**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

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**Form 10-K**

**FOR ANNUAL AND TRANSITIONREPORTSPURSUANT TO SECTIONS 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**
| **(Mark One)**                                     |
|----------------------------------------------------|
| **x**                                              | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                         | ** ** | ** ** |
| **For the  fiscal year ended March 31, 2007** |
| ** **                                         | ** ** | ** ** |
| **or**                                             |
| ** **                                         | ** ** | ** ** |
| **o**                                              | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                         | ** ** | ** ** |

**Forthe transition periodfrom          to          **

**Commissionfile number: 0-27188**

**Accelrys, Inc.**

(Exact name of registrant asspecified in its charter)

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

**(858) 799-5000**

(Registrant’s telephonenumber, including area code)

Securities registeredpursuant to Section 12(b) of the Act:

| **Title of Each Class**                    | ** ** | **Name of  Each Exchange on Which Registered** |
|--------------------------------------------|------------|------------------------------------------------|
| Common Stock,  par value $0.0001 per share |       | NASDAQ Global  Market                          |
|                                       |       |                                           |

Securities registered pursuant toSection 12(g) of the Act:

**None**

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined inRule 405 of the Securities Act. Yes o   No x

Indicateby check mark if the registrant is not required to file reports pursuant toSection 13 or Section 15(d) of the Exchange Act. Yes o   No x

Note—checkingthe box above will not relieve any registrant required to file reports pursuantto Section 13 of 15(d) of the Exchange Act from their obligationsunder those Sections.

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x   No o

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K (§229.405 of this chapter) is not contained herein, and will notbe contained, to the best of the registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K. x

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act.(Check one):
| Large accelerated filer o | Accelerated filer x | Non-accelerated filer o |
|---------------------------|---------------------|-------------------------|
|                      |                |                    |

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). Yes o   No x

Theaggregate market value of the voting stock held by non-affiliates of theregistrant as of September 29, 2006 was $95.5 million (based upon theSeptember 29, 2006 closing price for shares of the registrant’s commonstock as reported by the NASDAQ Global Market). Shares of common stock held byeach officer, director and holder of 5% or more of the outstanding common stockhave been excluded in that such persons may be deemed to be affiliates. Thisdetermination of affiliate status is not necessarily a conclusive determinationfor other purposes.

Thenumber of outstanding shares of the registrant’s common stock, par value$0.0001 per share, as of May 3, 2007 was 26,510,602, net of treasuryshares.

**DOCUMENTSINCORPORATED BY REFERENCE**

Portionsof the registrant’s definitive Proxy Statement to be filed with the Securitiesand Exchange Commission within 120 days after registrant’s fiscal year endedMarch 31, 2007 are incorporated by reference into this report.

The Exhibit Index (Item No. 15) listsseveral documents incorporated by reference.

 

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**ACCELRYS,INC.FORM 10-K—ANNUAL REPORTFor the Fiscal Year Ended March 31, 2007Table of Contents**
|                   | ** ** | ** **                                                                                                          | ** ** |
|-------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|
| **PART I**   |       |                                                                                                                |       |
| Item  1           |       | Business                                                                                                            |       |
| Item  1A          |       | Risk  Factors                                                                                                       |       |
| Item 1B           |       | Unresolved  Staff Comments                                                                                          |       |
| Item  2           |       | Properties                                                                                                          |       |
| Item 3            |       | Legal Proceedings                                                                                                   |       |
| Item 4            |       | Submission  of Matters to a Vote of Security Holders                                                                |       |
| **PART II**  |       |                                                                                                                |       |
| Item 5            |       | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |       |
| Item 6            |       | Selected Consolidated  Financial Data                                                                               |       |
| Item 7            |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |       |
| Item 7A           |       | Quantitative  and Qualitative Disclosures About Market Risk                                                         |       |
| Item 8            |       | Financial  Statements and Supplementary Data                                                                        |       |
| Item 9            |       | Changes in  and Disagreements With Accountants on Accounting and Financial Disclosure                               |       |
| Item 9A           |       | Controls and  Procedures                                                                                            |       |
| Item 9B           |       | Other Information                                                                                                   |       |
| **PART III** |       |                                                                                                                |       |
| Item 10           |       | Directors,  Executive Officers and Corporate Governance                                                             |       |
| Item 11           |       | Executive  Compensation                                                                                             |       |
| Item 12           |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    |       |
| Item 13           |       | Certain  Relationships and Related Transactions, and Director Independence                                          |       |
| Item 14           |       | Principal  Accounting Fees and Services                                                                             |       |
| **PART IV**  |       |                                                                                                                |       |
| Item 15           |       | Exhibits,  Financial Statement Schedules                                                                            |       |
| **Signatures**    |       |                                                                                                                |       |

 

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**Forward-LookingStatements**

When used anywhere in this Annual Report onForm 10-K (this “Report”), the words “expect”, “believe”, “anticipate”, “estimate”,“intend”, “plan” and similar expressions are intended to identifyforward-looking statements. These forward-looking statements may includestatements addressing our future financial and operating results. We have basedthese forward-looking statements on our current expectations about futureevents. Such statements are subject to certain risks and uncertaintiesincluding those related to execution upon our strategic plans, the successfulrelease and**acceptance of new products, the demandfor new and existing products, additional competition, changes in economicconditions and those described in documents we have filed with the Securitiesand Exchange Commission, including this Report in “Management’s Discussion andAnalysis of Financial Condition and Results of Operations,” “Risk Factors,” andsubsequent reports on Form 10-Q. All forward-looking statements in thisdocument are qualified entirely by the cautionary statements included in thisdocument and such other filings. These risks and uncertainties could causeactual results to differ materially from results expressed or implied byforward-looking statements contained in this document. These forward-lookingstatements speak only as of the date of this document. We disclaim anyundertaking to publicly update or revise any forward-looking statementscontained herein to reflect any change in our expectations with regard theretoor any change in events, conditions or circumstances on which any suchstatement is based.

Unless the context requires otherwise, in this reportthe terms “we,” “us” and “our” refer to Accelrys, Inc. and its whollyowned or indirect subsidiaries, and their predecessors.

**PART I**

**Item1.         Business**

**Overview**

We develop and commercialize scientific businessintelligence software for the aggregation, mining, integration, analysis,simulation, management and interactive reporting of scientific data used bybiologists, chemists, materials scientists, including nanotechnologyresearchers, and information technology professionals for product design anddrug discovery and development. Our technology and services are designed tomeet the needs of today’s leading research and development organizations. Weare headquartered in San Diego, California and were incorporated in Delaware in1993. Our company website is located at www.accelrys.com. Copies of our annualreports on Form 10-K, quarterly reports on Form 10-Q, current reportson Form 8-K, and amendments to those reports are available without chargeon our website as soon as reasonably practicable after being filed with orfurnished to the U.S. Securities and Exchange Commission (the “SEC”).

**Description of OurIndustry**

For companies in the pharmaceutical, biotechnology,chemical, petrochemical and materials industries, innovation in the discoveryand development of new products and the rapid, cost-effective commercializationof these products can be crucial to success. Companies in these industriesinvest considerable resources in technologies that suggest productive newpathways for research projects, increase the efficiency of discovery anddevelopment processes, or enable them to maximize the use of corporatescientific data, information and knowledge. One such set of technologies issoftware and professional services in the area of computation, analysis,informatics, workflow and knowledge management solutions. These solutions allowusers to leverage the vast amounts of information stored in both corporatedatabases and public data sources and, when combined with predictive analysis,help these users make informed scientific and business decisions during theresearch and development process.

**Description of OurBusiness**

We design, develop, market, and support software basedsolutions that facilitate the discovery and development of new and improvedproducts and processes in the pharmaceutical, biotechnology, chemical,petrochemical and materials industries. Using our solutions, researchers getreal time access to the scientific data 

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that allows them insightsto make informed decisions, which increase the probability of success of thechosen path. The desired outcome is a reduction in product development costsand shortening the time to market for new product introductions and processimprovements. Our customers include leading commercial, government and academicorganizations. Many of the largest pharmaceutical, biotechnology, chemical,petroleum and semiconductor companies worldwide use our software. We market ourproducts and services worldwide, principally through our direct sales force,augmented by the use of third-party distributors.

**Business Strategy**

Our objective is to be the leader in scientificbusiness intelligence solutions and scientific innovation. We plan toaccomplish this objective by providing a comprehensive set of integratedsolutions, built on our industry leading scientific operating platform that arecentral to the enterprise-wide research and development activities of ourcustomers.  By accomplishing ourobjective we will assist our customers in research and developmentorganizations to manage data, information, knowledge, and collaborative processes.

**Products andServices**

The following is a brief description of each of ourproduct lines:

*ScientificOperating Platform.   *In research anddevelopment intensive industries, such as pharmaceutical/biotechnology andindustrial chemicals, managing the explosion of scientific data has become atop priority for line of business and IT executives. While these industries arefamiliar with business intelligence solutions for extracting insight andknowledge from customer data for sales and marketing teams, they have an unmetneed for such a solution for their research and development teams.  Our scientific operating platform forms thebasis of our scientific business intelligence and innovation offerings. Itsopen service oriented architecture allows users to aggregate, integrate, andmine the vast quantities of both structured and unstructured scientific datasuch as chemical structures, biological sequences, and complex digital images.It also filters, normalizes, and performs statistical analysis on thisscientific data and provides interactive visual reports to both scientists andscientific managers. In addition, this scientific operating platform providesthe underlying platform on which we have built our modeling and simulations andinformatics solutions thus delivering a fully integrated experience for ourcustomers. The openness of the platform allows our users to integrate not onlyAccelrys solutions, but best of breed scientific applications they have builtthemselves, or solutions they have acquired from academic collaborators orother commercial independent software vendors (“ISVs”).  Accelrys has built an ecosystem of scientificinnovation by partnering with over 30 ISVs who build scientific and technologysolutions based on this platform.

*Modelingand Simulation Software.   *Many factorsthat affect a molecule, including activity, bioavailability, toxicity, shelflife and environmental impact, are governed by fundamental properties such asshape, structure and reactivity that are determined at the sub-atomic,molecular, or near-molecular levels. A spectrum of simulationtechnologies—quantum mechanical simulation, molecular simulation, and mesoscalesimulation—predict these properties and help researchers discover new products,sharpen the focus of experimental activities and improve ultimate productperformance. We are a leading provider of such modeling and simulationsoftware.

We have a broad product suite consisting of over 100application modules based on proprietary and licensed technologies that employfundamental scientific principles, advanced computer visualization, molecularmodeling techniques and computational chemistry. These products allowscientists to perform computations of chemical, biological and materialsproperties, to simulate, visualize and analyze chemical and biological systems,and to communicate the results to other scientists. We also offer open accessto many of our core software development environments, within which customersand third-party licensees can develop, integrate and distribute their ownsoftware applications for computational chemistry, biology and materialsresearch.

We continually enhance our product and serviceofferings for computational chemists and biologists, who are the principalusers of modeling and simulation products. In addition, we plan to broaden ouruser base through a modernized user interface and open platform architecture tooffer straightforward access to our modeling and simulation software frompersonal computers thereby making our products available to a much largerpopulation of biologists, chemists and engineers. This open platformarchitecture also allows users to “plug 

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and play” best of breedcomputational solutions from Accelrys, academia, other ISVs or solutions theyhave developed themselves. This also helps expert modelers to connect andcommunicate more effectively to the wider research organization. Further, theseproducts assist organizations in capturing, managing, and sharing the criticalknowledge developed through computer aided modeling and simulation.

*Informatics Software.   *Weare a leading provider of software based solutions designed to capture, store,manage, and mine scientific data and information. Informatics is awell-established technology in life sciences, where bioinformatics tools areintegral to genetic and biological research, and cheminformatics applicationsare widely used to manage chemical information.

Our bioinformatics solutions include a suite ofprograms enabling molecular biologists to search, edit, compare, map and alignsequence data. Researchers use these tools to enable the analysis of DNA andprotein sequences and structure, predict RNA secondary structure and annotateprotein sequences. Such capabilities help them to use the genomic data that isbeing made available by projects such as the Human Genome Project. In addition,we provide enterprise-wide data management and analysis tools that assist inthe management of this data. Data visualization and analysis capabilities allowthis data to be viewed and understood on standard desktop computers.

Our cheminformatics software is based on standarddatabase architectures such as Oracle® and Microsoft Access®. We provide comprehensive datavisualization and analysis software components based on a services orientedarchitecture enabling users to search, retrieve, and use chemical structures,biological and chemical data, experimental data, and registration information.Many of these tools use industry standard software components and are compliantwith applications such as Microsoft Excel®, allowing chemists to interact with chemical data withinfamiliar productivity tools. We also use this component technology, combinedwith our scientific operating platform and our database architectures to buildenterprise-wide systems for our clients.

*Services.   *Thevalue of our software is enhanced by robust service offerings that provide avariety of options to our clients and create greater returns on theirinvestments.

Our solutions consulting team delivers integratedscientific solutions and enhances the value of our software products bycreating extensions to functionality to address a client’s specific businessneeds.  Our scientific operating platformis highlighted as one of the primary technologies used in these solutions.  The group delivers solutions both large andsmall, from software wrappers that allow customers to run their own algorithmson our scientific operating platform, to enterprise-wide life scienceinformatics systems that integrate customers’ internal systems with softwarefrom many vendors, including Accelrys. The group specializes in deploying systems for use by customers in allscientific domains, including cheminformatics, bioinformatics and materialsscience.

Our contract research services team provides solutionsto clients’ proprietary business-critical scientific problems.  The world-wide client base for this serviceranges from those who don’t have expert modeling resources on staff to thosewho have expert modelers but need to accommodate peaks in resource requirementsor to fill a special skill set.  We workon a project by project basis, or provide longer term resources that arelocated at client sites for a year or greater. This scientific collaboration enhances our partnerships with our clientsand helps them achieve their research goals. Our value is enhanced by the broad set of scientific domain expertiseamong our staff, our years of experience solving industrial “real-world”application problems, our commitment to maintaining confidentiality and toprotecting our clients’ intellectual property, the accessibility we offer tothe extensive Accelrys ecosystem, and all of our modeling tools.

Both internally and through our distribution channels,we offer training conducted by staff knowledgeable in both the theory andapplication of our products. Our implementation and training services ensurethat our clients are able to quickly install our products and become expertusers of our solutions.  We offer onsitetraining and implementation services, web-based training, and data migrationservices.

We are committed to providing customers with superiorsupport, including telephone, e-mail, fax and Internet-based technical supportservices; training; user group conferences; and targeted contract servicesinvolving application of our technology and scientific expertise to particularresearch needs of customers. We believe that customer service, support andtraining are part of the successful adoption and utilization of our products.

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Our support services give customers access to new releases,technical notes, documentation addenda and other support which enablescustomers to utilize our products more effectively, including access to ourtechnical and scientific support personnel during extended business hours.Technical newsletters and bulletins about future software releases are sent tocustomers to keep them informed and to help them with resource allocation andscheduling. To maintain an ongoing understanding of customer requirements, wesponsor scientific symposia and user group meetings throughout the year.

**Customers**

Our customer base consists of commercial, governmentaland academic organizations, including many of the world’s largestpharmaceutical, biotechnology, chemical, petroleum and material sciencecompanies. Our academic customers have historically used our products foracademic research purposes, but we believe our products increasingly may beused as a part of formal university teaching curricula.  No single customer accounted for more than10% of our revenue during any of the three most recently completed fiscalyears.

**Strategic andAcademic Alliances**

We have entered into a number of strategic alliancesrelating to product development, product distribution and joint marketing. Weplan to continue to cultivate relationships with academic, governmental andcommercial research organizations for purposes of identifying and licensing newtechnology to use in product development. In addition, we plan to maintain andexpand our alliances focusing on the compatibility of our products withdatabases and database management systems, other computational chemistry andmolecular simulation products, and products in related markets such as imagingand clinical informatics. We also intend to continue to enter into porting andjoint marketing arrangements with hardware vendors on whose systems ourproducts operate.

**Sales andMarketing**

We market our products and services worldwide.Historically, we have generated approximately 55%, 25% and 20% of our revenuesfrom the United States, Europe and the Asia/Pacific region, respectively.Please refer to Note 2 toour consolidated financial statements included elsewhere in this Report for abreakdown of revenues and long-lived assets by geographic region. Ourcontinuing reliance on sales in international markets exposes us to risksattendant to foreign sales, as described more fully in Item 1A of this Report.

We sell our products and services through our directsales force, telesales and, in some markets, arrangements with distributors.Our direct sales representatives focus on a defined list of customers or coveran assigned geographic territory. These direct sales representatives typicallywork closely with our pre-sales scientists in order to demonstrate our productsand their applicability to various research and development efforts. Ourtelesales effort is directed at smaller sized commercial accounts and academicinstitutions. Our distributor relationships primarily exist in the Asia/Pacificregion, specifically in Japan, China and Korea, and complement our direct salesforce in those markets. Historically, we have conducted a small percentage ofour business via our webstore, and we are currently enhancing our web-basedsales channel.

In support of our sales activities, we participate inindustry trade shows, publish our own newsletters, place advertisements inother industry publications, publish articles in industrial and scientificpublications, conduct direct mail campaigns, sponsor industry conferences andseminars, and maintain a website that contains information about us and ourproduct and service offerings.

Our products, together with the associated productliterature, are generally shipped to our customers at the time of placing andprocessing their order. We recently initiated an electronic softwaredistribution (“ESD”) program, which allows our customers to download ourproducts over the World Wide Web.

Our customers’ buying habits have historicallyresulted in a higher concentration of sales in the third quarter of our fiscalyear, due to traditionally higher purchasing activity in the month ofDecember in many commercial organizations.

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**ProductDevelopment**

Development of our software is focused on expandingproduct lines, designing enhancements to our core technology and integratingexisting and new products into our principal software architecture and platformtechnology. We intend to offer regular updates to our products and to continueto look for opportunities to expand our existing product suite.

We develop most of our products internally and, duringthe years ended March 31, 2007, 2006 and 2005, we incurred productdevelopment expenses totaling $18.9 million, $21.7 million, and $22.7 million,respectively. We have also licensed products or otherwise have acquiredproducts, or portions of our products, from the open source community, as wellas corporate, governmental and academic institutions. These arrangementssometimes involve joint development efforts and frequently require the paymentof royalties by us. The development and royalty obligations, scope ofdistribution rights, duration and other terms of these arrangements varydepending on the product, the market, resource requirements, the other partieswith which we contract and other factors. We intend to continue to license or otherwiseacquire technology or products from third parties.

**Competitors**

The market for our products is intensely competitive,subject to rapid change and significantly affected by new product introductionsand other market activities of industry participants. Our competitors offer avariety of products and services to address this market. We believe that theprincipal competitive factors in this market are product quality, flexibility,ease-of-use, scientific validation and performance, functionality and features,open architecture, quality of support and service, reputation and price.Competition currently comes from the following principal sources (andcompetitors that supply such sources listed in alphabetical order): othersoftware packages for analysis of chemical and biological data (MDL Information Systems, IDBS);workflow and data-pipeline applications (Inforsense); desktop softwareapplications (CambridgeSoft, Tripos), including chemical drawing applications(CambridgeSoft, MDL InformationSystems), molecular modeling and analytical data simulation applications(Chemical Computing Group, OpenEye, Schrodinger,Tripos); other types of simulation software provided to engineers (ReactionDesign); and firms supplying databases, such as chemical or genomic informationdatabases (MDL Information Systems), and database managementsystems and information technology (MDLInformation Systems, IDBS).

**IntellectualProperty and Other Proprietary Rights**

We rely primarily on a combination of copyright,trademark and trade secret laws, confidentiality procedures and contractualprovisions to protect our proprietary rights. We also have 20 United States andforeign patents and several pending patent applications. We believe thatfactors such as the technological and creative skills of our personnel, newproduct development, frequent product enhancements, name recognition andreliable product maintenance are essential to establishing and maintaining atechnological leadership position. There can be no assurance that our means ofprotecting our proprietary rights in the United States or abroad will beadequate. We seek to protect our software, documentation and other writtenmaterials under trade secret and copyright laws, which afford only limitedprotection. Further, there can be no assurance that our patents will offer anyprotection or that they will not be challenged, invalidated or circumvented.

**Employees**

As of March 31, 2007, we had 372 full-timeemployees. None of our employees are covered by collective bargaining agreements.Substantially all of our employees, other than certain of our executiveofficers and employees with customary employment arrangements within Europe,are at will employees, which means that each employee can terminate his or herrelationship with us and we can terminate our relationship with him or her atany time. We offer industry competitive wages and benefits and are committed tomaintaining a workplace environment that promotes employee productivity andsatisfaction. We believe our relations with our employees are good.

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**Item1A.      Risk Factors**

*You shouldcarefully consider the risks described below before investing in ourpublicly-traded securities. The risks described below are not the only onesfacing us. Our business is also subject to the risks that affect many othercompanies, such as competition, technological obsolescence, labor relations,general economic conditions, geopolitical changes and international operations.Additional risks not currently known to us or that we currently believe areimmaterial also may impair our business operations and our liquidity.*The risks described below could cause ouractual results to differ materially from those contained in forward-lookingstatements we have made in this Report, the information incorporated herein byreference and those we may make from time to time.

