |   |   |   |
| Interest                                                              |   | $                                      | 5      |   | $ | 20 |   |
| Income taxes                                                          |   | $                                      | 214    |   | $ | 395 |   |

 

Seeaccompanying notes to these unaudited financial statements.

#### ** **

5

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#### **Pharmacopeia,Inc.**

**Notes to Unaudited Consolidated FinancialStatements**

 

**1.  Basis of Presentation**

 

The accompanying unaudited financial statements have been prepared in accordancewith accounting principles generally accepted in the United States for interimfinancial information and with instructions to Form 10-Q and Article 10of Regulation S-X. Accordingly, these unaudited financial statementsdo not include all of the information and disclosures required by generallyaccepted accounting principles for complete financial statements.  In the opinion of management, alladjustments (consisting of normal recurring accruals) considered necessary fora fair presentation of the financial statements have been included.  Interim results are not necessarilyindicative of the results that may be expected for the year.  These financial statements should be read inconjunction with the audited financial statements and disclosures theretoincluded in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2002.

 

Certain amounts in prior periods have been reclassified to conform withthe current period presentation.

 

**2.  Net Loss Per Share**

 

The Company computes net income (loss) per share in accordance withStatement of Financial Accounting Standard No. 128, “Earnings Per Share” (“SFAS128”).  Under the provisions of SFAS128, basic net income (loss) per share is computed by dividing the net income(loss) for the period by the weighted-average number of common sharesoutstanding during the period.  Dilutednet income (loss) per share is computed by dividing the net income (loss) forthe period by the weighted-average number of common and dilutive commonequivalent shares outstanding during the period.  Diluted earnings per share are required to be calculated toinclude the potentially dilutive effect of outstanding stock options, or otherdilutive securities.  The Company has anet loss for the periods presented; accordingly, the inclusion of outstandingstock options would be anti-dilutive and therefore the weighted-average sharesused to calculate both basic and diluted loss per share are the same.

 

**3.  Segment Information**

 

The Company operates in two industry segments.  The Company’s Software segment, AccelrysInc. (“Accelrys”), provides molecular modeling and simulation, bioinformaticsand cheminformatics software, and related services that facilitate thediscovery and development of new drug and chemical products and processes inthe pharmaceutical, biotechnology, chemical, petrochemical and materialsindustries.  The Company’s DrugDiscovery segment, Pharmacopeia Drug Discovery, Inc. (“PDD”), provides drugdiscovery services to pharmaceutical and biotechnology companies based onproprietary combinatorial chemistry, medicinal chemistry, high-throughputscreening, and Accelrys technologies. The accounting policies of the reportablesegments are the same as those of the Company. Summarized financial informationconcerning industry segments is as follows (dollars in thousands):

 

6

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|                                 |   | **Three Months Ended  June 30, 2003** |   | **Six Months Ended  June 30, 2003** |   |
|--------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
|                                 |   | **Accelrys**                          |   | **PDD**                             |   | **Total** |   | **Accelrys** |   | **PDD** |   | **Total** |   |
| Revenue:                             |   |                                  |   |                                |   |   |   |   |   |   |   |   |   |
| Software licenses, service and other |   | $                                     | 19,090 |                                | $      | — |   | $ | 19,090 |   | $ | 36,309 |   | $ | — |   | $ | 36,309 |   |
| Drug discovery                       |   | —                                |   | 7,014                               |   | 7,014 |   | — |   | 14,535 |   | 14,535 |   |
| Total revenue                        |   | $                                     | 19,090 |                                | $      | 7,014 |   | $ | 26,104 |   | $ | 36,309 |   | $ | 14,535 |   | $ | 50,844 |   |
| Operating loss                       |   | $                                     | (3,589 | )                                   | $      | (702 | ) | $ | (4,291 | ) | $ | (8,961 | ) | $ | (1,542 | ) | $ | (10,503 | ) |

 
|                                 |   | **Three Months Ended  June 30, 2002** |   | **Six Months Ended  June 30, 2002** |   |
|--------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
|                                 |   | **Accelrys**                          |   | **PDD**                             |   | **Total** |   | **Accelrys** |   | **PDD** |   | **Total** |   |
| Revenue:                             |   |                                  |   |                                |   |   |   |   |   |   |   |   |   |
| Software licenses, service and other |   | $                                     | 21,413 |                                | $      | — |   | $ | 21,413 |   | $ | 41,034 |   | $ | — |   | $ | 41,034 |   |
| Drug discovery                       |   | —                                |   | 7,887                               |   | 7,887 |   | — |   | 15,106 |   | 15,106 |   |
| Total revenue                        |   | $                                     | 21,413 |                                | $      | 7,887 |   | $ | 29,300 |   | $ | 41,034 |   | $ | 15,106 |   | $ | 56,140 |   |
| Operating loss                       |   | $                                     | (5,166 | )                                   | $      | (385 | ) | $ | (5,551 | ) | $ | (11,509 | ) | $ | (1,204 | ) | $ | (12,713 | ) |

 
|                             |   | **Accelrys** |    | **PDD** |   | **Total** |   |
|----------------------------------|--------|--------------|---------|---------|--------|-----------|--------|
| Total assets - June 30, 2003     |   | $            | 89,708  |    | $      | 131,007   |   | $ | 220,715 |   |
| Total assets - December 31, 2002 |   | $            | 104,143 |    | $      | 135,962   |   | $ | 240,105 |   |

 

**4.  Stock-Based Compensation**

 

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

 

Had the Company followed the fair value measurement provisions of SFAS123, the following table summarizes the pro forma net loss and pro forma netloss per share that would have been recorded (in thousands, except per sharedata):

 
|                                                                                                             |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|------------------------------------------------------------------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                                                                             |   | **2003**                        |   | **2002**                      |   | **2003** |   | **2002** |   |
| Net loss                                                                                                         |   |                            |   |                          |   |   |   |   |   |
| As reported                                                                                                      |   | $                               | (3,764 | )                             | $      | (5,080 | ) | $ | (9,217 | ) | $ | (11,083 | ) |
| Deduct: total stock-based employee compensation  expense determined under fair value based method for all awards |   | (3,101                          | )      | (3,176                        | )      | (6,203 | ) | (6,353 | ) |
| Pro forma                                                                                                        |   | $                               | (6,865 | )                             | $      | (8,256 | ) | $ | (15,420 | ) | $ | (17,436 | ) |
| Basic and diluted net loss per share:                                                                            |   |                            |   |                          |   |   |   |   |   |
| As reported                                                                                                      |   | $                               | (0.16  | )                             | $      | (0.22 | ) | $ | (0.39 | ) | $ | (0.47 | ) |
| Pro forma                                                                                                        |   | $                               | (0.29  | )                             | $      | (0.35 | ) | $ | (0.65 | ) | $ | (0.74 | ) |

 

The fair value of each option granted during 2003 and 2002 is estimatedon the date of grant using the Black-Scholes option-pricing model with thefollowing assumptions:

 
|                    |   | **2003** |   | **2002** |   |
|-------------------------|--------|----------|--------|----------|--------|
| Dividend yield          |   | 0        | %      | 0        | %      |
| Expected volatility     |   | 87.02    | %      | 90.70    | %      |
| Risk-free interest rate |   | 2.84     | %      | 4.60     | %      |
| Expected life (years)   |   | 6.6      |   | 5.5      |   |

 

7

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**5.  Restructuring**

 

During the third quarter of 2002, the Company announced that it wasundertaking various actions to restructure its operations to improve itsoverall financial performance.  Therestructuring effort included a reduction in force of 71 employees, all of whomhad been terminated as of June 30, 2003, and the closure of certain facilities.As a result of this plan, restructuring related charges of approximately $4.3million were recognized as operating expense in the third quarter of 2002.