**Certain RisksRelated to Our Marketplace and Environment**

***Our revenue fromthe sale of modeling and simulation software to the life science discoveryresearch marketplace, which has historically constituted a significant portionof our overall revenue, has been declining over the past several years and maycontinue to decline in future years.******  ***Historically we have deriveda significant portion of our revenue from the sale of modeling and simulationsoftware to the discovery research departments in pharmaceutical andbiotechnology companies. Such revenues have been declining over the pastseveral years. We believe this decline is due to several factors, includingindustry consolidation, a general reduction in the level of discovery researchactivity by our customers, increased competition, including competition fromopen source software, and reductions in profit and related informationtechnology spending by our customers. If such declines continue and we do notincrease the revenue we derive from our other product and service offerings,our business could be adversely impacted.

***Our ability tosustain or increase revenues will depend upon our success in entering newmarkets and in deriving additional revenues from our existing customers.******  ***Our products are currentlyused primarily by molecular modeling and simulation specialists in discoveryresearch organizations. Our strategy is to expand usage of our products andservices by utilizing our scientific operating platform and our tools and componentsto leverage vast amounts of information stored in both corporate databases andpublic data sources in order to make informed scientific and business decisionsduring the research and development process. This strategy would allow increased usage of our software and servicesby biologists, chemists, engineers and informaticians within our existingpharmaceutical and biotechnology customers, as well as to new customers inother industries. However, our products and services may not achieve market acceptanceor penetration in targeted new departments within our customers or in newindustries. As a result, we may not be able to sustain or increase revenue.

***Our focus onoffering scientific business intelligence solutions to both existing and newcustomers and markets may make it more difficult for us to sustain our revenuefrom the sale of modeling and simulation products to the life science discoveryresearch marketplace.******  ***Ourstrategy involves transforming our product and service offerings by utilizingour scientific operating platform and our tools and components in order toenable our customers to more effectively utilize the vast amounts ofinformation stored in both their databases and public data sources in order tomake informed scientific and business decisions during the research anddevelopment process.  This strategy isintended to lead us to new and different markets and customers, as well asincrease the usage of our offerings by existing customers.  Executing this strategy will requiresignificant management focus and utilization of resources.  Though we intend to continue to dedicate sufficientresources and management focus to our life science modeling and simulationproducts, it is possible that the strategy will result in loss of managementfocus and resources relating to these existing products and markets, therebyresulting in decreasing revenues from these markets.  If these revenues are not offset by increasingrevenues from new markets and/or customers, our overall revenues will suffer.

***We may be unableto develop strategic relationships with our customers.******  ***Our strategy is to expandusage of our products and services by marketing and distributing our solutionsto a broader, more diversified group of biologists, chemists, engineers andinformaticians throughout our customers’ research and development organizations.A key component of our business strategy is to become a preferred provider ofscientific software and solutions. Becoming a preferred vendor will requiresubstantial re-training and new skills development 

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within our sales andservice personnel and deployment of a successful account-management salesmodel. We believe that developing strategic relationships with our customersmay lead to additional revenue opportunities. However, there can be noassurance that any such relationships will develop or that such relationshipswill produce additional revenue or profit opportunities.

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

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

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

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

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

There can be no assurance that our current orpotential competitors will not develop products, services or technologies thatare comparable to, superior to, or render obsolete, the products, services andtechnologies we offer. There can be no assurance that our competitors will notadapt more quickly than us to technological advances and customer demands,thereby increasing such competitors’ market share relative to ours.

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Any material decrease indemand for our technologies or services may have a material adverse effect onour business, financial condition and results of operations.

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

***Our operations maybe interrupted by the occurrence of a natural disaster or other catastrophicevent at our primary facilities.***   Ourresearch and development operations and administrative functions are primarilyconducted at our facilities in San Diego, California, and Cambridge, UnitedKingdom. We also conduct sales and customer support activities at ourfacilities in Burlington, Massachusetts, Paris, France, and Tokyo, Japan.Although we have contingency plans in effect for natural disasters or othercatastrophic events, catastrophic events could still disrupt our operations.For example, our San Diego and Tokyo facilities are located in areas that areparticularly susceptible to earthquakes. Any natural disaster or catastrophicevent in our facilities or the areas in which they are located could have asignificant negative impact on our operations.

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

**Certain RisksRelated to Our Operations**

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

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

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

·       unexpected changes inregulatory requirements;

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·       longer payment cycles;

·       currency exchange ratefluctuations;

·       import and export licenserequirements;

·       tariffs and other barriers;

·       political unrest, terrorismand economic instability;

·       disruption of ouroperations due to local labor conditions;

·       limited intellectualproperty protection;

·       difficulties in collectingtrade receivables;

·       difficulties in managingdistributors or representatives;

·       difficulties in managing anorganization spread over various countries;

·       difficulties in staffingforeign subsidiary or joint venture operations; and

·       potentially adverse taxconsequences.

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

***In order toimprove our financial position, we have reduced our headcount, which couldnegatively impact our business.******  ***We have undergone severalreductions-in-force over the past several years, and our workforce hasdeclined. While we believe we have sufficient staff to operate our business, wedo not have duplicative or redundant resources in many of our functions or operations.As a result, there can be no assurance that further attrition will not impactour ability to operate our business, or adversely impact our revenues.

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

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

**Certain RisksRelated To Our Financial Performance**

***We have a historyof losses and our future profitability is uncertain.****  *We generated net losses for the years endedMarch 31, 2007, 2006 and 2005. Continuing net losses may limit our abilityto fund our operations and we may not generate income from operations in thefuture. Our future profitability depends upon many factors, including severalthat are beyond our control. These factors include without limitation:

·       changes in the demand forour products and services;

·       the introduction ofcompetitive software;

·       our ability to licensedesirable technologies;

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

·       ourability to successfully, cost effectively and timely develop, introduce andmarket new products, services and product enhancements; and

·  theacquisition of any new entities or businesses which may have a dilutive effectupon our earnings.

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

***If we are unableto license software to, or collect receivables from our customers our operatingresults may be adversely affected.***   While themajority of our current customers are well-established, large pharmaceuticalcustomers and universities, we also provide products and services to smallerbiotechnology companies. We have not experienced significant customer defaultsduring the past three fiscal years. Our financial success depends upon thecreditworthiness and ultimate collection of amounts due from our customers,including our smaller customers with fewer financial resources. If we are notable to collect from our customers, we may be required to write-off significantaccounts receivable and recognize bad debt expenses which could materially andadversely affect our operating results.

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

***We may be requiredto indemnify Pharmacopeia Drug Discovery, Inc. (“PDD”), or may not be ableto collect on indemnification rights from PDD.***   On April 30, 2004, we spun-offour drug discovery subsidiary, PDD, into an independent, separately traded,publicly held company through the distribution to our stockholders of a dividendof one share of PDD common stock for every two shares of our common stock. Aspart of the spin-off, we agreed to indemnify the indebtedness,liabilities and obligations of PDD. One such obligation includes a guarantee byus to the landlord of PDD’s obligations under certain facility leases, withrespect to which PDD will indemnify us should we be required to make anypayment under the guarantee. These indemnification obligations could be assignificant as the remaining future minimum lease payments, which totaledapproximately $21 million as of March 31, 2007. PDD’s ability to satisfyany such indemnification obligations (including, without limitation, PDD’scommitment to indemnify us in the event of our payment under our guarantee ofits leases) will depend upon PDD’s future financial strength. We cannot assureyou that, if PDD becomes obligated to indemnify us for any substantialobligations, PDD will have the ability to do so. There also can be no assurancethat we will be able to satisfy any indemnification obligations to PDD. Anyfailure by PDD to satisfy its obligations and any required payment by us couldhave a material adverse effect on our business.

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

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

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

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appropriate, we mayengage in currency exchange rate hedging transactions in an attempt to mitigatethe impact of adverse exchange rate fluctuations. However, currency hedgingpolicies may not be successful, and they may increase the negative impact ofexchange rate fluctuations.

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

**Certain RisksRelated to Owning Our Stock**

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

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

·       market conditions in thetechnology and software sectors;

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

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

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

·       market acceptance of ourproducts and services;

·       additions or departures ofkey personnel; and

·       the acquisition of newbusinesses or technologies;

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

***As institutionshold the majority of our common stock in large blocks, substantial sales bythese stockholders could depress the market price for our shares.***   Asof May 3, 2007, the top ten institutional holders of our common stock heldapproximately 56% of our outstanding common stock. As a result, if one or moreof these major stockholders were to sell all or a portion of their holdings, orif the market were to perceive that such sale or sales may occur, the marketprice of our common stock may fall significantly.

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

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***Anti-takeoverprovisions under the Delaware General Corporation Law, provisions in ourcertificate of incorporation and bylaws, and our adoption of a stockholderrights plan may render more difficult the accomplishment of mergers or theassumption of control by a principal stockholder, making more difficult theremoval of management.***   Certain provisions ofthe Delaware General Corporation Law may delay or deter attempts to securecontrol of our company without the consent of our management. Also, ourgoverning documents provide for a staggered board of directors, which will makeit more difficult for a potential acquirer to gain control of our board ofdirectors. In 2002, we adopted a stockholder rights plan, which is triggeredupon commencement or announcement of a hostile tender offer or when any oneperson or group acquires 15% or more of our common stock. The rights plan, oncetriggered, enables our stockholders (other than the stockholder responsible fortriggering the rights plan) to purchase our common stock at reduced prices.These provisions of our governing documents and stockholder rights plan, and ofDelaware law, could have the effect of delaying, deferring or preventing achange of control, including without limitation a proxy contest, making moredifficult the acquisition of a substantial block of our common stock. Theprovisions could also limit the price that investors might be willing to pay inthe future for shares of our common stock. Further, the existence of theseanti-takeover measures may cause potential bidders to look elsewhere, ratherthan initiating acquisition discussions with us.

**Certain RisksRelated to Intellectual Property**

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

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

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

***We may be subjectto claims of infringement by third parties.****  *A number of patents may have been issued or may beissued in the future that could cover certain aspects of our technology orfunctionality of our products and could prevent us from using technology thatwe use or expect to use, or making or selling certain of our products. Inaddition, to the extent our employees are involved in research areas similar tothose areas in which they were involved at their former employers, we mayinadvertently use or disclose alleged trade secrets or other

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proprietary informationof their former employer. Thus, our products may infringe patent or otherintellectual property rights of third parties, and we may be subject toinfringement claims by third parties. Any such claims, with or without merit,could be time consuming to defend, result in costly litigation, divertmanagement’s attention and resources, cause product shipment delays or requireus to enter into royalty or licensing agreements. Such licenses may not beavailable on terms acceptable to us, if at all. In the event of a successfulclaim of product infringement against us, our failure or inability to licenseor design around the infringed technology could have a material adverse effecton our business, financial condition and results of operations.

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

**Item 1B.**                 Unresolved StaffComments

None.

**Item2.**                          Properties

The following is asummary of our principal business locations:
| **Location**                   | ** ** | **Principal activities**                                                                       | ** ** | **Lease  Ends (Fiscal Year)** | ** ** | **Square  Feet** | ** ** |
|--------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|------------------|------------|
| San Diego, California, USA     |       | Corporate headquarters, sales, customer support,  marketing, product development and administration |       | 2013                          |       | 68,436           |       |
| Burlington, Massachusetts, USA |       | Sales                                                                                               |       | 2009                          |       | 4,830            |       |
| Cambridge, UK                  |       | Sales, customer support, marketing, product  development and administration                         |       | 2022                          |       | 24,451           |       |
| Paris, France                  |       | Sales and administration                                                                            |       | 2015                          |       | 2,486            |       |
| Tokyo, Japan                   |       | Sales, marketing and administration                                                                 |       | 2008                          |       | 5,405            |       |
| Bangalore, India               |       | Sales                                                                                               |       | 2010                          |       | 1,500            |       |

**Item 3.**                          Legal Proceedings

We are not a party to any legal proceedings thenegative outcome of which would have a material adverse effect on our business,financial condition or results of operations.

**Item4.**                          Submissionof Matters to a Vote of Security Holders

Not applicable.

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**PART II**

**Item5.**                          Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities

**Market for CommonStock**

Our common stocktrades on the NASDAQ Global Market tier of The NASDAQ Stock Market under thesymbol ACCL. The following table sets forth, for the periods indicated, therange of high and low sale prices per share of our common stock:
|                                    | ** ** | **High**   | ** ** | **Low**    | ** ** |
|------------------------------------|------------|------------|------------|------------|------------|
| **Year Ended March 31, 2007** | ** ** | ** ** | ** ** | ** ** | ** ** |
| First Quarter                      |       | $          | 7.61       |       | $          | 6.44 |   |
| Second Quarter                     |       | $          | 7.25       |       | $          | 5.25 |   |
| Third Quarter                      |       | $          | 6.60       |       | $          | 5.51 |   |
| Fourth Quarter                     |       | $          | 6.62       |       | $          | 5.82 |   |
| **Year Ended March 31, 2006** |       |       |       |       |       |
| First Quarter                      |       | $          | 6.18       |       | $          | 4.73 |   |
| Second Quarter                     |       | $          | 6.84       |       | $          | 4.74 |   |
| Third Quarter                      |       | $          | 8.74       |       | $          | 6.10 |   |
| Fourth Quarter                     |       | $          | 8.09       |       | $          | 5.00 |   |

**Fromthe date of our initial public offering on December 5, 1995 untilFebruary 26, 2004, our stock traded under the symbol PCOP. SinceFebruary 27, 2004, our common stock has traded under the symbol ACCL.**

**Holders of Record**

As of May 3, 2007, therewere 426 holders of record of our common stock.

**Dividends**

No cash dividends havebeen paid on the common stock to date, nor do we anticipate paying dividends inthe foreseeable future.

**EquityCompensation Plan Information**

The information required by Item 201(d) ofRegulation S-K will be included in our definitive proxy statement (“ProxyStatement”) to be filed with the SEC within 120 days after our fiscal yearended March 31, 2007, and is incorporated in this Report by reference.

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**Comparison ofStockholder Return**

The followinginformation shall not be deemed to be “filed” with the Securities and ExchangeCommission nor shall this information be incorporated by reference into anyfuture filing under the Securities Act of 1933, as amended, or the SecuritiesExchange Act of 1934, as amended, except to the extent that we specificallyincorporate it by reference into a filing.

The following graph compares the five-year cumulativetotal return through March 31, 2007 for our common stock, which is tradedunder the symbol ACCL on the NASDAQ Global Market tier of The NASDAQ StockMarket, a broad market index, namely the NASDAQ U.S. Composite Index (the “NASDAQIndex”) and an industry index, namely the NASDAQ Computer and Data ProcessingServices Index (the “Industry Index”). This graph assumes an investment of $100was made in both our common stock and in each index on March 31, 2002 andfurther assumes that all dividends were reinvested. The stock price performanceon the graph is not necessarily indicative of future stock price performance.
|                     | ** ** | **Accelrys, Inc.** | ** ** | **NASDAQ Index** | ** ** | **Industry Index** | ** ** |
|---------------------|------------|-------------------------|------------|-----------------------|------------|-------------------------|------------|
| March 31, 2002 |       | $                       | 100.00     |                  | $          | 100.00                  |       | $ | 100.00 |   |
| March 31, 2003 |       | 65.89                   |       | 73.40                 |       | 72.76                   |       |
| March 31, 2004 |       | 151.17                  |       | 108.34                |       | 92.00                   |       |
| March 31, 2005 |       | 44.55                   |       | 109.06                |       | 97.95                   |       |
| March 31, 2006 |       | 54.62                   |       | 128.61                |       | 115.34                  |       |
| March 31, 2007 |       | 47.93                   |       | 133.40                |       | 125.86                  |       |
|                     |            |                         |            |                       |            |                         |            |  |  |  |

 

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**Item6.**                          SelectedConsolidated Financial Data

The following selected consolidated financial datahave been derived from our audited consolidated financial statements. This datashould be read in conjunction with “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” and our consolidated financialstatements and related notes thereto included elsewhere in this Report. OnApril 1, 2004, we changed our fiscal year end from December 31 toMarch 31. The following table sets forth our selected consolidatedfinancial data as of and for the years ended March 31, 2007, 2006 and2005, the three months ended March 31, 2004, and the years ended December 31,2003 and 2002.
| ** **                                                                               | ** ** | **Years Ended**                                                  | ** ** | **Three  Months  Ended** | ** ** |
|------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                               | ** ** | **March 31,  2007**                                              | ** ** | **March 31,  2006** | ** ** | **March 31,  2005(1)** | ** ** | **December 31,  2003** | ** ** | **December 31,  2002** | ** ** | **March 31,  2004** | ** ** |
| ** **                                                                               | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **Consolidated Statement of  Operations Data:**                           |       |                                                                  |       |                     |       |   |   |   |   |   |   |   |   |
| Revenue                                                                                  |       | $                                                                     | 80,955     |                     | $          | 82,001 |   | $ | 79,030 |   | $ | 86,209 |   | $ | 98,497 |   | $ | 19,359 |   |
| Cost of revenue                                                                          |       | 15,498                                                                |       | 16,029                   |       | 13,268 |   | 13,529 |   | 17,887 |   | 2,406 |   |
| Gross margin                                                                             |       | 65,457                                                                |       | 65,972                   |       | 65,762 |   | 72,680 |   | 80,610 |   | 16,953 |   |
|                                                                                     |       |                                                                  |       |                     |       |   |   |   |   |   |   |   |   |
| Operating expenses:                                                                      |       |                                                                  |       |                     |       |   |   |   |   |   |   |   |   |
| Product  development                                                                     |       | 18,931                                                                |       | 21,721                   |       | 22,717 |   | 22,394 |   | 23,315 |   | 5,248 |   |
| Sales and  marketing                                                                     |       | 30,680                                                                |       | 33,723                   |       | 37,965 |   | 38,240 |   | 41,191 |   | 9,268 |   |
| General and  administrative                                                              |       | 17,342                                                                |       | 16,060                   |       | 17,290 |   | 16,637 |   | 21,586 |   | 4,434 |   |
| Restructuring  charges (recoveries)                                                      |       | 1,201                                                                 |       | 3,178                    |       | 5,110 |   | (384 | ) | 4,340 |   | 5,199 |   |
| Acquired  in-process product development                                                 |       | —                                                                |       | —                   |       | 450 |   | — |   | — |   | — |   |
| Spin-off  transaction costs                                                              |       | —                                                                |       | —                   |       | — |   | 700 |   | — |   | 2,321 |   |
| Total operating  expenses                                                                |       | 68,154                                                                |       | 74,682                   |       | 83,532 |   | 77,587 |   | 90,432 |   | 26,470 |   |
| Operating loss from  continuing operations                                               |       | (2,697                                                                | )          | (8,710                   | )          | (17,770 | ) | (4,907 | ) | (9,822 | ) | (9,517 | ) |
| Interest and other  income, net                                                          |       | 1,954                                                                 |       | 1,869                    |       | 1,738 |   | 4,160 |   | 3,894 |   | 921 |   |
| Loss from continuing  operations before income taxes                                     |       | (743                                                                  | )          | (6,841                   | )          | (16,032 | ) | (747 | ) | (5,928 | ) | (8,596 | ) |
| Income tax expense  (benefit)                                                            |       | 782                                                                   |       | 898                      |       | (571 | ) | 1,001 |   | 629 |   | 128 |   |
| Loss from continuing  operations                                                         |       | (1,525                                                                | )          | (7,739                   | )          | (15,461 | ) | (1,748 | ) | (6,557 | ) | (8,724 | ) |
| Loss from discontinued  operations                                                       |       | —                                                                |       | —                   |       | (1,117 | ) | (2,848 | ) | (2,142 | ) | (9,936 | ) |
| Net loss                                                                                 |       | $                                                                     | (1,525     | )                        | $          | (7,739 | ) | $ | (16,578 | ) | $ | (4,596 | ) | $ | (8,699 | ) | $ | (18,660 | ) |
|                                                                                     |       |                                                                  |       |                     |       |   |   |   |   |   |   |   |   |
| Basic and diluted loss  per share amounts:                                               |       |                                                                  |       |                     |       |   |   |   |   |   |   |   |   |
| Loss from continuing  operations                                                         |       | $                                                                     | (0.06      | )                        | $          | (0.30 | ) | $ | (0.62 | ) | $ | (0.07 | ) | $ | (0.28 | ) | $ | (0.36 | ) |
| Loss from discontinued  operations                                                       |       | —                                                                |       | —                   |       | (0.04 | ) | (0.12 | ) | (0.09 | ) | (0.41 | ) |
| Net loss                                                                                 |       | $                                                                     | (0.06      | )                        | $          | (0.30 | ) | $ | (0.66 | ) | $ | (0.19 | ) | $ | (0.37 | ) | $ | (0.77 | ) |
|                                                                                     |       |                                                                  |       |                     |       |   |   |   |   |   |   |   |   |
| Weighted average shares used in computing basic and diluted loss  per share amounts |       | 26,351                                                                |       | 26,116                   |       | 25,137 |   | 23,752 |   | 23,512 |   | 24,090 |   |

 

19

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| ** **                                                                                   | ** ** | **As of**           | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                   | ** ** | **March 31,  2007** | ** ** | **March 31,  2006** | ** ** | **March 31,  2005(3)** | ** ** | **March 31,  2004** | ** ** | **December 31,  2003** | ** ** | **December 31,  2002** | ** ** |
| ** **                                                                                   | ** ** | **(In thousands)**  | ** ** |
| **Consolidated Balance Sheet  Data:**                                                        |       |                     |       |   |   |   |   |   |   |   |   |   |   |
| Cash, cash equivalents,  marketable securities and restricted cash and marketable securities |       | $                        | 70,757     |   | $ | 66,022 |   | $ | 63,304 |   | $ | 141,261 |   | $ | 134,055 |   | $ | 141,071 |   |
| Total assets                                                                                 |       | 154,601                  |       | 146,755 |   | 152,415 |   | 213,144 |   | 232,447 |   | 234,632 |   |
| Total deferred revenue                                                                       |       | 56,133                   |       | 61,269 |   | 58,614 |   | 53,182 |   | 66,145 |   | 68,123 |   |
| Noncurrent  liabilities(2)                                                                   |       | 8,342                    |       | 5,718 |   | 5,131 |   | 3,770 |   | — |   | 8 |   |
| Accumulated deficit                                                                          |       | (182,681                 | )          | (181,156 | ) | (173,417 | ) | (156,839 | ) | (138,179 | ) | (133,583 | ) |
| Total stockholders’ equity                                                              |       | 68,990                   |       | 63,208 |   | 69,596 |   | 127,501 |   | 141,873 |   | 143,575 |   |
|                                                                                              |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)             Amountsinclude the results of SciTegic, Inc. from September 27, 2004, thedate of the acquisition.

(2)             Noncurrentliabilities primarily consist of long-term, lease-related liabilities.

(3)           The decrease in ourcash, cash equivalents, marketable securities and restricted marketablesecurities and total stockholders’ equity from March 31, 2004 toMarch 31, 2005 primarily resulted from our April 30, 2004 spin-off ofPDD. In connection with the spin-off, we distributed to our stockholders adividend of one share of PDD common stock for every two shares of our commonstock and contributed to PDD $42.3 million of marketable securities and $5.4million in cash.

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**Item7.**                          Management’sDiscussion and Analysis of Financial Condition and Results of Operations

The following discussion andanalysis of our financial condition and results of operations should be read inconjunction with “Selected Consolidated Financial Data” and our consolidatedfinancial statements and related notes thereto included elsewhere in thisReport.

In addition to historicalinformation, the following discussion contains forward-looking statements thatare subject to certain risks and uncertainties, including those risks anduncertainties described in Item 1A of this Report. Actual results maydiffer substantially from those referred to herein due to a number of factors,including but not limited to those risks and uncertainties.

**Overview**

***Our Business***

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

***Our Marketplace***

Historically, we have primarily sold molecularmodeling and simulation software. The market for molecular modeling andsimulation products in the pharmaceutical and biotechnology industries ischallenging due to the maturity of the market, industry consolidation,reduction in the level of discovery research activity, and increasedcompetition, including competition from open source software. We also sellmodeling and simulation products to the chemical, petrochemical and materialsindustries. We believe these industries are in the early stages of adoption ofthese technologies. Thus we believe the market for our products within theseindustries is nascent and has experienced modest growth over the past severalyears. Following the acquisition of SciTegic, we began to offer data-pipeliningand workflow software. This technology is widely applicable within our targetindustries and represents a significant growth opportunity. There is currentlylimited competition to this technology in our targeted industries, which isexperiencing growth within our customer base.

***Our Strategy***

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

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

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

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

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

**CriticalAccounting Policies**

Our discussion and analysis of our financial conditionand results of operations are based on our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of the consolidated financialstatements requires us to make estimates and judgments that affect the reportedamounts of assets, liabilities, revenues and expenses and the relateddisclosure of contingent assets and liabilities. We review our estimates on anon-going basis, including those related to revenue recognition, income taxesand the valuation of goodwill, intangibles and other long-lived assets. We baseour estimates on historical experience and on various other assumptions that webelieve to be reasonable under the circumstances, the results of which form thebasis for making judgments about the carrying values of assets and liabilities.Actual results may differ from these estimates under different assumptions orconditions. Our accounting policies are described in more detail in Note 2 toour consolidated financial statements included elsewhere in this Report. Wehave identified the following as the most critical accounting policies andestimates used in the preparation of our consolidated financial statements.

*RevenueRecognition*

We recognize revenues inaccordance with the American Institute of Certified Public Accountants (“AICPA”)Statement of Position (“SOP”) No. 97-2, *SoftwareRevenue Recognition*, as amended, SEC Staff Accounting Bulletin (“SAB”)No. 104, *Revenue Recognition*, EmergingIssues Task Force (“EITF”) Issue No. 00-21, *RevenueArrangements with Multiple Deliverables*, and SOP No. 81-1,*Accounting for Performance of Construction-Type and CertainProduction-Type Contracts.*

We generate revenue from the following primarysources:

·       software licenses,

·       provisionof post-contract customer support and maintenance services on licensedsoftware, collectively referred to as PCS, and

·       professional services.

Customer billings generated in connection with ourrevenue-generating activities are initially recorded as deferred revenue. Wethen recognize the revenue from these customer billings as set forth below andwhen all of the following criteria are met:

·       afully executed written contract and/or purchase order has been obtained fromthe customer (i.e., persuasive evidence of an arrangement exists),

·       thecontractual price of the product or services has been defined and agreed to inthe contract (i.e., price is fixed or determinable),

·       deliveryof the product or service has occurred and no material uncertainties regardingcustomer acceptance of the delivered product or service exist, and

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

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*SoftwareLicenses.   *We license software eitherperpetually or on a term basis. Our standard perpetual software licensingarrangements include twelve months of bundled PCS, while our standardterm-based software licensing arrangements typically include PCS for the fullduration of the term license. Because we do not have vendor specific objectiveevidence (“VSOE”) of the fair value of these elements, we recognize as revenuethe entire fee for such perpetual or term-based licenses ratably over the termof the bundled PCS. Certain of our term-based licenses also allow the customerto substitute purchased products for other products of equal value throughoutthe term. We account for these arrangements as in-substance subscriptions and,accordingly, we recognize as revenue the entire fee for such licenses ratablyover the contractual term of the arrangement, which is typically the same asthe term of the bundled PCS.

*Renewalof PCS under Perpetual Software Licenses.   *OurPCS includes the right to receive unspecified upgrades or enhancements andtechnical support. Fees from customer renewals of PCS related to previouslypurchased perpetual licenses are recognized ratably over the term of the PCS.

*ProfessionalServices.   *We provide certain services to ourcustomers, including non-complex product training, installation, implementationand other professional services which are non-essential to the operation of thesoftware. When sold separately, revenue from these services is generallyrecognized as the services are delivered, according to the contractual terms.Amounts billed but not yet recognized as revenue, and other payments receivedprior to the recognition of revenue, are recorded as deferred revenue.

We also performprofessional services for our customers designed to enhance the value of oursoftware products by creating extensions to functionality to address a client’sspecific business needs.  When soldseparately, revenue from these services is recorded under thepercentage-of-completion or completed contract method.

*Multi-ElementArrangements.   *For multi-element arrangementswhich include software licenses, PCS and non-complex training, installation,implementation and other professional services which are non-essential to theoperation of the software, the entire fee for such arrangements is recognizedas revenue ratably over the term of the PCS or delivery of the services,whichever is longer.  For multi-elementarrangements which include software licenses, PCS, non-essential services andservices that are essential to the operation of the software, the fee for sucharrangements is generally deferred until the services essential to theoperation of the software have been performed and the modified software hasbeen delivered, at which point the entire fee for such arrangements isrecognized as revenue ratably over the term of the PCS or delivery of thenon-essential services, whichever is longer.

*SoftwareDevelopment Costs*

We account for costs incurred to develop our softwareproducts in accordance with Statement of Financial Accounting Standards (“SFAS”)No. 86, *Accounting for the Cost of Computer Softwareto be Sold, Leased or Otherwise Marketed*. Accordingly, costsincurred in the research and development of new software products andsignificant enhancements to existing software products are expensed asincurred, until the technological feasibility of the product has beenestablished. Technological feasibility occurs shortly before our softwareproducts are available for general release, and we have determined that costseligible for capitalization are not material. Accordingly, no softwaredevelopment costs were capitalized as of March 31, 2007 and 2006.

*Valuation ofGoodwill*

Our goodwill resulted from acquisitions in fiscalyears 1999, 2000, 2001 and 2005. In accordance with SFAS No. 142, *Goodwill and Other Intangible Assets*, we review goodwill forimpairment at least annually and more frequently if events or changes incircumstances occur that indicate a potential reduction in the fair value ofthe reporting unit to which the goodwill has been assigned below its carryingvalue. Examples of such events or circumstances include: a significant adverse change in legal factorsor in the business climate, a significant decline in our stock price, asignificant decline in our projected revenue or cash flows, an adverse actionor 

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assessmentby a regulator, unanticipated competition, a loss of key personnel, or thepresence of other indicators that would indicate a reduction in the fair valueof a reporting unit.

Our goodwill is considered to be impaired if wedetermine that the carrying value of the reporting unit to which the goodwillhas been assigned exceeds its estimated fair value. In the fourth quarter offiscal year 2007, we completed our annual goodwill impairment test andconcluded that our goodwill was not impaired. Based on the guidance provided bySFAS No. 142 and SFAS No. 131, *Disclosures about Segmentsof an Enterprise and Related Information*, management has determinedthat our company consists of one reporting unit given the similarities ofeconomic characteristics between the operations and the common nature of theproducts, services and customers. Because we have only one reporting unit, andwe are publicly traded, we determine the fair value of the reporting unit basedon our market capitalization as we believe this represents the best evidence offair value. Our conclusion that goodwill was not impaired was based on a comparisonof our net assets as of March 31, 2007 to our market capitalization.

Because we determine the fair value of our reportingunit based on our market capitalization, our future reviews of goodwill forimpairment may be impacted by changes in the price of our common stock. Forexample, a significant decline in the price of our common stock may cause thefair value of our goodwill to fall below its carrying value. Therefore, wecannot assure you that when we complete our future reviews of goodwill for impairmentthat a material impairment charge will not be recorded.

*Valuation of Indefinite-Lived Intangible Asset*

In connection with our acquisition of SciTegic inSeptember 2004, we acquired the SciTegic trade name which was determinedto be indefinitely lived. In accordance with SFAS No. 142, *Goodwill and Other Intangible Assets*, we review ourindefinite-lived intangible asset for impairment at least annually in ourfiscal fourth quarter and more frequently if events or changes in circumstancesoccur that indicate a potential reduction in the fair value of the asset belowits carrying value. Examples of such events or circumstances include: a significant adverse change in legal factorsor in the business climate, a significant decline in our stock price, a significantdecline in our projected revenue or cash flows, an adverse action or assessmentby a regulator, unanticipated competition, a loss of key personnel, or thepresence of other indicators that would indicate a reduction in the fair valueof an asset.

Our indefinite-lived intangible asset is considered tobe impaired if we determine that the carrying value of the asset exceeds itsestimated fair value. In the fourth quarter of fiscal year 2007, we completedour annual indefinite-lived intangible asset impairment test and concluded thatour indefinite-lived intangible asset was not impaired. We estimated the fairvalue of our indefinite-lived intangible asset utilizing a discounted cash flowanalysis which considers the estimated future customer orders for ourscientific operating platform and the associated direct and incrementalselling, marketing, and product development costs. Key assumptions included inthe discounted cash flow analysis include projections of future customer ordergrowth for our scientific operating platform and developing an appropriatediscount rate.

We cannot assure you that the underlying assumptionsused to forecast the cash flows will materialize as estimated. For example, ifour projections of future customer order growth do not materialize, the fairvalue of our indefinite-lived intangible asset may fall below its carryingvalue. Therefore, we cannot assure you that when we complete our future reviewsof our indefinite-lived intangible asset for impairment that a material impairmentcharge will not be recorded.

*Impairment ofLong-Lived Assets*

In accordance with SFAS No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*,we review long-lived assets to be held and used, including acquired intangibleassets subject to amortization and property and equipment, for impairmentwhenever events or changes in circumstances indicate that the carrying amountof the assets may not be fully recoverable. Conditions that would necessitate animpairment assessment include a significant decline in the market price of anasset or asset group, a significant adverse change in the extent or manner inwhich an asset or asset group is being used, the loss of legal ownership ortitle to the asset, 

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significantnegative industry or economic trends or the presence of other indicators thatwould indicate that the carrying amount of an asset or asset group is notrecoverable.

A long-lived asset is considered to be impaired if theestimated undiscounted future cash flows resulting from the use of the assetand its eventual disposition are not sufficient to recover the carrying valueof the asset. In order to estimate an asset’s undiscounted future cash flows,we utilize our internal forecast of our future operating results and cashflows, our strategic business plans and anticipated future economic and marketconditions. There are inherent estimates and assumptions underlying thisinformation and management’s judgment is required in the application of thisinformation to the determination of an asset’s undiscounted future cash flows.No assurance can be given that the underlying estimates and assumptionsutilized in our determination of an asset’s undiscounted future cash flows willmaterialize as anticipated.

As a result of the closure of our research anddevelopment facility in Bangalore, India in the fourth quarter of fiscal year2007, we assessed the recoverability of the associated property and equipmentand determined that a portion of the assets were not recoverable.  Accordingly, we recorded an asset impairmentcharge of $0.1 million in the fourth quarter of fiscal year 2007.  The asset impairment charge of $0.1 millionrepresents the carrying value of these assets as we expect that any amount we willrecover from their disposal will be negligible.

*Valuation of Share-Based Awards*

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

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

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

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

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

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

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Ourdetermination of the input variables used in the Black-Scholes option pricingmodel as well as the pre-vesting forfeiture rate is based on various underlyingestimates and assumptions that are highly subjective and are affected by ourstock price, among other factors. Changes in these underlying estimates andassumptions could materially affect the fair value of our share-based awardsand, therefore, the amount of share-based compensation expense to be recognizedin our results of operations.

*Income Taxes*

Significant judgment is required in determining ourworldwide provision for income taxes. In the ordinary course of a globalbusiness, there are many transactions for which the ultimate tax outcome isuncertain. Some of these uncertainties arise as a consequence of intercompanyarrangements to share revenue and costs. In such arrangements there areuncertainties about the amount and manner of such sharing which couldultimately result in changes once the arrangements are reviewed by taxingauthorities. Although we believe that our approach to determining the amount ofsuch arrangements is reasonable, no assurance can be given that the finalresolution of these matters will not be materially different than that which isreflected in our historical income tax provisions and accruals. Such differencescould have a material effect on our income tax expense or benefit in the periodin which such determination is made.

Despite our belief that our tax return positions areconsistent with applicable tax laws, we expect that certain positions are likelyto be challenged by taxing authorities. Settlement of any challenge can resultin no change, a complete disallowance, or some partial adjustment reachedthrough negotiations or litigation. Significant judgment is required inevaluating our tax reserves. Our reserves are adjusted in light of changingfacts and circumstances, such as the progress of our tax audits. Our income taxexpense includes the impact of reserve provisions and changes to reserves thatwe consider appropriate, as well as related interest and penalties. Favorableresolution of such an income tax matter would be recognized as a reduction toincome tax expense.

We establish a valuation allowance against our net deferred tax assets toreduce deferred tax assets to the amount expected to be realized. Thelikelihood of a material change in the expected realization of our deferred taxassets depends on our ability to generate sufficient future taxable income. Ourability to generate enough taxable income to utilize our deferred tax assets dependson many factors, among which are our ability to deduct tax loss carryforwardsagainst future taxable income, the effectiveness of our tax planningstrategies, reversing deferred tax liabilities and any significant changes inthe tax treatment received on our business combinations. Since ourinception, we have provided a full valuation allowance against our net U.S.deferred tax assets as we believe it is more likely than not that we will notultimately realize our deferred tax assets.

**Results of Operations**

Our results of operations include the results ofoperations of SciTegic from September 27, 2004, the date of theacquisition.

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**Comparison of theYears Ended March 31, 2007 and 2006**

***The following tablesummarizes our results of operations as a percentage of revenue for therespective periods:***
| ** **                      | ** ** | **Years Ended  March 31,** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2007**                             | ** ** | **2006** | ** ** |
| ** **                      | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Revenue                         |       | 100                                  | %          | 100 | % |
| Cost of revenue                 |       | 19                                   | %          | 20 | % |
| Gross margin                    |       | 81                                   | %          | 80 | % |
|                            |       |                                 |       |   |   |
| Operating expenses:             |       |                                 |       |   |   |
| Product  development            |       | 23                                   | %          | 26 | % |
| Sales and  marketing            |       | 38                                   | %          | 41 | % |
| General and  administrative     |       | 21                                   | %          | 20 | % |
| Restructuring  charges          |       | 1                                    | %          | 4 | % |
| Total operating  expenses       |       | 84                                   | %          | 91 | % |
| Operating loss                  |       | (3                                   | )%         | (11 | )% |
| Interest and other  income, net |       | 2                                    | %          | 2 | % |
| Loss before income  taxes       |       | (1                                   | )%         | (8 | )% |
| Income tax expense              |       | 1                                    | %          | 1 | % |
| Net loss                        |       | (2                                   | )%         | (9 | )% |

 

***Revenue***

Revenue decreased 1% to $81.0 million for the year endedMarch 31, 2007 compared to $82.0 million for the year ended March 31,2006. The decrease in revenue was primarily attributable to the continued growth in the Company’s scientificoperating platform product line, offset by reduced sales of certain legacyproducts that were deemphasized in connection with the restructuring andproduct line adjustments that have occurred over the past two fiscal years.

***Operating Costs and Expenses***

*Costof Revenue.**  *Cost of revenue decreased 3% to $15.5 million forthe year ended March 31, 2007, as compared to $16.0 million for the yearended March 31, 2006. As a percentage of revenue, cost of revenuedecreased to 19% for the year ended March 31, 2007, as compared to 20% forthe year ended March 31, 2006. The decrease in cost of revenue wasprimarily attributable to a decrease in fulfillment costs of $0.3 milliondriven by an increase in fiscal year 2007 of electronic software distributionto our customers.  We also incurredapproximately $0.4 million less in royalty costs and distributor commissions,primarily due to a more favorable product mix, but partially impacted by aslight decrease in sales volume year over year.   Additionally, a portion of the intangibleassets acquired in the SciTegic acquisition in September 2004 became fullyamortized in fiscal year 2007, resulting in a year-over-year decrease inpurchased intangible asset amortization of approximately $0.2 million.  These amounts were offset by a $0.3 millionincrease in share-based compensation expense resulting from our adoption ofSFAS No. 123R.

*ProductDevelopment Expenses.**  *Productdevelopment expenses decreased 13% to $18.9 million for the year endedMarch 31, 2007, as compared to $21.7 million for the year endedMarch 31, 2006. As a percentage of revenue, product development expensesdecreased to 23% for the year ended March 31, 2007, as compared to 26% forthe year ended March 31, 2006. The decrease in product developmentexpenses was primarily attributable to lower personnel expenses of $3.0 millionresulting from headcount reductions and cost control measures implementedduring fiscal year 2006, and savings of $0.5 million resulting from the closureof our research and development facility in Bangalore, India in the fourthquarter of fiscal year 2007.  Theseamounts were offset by a $0.5 million increase in share-based compensationexpense resulting from our adoption of SFAS No. 123R.

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*Salesand Marketing Expenses.**  *Sales andmarketing expenses decreased 9% to $30.7 million for the year endedMarch 31, 2007, as compared to $33.7 million for the year endedMarch 31, 2006. As a percentage of revenue, sales and marketing expensesdecreased to 38% for the year ended March 31, 2007, as compared to 41% forthe year ended March 31, 2006. The decrease in sales and marketingexpenses was primarily attributable to lower personnel and other sales-relatedexpenses of $3.8 million resulting from headcount reductions and cost controlmeasures implemented during fiscal year 2006, offset by a $0.7 million increasein share-based compensation expense resulting from our adoption of SFAS No. 123R.

*Generaland Administrative Expenses.**  *General andadministrative expenses increased 8% to $17.3 million for the year endedMarch 31, 2007, as compared to $16.1 million for the year endedMarch 31, 2006. As a percentage of revenue, general and administrativeexpenses increased to 21% for the year ended March 31, 2007, as comparedto 20% for the year ended March 31, 2006. The increase in general andadministrative costs was primarily attributable to a $1.9 million increase inshare-based compensation expense resulting from our adoption of SFAS No. 123R,offset by a $0.6 million reduction in outside consulting and accounting feesrelated to the restatement of our previously issued consolidated financialstatements.