 

Based on a subsequent analysis of costs incurred and remaining costs tocomplete the restructuring, the Company determined that certain costsoriginally contemplated under the plan would not be incurred, and as such, therelated amounts were reversed during the first quarter of 2003.  Certain of the Costs to Exit LeaseObligations were denominated in a foreign currency which has strengthened sincethe establishment of the reserve; accordingly, the ending balance (expressed inUS Dollars) translates into more dollars than in the prior quarter even thoughcertain of the reserves were utilized during the period.

 

The following table summarizes the balance of the accrued restructuringreserve, which has been included in accrued liabilities as of June 30, 2003 (dollarsin thousands):

 
|                      |   | **Severance Costs for Involuntary  Employee Terminations** |   | **Costs to Exit  Lease Obligations** |   | **Total** |   |
|---------------------------|--------|------------------------------------------------------------|--------|--------------------------------------|--------|-----------|--------|
| Balance at August 6, 2002 |   | $                                                          | 2,367  |                                 | $      | 1,973     |   | $ | 4,340 |   |
| Utilization of Reserves:  |   |                                                       |   |                                 |   |      |   |
| Cash                      |   | (2,192                                                     | )      | (358                                 | )      | (2,550    | )      |
| Reserve reductions        |   | (95                                                        | )      | (289                                 | )      | (384      | )      |
| Balance at June 30, 2003  |   | $                                                          | 80     |                                 | $      | 1,326     |   | $ | 1,406 |   |

 

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

 

The following discussion and analysis offinancial condition and results of operations of Pharmacopeia, Inc.(“Pharmacopeia” or the “Company”) should be read in conjunction with theUnaudited Consolidated Financial Statements and related notes includedelsewhere in this Form 10-Q, and also in conjunction with the Consolidated FinancialStatements and related notes included in the Company’s Form 10-K for the yearended December 31, 2002.

 

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

 

Although forward-looking statements in thisReport reflect the good faith judgment of the Company’s management, suchstatements can only be based on facts and factors currently known by theCompany.  Consequently, forward-lookingstatements are inherently subject to risks and uncertainties and actual resultsand outcomes may differ materially from the results and outcomes discussed inor anticipated by the forward-looking statements.  The Company undertakes no obligation to revise or update anyforward-looking statements in order to reflect any event or

 

8

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circumstance that may arise after the date ofthis Report.  Readers areurged not to place undue reliance on these forward-looking statements, whichspeak only as of the date of this Report.

 

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

 

**BUSINESS OVERVIEW**

 

Pharmacopeia is a leader in enabling science and technology thataccelerates and improves the drug discovery and chemical development processes.Pharmacopeia’s drug discovery subsidiary, Pharmacopeia Drug Discovery, Inc.(“PDD”), integrates proprietary small molecule combinatorial chemistry, medicinalchemistry, high-throughput screening, in-vitro pharmacology, computationalmethods and informatics to discover and optimize lead compounds.  Pharmacopeia’s software subsidiary, AccelrysInc. (“Accelrys”), develops and commercializes molecular modeling andsimulation software for the life sciences and materials research markets,cheminformatics and decision support systems, and bioinformatics toolsincluding gene sequence analysis. Pharmacopeia employs approximately 700 peopleand is headquartered in Princeton, NJ.

 

##### RESULTS OFOPERATIONS

 

THREE MONTHS ENDED JUNE 30, 2003 AND 2002

 

Total revenue decreased 11% to $26.1 millionin the second quarter of 2003 compared to $29.3 million in the second quarterof 2002.

 

Accelrys software license, service and otherrevenue decreased 11% to $19.1 million in the second quarter of 2003 comparedto $21.4 million in the second quarter of 2002.  Revenue decreased 11% to $15.6 million in the European and USregions combined, including revenue from a strategic alliance.  Excluding the effect of the strategicalliance, revenue in the European and US regions combined decreased 9%.  Revenue in Asia decreased 8% to $3.4million.  The net decrease in revenuewas due primarily to continuing pricing pressure and higher discounting requiredacross all customer types and, particularly in the biotech and materialsscience sectors throughout the world, to fewer renewals of annual licenses,attributable in part to changes in customers’ business focus.

 

Drug Discovery revenue decreased 11% to $7.0million in the second quarter of 2003 compared to $7.9 million in the secondquarter of 2002.  The decrease wasprimarily due to timing of milestone revenue. Milestone revenue recorded in the second quarter of 2003 was $0.1million and milestone revenue recorded in the second quarter of 2002 was $1.4million.  Excluding the effect ofmilestone revenue from both periods, revenue increased 6% to $6.9 million inthe second quarter of 2003 compared to $6.5 million in the second quarter of2002.

 

Accelrys software license, service and othergross margin decreased 12% to $14.1 million (74% of related revenue) in thesecond quarter of 2003 compared to $16.0 million (75% of related revenue) inthe second quarter of 2002.  The $1.9million decrease in gross margin resulted principally from the fixed cost ofour customer services group at Accelrys being changed against a lower revenuebase.

 

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Gross margin generated from Drug Discoverydecreased 40% to $1.6 million (23% of related revenue) in the second quarter of2003 compared to $2.7 million (34% of related revenue) in the second quarter of2002 including the effect of milestone revenue.  Excluding the effect of the milestone revenue from both periods,the gross margin increased by 14% to $1.5 million (22% of related revenue) from$1.3 million (20% of related revenue). The increase was related to the mix of collaborations generatingrevenue.

 

Research and development expenses decreasedby 21% to $5.5 million in the second quarter of 2003 compared to $7.0 millionin the second quarter of 2002.  Thedecrease in research and development expenses is attributable to costefficiencies realized at Accelrys through the consolidation of researchefforts, cost reductions implemented in the prior year, and the reduction ofinternally funded drug discovery programs in the Drug Discovery business.

 

Sales, general and administrative expensesdecreased by 16% to $14.5 million in the second quarter of 2003 compared to$17.2 million in the second quarter of 2002. The decrease in sales, general and administrative expenses isattributable to the restructuring undertaken in the third quarter of 2002, andcontinuing cost reduction initiatives implemented by management.

 

Interest and other income, net, increased 36%to $0.9 million in the second quarter of 2003 compared to $0.7 million in thesecond quarter of 2002.  The increase isdue to lower exchange rate losses, partially offset by decreases in marketinterest rates and average investment balances.

 

The Company recorded an income tax provisionof $0.4 million for the second quarter of 2003 compared to $0.2 million forsecond quarter of 2002.  Tax expense isbased on the annual estimatedeffective tax rate, after considering estimated taxable income for each taxjurisdiction.

 

As a result of the lower revenue and lowercosts described above, the Company generated a net loss of $3.8 million ($0.16per diluted share) in the second quarter of 2003, 26% lower than the net lossof $5.1 million ($0.22 per diluted share) in the second quarter of 2002.

 

SIX MONTHS ENDED JUNE 30, 2003 AND 2002

 

Total revenue decreased 9% to $50.8 millionin the first half of 2003 compared to $56.1 million in the first half of 2002.

 

Accelrys software license, service and otherrevenue decreased 12% to $36.3 million in the first half of 2003 compared to$41.0 million in the first half of 2002. Revenue decreased 16% to $28.5 million in the European and US regionscombined, including revenue from a strategic alliance.  Excluding the effect of the strategicalliance, revenue in the European and US regions combined decreased by13%.  The net decrease in revenue wasdue primarily to pricing pressure and higher discounting required across allcustomer types and, particularly in the biotech and materials science sectors,fewer renewals of annual licenses, attributable in part to changes incustomers’ business focus.  Revenue inAsia increased 11% due to revenue growth in the first quarter of 2003, Japan’straditional fiscal year end, partially offset by decreased revenue in thesecond quarter of 2003 described above.

 

Drug Discovery revenue decreased 4% to $14.5million in the first half of 2003 compared to $15.1 million in the first halfof 2002. This decrease is largely due to a decrease in lead optimizationrevenue due to the expiration of a collaboration agreement. Milestone revenuewas consistent in the comparable six month period.

 

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Accelrys software license, service and othergross margin decreased 15% to $26.1 million (72% of related revenue) in thefirst half of 2003 compared to $30.9 million (75% of related revenue) in thefirst half of 2002.  The $4.8 milliondecrease in gross margin resulted principally from the fixed cost of ourcustomer services group at Accelrys being charged against a lower revenue base.

 

Gross margin generated from Drug Discoverydecreased 33% to $3.4 million (23% of related revenue) in the first half of2003 compared to $5.0 million (33% of related revenue) in the first half of2002.  The lower margin resulted fromthe decreased revenue, and from increased resources allocated to collaborationswhich resulted in increased direct and allocated fixed costs associated withcurrent period revenue.

 

Research and development expenses decreasedby 21% to $11.2 million in the first half of 2003 compared to $14.3 million inthe first half of 2002. The decrease in research and development expenses isattributable to cost efficiencies realized at Accelrys due to the consolidationof research efforts, cost reductions implemented in the prior year, and thereduction of internally funded drug discovery programs in the Drug Discoverybusiness.

 

Sales, general and administrative expensesdecreased by 15% to $29.1 million in the first half of 2003 compared to $34.3million in the first half of 2002.  Thedecrease in sales, general and administrative expenses is attributable to therestructuring undertaken in the third quarter of 2002, and continuing cost reductioninitiatives implemented by management.

 

During the first half of 2003, the Companyterminated a facility lease, the expected remaining obligation under which hadbeen included in the restructuring provision taken in the third quarter of2002, and finalized certain remaining severance obligations.  As such, the Company reversed an excessportion of the restructuring liability during the first half of 2003.

 

Interest and other income, net, increased 5%to $2.0 million in the first half of 2003 compared to $1.9 million in the firsthalf of 2002.  The increase is due tolower exchange rate losses, partially offset by decreases in market interestrates and average investment balances.

 

The Company recorded an income tax provisionof $0.8 million for the first half of 2003 compared to $0.3 million for firsthalf of 2002.  Tax expense is based on the annual estimated effective tax rate, afterconsidering estimated taxable income for each tax jurisdiction.

 

As a result of the lower revenue and lowercosts described above, the Company generated a net loss of $9.2 million ($0.39per diluted share) in the first half of 2003, 17% lower than the loss of $11.1million ($0.47 per diluted share) in the first half of 2002.

 

**LIQUIDITY AND CAPITALRESOURCES**

 

The Company has funded its activities to dateprimarily through the sale of equity securities, software licenses, softwaremaintenance services, and drug discovery services and milestones.  As of June 30, 2003, the Company had cash,cash equivalents, and marketable securities of $143.0 million compared to$141.0 million as of December 31, 2002.

 

Cash provided by operations increased by $2.9million in the first half of 2003 compared to the first half of 2002.  The increase is primarily attributable tothe lower net loss generated in the first half of 2003, and increasedcollection of high dollar accounts receivable balances generated during thefourth quarter of 2002.  Cash used ininvesting activities decreased by $37.2 million in

 

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the first half of 2003 compared to the firsthalf of 2002 due to the timing of investments and reduced capitalpurchases.  Cash used in financingactivities decreased by $6.9 million in the first half of 2003 compared to thefirst half of 2002 due to purchases of treasury stock in the prior year.

 

The Company anticipates that its capitalrequirements may increase in future periods as a result of seasonal salestrends, additional research and development activities, and the acquisition ofadditional equipment.  The Company’scapital requirements may also increase in future periods as the Company seeksto expand its technology platform through investments, licensing arrangements,technology alliances, or acquisitions.

 

The Company anticipates that its existingcapital resources will be adequate to fund the Company’s operations at leastthrough 2004.  However, there can be noassurance that changes will not occur that would consume available capitalresources before then.  The Company’scapital requirements depend on numerous factors, including the ability of theCompany to continue to generate software sales, the ability of the Company toextend existing Drug Discovery agreements and to enter into additionalarrangements, competing technological and market developments, changes in theCompany’s existing collaborative relationships, the cost of filing,prosecuting, defending, and enforcing patent claims and other intellectualproperty rights and the outcome of related litigation, the purchase of additionalcapital equipment, acquisitions of other businesses or technologies, and theprogress of the Company’s customers’ milestone and royalty producingactivities.  There can be no assurancethat additional funding, if necessary, will be available on favorable terms, ifat all.  The Company’s forecasts of theperiod of time through which its financial resources will be adequate tosupport its operations are forward looking information, and actual resultscould vary.  The factors describedearlier in this paragraph will impact the Company’s future capital requirementsand the adequacy of its available funds.

 

RISK FACTORS

 

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

 

CERTAIN RISKS RELATED TO OUR BUSINESS AS AWHOLE

 

*Our successdepends in part upon the successful implementation of our management’sstrategic plan.* Our management has been, and continuesto be, engaged in the consideration and exploration of strategic alternativesfor our businesses, including the possible separation by various means of ourDrug Discovery business from our Accelrys software operation.  There can be no assurance that any suchstrategic alternative will be implemented or, if completed, that it willenhance the value of either or both of our businesses.  Such alternatives also may include the acquisitionof businesses and technologies which complement or supplement our existingbusinesses and technologies. However, management may be unable to identifysuitable strategic opportunities, choose the wrong technologies or businessesto pursue or be unable to negotiate suitable prices or favorable terms withrespect to strategic opportunities.  Theoccurrence of any of the foregoing may have a material adverse effect on ourbusiness.

 

*The agreementwith our major Drug Discovery customer expires in March 2004.*** **During the year ended December31, 2002, we earned approximately 12% of our consolidated revenue from themajor customer in our Drug Discovery segment. The agreement with this key customer

 

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expires by its terms in March 2004. We are in the process of negotiating with the customer terms of apotential new collaboration agreement; however, completion of an agreement onterms that are favorable to us, or at all, is uncertain.  The termination of the existing agreement,without completion of a new collaboration arrangement on acceptable terms, willhave a material adverse effect on PDD, and our business as a whole.  There can be no assurance we will be able tocomplete a new agreement with this significant customer on acceptable terms, orat all.

 

*Pharmaceuticaland biotechnology companies may discontinue or decrease their use of ourservices and products.*** **We depend on pharmaceutical and biotechnology companies thatuse our services for a large portion of our PDD revenue. Further, thesecompanies (together with diversified chemical and other industrial companies)comprise the principal market for our Accelrys modeling, simulation, dataanalysis and related software products and services.  Although there is a history among pharmaceutical andbiotechnology companies of outsourcing drug research and development functions,this practice may not continue. Similarly, these companies have frequentlyutilized outside software vendors for key tools used in drug discovery andchemical development, rather than developing needed information and analysistools internally.  Our revenue dependsto a large extent on research and development expenditures by thepharmaceutical, biotechnology, chemical and agricultural industries,particularly companies in these industries outsourcing research and developmentprojects and adding new and improved technologies to accelerate their drugdiscovery and chemical development initiatives.  These expenditures are based on a wide variety of factors,including the resources available for purchasing research equipment, thespending priorities among various types of research, policies regardingexpenditures during recessionary periods and the benefits of new software toolsversus their costs of licensure.  Sincea large proportion of our software customers license our products on an annualbasis or buy maintenance contracts from us annually, if their spendingpriorities shift, our revenue may be impacted. Also, general economic downturns in our customers’ industries or anydecrease in research and development expenditures could harm our operations, ascould increased popularity of management theories which counsel againstoutsourcing of critical business functions. In addition, the popularity ofscientific thinking that disfavors expensive products such as large diversitylibraries could negatively impact our revenue or our sales mix. Any decrease indrug discovery spending by pharmaceutical and biotechnology companies, or inchemical or materials spending by chemical and agricultural companies, couldcause our revenue to decline and adversely impact our profitability.