*RestructuringCharges.**  *Restructuringcharges were $1.2 million for the year ended March 31, 2007, ascompared to $3.2 million for the year ended March 31, 2006. In fiscal year2007, as a result of the substantial completion of our product modernizationand integration efforts, we implemented a restructuring plan which resulted inthe closure of our research and development facility in Bangalore, India, andthe termination of approximately 60 research and development employees inBangalore.  As a result of therestructuring, we recognized a charge of $0.8 million, consisting of $0.3million in severance benefits and $0.5 million in asset impairment and otherfacility closure costs.  All severanceand facility closure costs have been paid as of March 31, 2007.  Additionally, in fiscal year 2007 we incurredadditional lease abandonment charges of $0.1 million and $0.3 million inseverance charges related to restructuring activities originated in previousperiods.

In March 2006, we implemented various actions designedto realign our resources with our portfolio of products and services, eliminateredundancies in our workforce and streamline our operations through workforcereductions and abandoning a portion of a leased facility in the United Kingdom.As a result of the implementation of these actions, we recognized a charge of$3.2 million, consisting of $1.8 million in severance benefits from thetermination of approximately 50 employees and $1.4 million for our future leaseobligations related to the abandoned facility, net of estimated future subleaseincome. We anticipate completing the payment of the severance benefits in thefirst quarter of fiscal year 2008. The lease obligation for the abandonedfacility terminates in fiscal year 2016.

***Net Interest and Other Income***

Net interest and other incomewas $2.0 million for the year ended March 31, 2007, as compared to $1.9million for the year ended March 31, 2006. Net interest and other incomewas favorably impacted by higher cash, cash equivalents and marketablesecurities balances during fiscal year 2007, offset by unfavorable fluctuationsin the value of the U.S. dollar.

***Income Tax Expense***

Income tax expense was $0.8million for the year ended March 31, 2007, as compared to $0.9 million forthe year ended March 31, 2006. The decrease in income tax expense wasprimarily attributable to timing differences in the deductibility of certainexpenses for foreign income tax purposes.

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**Comparison of theYears Ended March 31, 2006 and 2005**

***The following tablesummarizes our results of operations as a percentage of revenue for therespective periods:***
| ** **                               | ** ** | **Years Ended  March 31,** | ** ** |
|------------------------------------------|------------|--------------------------------------|------------|
| ** **                               | ** ** | **2006**                             | ** ** | **2005** | ** ** |
| ** **                               | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Revenue                                  |       | 100                                  | %          | 100 | % |
| Cost of revenue                          |       | 20                                   | %          | 17 | % |
| Gross margin                             |       | 80                                   | %          | 83 | % |
|                                     |       |                                 |       |   |   |
| Operating expenses:                      |       |                                 |       |   |   |
| Product  development                     |       | 26                                   | %          | 29 | % |
| Sales and marketing                      |       | 41                                   | %          | 48 | % |
| General and  administrative              |       | 20                                   | %          | 22 | % |
| Restructuring  charges                   |       | 4                                    | %          | 6 | % |
| Acquired  in-process product development |       | —                               | %          | 1 | % |
| Total operating  expenses                |       | 91                                   | %          | 106 | % |
| Operating loss                           |       | (11                                  | )%         | (22 | )% |
| Interest and other  income, net          |       | 2                                    | %          | 2 | % |
| Loss before income  taxes                |       | (8                                   | )%         | (20 | )% |
| Income tax expense  (benefit)            |       | 1                                    | %          | (1 | )% |
| Loss from continuing  operations         |       | (9                                   | )%         | (20 | )% |
| Loss from discontinued  operations       |       | —                               | %          | (1 | )% |
| Net loss                                 |       | (9                                   | )%         | (21 | )% |

 

***Revenue***

Revenue increased 4% to $82.0 million for the year endedMarch 31, 2006, compared to $79.0 million for the year endedMarch 31, 2005. The increase in revenue was primarily attributableto the additive effect of a full year of revenue recognized by our SciTegicsubsidiary included in fiscal year 2006, as compared to SciTegic revenues fromthe date of the acquisition included in fiscal year 2005, offset by continueddeclines in sales of certain legacy products.

***Operating Costs and Expenses***

*Costof Revenue.*   Costof revenue increased 21% to $16.0 million for the year ended March 31,2006, as compared to $13.3 million for the year ended March 31, 2005. As apercentage of revenue, cost of revenue increased to 20% for the year endedMarch 31, 2006, as compared to 17% for the year ended March 31, 2005.The increase in cost of revenue was primarily attributable to a $1.8 millionincrease in client services costs resulting from an increase in personnel as wetransition to more of a solutions-based sales model that includes software andscientific services and a $0.6 million increase in intangible assetamortization resulting from a full year of amortization of the intangibleassets resulting from the acquisition of SciTegic in September 2004.

*ProductDevelopment Expenses.**  *Productdevelopment expenses decreased 4% to $21.7 million for the year endedMarch 31, 2006, as compared to $22.7 million for the year endedMarch 31, 2005. As a percentage of revenue, product development expensesdecreased to 26% for the year ended March 31, 2006, as compared to 29% forthe year ended March 31, 2005. The decrease in product developmentexpenses was primarily attributable to lower personnel expenses resulting fromheadcount reductions and cost control measures implemented during fiscal year2006.

*Salesand Marketing Expenses.**  *Sales andmarketing expenses decreased 11% to $33.7 million for the year endedMarch 31, 2006, as compared to $38.0 million for the year endedMarch 31, 2005. As a percentage of revenue, sales and marketing expensesdecreased to 41% for the year ended March 31, 2006, as compared to 48% 

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forthe year ended March 31, 2005. The decrease in sales and marketingexpenses was primarily attributable to lower personnel expenses resulting fromheadcount reductions and cost control measures implemented during fiscal year2006 as we took measures to improve the efficiency of our salesforce.

*Generaland Administrative Expenses.**  *General andadministrative expenses decreased 7% to $16.1 million for the year endedMarch 31, 2006, as compared to $17.3 million for the year endedMarch 31, 2005. As a percentage of revenue, general and administrativeexpenses decreased to 20% for the year ended March 31, 2006, as comparedto 22% for the year ended March 31, 2005. The decrease in general andadministrative expenses was primarily attributable to lower personnel expensesresulting from headcount reductions during fiscal year 2006, a $0.2 milliondecrease in outside legal fees, a $0.3 million decrease in outside consultingfees related to compliance with Section 404 of Sarbanes-Oxley resultingfrom efficiencies gained in the second year of compliance and a $0.4 milliondecrease in bad debt expense, offset by $1.1 million of outside consulting andaccounting fees incurred during fiscal year 2006 related to the restatement ofour previously issued consolidated financial statements.

*RestructuringCharges.**  *Restructuringcharges were $3.2 million for the year ended March 31, 2006, ascompared to $5.1 million for the year ended March 31, 2005. In March 2006,we implemented various actions designed to realign our resources with ourportfolio of products and services, eliminate redundancies in our workforce andstreamline our operations through workforce reductions and abandoning a portionof a leased facility in the United Kingdom. As a result of the implementationof these actions, we recognized a charge of $3.2 million, consisting of$1.8 million in severance benefits from the termination of approximately50 employees and $1.4 million for our future lease obligations related to theabandoned facility, net of estimated future sublease income.

During the year ended March 31, 2005, we incurreda severance charge of $1.4 million and a lease abandonment charge of $3.9million. These charges were offset by the recovery of previously recognizedlease abandonment charges of $0.2 million, resulting in a net charge of $5.1million for the period. During fiscal year 2005, we implemented various actionsdesigned to improve the efficiency of our sales department and eliminateduplicative general and administrative personnel through workforce reductionsand abandoning a leased facility in Germany. As a result of the implementationof these actions, we recognized a charge of $1.7 million, consisting of $1.4million in severance benefits from the termination of 42 employees and $0.3million related to the abandonment of the leased facility. Additionally, duringfiscal year 2005, as a result of the relocation of our corporate headquarters,we recorded a lease abandonment charge of $3.6 million representing our futurelease obligations, net of sublease income. The $0.2 million recovery of apreviously recognized lease abandonment charge resulted from the completion ofa sublease for an abandoned facility in the United Kingdom.

*AcquiredIn-Process Product Development.**  *In connectionwith our acquisition of SciTegic on September 27, 2004, we recorded anon-cash charge of $0.5 million for the estimated fair value of acquiredin-process product development.

***Net Interest and Other Income***

Net interest and other incomewas $1.9 million for the year ended March 31, 2006, as compared to $1.7million for the year ended March 31, 2005. The increase in net interestand other income was primarily attributable to foreign exchange gains resultingfrom the strengthening of the U.S. dollar during fiscal year 2006.

***Income Tax Expense (Benefit)***

We recognized income tax expenseof $0.9 million for the year ended March 31, 2006, as compared to anincome tax benefit of $(0.6) million for the year ended March 31, 2005.The income tax expense recognized for fiscal year 2006 results from taxableincome generated by certain of our foreign operations. The income tax benefitrecognized for fiscal year 2005 was primarily attributable to a $0.9 millionincome tax benefit related to a refund of taxes previously withheld in Japanand the release of a $1.0 million income tax reserve related to atransfer-pricing matter, offset by income tax expense resulting from taxableincome generated by certain of our foreign operations.

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***Loss from Discontinued Operations***

On April 30, 2004, wespun-off our drug discovery subsidiary, PDD, into an independent, separatelytraded, publicly held company through the distribution to our stockholders of adividend of one share of PDD common stock for every two shares of our commonstock. In accordance with SFAS No. 144, we have reported PDD’s results ofoperations, assets and liabilities, and cash flows as discontinued operationsin our consolidated financial statements for all periods presented. There wereno discontinued operations reported during the year ended March 31, 2006as PDD was spun-off prior to the start of the fiscal year. During the yearended March 31, 2005, we recognized a loss from discontinued operations of$1.1 million, or $0.04 per share, which consisted of revenue of $1.3 millionand expenses of $2.4 million.

**Liquidity andCapital Resources**

We had cash, cash equivalents,marketable securities, and restricted cash and marketable securities of $70.8million as of March 31, 2007, as compared to $66.0 million as ofMarch 31, 2006, an increase of $4.8 million. Significant components ofthis increase include cash provided by operations of $0.2 million, an increasein restricted cash and marketable securities of $1.6 million resulting from thereceipt of a subtenant security deposit, proceeds from the sale of common stockof $1.5 million and a $2.1 million favorable effect on cash and cashequivalents of changes in foreign currency rates, offset by net purchases ofproperty and equipment of $0.9 million.

Net cash provided by operating activities was $0.2million for the year ended March 31, 2007, as compared to $5.8 million forthe year ended March 31, 2006. The reduction in cash flows from operatingactivities was primarily attributable to a decrease in deferred revenue, drivenin part by the prepayment in fiscal year 2006 by a significant customer offuture software license fees of approximately $3.0 million.

Net cash provided by investing activities was $4.8million for the year ended March 31, 2007, as compared to net cash used ininvesting activities of $2.1 million for the year ended March 31, 2006.Significant components of cash flows from investing activities for the yearended March 31, 2007 included net purchases of property and equipment of$0.9 million and a net decrease in our marketable securities portfolio of $5.8million. Significant components of cash flows from investing activities for theyear ended March 31, 2006 included net purchases of property and equipmentof $3.0 million and a net decrease in our marketable securities portfolio of$0.9 million.

Net cash provided by financing activities was $1.5million for the year ended March 31, 2007, as compared to $0.9 million forthe year ended March 31, 2006. Cash flows from financing activities forthe years ended March 31, 2007 and 2006 consist entirely of proceeds fromthe issuance of our common stock under our employee stock plans.

We have funded our activities todate primarily through the sales of software licenses and related services andthe issuance of equity securities.

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

We anticipate that our existingcapital resources will be adequate to fund our operations for at least the next12 months. However, there can be no assurance that changes will not occur thatwould consume available capital resources before then. Our capital requirementsdepend on numerous factors, including our ability to continue to generatesoftware sales, the purchase of additional capital equipment and acquisitionsof other businesses or technologies. There can be no assurance that additionalfunding, if necessary, will be available to us on favorable terms, if at all.Our forecast for the period of time through which our financial resources willbe adequate to support our operations is forward looking information, andactual results could vary.

At March 31, 2007, our wholly-owned Japanesesubsidiary, Accelrys, K.K., recognized an income tax reserve and associateddeferred tax asset of $4.8 million for revenue recognized for Japanese incometax purposes in advance of being recognized for book purposes as a result ofthe change in our revenue recognition policy in connection with the restatement

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of our previously issuedconsolidated financial statements. Because this timing difference is temporary,it had no net impact on income tax expense recognized in fiscal year 2007.Management is currently assessing potential alternative tax return positionsthat are consistent with Japanese tax law and would reduce our income taxobligation in Japan.

**Contractual Obligations**

Our long-term contractual obligations as of March 31, 2007 are asfollows (in thousands):
| ** **                          | ** ** | ** ** | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------------|------------|------------|------------|-------------------------------------------|------------|
| **Contractual Obligations**    | ** ** | **Total**  | ** ** | **Less than 1  Year**           | ** ** | **1 to 3  Years** | ** ** | **4 to 5  Years** | ** ** | **After 5  Years** | ** ** |
| Operating leases, net  of subleases |       | $          | 39,548     |                                      | $          | 3,912 |   | $ | 7,223 |   | $ | 7,777 |   | $ | 20,636 |   |
| Minimum royalty  payments(1)        |       | 3,080      |       | 434                                       |       | 697 |   | 569 |   | 1,380 |   |
| Total                               |       | $          | 42,628     |                                      | $          | 4,346 |   | $ | 7,920 |   | $ | 8,346 |   | $ | 22,016 |   |

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(1)                                 Forpurposes of the contractual obligations table, we have includedindefinite-lived contractual minimum royalty payments due in the ten fiscalyears following fiscal year 2007.

We are obligatedto pay royalties for licenses to enhance and market certain software used inconnection with our product offerings. In addition to the contractual minimumroyalties included in the table above, we have several royalty agreements thatare long term or perpetual in nature with royalty obligations that aregenerally based on a percentage of revenues derived from certain softwarelicense sales and associated sales of PCS. The royalty agreements requirequarterly payments and generally do not limit the maximum royalties owed.During the years ended March 31, 2007, 2006 and 2005, we incurred royaltyexpenses of $2.7 million, $3.0 million, and $2.8 million, respectively. Ourfuture annual royalty obligations will vary based on the volume and mix of ourproduct sales and, as a result, may increase in the future.

On April 30,2004, relating to the spin-off of PDD, the landlords of our New Jerseyfacilities, which were used by our PDD operations, consented to the assignmentof the leases to PDD. Despite the assignment, the landlords required us toguarantee the remaining lease obligations, which totaled approximately $21million as of March 31, 2007. In accordance with Financial AccountingStandards Board (“FASB”) Interpretation (“FIN”) No. 45,*Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others*, werecognized a liability and corresponding charge to stockholders’ equity for theprobability-weighted fair market value of the guarantee. Changes to the fairmarket value of the liability are recognized in stockholders’ equity. At eachof March 31, 2007 and 2006, the liability for our guarantee of the leaseobligation was $0.6 million.

**Off-Balance Sheet Arrangementsand Related Party Transactions**

As ofMarch 31, 2007, we did not have any relationships with unconsolidatedentities or financial partnerships, such as entities often referred to asstructured finance or special purpose entities, which would have beenestablished for the purpose of facilitating off-balance sheet arrangements orother contractually narrow or limited purposes. As such, we are not materiallyexposed to any financing, liquidity, market or credit risk that could arise ifwe had engaged in such relationships.

We do not haverelationships or transactions with persons or entities that derive benefitsfrom their non-independent relationship with us or our related parties.

**New Accounting Standards**

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities*, which is effective forfiscal years beginning after November 15, 2007. SFAS No. 159 also amendscertain provisions of SFAS No. 115, *Accounting for CertainInvestments in Debt and Equity Securities*. This statement permitsentities to choose to measure many financial instruments and certain otheritems at fair value.  We do not expectour adoption of SFAS No. 159 in fiscal year 2009 to have a material impact onour results of operations or financial position.

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In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*, which is effective for fiscal years beginning after November15, 2007. SFAS No. 157 provides a definition of fair value, establishesacceptable methods of measuring fair value and expands disclosures for fairvalue measurements. The principles apply under accounting pronouncements whichrequire measurement of fair value and do not require any new fair valuemeasurements in accounting pronouncements where fair value is the relevantmeasurement attribute. We do not expect our adoption of SFAS No. 157 in fiscalyear 2008 to have a material impact on our results of operations or financialposition.

In September 2006,the SEC issued SAB No. 108, *Considering the Effects ofPrior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements*. SAB No. 108 provides interpretive guidance onhow the effects of the carryover or reversal of prior year misstatements shouldbe considered in quantifying a current year misstatement. Specifically, SAB No.108 states that registrants should quantify errors using both a balance sheetand an income statement approach and evaluate whether either approach resultsin quantifying a misstatement that, when all relevant quantitative andqualitative factors are considered, is material. SAB No. 108 is effective forfiscal years ending after November 15, 2006. Our adoption of SAB No. 108 infiscal year 2007 did not have a material affect on our results of operations orfinancial position.

InJune 2006, the FASB issued FIN No. 48, *Accountingfor Uncertainty in Income Taxes.* FIN No. 48, which is effective forfiscal years beginning after December 15, 2006, addresses the accountingfor income taxes by prescribing the minimum recognition threshold a taxposition is required to meet before being recognized in the financialstatements. In addition, FIN No. 48 expands the disclosure requirementsconcerning unrecognized tax benefits as well as any significant changes thatmay occur in the next twelve months associated with such unrecognized taxbenefits. We will adopt the provisions of FIN No. 48 in the first quarter offiscal year 2008. We are currently evaluating the impact, if any, FIN No. 48will have on our results of operations or financial position.

**Item7A.**                 Quantitativeand Qualitative Disclosures About Market Risk

In addition to our U.S. operations, we have operationsin Europe and the Asia/Pacific region. As a result, our financial position,results of operations and cash flows can be affected by fluctuations in foreigncurrency exchange rates, particularly fluctuations in the pound sterling, euroand yen exchange rates. Many of our reporting entities conduct a portion oftheir business in currencies other than the entity’s functional currency. Thesetransactions give rise to receivables and payables that are denominated incurrencies other than the entity’s functional currency. The value of thesereceivables and payables is subject to changes in exchange rates because theymay become worth more or less than they were worth at the time we entered intothe transaction due to changes in currency exchange rates. Both realized andunrealized gains or losses on the value of these receivables and payables,along with the settlement of certain intercompany transactions, are included inthe determination of net income. We analyze our exposure to currencyfluctuations and may engage in financial hedging techniques in the future toreduce the effect of these potential fluctuations. We do not currently havehedging contracts in effect since exchange rate fluctuations have had littleimpact on our operating results and cash flows. The majority of our softwarelicense agreements are denominated in U.S. dollars.

Our investment portfolio is maintained in accordancewith our investment policy that defines allowable investments, specifies creditquality standards and limits the credit exposure of any single issuer. None ofour investments are held for trading or speculative purposes. The fair value ofour cash equivalents and marketable securities is subject to change as a resultof changes in market interest rates and investment risk related to the issuers’credit worthiness. We do not utilize financial contracts to manage our exposurein our investment portfolio to changes in interest rates. A hypothetical 100basis point increase or decrease in market interest rates would not have amaterial impact on the fair value of our cash equivalents and marketablesecurities due to the relatively short maturities of these investments. Whilechanges in interest rates may affect the fair value of our investmentportfolio, any gains or losses will not be recognized in our results ofoperations until the investment is sold or if the reduction in fair value wasdetermined to be a permanent impairment.

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**Item8.   Financial Statements and Supplementary Data**

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

The Board of Directors and StockholdersAccelrys, Inc.

We have audited the accompanying consolidated balancesheets of Accelrys, Inc. as of March 31, 2007 and 2006, and therelated consolidated statements of operations, stockholders’ equity, and cashflows for each of the years in the three year period ended March 31, 2007.Our audits also included the financial statement schedule listed in the indexat Item 15(a)(2). These financial statements and schedule are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of Accelrys, Inc. at March 31, 2007 and 2006, and the consolidatedresults of its operations and its cash flows for each of the three years in theperiod ended March 31, 2007, in conformity with U.S. generally acceptedaccounting principles. Also, in our opinion, the related financial statementschedule, when considered in relation to the basic financial statements takenas a whole, presents fairly in all material respects the information set forththerein.

As discussed in Note 1 to the consolidated financialstatements, Accelrys, Inc. changed its method of accounting for Share-BasedPayments in accordance with Statement of Financial Accounting Standards No. 123(revised 2004) on April 1, 2006.