 

*Our ability toincrease revenue and grow our business is dependent upon our success in addingnew customers and expanding our existing customer relationships.*  In order to generate the additional revenueneeded to grow, we must add new customers and retain, and expand upon, ourexisting customer relationships. These efforts depend significantly upon, amongother factors:

 

•                  oursuccessful development of new products;

•                  thesuccess of our business development, sales and marketing efforts;

•                  biotechnologyand pharmaceutical company spending for the outsourcing of chemistry and otherdrug discovery services; and

•                  thewillingness of current and potential biotechnology, pharmaceutical anddiversified chemical customers to invest in new modeling, simulation andinformatics solutions.

 

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

 

*Our futureprofitability is uncertain.*We generated a small profit in 2000, and we have generated losses in2001, 2002 and the first half of 2003.  Ourfuture profitability depends upon many factors, including several that arebeyond our control. These factors include:

 

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•                  changesin the demand for our products and services;

•                  theintroduction of competitive drug discovery services and software;

•                  ourability to license desirable technologies;

•                  changesin the research and development budgets of our customers and potentialcustomers; and

•                  ourability to successfully and timely develop, introduce and market new products,services and product enhancements cost effectively.

 

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

 

*Failure toattract and retain skilled personnel could have a material adverse effect onus.* Our success depends in part on the continuedservice of key scientific, software, sales, engineering and managementpersonnel and our ability to identify, hire and retain additional personnel.There is intense competition for qualified personnel. In particular, we believethat there is a shortage of scientists qualified to work in the Drug Discoverysegment. The competition among drug discovery and development companies to hiresuch scientists is particularly intense. Immigration laws may further restrictour ability to attract or hire qualified personnel. We may not be able tocontinue to attract and retain the personnel necessary for the development ofthe Drug Discovery segment. 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 ourscientific and management staff, including:

 

•                  JosephA. Mollica, Ph.D., Chairman of the Board, President and Chief ExecutiveOfficer;

•                  MarkJ. Emkjer, Executive Vice President and President, Accelrys; and

•                  StephenA. Spearman, Ph.D., Executive Vice President and Chief Operating Officer, PDD,

 

and the managers reporting to these senior executives.  One or more of these key employees couldretire or otherwise leave our employ within the foreseeable future, and theloss of any of these people could have a material adverse effect on ourbusiness, financial condition and results of operations. We do not, and do notintend to, maintain key person life insurance on the life of any employee.

 

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

 

*We may beunable to develop strategic relationships with large pharmaceutical,biotechnology, chemical and technology companies.* A component of our business strategy is todevelop strategic relationships with larger pharmaceutical, biotechnology,chemical and technology companies.  Webelieve that through such relationships we can add revenue, expand ourdistribution channels, maximize our research and development resources, improveour competitive position and increase market awareness and acceptance of DrugDiscovery and

 

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scientific software products. To date, we have entered into significantstrategic relationships with such companies as Schering-Plough, IBM, Oracle andHP.  There can be no assurance that anysuch relationship will continue, that relationships with similar large organizationscan be developed, or that any such existing or new alliances will producesubstantial revenue or profit opportunities.

 

*We are subjectto risks associated with the operation of an international business.*In 2002, approximately 53% of our consolidated revenue was derived from customers outsidethe United States, both through international subsidiaries and on an exportbasis. Approximately 36% of our revenue was derived from customers in Europe andapproximately 17%was derived from customers in the Asia/Pacific region. These trends have continuedthrough the first half of 2003, and we anticipate that international revenuewill continue to account for a significant percentage of future overallrevenue. Our international operations are subject to risks inherent in theconduct of international business, including:

 

•                  unexpectedchanges in regulatory requirements;

•                  longerpayment cycles;

•                  currencyexchange rate fluctuations;

•                  importand export license requirements;

•                  tariffsand other barriers;

•                  politicaland economic instability;

•                  limitedintellectual property protection;

•                  difficultiesin collecting trade receivables;

•                  difficultiesin managing distributors or representatives;

•                  difficultiesin staffing and managing foreign subsidiary or joint venture operations; and

•                  potentiallyadverse tax consequences.

 

We may not be able to sustain or increase international revenue. Any ofthe foregoing factors may have a material adverse effect on our internationaloperations and, therefore, our business, financial condition and results ofoperations. Our direct international sales generally are denominated in localcurrencies. Fluctuations in the value of currencies in which we conductbusiness relative to the United States dollar result in currency transactiongains and losses, and the impact of future exchange rate fluctuations cannot beaccurately predicted. Future fluctuations in currency exchange rates may have amaterial adverse impact on revenue from international sales, and thus on ourbusiness, financial condition and results of operations. When deemedappropriate, we may engage in currency exchange rate hedging transactions in anattempt to mitigate the impact of adverse exchange rate fluctuations. However,currency hedging policies may not be successful, and they may increase thenegative impact of exchange rate fluctuations.

 

*Investments inSales Efforts.* Both our Drug Discovery and software products and services involvelengthy sales cycles, often requiring us to expend considerable financial andpersonnel resources without any assurance that revenue will be recognized.  These sales cycles typically are long for anumber of reasons.  In Drug Discovery,factors include the strategic nature of Drug Discovery partnerships, the sizeof many such transactions, the confidential and proprietary nature of thebiological targets against which we screen our chemical compound libraries, andthe unique terms typically found in each services transaction.  With respect to software sales, sales cyclesare impacted by the time and resources required to educate potential customerorganizations as to the value and comparative advantages of our products. As aresult, we may expend substantial funds and effort to negotiate agreements forservices and products in both of our business segments, but may ultimately beunable to consummate a sale. In these circumstances, our results of operationsand ability to achieve profitability are adversely affected.

 

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*Consolidationwithin the pharmaceutical and biotechnology industries may lead to fewerpotential customers for our products and services. *A significant portion of our customerbase consists of pharmaceutical and biotechnology companies. Mergers betweenlarge multinational pharmaceutical companies have accelerated in recent years.Continued consolidation within the pharmaceutical and biotechnology industriesmay result in fewer customers for our products and services. If one of theparties to a consolidation uses the products or services of our competitors, wemay lose existing customers as a result of such consolidation.

 

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

 

*Terroristattacks or acts of war may seriously harm our business.***  **Terrorist attacks or acts of warmay cause damage or disruption to our company, our employees, our facilitiesand our customers, which could significantly impact our revenue, costs andexpenses and financial condition. The long-term effects on our company of theattacks that took place in the United States on September 11, 2001 are unknown.The potential for future terrorist attacks, the national and internationalresponses to terrorist attacks, and other acts of war or hostility have createdmany economic and political uncertainties, which could materially adverselyaffect our business, results of operations, and financial condition in waysthat we currently cannot predict.

 

*Because ourstock price may be volatile, our stock price could experience substantialdeclines.*** **Themarket price of our common stock has historically experienced and may continueto experience volatility. Our quarterly operating results, changes in generalconditions in the economy or the financial markets and other developmentsaffecting us or our competitors could cause the market price of our commonstock to fluctuate substantially. In addition, in recent years, the stockmarket has experienced significant price and volume fluctuations. During thepast two years, the stock market, and in particular technology companies, alsohave experienced significant decreases in market value. This volatility and therecent market decline has affected the market prices of securities issued bymany companies, often for reasons unrelated to their operating performance, andmay adversely affect the price 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.*  As of June 30, 2003, our company’s sevenlargest stockholders held approximately 62% of our outstanding commonstock.  As a result, if one or more ofthese major stockholders were to sell all or a portion of their holdings, or ifthe market were to perceive that such sale or sales may occur, the market priceof our common stock may fall significantly.

 

*Because we donot intend to pay dividends, you will benefit from an investment in our commonstock only if it 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 your 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 you purchased your shares.

 

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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 stockholders to purchase our common stock, and the stock ofthe entity acquiring us, at reduced prices. These provisions of our governingdocuments and stockholder rights plan, and of Delaware law, could have theeffect of delaying, deferring or preventing a change of control, includingwithout limitation a proxy contest, making more difficult the acquisition of asubstantial block of our common stock. The provisions could also limit theprice that investors might be willing to pay in the future for shares of ourcommon stock. Further, the existence of these anti-takeover measures may causepotential bidders to look elsewhere, rather than initiating acquisitiondiscussions with us.

 

*If we consumecash more quickly than expected, we may be unable to raise additional capitaland we may be forced to curtail operations.*We anticipatethat our existing capital resources will be adequate to fund our operations atleast through 2004***.*** However, changes may occur that would consumeavailable capital resources before that time. Our capital requirements willdepend on numerous factors, including:

 

•                  costsassociated with software sales;

•                  costsassociated with drug discovery services;

•                  ourinternal proprietary drug discovery activities;

•                  competingtechnological and market developments;

•                  changesin our existing collaborative relationships;

•                  thecost of filing, prosecuting, defending and enforcing patent claims and otherintellectual property rights and the outcome of related litigation;

•                  thepurchase of additional capital equipment;

•                  acquisitionsof other businesses or technologies; and

•                  theprogress of our milestone and royalty producing activities.

 

If we determine that we must raise additional capital, we may attemptto do so through public or private financings involving debt or equity.However, additional capital may not be available on favorable terms, or at all.If adequate funds are not available, we may be required to curtail 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.

 

CERTAIN RISKS RELATED TO INTELLECTUALPROPERTY

 

*Positions takenby the U.S. patent and trademark office or non-U.S. patent and trademarkofficials may preclude us from obtaining sufficient or timely protection forour intellectual property.*The patent positions ofpharmaceutical, biotechnology and software companies are uncertain and involvecomplex legal and factual questions. Consequently, some or all of our patentapplications may not issue into patents, and any issued patents may provideineffective remedies or be challenged or circumvented. The coverage claimed ina patent application can be significantly reduced before the patent is issued.There is a significant risk that the scope of a

 

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patent may not be sufficient to prevent third parties from marketingother products or technologies with the same functionality of our products andtechnologies. 

 

*Third partiesmay have filed patent applications of which we may or may not have knowledge,and which may adversely affect our business*. Patentapplications in the U.S. are maintained in secrecy for 18 months from filing oruntil a patent issues. Under certain circumstances, patent applications arenever published but remain in secrecy until issuance. As a result, others mayhave filed patent applications for products or technology covered by one ormore pending patent applications upon which we are relying. There have been,and may continue to be, third-party patents, patent applications and otherintellectual property or information relevant to our software, chemicalcompositions and other technologies not known to us and that block or competewith our software, chemical compositions or other technologies, or limit thescope of patent protection available to us. Moreover, from time to time,patents have issued and in the future may issue which block or compete with oursoftware, chemical compositions or other technologies, or limit the scope ofpatent protection available to us.** **Litigationmay be necessary to enforce patents issued to us or to determine the scope andvalidity of the intellectual property rights of third parties.

 

*We may not beable to protect adequately the trade secrets and confidential information thatwe disclose to our employees*. We rely upon tradesecrets, technical know-how and continuing technological innovation to developand maintain our competitive position. Competitors through their independentdiscovery (or improper means, such as unauthorized disclosure or industrialespionage) may come to know proprietary information. We generally requireemployees and consultants to execute confidentiality andassignment-of-inventions agreements. These agreements typically provide thatall materials and confidential information developed by or made known to theemployee or consultant during that party’s relationship with us are to be keptconfidential, and that all inventions arising out of the employee’s orconsultant’s relationship with us are our exclusive property. Our employees andconsultants may breach these agreements, and in some instances we may not havean adequate remedy. Additionally, in some instances, we may have failed torequire that employees and consultants execute confidentiality andassignment-of-inventions agreements.

 

*Foreign lawsmay not afford us sufficient protections for our intellectual property, and wemay not seek patent protection outside the United States*.We believe 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 U.S. and maynot be sufficient to protect our proprietary rights abroad. In addition, we maydecide not to pursue patent protection outside the United States, because ofcost and confidentiality concerns. Accordingly, our international competitorscould obtain foreign patent protection for, and market overseas, products andtechnologies for which we are seeking U.S. patent protection.

 

*We may not beable to adequately defend our intellectual property from third partyinfringement, and third party challenges to our intellectual property mayadversely affect our rights and be costly and time consuming*.Some of our competitors have, or are affiliated with companies having,substantially greater resources than we have, and those competitors may be ableto sustain the costs of complex patent litigation to a greater degree and forlonger periods of time than us. Uncertainties resulting from the initiation andcontinuation of any patent or related litigation could have a material adverseeffect on our ability to compete in the marketplace pending resolution of thedisputed matters. If our competitors prepare and file patent applications inthe United States that claim technology also claimed by us, we may have toparticipate in interference proceedings declared by the U.S. Patent andTrademark Office to determine the

 

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priority of invention, which could result in substantial costs to us,even if the outcome is favorable to us. Similarly, opposition proceedings mayoccur overseas, which may result in the loss or narrowing of the scope ofclaims or legal rights. Such proceedings will at least result in delay in theissuance of enforceable claims. An adverse outcome could subject us tosignificant liabilities to third parties and require us to license disputedrights from third parties or cease using the technology. Despite our efforts toprotect our proprietary rights, unauthorized parties may attempt to copyaspects of our products or to obtain and use information that we regard asproprietary. In limited instances, we have licensed source codes of certainproducts to customers or collaborators. For these reasons, policingunauthorized use of our software products may be difficult.

 

*A patent issuedto us may not be sufficiently broad to protect adequately our rights inintellectual property to which the patent relates*.Even if patents are issued to us, these patents may not sufficiently protectour interest in our software, chemical compositions or other technologiesbecause the scope of protection provided by any patents issued to or licensedby us are subject to the uncertainty inherent to 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, chemical compositions or technologies other than those uses coveredin our patents, and these other uses may be separately patentable. A number ofpharmaceutical and biotechnology companies, software organizations and researchand academic institutions, have developed technologies, filed patentapplications or received patents on various technologies that may be related toour business. Some of these technologies, patent applications or patents mayconflict with our technologies, patent applications or patents. These conflictscould also limit the scope of patents, if any, that we may be able to obtain,or result in the denial of our patent applications.

 

*We may besubject to claims of infringement by third parties*.Third parties may claim infringement by us of their intellectual propertyrights. In addition, to the extent our employees are involved in research areassimilar to those areas in which they were involved at their former employers,we may be subject to claims that our employees or we have inadvertently orotherwise used or disclosed the alleged trade secrets or other proprietaryinformation of a former employer. From time to time, we have received lettersclaiming or suggesting that our products or activities may infringe third partypatents or other intellectual property rights. Our products may infringe patentor other intellectual property rights of third parties. A number of patents mayhave been issued or may be issued in the future that could cover certainaspects of our technology and that could prevent us from using technology thatwe use or expect to use. We may be required to seek licenses for or otherwiseacquire rights to technology as a result of claims of infringement. We may notpossess proper ownership or access rights to the intellectual property we use.Third parties or other companies may bring infringement suits against us.  We expect, in general, that software productdevelopers will be subject to more infringement claims as the number ofproducts and competitors in our industry segments grows and the functionalityof products in different industry segments overlaps. Any claims, with orwithout merit, could adversely affect our ability to market and sell ourproducts and services, be time consuming to defend, result in costlylitigation, divert management’s attention and resources, cause product shipmentdelays or require us to enter into royalty or licensing agreements. Royalty orlicensing agreements, if required, may not be available on terms acceptable tous, if at all. In the event of a successful claim of product infringementagainst us, our failure or inability to license or design around the infringedtechnology could have a material adverse effect on our business, financialcondition and results of operations.