We have also audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theeffectiveness of Accelrys, Inc.’s internal control over financialreporting as of March 31, 2007, based on the criteria established inInternal Control-Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated June 1,2007, expressed an unqualified opinion thereon.
|                        |   | /s/ Ernst &  Young LLP |
|------------------------|--------|---------------------------------|
|                   |   |                            |
| San Diego,  California |   |                            |
| June 1,  2007     |   |                            |

 

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**Accelrys, Inc.Consolidated Balance Sheets(In thousands, except per share amounts)**
| ** **                                                                                                                                                | ** ** | **March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                                                                                                | ** ** | **2007**           | ** ** | **2006** | ** ** |
| ** **                                                                                                                                                | ** ** | ** **         | ** ** | ** ** | ** ** |
| **Assets**                                                                                                                                                | ** ** | ** **         | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                                           |       |               |       |   |   |
| Cash and cash equivalents                                                                                                                                 |       | $                  | 33,247     |   | $ | 24,656 |   |
| Marketable securities                                                                                                                                     |       | 29,322             |       | 34,733 |   |
| Trade receivables, net of allowance for doubtful  accounts of $213 and $351 as of March 31, 2007 and 2006,  respectively                        |       | 18,617             |       | 17,289 |   |
| Prepaid expenses, deferred tax asset and other  current assets                                                                                            |       | 8,652              |       | 3,438 |   |
| Total current  assets                                                                                                                                     |       | 89,838             |       | 80,116 |   |
| Restricted cash  and marketable securities                                                                                                                |       | 8,188              |       | 6,633 |   |
| Property and  equipment, net                                                                                                                              |       | 6,049              |       | 7,860 |   |
| Goodwill                                                                                                                                                  |       | 42,663             |       | 42,663 |   |
| Purchased  intangible assets, net                                                                                                                         |       | 7,138              |       | 8,671 |   |
| Other assets                                                                                                                                              |       | 725                |       | 812 |   |
| Total assets                                                                                                                                              |       | $                  | 154,601    |   | $ | 146,755 |   |
|                                                                                                                                                      |       |               |       |   |   |
| **Liabilities  and stockholders’ equity**                                                                                                            | ** ** | ** **         | ** ** | ** ** | ** ** |
| Current  liabilities:                                                                                                                                     |       |               |       |   |   |
| Accounts payable                                                                                                                                          |       | $                  | 1,199      |   | $ | 1,676 |   |
| Accrued liabilities                                                                                                                                       |       | 10,911             |       | 4,701 |   |
| Accrued compensation and benefits                                                                                                                         |       | 8,353              |       | 7,009 |   |
| Current portion of accrued restructuring charges                                                                                                          |       | 673                |       | 2,936 |   |
| Current portion of deferred revenue                                                                                                                       |       | 53,218             |       | 51,710 |   |
| Total current  liabilities                                                                                                                                |       | 74,354             |       | 68,032 |   |
| Deferred  revenue, net of current portion                                                                                                                 |       | 2,915              |       | 9,559 |   |
| Deferred tax  liability                                                                                                                                   |       | 505                |       | 238 |   |
| Accrued  restructuring charges, net of current portion                                                                                                    |       | 1,371              |       | 1,338 |   |
| Lease-related  liabilities, net of current portion                                                                                                        |       | 6,466              |       | 4,380 |   |
| Stockholders’  equity:                                                                                                                               |       |               |       |   |   |
| Preferred stock, $.0001 par value; 2,000 shares  authorized; no shares issued and outstanding                                                        |       | —             |       | — |   |
| Common stock, $.0001 par value; 40,000 shares  authorized; 27,155 and 26,856 shares issued and outstanding at March 31,  2007 and 2006, respectively |       | 3                  |       | 3 |   |
| Additional paid-in capital                                                                                                                                |       | 259,435            |       | 254,224 |   |
| Deferred compensation                                                                                                                                     |       | —             |       | (522 | ) |
| Lease guarantee                                                                                                                                           |       | (572               | )          | (635 | ) |
| Treasury stock; 644 shares at March 31, 2007  and 2006                                                                                               |       | (8,340             | )          | (8,340 | ) |
| Accumulated deficit                                                                                                                                       |       | (182,681           | )          | (181,156 | ) |
| Accumulated other comprehensive income (loss)                                                                                                             |       | 1,145              |       | (366 | ) |
| Total  stockholders’ equity                                                                                                                          |       | 68,990             |       | 63,208 |   |
| Total liabilities and  stockholders’ equity                                                                                                          |       | $                  | 154,601    |   | $ | 146,755 |   |

 

See accompanying notes to these consolidated financialstatements.

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**Accelrys, Inc.Consolidated Statements of Operations(In thousands, except per share amounts)**
| ** **                                                                                       | ** ** | **Years Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2007**                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                       | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                                                          |       | $                                        | 80,955     |   | $ | 82,001 |   | $ | 79,030 |   |
| Cost of revenue                                                                                  |       | 15,498                                   |       | 16,029 |   | 13,268 |   |
| Gross margin                                                                                     |       | 65,457                                   |       | 65,972 |   | 65,762 |   |
|                                                                                             |       |                                     |       |   |   |   |   |
| Operating  expenses:                                                                             |       |                                     |       |   |   |   |   |
| Product development                                                                              |       | 18,931                                   |       | 21,721 |   | 22,717 |   |
| Sales and marketing                                                                              |       | 30,680                                   |       | 33,723 |   | 37,965 |   |
| General and administrative                                                                       |       | 17,342                                   |       | 16,060 |   | 17,290 |   |
| Restructuring charges, including $101 asset  impairment charge for the year ended March 31, 2007 |       | 1,201                                    |       | 3,178 |   | 5,110 |   |
| Acquired in-process product development                                                          |       | —                                   |       | — |   | 450 |   |
| Total operating  expenses                                                                        |       | 68,154                                   |       | 74,682 |   | 83,532 |   |
| Operating loss  from continuing operations                                                       |       | (2,697                                   | )          | (8,710 | ) | (17,770 | ) |
| Interest and  other income, net                                                                  |       | 1,954                                    |       | 1,869 |   | 1,738 |   |
| Loss from  continuing operations before taxes                                                    |       | (743                                     | )          | (6,841 | ) | (16,032 | ) |
| Income tax  expense (benefit)                                                                    |       | 782                                      |       | 898 |   | (571 | ) |
| Loss from  continuing operations                                                                 |       | (1,525                                   | )          | (7,739 | ) | (15,461 | ) |
| Loss from  discontinued operations                                                               |       | —                                   |       | — |   | (1,117 | ) |
| Net loss                                                                                         |       | $                                        | (1,525     | ) | $ | (7,739 | ) | $ | (16,578 | ) |
|                                                                                             |       |                                     |       |   |   |   |   |
| Basic and  diluted loss per share amounts:                                                       |       |                                     |       |   |   |   |   |
| Loss from  continuing operations                                                                 |       | $                                        | (0.06      | ) | $ | (0.30 | ) | $ | (0.62 | ) |
| Loss from  discontinued operations                                                               |       | —                                   |       | — |   | (0.04 | ) |
| Net loss per  share                                                                              |       | $                                        | (0.06      | ) | $ | (0.30 | ) | $ | (0.66 | ) |
|                                                                                             |       |                                     |       |   |   |   |   |
| Weighted averaged  shares used to compute basic and diluted loss per share amounts               |       | 26,351                                   |       | 26,116 |   | 25,137 |   |

 

See accompanying notes to these consolidated financialstatements.

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**Accelrys, Inc.Consolidated Statements of Stockholders’s Equity(In thousands)**
|                                                                                                                          | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **       | ** ** | ** **              | ** ** | ** **      | ** ** | ** ** | ** ** | ** **             | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|------------------|------------|-------------------------|------------|-----------------|------------|------------|------------|------------------------|------------|-------------------|------------|------------|------------|
| ** **                                                                                                               | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **       | ** ** | ** **              | ** ** | ** **      | ** ** | ** ** | ** ** | ** **             | ** ** | **Other**         | ** ** | ** ** | ** ** |
| ** **                                                                                                               | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **       | ** ** | ** **              | ** ** | ** **      | ** ** | ** ** | ** ** | ** **             | ** ** | **Comprehensive** | ** ** | **Total**  | ** ** |
| ** **                                                                                                               | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Deferred**   | ** ** | **Lease**        | ** ** | **Treasury Stock** | ** ** | **Accumulated** | ** ** | **Income** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                                                               | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Compensation** | ** ** | **Guarantee**           | ** ** | **Shares**      | ** ** | **Amount** | ** ** | **Deficit**            | ** ** | **(Loss)**        | ** ** | **Equity** | ** ** |
| Balance at March 31, 2004                                                                                           |       | 24,949                |       | 2           |       | 291,977        |       | (861             | )          | —                  |       | 644             |       | (8,340     | )          | (156,839               | )          | 1,562             |       | 127,501    |       |
| Comprehensive loss:                                                                                                      |       |                  |       |        |       |           |       |             |       |                    |       |            |       |       |       |                   |       |              |       |       |       |
| Net loss                                                                                                                 |       | —                |       | —      |       | —         |       | —           |       | —                  |       | —          |       | —     |       | (16,578                | )          | —            |       | (16,578    | )          |
| Foreign currency  translation adjustment                                                                                 |       | —                |       | —      |       | —         |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | 115               |       | 115        |       |
| Unrealized loss on  marketable securities                                                                                |       | —                |       | —      |       | —         |       | —           |       | —                  |       | —          |       | —     |       |                   |       | (1,487            | )          | (1,487     | )          |
| Total comprehensive loss                                                                                                 |       | —                |       | —      |       | —         |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | (17,950    | )          |
| Lease guarantee                                                                                                          |       | —                |       | —      |       | —         |       | —           |       | (756                    | )          | —          |       | —     |       | —                 |       | —            |       | (756       | )          |
| Change in value of lease guarantee                                                                                       |       | —                |       | —      |       | —         |       | —           |       | 58                      |       | —          |       | —     |       | —                 |       | —            |       | 58         |       |
| Amortization of deferred stock-based compensation related to  restricted stock                                           |       | —                |       | —      |       | —         |       | 253              |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | 253        |       |
| Spin-off of PDD                                                                                                          |       | —                |       | —      |       | (49,750        | )          | 335              |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | (49,415    | )          |
| Issuance of common stock in SciTegic acquisition                                                                         |       | 1,374                 |       | 1           |       | 8,749          |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | 8,750      |       |
| Issuance of below market stock options to SciTegic employees                                                             |       | —                |       | —      |       | —         |       | (249             | )          | —                  |       | —          |       | —     |       | —                 |       | —            |       | (249       | )          |
| Amortization of deferred stock-based compensation related to below  market stock options issued to SciTegic employees    |       | —                |       | —      |       | —         |       | 48               |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | 48         |       |
| Issuance of common stock earn-out to SciTegic                                                                            |       | —                |       | —      |       | —         |       | (1,326           | )          | —                  |       | —          |       | —     |       | —                 |       | —            |       | (1,326     | )          |
| Amortization of deferred stock-based compensation related to common  stock earn-out to SciTegic                          |       | —                |       | —      |       | —         |       | 331              |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | 331        |       |
| Non-cash stock-based compensation expense                                                                                |       | —                |       | —      |       | 57             |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | 57         |       |
| Retirement of restricted stock                                                                                           |       | (4                    | )          | —      |       | —         |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | —     |       |
| Issuance of common stock upon exercise of stock options and under  employee stock purchase plan                          |       | 237                   |       | —      |       | 1,682          |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | 1,682      |       |
| Issuance of common stock for 401(K) plan matching contribution                                                      |       | 87                    |       | —      |       | 612            |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | 612        |       |
| Balance at March 31, 2005                                                                                           |       | 26,643                |       | 3           |       | 253,327        |       | (1,469           | )          | (698                    | )          | 644             |       | (8,340     | )          | (173,417               | )          | 190               |       | 69,596     |       |
| Comprehensive loss:                                                                                                      |       |                  |       |        |       |           |       |             |       |                    |       |            |       |       |       |                   |       |              |       |       |       |
| Net loss                                                                                                                 |       | —                |       | —      |       | —         |       | —           |       | —                  |       | —          |       | —     |       | (7,739                 | )          | —            |       | (7,739     | )          |   |
| Foreign currency  translation adjustment                                                                                 |       | —                |       | —      |       | —         |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | (783              | )          | (784       | )          |   |
| Unrealized gain on  marketable securities                                                                                |       | —                |       | —      |       | —         |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | 227               |       | 228        |       |   |
| Total comprehensive loss                                                                                                 |       | —                |       | —      |       | —         |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | (8,295     | )          |   |
| Change in value of lease guarantee                                                                                       |       | —                |       | —      |       | —         |       | —           |       | 63                      |       | —          |       | —     |       | —                 |       | —            |       | 63         |       |   |
| Amortization of deferred stock-based compensation related to  restricted stock                                           |       | —                |       | —      |       | —         |       | 97               |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | 97         |       |   |
| Amortization of deferred stock-based compensation related to common  stock earn-out and below market options to SciTegic |       | —                |       | —      |       | —         |       | 756              |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | 756        |       |   |
| Retirement of restricted stock                                                                                           |       | (6                    | )          | —      |       | (94            | )          | 94               |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | —     |       |   |
| Issuance of common stock upon exercise of stock options and under  employee stock purchase plan                          |       | 193                   |       | —      |       | 857            |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | 857        |       |   |
| Issuance  of common stock for 401(K) plan matching contribution                                                     |       | 26                    |       | —      |       | 134            |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | 134        |       |   |
| Balance at  March 31, 2006                                                                                          |       | 26,856                |       | $           | 3          |           | $          | 254,224          |       | $                       | (522       | )               | $          | (635       | )          | 644                    |       | $                 | (8,340     | )          | $          | (181,156 | ) | $ | (366 | ) | $ | 63,208 |   |   |
| Comprehensive loss:                                                                                                      |       |                  |       |        |       |           |       |             |       |                    |       |            |       |       |       |                   |       |              |       |       |       |   |
| Net loss                                                                                                                 |       | —                |       | —      |       | —         |       | —           |       | —                  |       | —          |       | —     |       | (1,525                 | )          | —            |       | (1,525     | )          |   |
| Foreign currency  translation adjustment                                                                                 |       | —                |       | —      |       | —         |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | 971               |       | 971        |       |   |
| Unrealized gain  on marketable securities                                                                                |       | —                |       | —      |       | —         |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | 540               |       | 540        |       |   |
| Total  comprehensive loss                                                                                                |       | —                |       | —      |       | —         |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | (14        | )          |   |
| Change in value of lease guarantee                                                                                       |       | —                |       | —      |       | —         |       | —           |       | 63                      |       | —          |       | —     |       | —                 |       | —            |       | 63         |       |   |
| Reclassification of deferred compensation upon adoption  of SFAS No. 123R                                                |       | —                |       | —      |       | (522           | )          | 522              |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | —     |       |   |
| Stock-based compensation expense                                                                                         |       | —                |       | —      |       | 4,270          |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | 4,270      |       |   |
| Issuance of common stock upon exercise of stock  options and under employee stock purchase plan                          |       | 301                   |       | —      |       | 1,463          |       | —           |       | —                  |       | —          |       | —     |       | —                 |       | —            |       | 1,463      |       |   |
| Balance at March 31, 2007                                                                                           |       | 27,155                |       | $           | 3          |           | $          | 259,435          |       | $                       | —     |            | $          | (572       | )          | 644                    |       | $                 | (8,340     | )          | $          | (182,681 | ) | $ | 1,145 |   | $ | 68,990 |   |   |
|                                                                                                                          |            |                       |            |             |            |                |            |                  |            |                         |            |                 |            |            |            |                        |            |                   |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to these consolidated financialstatements.

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**Accelrys, Inc.Consolidated Statements of Cash Flows(In thousands)**
| ** **                                                                                 | ** ** | **Years Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2007**                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                 | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Cash  flows from operating activities:**                                                 | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                                                                   |       | $                                        | (1,525     | ) | $ | (7,739 | ) | $ | (16,578 | ) |
| Less: Loss from discontinued operations                                                    |       | —                                   |       | — |   | (1,117 | ) |
| Loss from continuing operations                                                            |       | (1,525                                   | )          | (7,739 | ) | (15,461 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used in) operating activities: |       |                                     |       |   |   |   |   |
| Depreciation                                                                               |       | 2,940                                    |       | 3,813 |   | 4,528 |   |
| Amortization of purchased intangible assets                                                |       | 1,533                                    |       | 1,698 |   | 1,131 |   |
| Non-cash stock-based compensation                                                          |       | 4,270                                    |       | 853 |   | 689 |   |
| Deferred income taxes                                                                      |       | (5,112                                   | )          | 309 |   | — |   |
| Other                                                                                      |       | 1,162                                    |       | 1,493 |   | 1,976 |   |
| Changes in operating assets and liabilities:                                               |       |                                     |       |   |   |   |   |
| Trade receivables                                                                          |       | (744                                     | )          | 2,040 |   | (8,119 | ) |
| Prepaid expenses and other current assets                                                  |       | 183                                      |       | 2,209 |   | 477 |   |
| Other assets                                                                               |       | (994                                     | )          | (309 | ) | 42 |   |
| Accounts payable                                                                           |       | (545                                     | )          | (69 | ) | (3,927 | ) |
| Accrued liabilities                                                                        |       | 5,817                                    |       | (2,419 | ) | 512 |   |
| Deferred revenue                                                                           |       | (6,746                                   | )          | 3,893 |   | 3,037 |   |
| Net cash provided by (used in) continuing operating  activities                            |       | 239                                      |       | 5,772 |   | (15,115 | ) |
| Net cash provided by discontinued operating  activities                                    |       | —                                   |       | — |   | 958 |   |
| Net cash provided by (used in) operating activities                                        |       | 239                                      |       | 5,772 |   | (14,157 | ) |
| **Cash  flows from investing activities:**                                                 | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchases of property and equipment, net                                                   |       | (942                                     | )          | (3,043 | ) | (5,053 | ) |
| Purchases of marketable securities                                                         |       | (26,177                                  | )          | (11,146 | ) | (52,661 | ) |
| Proceeds from maturities of marketable securities                                          |       | 31,956                                   |       | 12,055 |   | 69,273 |   |
| Acquisition of SciTegic, net of cash acquired                                              |       | —                                   |       | — |   | (10,989 | ) |
| Net cash provided by (used in) continuing investing  activities                            |       | 4,837                                    |       | (2,134 | ) | 570 |   |
| Net cash used in discontinued investing activities                                         |       | —                                   |       | — |   | (436 | ) |
| Net cash provided by (used in) investing activities                                        |       | 4,837                                    |       | (2,134 | ) | 134 |   |
| **Cash  flows from financing activities:**                                                 | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from issuance of common stock                                                     |       | 1,463                                    |       | 857 |   | 1,682 |   |
| Cash remitted to PDD                                                                       |       | —                                   |       | — |   | (5,445 | ) |
| Net cash provided by (used in) financing activities                                        |       | 1,463                                    |       | 857 |   | (3,763 | ) |
| Effect of changes in exchange rates on cash and cash  equivalents                          |       | 2,052                                    |       | (1,095 | ) | 81 |   |
| Change in cash and cash equivalents of discontinued  operations                            |       | —                                   |       | — |   | (743 | ) |
| Increase (decrease) in cash and cash equivalents                                           |       | 8,591                                    |       | 3,400 |   | (18,448 | ) |
| Cash and cash equivalents at beginning of year                                             |       | 24,656                                   |       | 21,256 |   | 39,704 |   |
| Cash and cash equivalents at end of year                                                   |       | $                                        | 33,247     |   | $ | 24,656 |   | $ | 21,256 |   |
| **Supplemental  cash flow information:**                                                   | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash paid during  the year for income taxes                                                |       | $                                        | 334        |   | $ | 515 |   | $ | 693 |   |

 

See accompanying notes to these consolidated financialstatements.

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**Accelrys, Inc.Notes to Consolidated Financial Statements**

**1.   Organizationand Description of Business**

Accelrys, Inc. (“we”, “our”, or “us”) develops andcommercializes scientific business intelligence software for the integration,mining, analysis, modeling and simulation, management and interactive reportingof scientific data. Our solutions are used by biologists, chemists, materialsscientists, and information technology professionals for product design as wellas drug discovery and development.

**2.   SignificantAccounting Policies**

*Principles ofConsolidation*

These consolidated financial statements include ouraccounts and those of our wholly owned subsidiaries. All significantintercompany balances and transactions have been eliminated in consolidation.

*Use of Estimates*

The preparation of financial statements in conformitywith accounting principles generally accepted in the U.S. requires managementto make estimates and assumptions that affect the reported amounts of assets,liabilities, revenues and expenses, and the disclosure of contingent assets andliabilities. On an on-going basis, we evaluate our estimates, including thoserelated to revenue recognition, income taxes and the valuation of goodwill,intangibles and other long-lived assets. We base our estimates on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances. Actual future results could differ from thoseestimates.

*Reclassifications*

Certain amounts in the previously reported financialstatements have been reclassified to conform to the current periodpresentation.

*Cash and Cash Equivalents*

We consider all highly liquid investments with anoriginal maturity of three months or less to be cash equivalents. We invest ourcash with financial institutions in money market funds and other investmentgrade securities such as prime-rated commercial paper.

*Marketable Securities*

Our marketable securities consist of debt securitieswith original maturities of greater than three months and include obligationsof U.S. government sponsored enterprises, U.S. corporate bonds and auction ratemunicipal bonds. We account for our investments in marketable securities inaccordance with Statement of Financial Accounting Standards (“SFAS”)No. 115, *Accounting for Certain Investments in Debtand Equity Securities*. Accordingly, our marketable securities havebeen classified as available-for-sale and are recorded at their estimated fairvalue. Changes in fair value are recorded as unrealized gains or losses whichare included in accumulated other comprehensive income (loss) in stockholders’equity. The cost of marketable securities sold is determined based on thespecific identification method.