 

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CERTAIN RISKS RELATED TO ACCELRYS

 

*Our ability toincrease Accelrys software revenue may depend upon increased market acceptanceof our products and services*. Accelrys products arecurrently used primarily by molecular modeling and simulation and gene sequenceanalyses specialists. Our strategy is to expand usage of our products andservices by marketing and distributing our software, in part through ourdesktop-based products, to a broader, more diversified group ofexperimentalists, such as scientists and engineers. If we cannot expand ourcustomer base to include experimentalists, or if we otherwise cannotsuccessfully market and sell our desktop-based products and related services,we may not be able to increase our software revenue, or such revenue maydecline. In general, increased market acceptance and greater market penetrationof our software products depend upon several factors, including:

 

•                  overallproduct performance;

•                  easeof implementation and use;

•                  accuracyof simulation;

•                  breadthand integration of product offerings;

•                  theextent to which users achieve the intended research and development benefitsfrom their use of the products and services; and

•                  willingnessof customers to pay for such use.

 

Our software products and services may not achieve market acceptance orpenetration in their target industries or other industries. Failure to increasemarket acceptance or penetration may restrict substantially the future growthof our software business and may have a material adverse effect on our companyas a whole.

 

*We may beunable to develop and market new Accelrys products that are necessary toincrease revenue*. The success of our software businessplan depends heavily upon increases in revenue. Our strategy is to increasesoftware revenue in a number of ways, including:

 

•                  addingmore computational modeling, simulation, and analyses tools to our currentportfolio of tools for chemists and biologists;

•                  offeringmore bioinformatics and cheminformatics database software that captures andmanages the data created by customers’ drug discovery and chemical developmentactivities, including the data created by the use of computational modeling,simulation, and analysis software;

•                  creatingand marketing genomic, biological and/or chemical data content for use inconjunction with the software offered to support customers’ drug discoveryactivities; and

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

 

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

 

*We face strongcompetition in the scientific software sector*. Themarket for our software products is intensely competitive, subject to rapidchange and significantly affected by new product introductions, pricing strategiesand other market activities of industry participants. Competition currentlycomes from the following principal sources:

 

•                  othermolecular simulation software packages and software for analysis of chemicaland biological data;

 

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•                  desktopsoftware applications, including chemical drawing, molecular modeling andanalytical data simulation applications;

•                  consultingand outsourcing services;

•                  othertypes of simulation software provided to engineers; and

•                  firmssupplying databases, such as chemical or genomic information databases,database management systems and information technology.

 

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

 

*If we areunable to license software to, or collect receivables from, our early stagebiotechnology customers, it may have a material adverse effect on our operatingresults.*  Wefrequently license our modeling, simulation, data analysis and informaticssoftware to smaller, development stage biotechnology customers. Often thesecustomers have limited or no operating history, and require considerablefunding to launch their businesses. As we have experienced in recent quarters,they often significantly scale back, or altogether cease, operations.  Therefore, there is considerable risk incounting on these types of entities for revenue growth.  For entities that remain in business,transactions with these customers carry a higher degree of financial risk. Ourcustomers, particularly our development stage customers, are vulnerable to, andmay be impacted by, the current tightening of available credit and capital, andgeneral economic slowdown occurring in the United States and our other keymarkets. As a result of these conditions, our customers may be unable tolicense or, if under a license, may be unable to pay for, Accelrys softwareproducts. If we are not able to collect such amounts, we may be required towrite-off significant accounts receivable and recognize bad debt expense. Werecorded a provision for doubtful accounts of $1.3 million in fiscal 2002compared to $0.3 million in fiscal 2001. For the period ended June 30, 2003, we recorded a provision of $0.1million.  Failure of these businesses,write-offs and difficulties associated with collection of receivables fromthese customers, could materially adversely affect our operating results.

 

*Defects ormalfunctions in our software products, or in the products of our softwaretechnology partners, could hurt our reputation among software customers andexpose us to liability.* Our software business and thelevel of customer acceptance of our products depend upon the continuous,effective and reliable operation of our computer software and related tools andfunctions. Defects could occur in current or future Accelrys products. To theextent that our software malfunctions and our customers’ use of our products isinterrupted, our software reputation and business could suffer. We may also besubject to liability for the defects and malfunctions of third party technologypartners and others with whom our software products and services areintegrated.

 

*Our quarterlyoperating results in the software business could vary significantly*. We have historically experiencedstronger financial performance in the third and fourth calendar quarters ofeach year followed by a comparative decline in the first and second quarters.Quarterly

 

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operating results may continue to fluctuate as a result of a number offactors, including lengthy sales cycles, market acceptance of new products andupgrades, timing of new product introductions, changes in pricing policies,changes in general economic and competitive conditions, seasonal slowdowns, andthe timing and integration of acquisitions. We also expect to continue toexperience fluctuations in quarterly operating results due to general andindustry specific economic conditions that may affect the research anddevelopment expenditures of pharmaceutical and biotechnology companies. Due tothe possibility of fluctuations in our revenue and expenses, we believe thatquarter-to-quarter comparisons of our operating results are not a goodindication of our future performance.

 

CERTAIN RISKS RELATED TO PHARMACOPEIA DRUGDISCOVERY, INC.

 

*The agreementwith a second key PDD customer is terminable under certain circumstances.*** **During the year ended December31, 2002, we earned approximately 10% of our PDD revenue, and 2% of ourconsolidated revenue, from a second key customer in our Drug Discoverybusiness.  The agreement with thissignificant customer has a stated term of five years; however, the customer hasthe right to terminate the agreement as early as the first quarter of 2005 inthe event we are unable to deliver to the customer a lead compound meetingcriteria specified in the agreement by a certain deadline.  Thereafter, the customer again has the rightto terminate the agreement prior to the expiration of its stated term if wecannot deliver additional lead compounds meeting these criteria prior to datesset forth in the agreement.  Thetermination of this agreement will have a material adverse effect on PDD, andmay have a material adverse effect on our company’s business as a whole. Therecan be no assurance that we will be able to deliver compliant compounds to thecustomer before the enumerated dates.

 

*Some of thedevelopment and marketing activities of PDD are, or will be, conducted by thirdparties. If these third parties fail to perform their functions satisfactorily,our revenue and earnings from PDD could be delayed, reduced or eliminated.* The ultimate success of the business plan forour Drug Discovery subsidiary heavily depends upon the successful discovery,development and commercialization of pharmaceutical products. Our drugdiscovery endeavors will result in commercialized pharmaceutical products, ifat all, only after significant pre-clinical and clinical development, requisiteregulatory approvals, establishment of manufacturing capabilities andsuccessful marketing. We do not currently have the technology, facilities,personnel or experience to accomplish all of these tasks on our own, and wewill likely not have all the necessary resources in the foreseeable future.Therefore, we continue to depend heavily upon the expertise and dedication ofsufficient resources by collaborative partners and/or by third parties underservice contracts to develop and commercialize products primarily based ontherapeutic antibodies and lead compounds discovered by us. If a third partyworking for us under a service contract fails to perform the contractedservices adequately, our efforts with respect to the drug candidate undercontract could be delayed or terminated. Further, if a collaborative partnerfails to develop or commercialize a compound or product with respect to whichit has rights from us, we may not receive any future milestone payments orroyalties associated with that compound or product. Similarly, because we relyheavily on our strategic collaborators and service providers, our revenue couldbe adversely affected if our collaborators and/or service providers:

 

•                  failto select a target or product candidate we have identified for subsequentdevelopment;

•                  failto gain the requisite regulatory approvals of product candidates;

•                  donot successfully commercialize products that we originate;

•                  donot conduct their service or collaborative activities in a timely manner;

•                  donot devote sufficient time or resources to our partnered programs or potentialproducts;

 

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•                  terminatetheir alliances or arrangements with us;

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

•                  disputeour respective allocations of rights to any products or technology developedduring our collaborations; or

•                  mergewith a third party that may wish to terminate our collaboration or servicecontract.

 

*Disputes mayarise between our collaborative partners and us as to royalties and milestonesto which we are entitled.*  The compound basis for drugs developed by a customer may be aderivative or optimized version of the compound provided to the customer by us.While our existing collaborative agreements provide that we will receivemilestone payments and royalties with respect to certain products developedfrom certain derivative compounds, there can be no assurance that disputes willnot arise over the application of payment provisions to such products. Therecan be no assurance that current or future collaborative partners will notpursue alternative technologies, or develop alternative products either ontheir own or in collaboration with others, including our competitors, as a meansfor developing treatments based on the targets which are the subject of thecollaborative arrangements with us.

 

*There may beonly a limited market for PDD’s drug discovery services.*  The pricing and nature of PDD’s drugdiscovery services are such that there may only be a limited number ofpotential customers for these services. Continued consolidation in thepharmaceutical and biotechnology industries may further decrease the number ofpotential customers. The acceptance by potential customers of our services isimportant in determining profitability. Historically, pharmaceutical companieshave conducted lead compound identification and optimization within their ownresearch departments due to the highly proprietary nature of the activitiesbeing conducted, the central importance of these activities to their drugdiscovery and development efforts, and the desire to obtain maximum patent andother proprietary protection on the results of their internal programs. Inorder to achieve our business objectives for PDD, we must convince thesecompanies that our technology and expertise justify the outsourcing of theseprograms to us. There can be no assurance that we will be able to attractcustomers on acceptable terms for our products and services or to develop asustainable profitable business. Moreover, the pricing and nature of ourcombinatorial libraries is such that there may only be a limited number ofpharmaceutical companies that are potential customers for such libraries. Therecan be no assurance that we will be able to establish additional collaborativeor licensing arrangements, that any such arrangements or licenses will be onterms favorable to us, or that current or future collaborative or licensingarrangements will ultimately be successful.

 

*We may beunable to manage the multiple relationships and interests involved in ourcollaborative arrangements and drug discovery programs.*  We may need to successfully structure andmanage multiple drug discovery programs and collaborative relationships, includingmaintaining confidentiality of the research being performed for multiplecustomers. We may be unable to manage successfully conflicts between competingdrug development programs of third parties to which we offer services.Conflicts also may arise between customers as to proprietary rights toparticular compounds in our libraries or as to proprietary rights to biologicaltargets such as receptors or enzymes against which we screen compounds in ourlibraries. The occurrence of conflicts could have a material adverse effect onour business, financial condition or results of operations.

 

*Our current andpotential customers are primarily from, and are subject to risks faced by, thepharmaceutical, biotechnology and chemical industries*.  For the foreseeable future, we will derive asubstantial portion of our revenue from fees paid by pharmaceutical companies,chemical companies and larger biotechnology companies for our products andservices. As a result, we are subject to risks and uncertainties that affectthe pharmaceutical, chemical and biotechnology

 

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industries and to possible reduction and delays in research anddevelopment expenditures by companies in these industries. Our revenue may alsobe adversely affected by mergers and consolidation in the pharmaceutical,biotechnology and chemical industries, which will reduce the number ofpotential customers.

 

*We may beunsuccessful in producing and licensing proprietary technology developed fromour internal research and development efforts or acquired from a third party.*** **We have expended and continue toexpend time and money on internal research and development with the intentionof producing proprietary technologies in order to patent and then license themto other companies. However, we may not be successful in producing any valuabletechnology or successful in licensing it to a third party. To the extent we areunable to produce technology that we can license, we may not receive anyrevenue related to our internal research and development efforts.

 

*If we usebiological and hazardous materials in a manner that causes injury or violateslaws, we may be liable for damages.* Our Drug Discoveryactivities may involve the use of potentially harmful biological materials aswell as hazardous materials, chemicals and various radioactive compounds. Wecannot completely eliminate the risk of accidental contamination or injury fromthe use, storage, handling or disposal of these materials. In the event ofcontamination or injury, we could be held liable for damages that result, andany liability could exceed our resources. We are subject to federal, state andlocal laws and regulations governing the use, storage, handling and disposal ofthese materials and specified waste products. The cost of compliance with theselaws and regulations could be significant.

 

**SHOULD ONE OR MORE OFTHE ABOVE-DESCRIBED RISKS OR UNCERTAINTIES MATERIALIZE, OR SHOULD THEUNDERLYING ASSUMPTIONS PROVE INCORRECT, OUR ACTUAL RESULTS MAY VARY MATERIALLYFROM THOSE ANTICIPATED.**

 

**Item 3.****Quantitative and Qualitative Disclosures about Market Risk**

 

The Company is exposed to various marketrisks consisting primarily of changes in foreign currency exchange rates.  The Company’s international sales generallyare denominated in local currencies.  Inthe first half of 2003, approximately 56% of the Company’s consolidated revenuewas derived from customers outside the United States (including 39% fromcustomers in Europe and 17% from customers in the Asia/Pacific region).  As such, the Company’s exchange rate risk isgreatest for Dollar/Euro and Dollar/Yen fluctuations.  When deemed appropriate, the Company engages in exchange rate-hedgingtransactions in an attempt to mitigate the impact of adverse exchange ratefluctuations.  As of June 30, 2003, theCompany had no hedging transactions in effect.

 

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

 

The Company’s exposure to market risksassociated with changes in interest rates relates primarily to the increase ordecrease in the amount of interest income earned on its investment portfoliosince the Company has minimal debt.  TheCompany ensures the safety and preservation of invested funds by limitingdefault risks, market risk, and reinvestment risk.  The Company mitigates default risk by investing in investmentgrade securities.  A hypothetical 100basis point

 

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adverse move in interest rates along theentire interest rate yield curve would not materially affect the fair value ofthe Company’s interest sensitive financial instruments as of June 30, 2003.

 

**Item 4.****  Controls andProcedures**

 

Under the supervision and with theparticipation of our management, including our principal executive officer andprincipal financial officer, we conducted an evaluation of the effectiveness ofthe design and operation of our disclosure controls and procedures, as suchterm is defined under Rule 13a-14(c) promulgated under the Securities ExchangeAct of 1934, as amended. Based on their evaluation, our principal executiveofficer and principal financial officer concluded that our disclosure controlsand procedures were effective as of the end of the period covered by thisquarterly report.

 

There have been no significant changes(including corrective actions with regard to significant deficiencies ormaterial weaknesses) in our internal controls or in other factors that couldsignificantly affect these controls subsequent to the date of the evaluationdescribed above.

 

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**PARTII****- OTHER INFORMATION**

 

**Item 1.**                    Legal Proceedings

 

We are a party to certain litigation in the ordinary course of ourbusiness, and we do not believe these matters, even if adversely adjudicated orsettled, would have a material adverse effect on our financial condition orresults of operations.