We assess our marketable securities for impairmentunder the guidance provided by FASB Staff Position (“FSP”) Nos. 115-1 and124-1, *The Meaning ofOther-Than-Temporary Impairment and Its Application to CertainInvestments. *Accordingly, we review the fair valueof our marketable securities at least quarterly to determine if declines in thefair value of individual securities are other-than-temporary in nature. If webelieve the decline in the fair value of an individual security isother-than-temporary, we write-down the carrying value of the security to itsestimated fair value, generally determined using quoted market prices. Todetermine if a decline 

39

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in the fair value of aninvestment is other-than-temporary, we consider several factors including,among others, the period of time and extent to which the estimated fair valuehas been less than cost, overall market conditions, the historical andprojected future financial condition of the issuer of the security and ourability and intent to hold the security for a period of time sufficient toallow for a recovery of the market value.

Marketable securities, including marketable securitiesclassified as restricted marketable securities (see Note 6), consist of thefollowing:
|                                                            | ** ** | **Amortized  Cost**     | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------|------------|
| ** **                                                 | ** ** | **(In thousands)** | ** ** |
| **March 31,  2007:**                                  |       |                    |       |                         |       |                          |       |                |       |
| Obligations of  U.S. government sponsored enterprises |       | $                       | 15,521     |                         | $          | —                        |       | $                   | (137       | ) | $ | 15,384 |   |
| U.S. corporate  debt securities                            |       | 4,002                   |       | —                       |       | (21                           | )          | 3,981               |       |
| Auction rate  municipal bonds                              |       | 16,300                  |       | —                       |       | —                        |       | 16,300              |       |
|                                                       |       | $                       | 35,823     |                         | $          | —                        |       | $                   | (158       | ) | $ | 35,665 |   |
| **March 31,  2006:**                                  |       |                    |       |                         |       |                          |       |                |       |
| Obligations of  U.S. government sponsored enterprises |       | $                       | 24,051     |                         | $          | —                        |       | $                   | (544       | ) | $ | 23,507 |   |
| U.S. corporate  debt securities                            |       | 9,155                   |       | —                       |       | (154                          | )          | 9,001               |       |
| Auction rate  municipal bonds                              |       | 8,550                   |       | —                       |       | —                        |       | 8,550               |       |
|                                                       |       | $                       | 41,756     |                         | $          | —                        |       | $                   | (698       | ) | $ | 41,058 |   |

 

Included in marketable securities in the accompanyingconsolidated balance sheets is accrued interest receivable on marketablesecurities of $0.3 million at each of March 31, 2007 and 2006.

The contractual maturities of our marketablesecurities at March 31, 2007 are as follows (in thousands):
| Due within one year       |   | $      | 18,452 |   |
|---------------------------|--------|--------|--------|--------|
| Due in one to  five years |   | 1,963  |   |
| Due after five  years     |   | 15,250 |   |
|                      |   | $      | 35,665 |   |

 

Auction rate municipal bonds have been included in theabove contractual maturities table based on the stated maturity date of thebond.

The following table summarizes the gross unrealizedlosses and fair value of our marketable securities with unrealized losses thatare not deemed to be other-than-temporarily impaired, aggregated by investmentcategory and length of time that individual securities that have been in acontinuous unrealized loss position, at March 31, 2007:
| ** **                                            | ** ** | **Less Than 12 Months** | ** ** | **12 Months or Greater** | ** ** | **Total**           | ** ** |
|-------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------|------------|---------------------|------------|
| ** **                                            | ** ** | **Fair Value**                    | ** ** | **Unrealized  Losses**                  | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** |
| ** **                                            | ** ** | **(In thousands)**                | ** ** |
| Obligations of  U.S. government sponsored enterprises |       | $                                      | —     |                                    | $          | —              |       | $ | 15,384 |   | $ | (137 | ) | $ | 15,384 |   | $ | (137 | ) |
| U.S. corporate  debt securities                       |       | —                                 |       | —                                  |       | 3,981               |       | (21 | ) | 3,981 |   | (21 | ) |
|                                                  |       | $                                      | —     |                                    | $          | —              |       | $ | 19,365 |   | $ | (158 | ) | $ | 19,365 |   | $ | (158 | ) |

 

40

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The unrealized losses on these securities wereprimarily caused by recent increases in market interest rates, and not thecredit quality of the issuer, and we have the ability and intent to hold thesesecurities until a recovery of fair value, which may be at maturity. As aresult, we do not believe these securities to be other-than-temporarilyimpaired as of March 31, 2007.

*Allowance for DoubtfulAccounts*

We maintain an allowance for doubtful accounts forestimated losses resulting from the inability of our customers to make requiredpayments on accounts receivable. This estimate is based on a specific customeranalysis and an analysis of our historical write-offs as a percent ofoutstanding accounts receivable balances. If the financial condition of acustomer were to deteriorate, resulting in an impairment of its ability to makepayments against outstanding balances owed to us, an additional allowance maybe required.

*Fair Value of FinancialInstruments*

We carry our cash equivalents, marketable securitiesand restricted marketable securities at market value. The carrying amount ofaccounts receivable, accounts payable and accrued liabilities are considered tobe representative of their respective fair values due to their short-termnature.

*Property and Equipment*

Property and equipment, stated at cost, consists ofthe following:
|                                                 | ** ** | ** **                       | ** ** | **March 31,**      | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **Useful Lives (Yrs)** | ** ** | **2007**                | ** ** | **2006** | ** ** |
| ** **                                      | ** ** | ** **                       | ** ** | **(In thousands)** | ** ** |
| Computers and  software                         |       | 2-3                              |       | $                       | 14,352     |   | $ | 14,957 |   |
| Furniture and  fixtures                         |       | 3                                |       | 1,093                   |       | 1,131 |   |
| Leasehold  improvements                         |       | 5-10                             |       | 3,959                   |       | 3,554 |   |
|                                            |       |                             |       | 19,404                  |       | 19,642 |   |
| Less accumulated  depreciation and amortization |       |                             |       | (13,355                 | )          | (11,782 | ) |
|                                            |       |                             |       | $                       | 6,049      |   | $ | 7,860 |   |

 

Depreciation is provided on the straight-line methodover the estimated useful lives of the related assets. Leasehold improvementsare amortized over the shorter of their estimated useful lives or the remaininglease term. Repair and maintenance costs are charged to expense as incurred.

*Software DevelopmentCosts*

We account for costs incurred to develop our softwareproducts in accordance with SFAS No. 86, *Accountingfor the Cost of Computer Software to be Sold, Leased or Otherwise Marketed*.Accordingly, costs incurred in the research and development of new softwareproducts and significant enhancements to existing software products areexpensed as incurred until the technological feasibility of the product hasbeen established. Technological feasibility occurs shortly before our softwareproducts are available for general release, and we have determined that costseligible for capitalization are not material. Accordingly, no softwaredevelopment costs were capitalized as of March 31, 2007 and 2006.

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*Goodwill and PurchasedIntangible Assets*

Intangible assets resulted from our acquisition ofSciTegic, Inc. in September 2004 and consist of the following:
| ** **                                      | ** ** | **March 31, 2007**       | ** ** | **March 31, 2006** | ** ** |
|-------------------------------------------------|------------|------------------------------------|------------|------------------------------|------------|
| ** **                                      | ** ** | **Weighted  Average  Life  (yrs)** | ** ** | **Gross  Carrying  Amount**  | ** ** | **Accumulated  Amortization** | ** ** | **Weighted  Average  Life  (yrs)** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **                                      | ** ** | ** **                         | ** ** | **(In thousands)**      | ** ** | ** ** | ** ** | **(In thousands)** | ** ** |
| Intangible  assets subject to amortization:     |       |                               |       |                         |       |   |   |   |   |   |   |   |   |
| Purchased  technology                           |       | 5                                  |       | $                            | 6,750      |   | $ | 3,375 |   | 5 |   | $ | 6,750 |   | $ | 2,025 |   |
| Purchased  customer relationships               |       | 10                                 |       | 1,650                        |       | 412 |   | 10 |   | 1,650 |   | 248 |   |
| Purchased  backlog                              |       | 2.25                               |       | 550                          |       | 550 |   | 2.25 |   | 550 |   | 541 |   |
| Purchased  contract based                       |       | 5                                  |       | 50                           |       | 25 |   | 5 |   | 50 |   | 15 |   |
|                                            |       |                               |       | $                            | 9,000      |   | $ | 4,362 |   |   |   | $ | 9,000 |   | $ | 2,829 |   |
| Intangible  assets not subject to amortization: |       |                               |       |                         |       |   |   |   |   |   |   |   |   |
| Purchased  trademark/tradename                  |       |                               |       | $                            | 2,500      |   |   |   |   |   | $ | 2,500 |   |   |   |

 

Intangible assets are amortized using thestraight-line method over their estimated useful lives. During the years endedMarch 31, 2007, 2006 and 2005, intangible asset amortization expensetotaled $1.5 million, $1.7 million, $1.1 million, respectively.

Future estimated amortization expense for intangibleassets as of March 31, 2007 for each of the succeeding five years is asfollows (in thousands):
| Fiscal Year 2008 |   | $     | 1,525  |   |
|------------------|--------|-------|--------|--------|
| Fiscal Year 2009 |   | 1,525 |   |
| Fiscal Year 2010 |   | 845   |   |
| Fiscal Year 2011 |   | 165   |   |
| Fiscal Year 2012 |   | 165   |   |

 

In connection with our acquisition of SciTegic, $0.5million of in-process product development assets were written-off at the dateof acquisition in accordance with FASB Interpretation No. 4, *Applicability of FASB Statement No. 2 to Business CombinationsAccounted for by the Purchase Method*.

In accordance with SFAS No. 142, *Goodwill and Other Intangible Assets*, we review our goodwilland indefinite-lived intangible asset for impairment at least annually in ourfiscal fourth quarter and more frequently if events or changes in circumstancesoccur that indicate a potential reduction in the fair value of our reportingunit and/or our indefinite-lived intangible asset below their respectivecarrying values. Examples of such events or circumstances include: asignificant adverse change in legal factors or in the business climate, asignificant decline in our stock price, a significant decline in our projectedrevenue or cash flows, an adverse action or assessment by a regulator,unanticipated competition, a loss of key personnel, or the presence of otherindicators that would indicate a reduction in the fair value of a reportingunit.

Our goodwill is considered to be impaired if wedetermine that the carrying value of the reporting unit to which the goodwillhas been assigned exceeds management’s estimate of its fair value. Based on theguidance provided by SFAS No. 142 and SFAS No. 131, *Disclosures about Segments of an Enterprise and Related Information*,management has determined that our company consists of one reporting unit giventhe similarities 

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of economiccharacteristics between the operations and the common nature of the products,services and customers. Because we have only one reporting unit, and we arepublicly traded, we determine the fair value of the reporting unit based on ourmarket capitalization as we believe this represents the best evidence of fairvalue. In the fourth quarter of fiscal year 2007, we completed our annualgoodwill impairment test for fiscal year 2007 in accordance with SFASNo. 142 and concluded that our goodwill was not impaired. Our conclusionthat goodwill was not impaired was based on a comparison of our net assets asof March 31, 2007 to our market capitalization.

Our indefinite-lived intangible asset is considered tobe impaired if we determine that the carrying value of the asset exceeds itsestimated fair value. In the fourth quarter of fiscal year 2007, we completedour annual indefinite-lived intangible asset impairment test and concluded thatour indefinite-lived intangible asset was not impaired. We estimated the fairvalue of our indefinite-lived intangible asset utilizing a discounted cash flowanalysis which considers the estimated future customer orders for ourscientific operating platform product line and the associated direct andincremental selling, marketing and development costs. Key assumptions includedin the discounted cash flow analysis include projections of future customerorder growth for our scientific operating platform product line and developingan appropriate discount rate.

*Impairment of Long-LivedAssets*

In accordance with SFAS No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*,we review long-lived assets to be held and used, including acquired intangibleassets subject to amortization and property and equipment, for impairmentwhenever events or changes in circumstances indicate that the carrying amountof the assets may not be fully recoverable. Conditions that would necessitatean impairment assessment include a significant decline in the market price ofan asset or asset group, a significant adverse change in the extent or mannerin which an asset or asset group is being used, the loss of legal ownership ortitle to the asset, significant negative industry or economic trends or thepresence of other indicators that would indicate that the carrying amount of anasset or asset group is not recoverable. An asset is considered to be impairedif management’s estimate of the undiscounted future cash flows anticipated toresult from the use of the asset and its eventual disposition are notsufficient to recover the carrying value of the asset.

As a result of the closure of our research anddevelopment facility in Bangalore, India in the fourth quarter of fiscal year2007, we assessed the recoverability of the associated property and equipmentand determined that a portion of the assets were not recoverable.  Accordingly, we recorded an asset impairmentcharge of $0.1 million in the fourth quarter of fiscal year 2007 which isincluded in restructuring charges in the accompanying consolidated statement ofoperations.  The asset impairment chargeof $0.1 million represents the carrying value of these assets as we expect thatany amount we will recover from their disposal will be negligible.  Duringfiscal years 2006 and 2005, we did not identify any conditions that wouldnecessitate an impairment assessment of our long-lived assets.

*RevenueRecognition*

We recognize revenues inaccordance with the American Institute of Certified Public Accountants (“AICPA”)Statement of Position (“SOP”) 97-2, *Software RevenueRecognition*, as amended, SEC Staff Accounting Bulletin (“SAB”)No. 104, *Revenue Recognition*, EmergingIssues Task Force (“EITF”) Issue No. 00-21, *RevenueArrangements with Multiple Deliverables* and SOP No. 81-1*, Accounting for Performance of Construction-Type and CertainProduction-Type Contracts*.

We generate revenue from the following primarysources:

·                  softwarelicenses,

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·                  provisionof post-contract customer support and maintenance services on licensedsoftware, collectively referred to as PCS, and

·                  professionalservices.

Customer billings generated in connection with ourrevenue-generating activities are initially recorded as deferred revenue. Wethen recognize the revenue from these customer billings as set forth below andwhen all of the following criteria are met:

·                  afully executed written contract and/or purchase order has been obtained fromthe customer (i.e., persuasive evidence of an arrangement exists),

·                  thecontractual price of the product or services has been defined and agreed to inthe contract (i.e., price is fixed or determinable),

·                  deliveryof the product or service has occurred and no material uncertainties regardingcustomer acceptance of the delivered product or service exist, and

·                  collectionof the purchase price from the customer is deemed probable.

*SoftwareLicenses.*   We license software either perpetually or ona term basis. Our standard perpetual software licensing arrangements includetwelve months of bundled PCS, while our standard term-based software licensingarrangements typically include PCS for the full duration of the term license.Because we do not have VSOE of the fair value of these elements, we recognizeas revenue the entire fee for such perpetual and term-based licenses ratablyover the term of the bundled PCS. Certain of our term-based licenses also allowthe customer to substitute purchased products for other products of equal valuethroughout the term. We account for these arrangements as in-substancesubscriptions and, accordingly, we recognize as revenue the entire fee for suchlicenses ratably over the contractual term of the arrangement, which istypically the same as the term of the bundled PCS.

*Renewalof PCS under Perpetual Software Licenses.*   Our PCSincludes the right to receive unspecified upgrades or enhancements andtechnical support. Fees from customer renewals of PCS related to previouslypurchased perpetual licenses are recognized ratably over the term of the PCS.

*ProfessionalServices.*   We provide certain services to our customers,including non-complex product training, installation, implementation and otherprofessional services which are non-essential to the operation of the software.When sold separately, revenue from these services is generally recognized asthe services are delivered, according to the contractual terms. Amounts billed butnot yet recognized as revenue, and other payments received prior to therecognition of revenue, are recorded as deferred revenue.

We also performprofessional services for our customers designed to enhance the value of oursoftware products by creating extensions to functionality to address a client’sspecific business needs.  When soldseparately, revenue from these services is recorded under thepercentage-of-completion or completed contract method.

*Multi-ElementArrangements.*   For multi-element arrangements whichinclude software licenses, PCS and non-complex training, installation andimplementation services which are non-essential to the operation of thesoftware, the entire fee for such arrangements is recognized as revenue ratablyover the term of the PCS or delivery of the services, whichever is longer.  For multi-element arrangements which includedsoftware licenses, PCS, non-essential services and services that are essentialto the operation of the software, the fee for such arrangements is generallydeferred until the services essential to the operation of the software havebeen

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performed and themodified software has been delivered, at which point the entire fee for sucharrangements is recognized as revenue ratably over the term of the PCS or thedelivery of the non-essential services, whichever is longer.

*SalesTaxes Collected*

Sales taxes collectedfrom customers and remitted to various governmental agencies are excluded fromrevenues in our consolidated statement of operations.

*Shipping Costs*

The costs of shipping products to our customers areexpensed as incurred and are included in cost of revenue in our consolidatedstatements of operations. We incurred $0.4 million, $0.8 million, and $0.7million in shipping costs during the years ended March 31, 2007, 2006 and2005, respectively.

*Advertising Costs*

The costs of advertising are expensed as incurred andare included in sales and marketing expenses in our consolidated statements ofoperations. We incurred $0.1 million, $45,000 and $0.1 million in advertisingcosts during the years ended March 31, 2007, 2006 and 2005 respectively.

*Foreign CurrencyTranslation*

In accordance with SFAS No. 52, *Foreign Currency Translation*, we translate the financialstatements of our foreign subsidiaries into U.S. dollars using period-endexchange rates for assets and liabilities and average exchange rates duringeach reporting period for results of operations. Gains and losses resultingfrom foreign currency translation are excluded from results of operations andrecorded as accumulated other comprehensive income (loss) in stockholders’equity.

Gains and losses resulting from the cash settlement ofcertain intercompany transactions as well as transactions with customers andvendors that are denominated in currencies other than the functional currencyof each entity give rise to foreign exchange gains (losses). These foreignexchange gains (losses) are included in interest and other income, net in ourconsolidated statements of operations and totaled $(0.6) million, $0.3 millionand $(0.1) million for the years ended March 31, 2007, 2006 and 2005,respectively.

*Concentrations of Risk*

We maintain deposits in federally insured financialinstitutions in excess of federally insured limits. We do not believe we areexposed to significant credit risk due to the financial position of thedepository institutions in which those deposits are held. Additionally, we haveestablished guidelines regarding diversification of our investment portfolio,credit quality of issuers and maturities of investments, which are designed tomaintain the safety and liquidity of our deposits and investments.

In addition to our U.S. operations, we conductbusiness in Europe and in the Asia/Pacific region, primarily in Japan. Anysignificant decline in the economies or the value of the currencies in theseregions could have a material adverse impact on us.

*Income Taxes*

Despite our belief that our tax return positions areconsistent with applicable tax laws, we expect that certain positions arelikely to be challenged by taxing authorities. Settlement of any challenge canresult in no change, a 

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complete disallowance, orsome partial adjustment reached through negotiations or litigation. Significantjudgment is required in evaluating our tax reserves. Our reserves are adjustedin light of changing facts and circumstances, such as the progress of our taxaudits. Our income tax expense includes the impact of reserve provisions andchanges to reserves that we consider appropriate, as well as related interestand penalties. Favorable resolution of such an income tax matter would berecognized as a reduction to income tax expense.

We account for income taxes in accordance with SFASNo. 109, *Accounting for Income Taxes*.  Accordingly, deferred tax assets andliabilities are recognized for the tax consequences of temporary differencesbetween the financial carrying amounts and the tax basis of existing assets andliabilities by applying enacted statutory tax rates applicable to future years.The provision for income taxes is based on our estimates for taxable income ofthe various legal entities and jurisdictions in which we operate. As such,income tax expense may vary from the customary relationship between income taxexpense and pre-tax accounting income. We establish a valuation allowanceagainst our net deferred tax assets to reduce deferred tax assets to the amountexpected to be realized.

*Net Loss Per Share*

We compute net loss per share pursuant to SFASNo. 128, *Earnings Per Share*. Accordingly,basic and diluted net loss per share is computed by dividing the net loss forthe period by the weighted average number of common shares outstanding duringthe period, without consideration for potentially dilutive common stockequivalents.  Potentially dilutive commonshare equivalents consist of in-the-money common stock options and unvestedrestricted stock units (“RSUs”).

Potentiallydilutive common share equivalents that were excluded from the basic and dilutednet loss per share calculations as their effect would be anti-dilutive totaledapproximately 3.8 million shares, 3.5 million shares and 3.2 million shares foryears ended March 31, 2007, 2006, and 2005, respectively.

*ShareBased Compensation*

EffectiveApril 1, 2006, we adopted SFAS No. 123 (revised 2004), *Share-Based Payments* (“SFAS No. 123R”) using the modifiedprospective transition method. Under the modified prospective transitionmethod, the estimated grant date fair value of awards granted to employees anddirectors on or after April 1, 2006 is recognized as a charge against incomeover the requisite service period. Additionally, the remaining unrecognizedcompensation expense associated with the unvested portion of awards grantedprior to April 1, 2006, determined under the provisions of SFAS No. 123, isrecognized as a charge against income beginning April 1, 2006. In accordancewith the modified prospective transition method, our consolidated financialstatements for periods prior to April 1, 2006 have not been restated toreflect, and do not include, the impact of our adoption of SFAS No. 123R.