 

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

 

**Item 3.**                    Defaults uponSenior Securities – None

 

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

 

The Company held its Annual Meeting of Stockholders (the “AnnualMeeting”) on May 1, 2003.  Of the23,648,376 shares of Common Stock which could be voted at the Annual Meeting,19,976,390 shares of Common Stock, representing 84% were represented at theAnnual Meeting in person or by proxy, which constituted a quorum. Votingresults were as follows:

 

1.             To elect twodirectors to the Board of Directors for a term of three years.

 
|               |   | **FOR**    |   | **AGAINST  OR WITHHELD** |   | **BROKER  NON-VOTES** |   |
|--------------------|--------|------------|--------|--------------------------|--------|-----------------------|--------|
| Frank Baldino, Jr. |   | 19,174,734 |   | 801,656                  |   | 0                     |   |
| James J. Marino    |   | 18,073,707 |   | 1,902,683                |   | 0                     |   |

 

Other continuing directors whose terms of office continue after theAnnual Meeting are: Joseph A. Mollica, Ph.D.; Paul A. Bartlett, Ph.D.; RicardoB. Levy, Ph.D.; Gary E. Costley, Ph.D.

 

2.             To ratify the appointment of Ernst &Young LLP as the Company’s independent auditors for the fiscal year endingDecember 31, 2003.

 
| **FOR**    |   | **AGAINST** |   | **ABSTAIN** |   | **BROKER  NON-VOTES** |   |
|------------|--------|-------------|--------|-------------|--------|-----------------------|--------|
| 18,779,477 |   | 1,192,738   |   | 4,175       |   | 0                     |   |

 

**Item 5.****                   **Other Information

 

In July 2003, the Company entered into an amendment to its agreementwith its largest Drug Discovery customer, extending the expiration date of theagreement from October 2003 to March 31, 2004. The Company currently is in theprocess of negotiating with this customer a potential new collaborationagreement. As indicated in Item 2., “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations – Risk Factors – Certain RisksRelated to our Business as a Whole,” of this Report, completion of such a newagreement on terms favorable to the Company, or at all, is uncertain. Thetermination of the existing agreement with this customer without completion ofa new collaboration arrangement on acceptable terms, will have a materialadverse effect on Pharmacopeia Drug Discovery, Inc. and on the Company’sbusiness as a whole. There can be no assurance that the Company

 

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will be able to complete a new agreement with this significant customeron acceptable terms, or at all.

 

**Item 6.****                   **Exhibits and Reports on Form 8-K

 

(a)          Exhibits –

 
| 10.29++ |   | Amendment No. 3, effective as of April 17, 2003, to the Collaboration  and License Agreements, dated as of October 29, 1998, by and between  Pharmacopeia, Inc., Schering Corporation  and Schering-Plough, Ltd. (incorporated by reference to  Exhibit 10.13(a) to the Company’s Report on Form 10-Q for the quarterly  period ended March 31, 2003) |
|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                                                                                                                                                                                                                                      |
| 10.30++ |   | Amendment No. 4, effective as of May 29, 2003, to the Collaboration  and License Agreements, dated as of October 29, 1998, by and between  Pharmacopeia, Inc., Schering  Corporation, and Schering-Plough, Ltd.                                                                                                                                            |
|    |   |                                                                                                                                                                                                                                                                                                                                                                      |
| 10.31++ |   | Amendment No. 5, effective as of July 9, 2003, to the Collaboration  and License Agreements, dated as of October 29, 1998, by and between  Pharmacopeia, Inc., Schering Corporation, and Schering-Plough, Ltd.                                                                                                                                                            |
|    |   |                                                                                                                                                                                                                                                                                                                                                                      |
| 31.1    |   | Certification  of the Principal Executive Officer of Pharmacopeia, Inc. Pursuant to  Rule 13a-14 of the Securities Exchange Act of 1934, as amended, as  Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                      |
|    |   |                                                                                                                                                                                                                                                                                                                                                                      |
| 31.2    |   | Certification  of the Principal Financial Officer of Pharmacopeia, Inc. Pursuant to  Rule 13a-14 of the Securities Exchange Act of 1934, as amended, as  Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                      |
|    |   |                                                                                                                                                                                                                                                                                                                                                                      |
| 32.1    |   | Certification of the Chief Executive Officer of Pharmacopeia, Inc.  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 (*)                                                                                                                                                                               |
|    |   |                                                                                                                                                                                                                                                                                                                                                                      |
| 32.2    |   | Certification  of the Chief Financial Officer of Pharmacopeia, Inc. Pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 (*)                                                                                                                                                                              |

 

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++          Confidential Treatment Requested

 

*                 Thiscertification shall not be deemed “filed” for purposes of Section 18 ofthe Securities Exchange Act of 1934, as amended, or otherwise subject toliability pursuant to that section. Such certification shall not be deemed tobe incorporated by reference into any filing under the Securities Act of 1933,as amended, or the Securities Exchange Act of 1934, as amended, except to theextent that the Company specifically incorporates it by reference.

 

(b) Reports onForm 8-K –

 

On May 2, 2003, the Company filed a current report on Form 8-Kreporting that a press release was issued and a conference call was heldregarding the Company’s financial results for the first quarter of 2003.

 

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**SIGNATURE**

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|   | PHARMACOPEIA, INC. |
|--------|--------------------|
|   |               |
|   | By:                |   | /s/ John J. Hanlon |
|   |               |   |
|   |               | John J. Hanlon |
|   |               | Executive Vice President and  Chief Financial Officer (Duly Authorized  Officer and Chief Financial Officer) |
|   |               |   |
|   |               | Date:  August  8, 2003 |

 

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**PHARMACOPEIA, INC.**

 

**INDEXTO EXHIBITS**

 
| **No.** |   | **EXHIBIT**                                                                                                                                                                                                                                                                                                                                                         |
|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                                                                                                                                                                                                                                |
| 10.29++ |   | Amendment No. 3, effective as of April 17, 2003, to the Collaboration  and License Agreements, dated as of October 29, 1998, by and  between Pharmacopeia, Inc., Schering Corporation and Schering-Plough, Ltd. (incorporated  by reference to Exhibit 10.13(a) to the Company’s Report on Form 10-Q for the  quarterly period ended March 31, 2003) |
|    |   |                                                                                                                                                                                                                                                                                                                                                                |
| 10.30++ |   | Amendment No. 4, effective as of May 29, 2003, to the Collaboration  and License Agreements, dated as of October 29, 1998, by and  between Pharmacopeia, Inc., Schering Corporation, and Schering-Plough, Ltd.                                                                                                                                            |
|    |   |                                                                                                                                                                                                                                                                                                                                                                |
| 10.31++ |   | Amendment No. 5, effective as of July 9, 2003, to the Collaboration  and License Agreements, dated as of October 29, 1998, by and  between Pharmacopeia, Inc., Schering Corporation, and Schering-Plough, Ltd.                                                                                                                                       |
|    |   |                                                                                                                                                                                                                                                                                                                                                                |
| 31.1    |   | Section 302 Certification of the Principal Executive Officer                                                                                                                                                                                                                                                                                                        |
|    |   |                                                                                                                                                                                                                                                                                                                                                                |
| 31.2    |   | Section 302 Certification of the Principal Financial Officer                                                                                                                                                                                                                                                                                                        |
|    |   |                                                                                                                                                                                                                                                                                                                                                                |
| 32.1    |   | Section 906 Certification of the Chief Executive Officer                                                                                                                                                                                                                                                                                                            |
|    |   |                                                                                                                                                                                                                                                                                                                                                                |
| 32.2    |   | Section 906 Certification of the Chief Financial Officer                                                                                                                                                                                                                                                                                                            |

 

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