Pursuantto the provisions of SFAS No. 123R, deferred stock-based compensation is nolonger reflected as a separate component of stockholders’ equity. As a result,we reversed our remaining deferred stock-based compensation balance as of April1, 2006 of $0.5 million against additional paid-in capital.

InNovember 2005, the FASB issued Staff Position No. FAS 123R-3, *Transition Election Related to Accounting for Tax Effects ofShare-Based Payment Awards* (“FSP No. 123R-3”). We have electedto adopt the alternative transition method provided in FSP No. 123R-3 forcalculating the tax effects of stock-based compensation pursuant to SFASNo. 123R. The alternative transition method includes simplified methods toestablish the beginning balance of the additional paid-in capital pool (“APICpool”) related to the tax effects of employee stock-based compensation, and todetermine the subsequent impact on the APIC pool and consolidated statements ofcash flows of the tax effects of employee stock-based compensation awards thatare outstanding upon adoption of SFAS No. 123R.

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Additionalinformation and disclosure on our adoption of SFAS No. 123R are provided inNote 3.

*Segment and GeographicInformation*

In accordance with SFAS No. 131, our operationshave been aggregated into one reportable segment given the similarities ofeconomic characteristics between the operations and the common nature of theproducts, services and customers.

Financial information by geographic region is asfollows:
|              | ** ** | **Years Ended**                                  | ** ** |
|--------------|------------|-------------------------------------------------------|------------|
| ** **   | ** ** | **March 31, 2007**                          | ** ** | **March 31, 2006** | ** ** | **March 31, 2005** | ** ** |
| ** **   | ** ** | **Amount**                                            | ** ** | **Percentage  of  Total** | ** ** | **Amount** | ** ** | **Percentage  of  Total** | ** ** | **Amount** | ** ** | **Percentage  of  Total** | ** ** |
| ** **   | ** ** | **(In thousands, except percentages)** | ** ** |
| Revenues:    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |
| U.S.         |       | $                                                     | 43,909     |   | 54 | % | $ | 47,599 |   | 58 | % | $ | 42,022 |   | 53 | % |
| Europe       |       | 20,876                                                |       | 26 | % | 18,645 |   | 23 | % | 20,353 |   | 26 | % |
| Asia-Pacific |       | 16,170                                                |       | 20 | % | 15,757 |   | 19 | % | 16,655 |   | 21 | % |
| Total        |       | $                                                     | 80,955     |   | 100 | % | $ | 82,001 |   | 100 | % | $ | 79,030 |   | 100 | % |

 
|                     | ** ** | **As of March 31** | ** ** |
|---------------------|------------|-----------------------------------|------------|
| ** **          | ** ** | **2007**                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **          | ** ** | **Amount**                        | ** ** | **Percentage  of  Total** | ** ** | **Amount** | ** ** | **Percentage  of  Total** | ** ** | **Amount** | ** ** | **Percentage  of  Total** | ** ** |
| ** **          | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Long-lived  assets: |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| U.S.                |       | $                                 | 53,406     |   | 95 | % | $ | 56,445 |   | 94 | % | $ | 58,484 |   | 93 | % |
| Europe              |       | 2,365                             |       | 4 | % | 2,406 |   | 4 | % | 2,805 |   | 5 | % |
| Asia-Pacific        |       | 626                               |       | 1 | % | 1,155 |   | 2 | % | 1,567 |   | 2 | % |
| Total               |       | $                                 | 56,397     |   | 100 | % | $ | 60,006 |   | 100 | % | $ | 62,856 |   | 100 | % |

 

*Comprehensive Income(Loss)*

In accordance with SFAS No. 130, *Reporting Comprehensive Income*, we report the components ofcomprehensive income (loss), including net income (loss), in the financialstatements in the period in which they are recognized. Comprehensive income(loss) is defined as all changes in equity during a period from non-ownersources, including foreign currency translation adjustment and unrealized gainsand losses on marketable securities. We present comprehensive income (loss) inour consolidated statements of stockholders’ equity. Accumulated othercomprehensive income (loss) in stockholders’ equity consists of the following:
|                                           | ** ** | **March 31,**      | ** ** |
|-------------------------------------------|------------|-------------------------|------------|
| ** **                                | ** ** | **2007**                | ** ** | **2006** | ** ** |
| ** **                                | ** ** | **(In thousands)** | ** ** |
| Foreign currency  translation adjustment  |       | $                       | 1,303      |   | $ | 332 |   |
| Unrealized loss  on marketable securities |       | (158                    | )          | (698 | ) |
|                                      |       | $                       | 1,145      |   | $ | (366 | ) |

 

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*Guarantees*

We account for guarantees in accordance with FinancialAccounting Standards Board Interpretation (“FASB”) Interpretation (“FIN”)No. 45, *Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others*. FIN No. 45 requires that a guarantorrecognize, at the inception of a guarantee, a liability for the fair value ofcertain guarantees and requires certain disclosures to be made by a guarantorabout its obligations under certain guarantees that it has issued.

*Effect of New AccountingStandards*

InFebruary 2007, the FASB issued SFAS No. 159, *The FairValue Option for Financial Assets and Financial Liabilities*, whichis effective for fiscal years beginning after November 15, 2007. SFAS No. 159also amends certain provisions of SFAS No. 115, *Accountingfor Certain Investments in Debt and Equity Securities*. Thisstatement permits entities to choose to measure many financial instruments andcertain other items at fair value.  We donot expect our adoption of SFAS No. 159 in fiscal year 2009 to have a materialimpact on our results of operations or financial position.

InSeptember 2006, the FASB issued SFAS No. 157, *Fair Value Measurements*, which is effective for fiscal yearsbeginning after November 15, 2007. SFAS No. 157 provides a definition of fairvalue, establishes acceptable methods of measuring fair value and expandsdisclosures for fair value measurements. The principles apply under accountingpronouncements which require measurement of fair value and do not require anynew fair value measurements in accounting pronouncements where fair value isthe relevant measurement attribute. We do not expect our adoption of SFAS No.157 in fiscal year 2008 to have a material impact on our results of operationsor financial position.

InSeptember 2006, the SEC issued SAB No. 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements*. SAB No. 108 provides interpretiveguidance on how the effects of the carryover or reversal of prior yearmisstatements should be considered in quantifying a current year misstatement.Specifically, SAB No. 108 states that registrants should quantify errors usingboth a balance sheet and an income statement approach and evaluate whethereither approach results in quantifying a misstatement that, when all relevantquantitative and qualitative factors are considered, is material. SAB No. 108is effective for fiscal years ending after November 15, 2006. Our adoption ofSAB No. 108 in fiscal year 2007 did not have a material effect on our resultsof operations or financial position.

InJune 2006, the FASB issued FIN No. 48, *Accountingfor Uncertainty in Income Taxes.* FIN No. 48, which is effective forfiscal years beginning after December 15, 2006, addresses the accountingfor income taxes by prescribing the minimum recognition threshold a taxposition is required to meet before being recognized in the financialstatements. In addition, FIN No. 48 expands the disclosure requirementsconcerning unrecognized tax benefits as well as any significant changes thatmay occur in the next twelve months associated with such unrecognized taxbenefits. We will adopt the provisions of FIN No. 48 in the first quarter offiscal year 2008. We are currently evaluating the impact, if any, FIN No. 48will have on our results of operations or financial position.

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

*Share-BasedCompensation Plans*

OnAugust 2, 2005, our stockholders approved the Amended and Restated 2004Stock Incentive Plan (the “2004 Plan”). The 2004 Plan authorizes the grant ofequity awards to purchase the number of shares of our common stock equal to thesum of (i) 1,900,000 shares and (ii) the number of shares of commonstock underlying any stock awards granted under certain prior share-basedcompensation plans that expire or are cancelled or 

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forfeited withouthaving been exercised in full or that are repurchased by us. Potential types ofequity awards that may be granted under the 2004 Plan to our officers,directors, employees and consultants include stock options, restricted stockawards, common stock awards, stock appreciation rights, performance awards anddeferred stock units. Pursuant to the 2004 Plan, any shares of common stockthat are awarded under the 2004 Plan as restricted stock awards, common stockawards, performance awards or deferred stock units (but not as stock options orstock appreciation rights) are counted against the maximum number of shares ofcommon stock available for issuance under the 2004 Plan based on a 1.15-to-1ratio. The terms and conditions of specific awards are set at the discretion ofour board of directors although generally awards vest over not more than fiveyears, expire no later than ten years from the date of grant and do not haveexercise prices less than the fair market value of the underlying common stockon the date of grant. At March 31,2007, approximately 1,876,000 shares of our common stock remain available forissuance pursuant to awards granted under the 2004 Plan.

On August 2, 2005, our stockholders also approvedthe 2005 Employee Stock Purchase Plan (the “ESPP”), under which we havereserved 1,000,000 shares of our common stock for issuance. Under the ESPP,employees may defer up to 10% of their base salary to purchase shares of ourcommon stock, up to a maximum of 1,000 shares. The purchase price of the commonstock is equal to 85% of the lower of the fair market value per share of ourcommon stock on the commencement date of the applicable offering period or theapplicable purchase date. To date, we have issued 69,000 shares under the ESPPand 931,000 shares remain available for future issuance under the ESPP as of March 31, 2007.

Wealso maintain certain other share-based compensation plans, under which we didnot grant awards during fiscal year 2007 and do not intend to grant any furtherawards in the future.

Ourshare-based compensation plans contain a provision that allows eligibleparticipants to continue to vest in their stock options upon their retirement,as that term is defined in the plans. To be eligible for continued vesting,participants must be at least 55 years of age and have 5 years of service atthe time of their retirement.  Commencingin fiscal year 2008, we are no longer offering this retirement benefit forfuture awards of stock options.

During the second quarterof fiscal year 2007, we offered eligible employees the one-time opportunity tosurrender any and all stock options granted pursuant to any of our stock planswith an exercise price greater than $9.00 per share in exchange for RSUs (the “ExchangeOffer”) based on an exchange ratio determined by our board of directors. The RSUsvest in three equal annual installments commencing on the date of grant and aresubject to the terms and conditions set forth in the 2004 Plan. The offerperiod commenced on July 28, 2006 and expired on August 25, 2006.  On August 26, 2006, all eligible stockoptions tendered by eligible employees in accordance with the terms of theExchange Offer were cancelled and RSUs were issued to such eligible employeesin accordance with the exchange ratios established by the board of directors.  In total, stock options for the purchase ofapproximately 410,000 shares of our common stock were tendered and cancelled,and RSUs for approximately 105,000 shares of our common stock weregranted.  Any eligible stock options nottendered remain issued and outstanding in accordance with their original termsand conditions.

Pursuantto SFAS No. 123R, we accounted for the cancellation of the tendered stockoptions and concurrent grant of RSUs as a modification of the cancelled stockoptions. Accordingly, we measured the excess of the grant-date fair value ofthe RSUs over the fair value of the cancelled stock options at cancellation(the “incremental value”) and are recognizing the aggregate of the incrementalvalue and the remaining unamortized grant-date fair value of the cancelledstock options of approximately $0.3 million as share-based compensation expenseover the requisite service period of the RSUs.

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*Share-Based Award Activity*

Our stock options generally vest over four years andhave a contractual term of 10 years.  Asummary of stock option activity under our share-based compensation plans is asfollows:
| ** **                    | ** ** | **Number of  Shares**                                                                | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Aggregate   Intrinsic   Value** | ** ** | **Weighted  Average  Remaining  Contractual   Life** | ** ** |
|-------------------------------|------------|-------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                    | ** ** | **(In thousands, except per share amounts and years)** | ** ** |
| Outstanding at  April 1, 2006 |       | 4,306                                                                                     |       | $                                      | 9.78       |                                        |       |                                                      |       |   |
| Granted                       |       | 1,078                                                                                     |       | 6.96                                   |       |                                        |       |                                                      |       |
| Exercised                     |       | (232                                                                                      | )          | 4.76                                   |       |                                        |       |                                                      |       |
| Expired/Forfeited             |       | (1,422                                                                                    | )          | 14.05                                  |       |                                        |       |                                                      |       |
| Outstanding at March 31, 2007 |       | 3,730                                                                                     |       | 7.67                                   |       | $                                           | 870        |                                                      | 7.0        |   |
| Exercisable at March 31, 2007 |       | 2,218                                                                                     |       | 8.21                                   |       | $                                           | 600        |                                                      | 5.8        |   |
|                               |            |                                                                                           |            |                                        |            |                                             |            |                                                           |            |  |  |

 

Theaggregate intrinsic value of stock options outstanding and exercisable at March 31, 2007 was based on theclosing price of our common stock on March30, 2007 of $6.38 per share. The total intrinsic value of stock optionsexercised during the years ended March31, 2007, 2006, and 2005 was $0.4 million, $0.3 million, and $0.3million, respectively.  The total cashreceived from the exercise of stock options during the year ended March 31, 2007 was $1.1 million.

Infiscal year 2007, we granted RSUs under the 2004 Plan that vest annually overthree years and, once vested, do not expire. A summary of RSU activity underour share-based compensation plans is as follows:
| ** **                 | ** ** | **Number of  Shares**                                            | ** ** | **Weighted  Average  Grant Date   Fair Value** | ** ** |
|----------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                 | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Unvested at  April 1, 2006 |       | —                                                                |       | $                                                             | —     |   |
| Granted                    |       | 481                                                                   |       | 6.73                                                          |       |
| Vested                     |       | —                                                                |       | —                                                        |       |
| Forfeited                  |       | (42                                                                   | )          | 6.73                                                          |       |
| Unvested at March 31, 2007 |       | 439                                                                   |       | $                                                             | 6.73       |   |

 

*Valuationof Share-Based Awards*

Weestimate the fair value of our share-based awards on the date of grant usingthe Black-Scholes option-pricing model. The Black-Scholes option-pricing modelrequires the use of certain input variables, as follows:

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

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

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

*Expected Award Life.*We determine theexpected life of an award by considering various relevant factors, includingthe vesting period and contractual term of the award, our employees’ historicalexercise patterns and length of service, the expected future volatility of ourstock price, tax implications of exercising an award and employeecharacteristics. We also consider the expected terms of comparable publiclytraded companies.  For ESPP purchaserights, the expected life is equal to the current offering period under theESPP.

Under SFAS No. 123R, we are also required to estimateat grant the likelihood that the award will ultimately vest (the “pre-vestingforfeiture rate”) and revise the estimate, if necessary, in future periods ifthe actual forfeiture rate differs. We determine the pre-vesting forfeiturerate of an award based on our historical pre-vesting award forfeitureexperience, giving consideration to company-specific events impactinghistorical pre-vesting award forfeiture experience that are unlikely to occurin the future as well as anticipated future events that may impact forfeiturerates.  For purposes of calculating proforma information under SFAS No. 123 for periods prior to fiscal year 2007, weaccounted for pre-vesting forfeitures as they occurred.

Ourdetermination of the input variables used in the Black-Scholes option pricingmodel as well as the pre-vesting forfeiture rate is based on various underlyingestimates and assumptions that are highly subjective and are affected by ourstock price, among other factors. Changes in these underlying estimates andassumptions could materially affect the fair value of our share-based awards and,therefore, the amount of share-based compensation expense to be recognized inour results of operations.

Thefair value of stock options and ESPP purchase rights granted during the yearended March 31, 2007 wasestimated at the date of grant using the Black-Scholes option pricing modelwith the following weighted average assumptions:
| ** **                                        | ** ** | **Stock Options** | ** ** | **ESPP   Purchase   Rights** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|----------------------------------------|------------|
| Expected  volatility                              |       | 60                     | %          | 60                                     | %          |
| Risk-free  interest rate                          |       | 4.9                    | %          | 5.1                                    | %          |
| Expected option  life in years                    |       | 5                      |       | 0.5                                    |       |
| Expected  dividend yield                          |       | 0                      | %          | 0                                      | %          |
| Weighted average per  share grant date fair value |       | $                      | 3.87       |                                   | $          | 2.18 |   |
|                                                   |            |                        |            |                                        |            |  |  |

 

Thefair value of RSUs granted during the year ended March 31, 2007 was based onthe market price of our common stock on the date of grant.

*Share-BasedCompensation Expense*

Theestimated fair value of our share-based awards is recognized as a chargeagainst income on a straight-line basis over the requisite service period,which is the shorter of the vesting period of the award or, for applicableawards, the period until the participant becomes eligible for retirement. Theestimated fair value of applicable share-based awards granted toretirement-eligible participants is recognized as a charge against incomeimmediately upon grant. Total share-based compensation expense recognized inour consolidated statements of operations for the years ended March 31, 2007,2006 and 2005 was as follows:

51

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|                                         | ** ** | **Years  Ended March 31,** | ** ** |
|-----------------------------------------|------------|------------------------------------------------|------------|
| ** **                              | ** ** | **2007**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                    |       |                                           |       |   |   |   |   |
| Cost of revenue                         |       | $                                              | 326        |   | $ | 31 |   | $ | 19 |   |
| Product  development                    |       | 1,185                                          |       | 722 |   | 54 |   |
| Sales and  marketing                    |       | 781                                            |       | 58 |   | 62 |   |
| General and  administrative             |       | 1,978                                          |       | 42 |   | 223 |   |
| Total share-based  compensation expense |       | $                                              | 4,270      |   | $ | 853 |   | $ | 358 |   |

 

Share-basedcompensation expense recognized in the year ended March 31, 2007 reflects ouradoption of SFAS No. 123R effective April 1, 2006 using the modifiedprospective transition method. Share-based compensation expense recognized inthe years ended March 31, 2006 and 2005 relates to share-based awards grantedin prior periods accounted for under the provisions of Accounting PrincipalsBoard Opinion No. 25, *Accounting for StockIssued to Employees* (“APB No. 25”). The weighted-average intrinsicvalue of employee stock options granted during fiscal year 2005 was $5.51 pershare. Employee stock options granted in fiscal year 2006 had no intrinsicvalue upon grant. No share-based compensation expense was capitalized in theperiods presented. At March 31, 2007, the gross amount of unrecognizedshare-based compensation expense relating to unvested share-based awards wasapproximately $7.2 million, which we anticipate recognizing as a charge againstincome over a weighted average period of 1.27 years.

*ProForma Information Under SFAS No. 123 For Periods Prior to April 1, 2006*

Thefollowing table illustrates the effect on net loss and net loss per share forthe years ended March 31, 2006 and 2005 if we had applied the fair valuerecognition provisions of SFAS No. 123 to our employee stock awards. Forpurposes of the SFAS No. 123 pro forma disclosures, the estimated fair value ofemployee stock awards has been charged against income over the related vestingperiod of the award on a straight-line basis.
| ** **                                                                                                      | ** ** | **Years Ended March 31,**                              | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                                                      | ** ** | **2006**                                                              | ** ** | **2005** | ** ** |
| ** **                                                                                                      | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Net loss, as  reported                                                                                          |       | $                                                                     | (7,739     | ) | $ | (16,578 | ) |
| Add: Stock-based  employee compensation expense included in net loss, as reported                               |       | 853                                                                   |       | 358 |   |
| Deduct:  Stock-based employee compensation expense determined under the fair value  based method for all awards |       | (5,200                                                                | )          | (7,218 | ) |
| Pro forma net  loss                                                                                             |       | $                                                                     | (12,086    | ) | $ | (23,438 | ) |
| Basic and  diluted net loss per share:                                                                          |       |                                                                  |       |   |   |
| As reported                                                                                                     |       | $                                                                     | (0.30      | ) | $ | (0.66 | ) |
| Pro forma                                                                                                       |       | $                                                                     | (0.46      | ) | $ | (0.93 | ) |

 

The fair value of stock options and ESPP purchase rights granted duringfiscal year 2006 and 2005 was estimated at the date of grant using theBlack-Scholes option pricing model with the following weighted averageassumptions:
| ** **                                        | ** ** | **Year Ended March 31, 2006** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                        | ** ** | **Stock Options**                            | ** ** | **ESPP   Purchase   Rights** | ** ** |
| Expected  volatility                              |       | 66                                                | %          | 69 | % |
| Risk-free  interest rate                          |       | 4.1                                               | %          | 3.7 | % |
| Expected option  life in years                    |       | 4.0                                               |       | 0.5 |   |
| Expected  dividend yield                          |       | 0                                                 | %          | 0 | % |
| Weighted average per  share grant date fair value |       | $                                                 | 3.27       |   | $ | 1.23 |   |
|                                                   |            |                                                   |            |  |  |  |  |

 
| ** **                                        | ** ** | **Year Ended March 31, 2005** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                        | ** ** | **Stock Options**                            | ** ** | **ESPP   Purchase   Rights** | ** ** |
| Expected  volatility                              |       | 69                                                | %          | 69 | % |
| Risk-free  interest rate                          |       | 3.8                                               | %          | 3.8 | % |
| Expected option  life in years                    |       | 4.0                                               |       | 0.5 |   |
| Expected  dividend yield                          |       | 0                                                 | %          | 0 | % |
| Weighted average per  share grant date fair value |       | $                                                 | 4.10       |   | $ | 1.67 |   |
|                                                   |            |                                                   |            |  |  |  |  |

 

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**4.   IncomeTaxes**

Income (loss) fromcontinuing operations before taxes was as follows:
|            | ** ** | **Years Ended March 31,** | ** ** |
|------------|------------|------------------------------------------|------------|
| ** ** | ** ** | **2007**                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** ** | ** ** | **(In thousands)**                  | ** ** |
| U.S.       |       | $                                        | (6,421     | ) | $ | (6,897 | ) | $ | (19,762 | ) |
| Foreign    |       | 5,678                                    |       | 56 |   | 3,730 |   |
| Total      |       | $                                        | (743       | ) | $ | (6,841 | ) | $ | (16,032 | ) |

 

Income tax expense(benefit) consists of the following:
|                                            | ** ** | **Years Ended March 31,** | ** ** |
|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                 | ** ** | **2007**                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                 | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current:                                   |       |                                     |       |   |   |   |   |
| Federal                                    |       | $                                        | —     |   | $ | — |   | $ | (952 | ) |
| State                                      |       | 139                                      |       | 102 |   | 125 |   |
| Foreign                                    |       | 5,611                                    |       | 487 |   | 256 |   |
| Total current income tax expense (benefit) |       | 5,750                                    |       | 589 |   | (571 | ) |
| Deferred:                                  |       |                                     |       |   |   |   |   |
| Federal                                    |       | 267                                      |       | 238 |   | — |   |
| State                                      |       | —                                   |       | — |   | — |   |
| Foreign                                    |       | (5,235                                   | )          | 71 |   | — |   |
| Total deferred income tax expense          |       | (4,968                                   | )          | 309 |   | — |   |
| Total income tax  expense (benefit)        |       | $                                        | 782        |   | $ | 898 |   | $ | (571 | ) |

 

The significant increasein current and deferred income tax expense (benefit) incurred in foreignjurisdictions in fiscal year 2007 is attributable to a temporary book-taxtiming difference related to revenue recognized by our wholly-owned Japanesesubsidiary, Accelrys, K.K., for Japanese income tax purposes in advance ofbeing recognized for book purposes, as discussed further below.

The following reconcilesincome taxes computed at the U.S. statutory federal tax rate to income taxexpense (benefit):
|                                             | ** ** | **Years Ended March 31,** | ** ** |
|---------------------------------------------|------------|------------------------------------------|------------|
| ** **                                  | ** ** | **2007**                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                  | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income tax at  U.S. statutory rate          |       | $                                        | (253       | ) | $ | (2,327 | ) | $ | (5,451 | ) |
| State income  taxes, net of federal benefit |       | 80                                       |       | (309 | ) | (837 | ) |
| Reversal of tax  reserve                    |       | —                                   |       | — |   | (952 | ) |
| Receivable for  withholding tax from Japan  |       | —                                   |       | — |   | (880 | ) |
| Foreign taxes                               |       | (108                                     | )          | 568 |   | (100 | ) |
| Change in  valuation allowance and other    |       | 1,063                                    |       | 2,966 |   | 7,649 |   |
| Income tax expense  (benefit)               |       | $                                        | 782        |   | $ | 898 |   | $ | (571 | ) |

 

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Significant components of our deferred tax assets andliabilities are as follows:
|                                              | ** ** | **March 31,**      | ** ** |
|----------------------------------------------|------------|-------------------------|------------|
| ** **                                   | ** ** | **2007**                | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | **(In thousands)** | ** ** |
| Deferred tax  assets:                        |       |                    |       |   |   |
| Net operating loss carryforwards             |       | $                       | 54,140     |   | $ | 53,380 |   |
| Goodwill and intangibles                     |       | 6,500                   |       | 7,941 |   |
| Unused tax credits                           |       | 4,696                   |       | 4,456 |   |
| Accruals and reserves                        |       | 14,266                  |       | 4,674 |   |
| Gross deferred tax assets                    |       | 79,602                  |       | 70,451 |   |
| Deferred tax  liabilities:                   |       |                    |       |   |   |
| Property and equipment                       |       | 101                     |       | 9 |   |
| Intangible assets                            |       | 2,855                   |       | 3,468 |   |
| Gross deferred tax liabilities               |       | 2,956                   |       | 3,477 |   |
| Total net  deferred tax assets               |       | 76,646                  |       | 66,974 |   |
| Valuation  allowance for deferred tax assets |       | (71,573                 | )          | (66,869 | ) |
| Net deferred taxes                           |       | $                       | 5,073      |   | $ | 105 |   |

 

At March 31, 2007 and 2006, we had $0.5 million and $0.2 million,respectively, of net deferred tax liabilities in the U.S. related toindefinite-lived goodwill and intangible assets that are amortized for incometax purposes. For book purposes, the indefinite-lived goodwill and intangibleassets will be charged to results of operations when they are determined to beimpaired in accordance with SFAS No. 142. Because we can not predictwhen these assets will be impaired and therefore when the associated deferredtax liabilities will reverse, we can not assume that there will be sufficientdeferred tax assets to offset against these deferred tax liabilities when theyultimately reverse.  We haveprovided a full valuation allowance for our remaining net U.S. deferred taxassets as we do not believe that the ultimate realization of such deferred taxassets is more likely than not.

At March 31, 2007 and 2006, we also had $5.6 million and$0.3 million, respectively, of net deferred tax assets related to ourwholly-owned subsidiary, Accelrys, K.K., in Japan. We believe that the ultimaterealization of the net deferred tax assets of Accelrys, K.K. is more likelythan not since our intercompany transfer pricing arrangement provides forAccelrys, K.K. to achieve an annual operating profit margin.

The increase in the valuation allowance for deferredtax assets for the years ended March 31, 2007 and 2006 of $4.7 million and$3.2 million, respectively, was due primarily to the increase in netoperating loss carryforwards in the U.S.

As of March 31, 2007, we had U.S. federal netoperating loss carryforwards of approximately $140.7 million and taxcredit carryforwards of approximately $6.1 million. Approximately $46.7 millionof the net operating loss carryforwards relate to stock option deductionswhich, when realized, will result in an increase to paid-in capital and adecrease in income taxes payable. Our U.S. federal net operating loss and taxcredit carryforwards expire beginning in 2008 through 2027, if not fullyutilized. Realization is dependent on generating sufficient taxable incomeprior to expiration of the loss and credit carryforwards.

In addition to the net operating loss carryforwards inthe table above, as of March 31, 2007, we had pre-acquisition netoperating loss carryforwards of $57.0 million from acquisitions outsidethe U.S. which have been fully reserved. The realization of thesepre-acquisition net operating loss carryforwards will result in a reduction ofgoodwill. During the year ended March 31, 2005, we utilized $0.7 millionof pre-acquisition net operating loss 

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carryforwards thatresulted in a corresponding reduction to goodwill. No pre-acquisition netoperating loss carryforwards were utilized during the years ended March 31,2007 and 2006.

At each of March 31, 2007 and 2006, we had a taxreserve of $0.7 million related to a potential transfer pricing issue in theU.K.

At March 31, 2007, our Accelrys, K.K. subsidiaryrecognized an income tax reserve and associated deferred tax asset of $4.8million for revenue recognized for Japanese income tax purposes in advance ofbeing recognized for book purposes as a result of the change in our revenuerecognition policy in connection with the restatement of our previously issuedconsolidated financial statements. Because this timing difference is temporary,it had no net impact on income tax expense recognized in fiscal year 2007.Management is currently assessing potential alternative tax return positionsthat are consistent with Japanese tax law and would reduce our income taxobligation in Japan.

In April 2003, we established a wholly-ownedsubsidiary, Accelrys Software Solutions Pvt. Ltd. (“Accelrys, Pvt.”), inBangalore, India, that qualifies under applicable Indian law for a tax holidaythrough March 2009. The aggregate dollar amount of the tax holiday was$0.4 million, or $0.02 per share, as of March 31, 2007. As discussed furtherin note 7, in the fourth quarter of fiscal year 2007, we closed our researchand development facility in Bangalore and terminated the approximately 60employees of Accelrys, Pvt. While our discussions with the Indian taxingauthorities are ongoing, management does not believe that the Indian taxingauthorities will seek to recoup the income taxes foregone under the tax holidayas a result of the closure of the Bangalore research and development facility.Accordingly, we have not recorded a reserve for this matter as of March 31,2007.

A portion of our U.S. federal and state net operatingloss and tax credit carryforwards may be subject to annual usage limitationsunder Sections 382 and 383 of the Internal Revenue Code. Use of the U.K.net operating loss carryforwards may be limited upon the occurrence of certainevents such as the discontinuation or change in the nature or conduct of ourbusiness.

**5.   RetirementSavings Plans**

*U.S. Based Employees*

We have an employee savings and retirement plan (the “401(K) Plan”).The 401(K) Plan is intended to be a tax-qualified plan coveringsubstantially all U.S. based employees. Under the terms of the401(K) Plan, employees may elect to contribute up to 20% of theircompensation, or the statutory prescribed limit, if less. We may, at ourdiscretion, match employee contributions up to a maximum of 3% of the employee’scompensation. Employer matching contributions totaled $0.6 million, $0.4million and $0.6 million for the years ended March 31, 2007, 2006 and2005, respectively.

For our U.S. based executives and members of our boardof directors, we provide an executive deferred compensation plan (the “EDC Plan”).Eligible participants can contribute up to 90% of their base salary and 100% ofall other forms of compensation into the EDC Plan. On a discretionary basis, wecan make matching contributions up to $5,000 per participant into the EDC Plan,and such employer contributions, if any, vest over a three-year period. Todate, we have not made any matching contributions to the EDC Plan.

In addition, the EDC Plan contains a bonus employercontribution. The bonus employer contribution is determined based on eachpercent that our stock outperforms the Russell 2000 Index, up to a maximum of20% of the participant’s annual retainer or base salary, as appropriate. Nobonus employer contributions were made during the years ended March 31, 2007,2006 and 2005.

In March 2000, we established a rabbi trust forthe benefit of our directors and officers under the EDC Plan. In accordancewith FIN No. 46, *Consolidation of VariableInterest Entities, an Interpretation of ARB No. 51*, we 

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have included the assetsof the rabbi trust in our consolidated balance sheets since the trust’sinception. As of March 31, 2007 and 2006, the asset and liabilities of thetrust were $0.5 million and $0.4 million, respectively. Changes in the valuesof the assets held by the rabbi trust accrue to the directors and officers andnot to us.

On May 29, 2007, the Human Resources Committee of ourBoard of Directors authorized the termination of the EDC Plan, including thebonus employer contribution, and the distribution of plan account balances tothe participants.

*Non-U.S. Based Employees*

We provide retirement benefits for employees locatedoutside the U.S. commensurate with other similar companies in those respectivelocations. Employer contributions, in the form of cash, totaled$0.6 million, $0.7 million and $0.7 million for the years endedMarch 31, 2007, 2006 and 2005, respectively.

**6.   Commitments andContingencies**

*Operating Leases*

We lease office space in several facilities underoperating leases that expire through 2022. Certain of our lease agreementscontain renewal options, rent holidays or rent escalation clauses.  In accordance with SFAS No. 13, *Accounting for Leases*, we recognize rent expense on astraight-line basis over the term of the related operating leases, includingany cancelable option periods where failure to exercise such options wouldresult in economic penalty. Rent expense recognized in excess of rent paid isreflected as a deferred rent liability, which is included in lease relatedliabilities in the accompanying consolidated balance sheets. Rent expense underour operating leases for the years ended March 31, 2007, 2006 and 2005,was approximately $3.7 million, $4.2 million and $4.6 million, respectively.

Additionally, under the terms of the lease for our SanDiego, California corporate office, we were required to obtain an irrevocableletter of credit for $6.6 million to ensure our performance under the leaseagreement. If we are not in default under the lease, the letter of creditrequirement will decrease to $4.4 million on September 1, 2009, $3.0million on September 1, 2011 and will expire upon termination of the leaseon September 1, 2013. The letter of credit is fully secured by marketablesecurities, which are included in restricted cash and marketable securities inthe accompanying consolidated balance sheets.

We recognized sublease income in our consolidatedstatements of operations of $0.4 million and $0.5 million for the years endedMarch 31, 2006 and 2005, respectively. No sublease income was recognized in our consolidated statement ofoperations for the year ended March 31, 2007.

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Future minimum lease commitments and future committedsublease income as of March 31, 2007 are as follows:
|                  | ** ** | **Operating  Lease  Commitments** | ** ** | **Sublease  Income** | ** ** | **Net** | ** ** |
|------------------|------------|-----------------------------------|------------|----------------------|------------|---------|------------|
| ** **       | ** ** | **(In thousands)**           | ** ** |
| Fiscal year 2008 |       | $                                 | 4,492      |                 | $          | 580     |       | $ | 3,912 |   |
| Fiscal year 2009 |       | 4,204                             |       | 538                  |       | 3,666   |       |
| Fiscal year 2010 |       | 4,084                             |       | 527                  |       | 3,557   |       |
| Fiscal year 2011 |       | 4,141                             |       | 527                  |       | 3,614   |       |
| Fiscal year 2012 |       | 4,207                             |       | 44                   |       | 4,163   |       |
| Thereafter       |       | 20,636                            |       | —               |       | 20,636  |       |
|             |       | $                                 | 41,764     |                 | $          | 2,216   |       | $ | 39,548 |   |

 

*Lease Guarantee*

On April 30, 2004, wespun-off our drug discovery subsidiary, ***Pharmacopeia DrugDiscovery, Inc. (“PDD”)******,***into an independent, separately traded, publicly held company through thedistribution to our stockholders of a dividend of one share of PDD common stockfor every two shares of our common stock.  The landlords of our New Jersey facilities, which were used byour PDD operations, consented to the assignment of the leases to PDD. Despitethe assignment, the landlords required us to guarantee the remaining leaseobligations, which totaled approximately $21 million as of March 31, 2007.In the event that PDD defaults on their lease obligation, we are permittedunder the guarantee to sublease the facility in order to mitigate our leaseobligation.  In accordance with FINNo. 45, we recognized a liability and corresponding charge to stockholders’equity for the probability-weighted fair market value of the guarantee. Changesto the fair market value of the liability are recognized in stockholders’equity. The liability for our guarantee of the lease obligation was $0.6 millionat each of March 31, 2007 and 2006.

*Royalties*

We are obligated to payroyalties for licenses to enhance and market certain software used inconnection with our product offerings. Annual contractual minimum royaltypayments as of March 31, 2007 are as follows (in thousands):
| Fiscal year 2008 |   | $     | 434    |   |
|------------------|--------|-------|--------|--------|
| Fiscal year 2009 |   | 409   |   |
| Fiscal year 2010 |   | 288   |   |
| Fiscal year 2011 |   | 286   |   |
| Fiscal year 2012 |   | 283   |   |
| Through 2017 (1) |   | 1,380 |   |
|             |   | $     | 3,080  |   |

 

----

(1)             For purposes of the contractual minimum royaltypayments table, we have included indefinite-lived contractual minimum royaltypayments due in the ten fiscal years following fiscal year 2007.

In addition to the contractualminimum royalties included in the table above, we have several royaltyagreements that are long term or perpetual in nature and the royaltyobligations are generally based on a percentage of revenues derived fromcertain software license sales and associated sales of PCS. The royalty agreementsrequire quarterly payments and generally do not limit the maximum royaltiesowed. During the years

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ended March 31, 2007,2006 and 2005, we incurred related royalty expense of $2.7 million, $3.0million and $2.8 million, respectively.

*Litigation*

We are not a party to any legal proceedings thenegative outcome of which would have a material adverse effect on our business,financial condition or results of operations.

*Other Guarantees andIndemnifications*

We provide indemnifications of varying scope and sizeto certain customers against claims of intellectual property infringement madeby third parties arising from the use of our products. We have also enteredinto indemnification agreements with our officers and directors. Although themaximum potential amount of future payments we could be required to make underthese indemnifications is unlimited, to date we have not incurred materialcosts to defend lawsuits or settle claims related to these indemnificationprovisions. Additionally, we have insurance policies that, in most cases, wouldlimit our exposure and enable us to recover a portion of any amounts paid.Therefore, we believe the estimated fair value of these agreements is minimaland likelihood of incurring an obligation is remote. Accordingly, we have notaccrued any liabilities in connection with these indemnification obligations asof March 31, 2007.

**7.  Restructuring Activities**

The following summarizes the changes in our accruedrestructuring charges liability:
|                                                     | ** ** | **Severance and   Related Costs** | ** ** | **Lease  Obligation Exit   and Facility   Closure Costs** | ** ** | **Total**  | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|------------|------------|
| ** **                                          | ** ** | ** **                                       | ** ** | ** **                                                                         | ** ** | ** ** | ** ** |
| Balance at  March 31, 2005                     |       | $                                                | 1,067      |                                                                               | $          | 3,526      |       | $ | 4,593 |   |
| Additional severance and lease abandonment charges  |       | 1,766                                            |       | 1,412                                                                              |       | 3,178      |       |
| Cash payments                                       |       | (1,745                                           | )          | (1,662                                                                             | )          | (3,407     | )          |
| Effect of foreign exchange                          |       | (23                                              | )          | (67                                                                                | )          | (90        | )          |
| Balance at  March 31, 2006                     |       | 1,065                                            |       | 3,209                                                                              |       | 4,274      |       |
| Additional  severance and lease abandonment charges |       | 611                                              |       | 355                                                                                |       | 966        |       |
| Adjustments to  liability                           |       | —                                           |       | 237                                                                                |       | 237        |       |
| Cash payments                                       |       | (1,591                                           | )          | (2,230                                                                             | )          | (3,821     | )          |
| Effect of  foreign exchange                         |       | 79                                               |       | 309                                                                                |       | 388        |       |
| Balance at  March 31, 2007                     |       | $                                                | 164        |                                                                               | $          | 1,880      |       | $ | 2,044 |   |

 

In prior periods, weimplemented various actions designed to improve our operations and overallfinancial performance through workforce reductions and the abandonment ofleased facilities.  All severancebenefits related to these workforce reductions have been fully paid.  Our remaining obligations under the leaseobligations terminate in fiscal year 2008.

During fiscal year 2005, we implemented variousactions designed to improve the efficiency of our sales department andeliminate duplicative general and administrative personnel through workforcereductions and the abandonment of a leased facility in Germany. As a result ofthe implementation of these actions, we recognized a charge of $1.7 million,consisting of $1.4 million in severance benefits from the termination of 42employees and 

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$0.3 million related tothe abandonment of the leased facility. The severance benefits were paid infull in fiscal year 2006. In the second quarter of fiscal year 2007, we made a$0.1 million lease buy-out payment to the landlord of the abandoned facilitythat terminates our obligations under the lease. As a result of the terminationof the lease, we reduced the remaining liability for the abandoned facility toa negligible amount.

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

As a result of thesubstantial completion of our product modernization and integration efforts, inDecember 2006, we implemented a restructuring plan which resulted in theclosure of our research and development facility in Bangalore, India, and thetermination of approximately 60 research and development employees.  As aresult of the implementation of the restructuring plan, we recognized a chargeof $0.8 million, consisting of $0.3 million of severance benefits and $0.5million of asset impairment charges and other facility closure costs. Theseverance benefits and facility closure costs were fully paid in the fourthquarter of fiscal year 2007.

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**10.   SelectedQuarterly Financial Information (unaudited)**

The following quarterly financial data, in the opinionof management, reflects all adjustments, consisting of normal recurringadjustments necessary for a fair presentation of results for the periods presented.  Certain prior period information has beenreclassified to conform to the current period presentation.
| ** **                                     | ** ** | **Year Ended March 31, 2007**                     | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **First  Quarter**                                                    | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
| ** **                                     | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenue                                        |       | $                                                                     | 20,150     |   | $ | 20,232 |   | $ | 20,684 |   | $ | 19,889 |   |
| Cost of revenue                                |       | 3,656                                                                 |       | 3,537 |   | 4,264 |   | 4,041 |   |
| Gross margin                                   |       | 16,494                                                                |       | 16,695 |   | 16,420 |   | 15,848 |   |
|                                           |       |                                                                  |       |   |   |   |   |   |   |
| Operating  expenses:                           |       |                                                                  |       |   |   |   |   |   |   |
| Product development                            |       | 5,126                                                                 |       | 4,916 |   | 4,697 |   | 4,192 |   |
| Sales and marketing                            |       | 7,066                                                                 |       | 6,568 |   | 8,878 |   | 8,168 |   |
| General and administrative                     |       | 4,718                                                                 |       | 4,373 |   | 4,077 |   | 4,174 |   |
| Restructuring charges                          |       | —                                                                |       | (6 | ) | 252 |   | 955 |   |
| Total operating  expenses                      |       | 16,910                                                                |       | 15,851 |   | 17,904 |   | 17,489 |   |
| Operating income  (loss)                       |       | (416                                                                  | )          | 844 |   | (1,484 | ) | (1,641 | ) |
| Interest and  other income, net                |       | 484                                                                   |       | 360 |   | 601 |   | 509 |   |
| Income (loss)  before taxes                    |       | 68                                                                    |       | 1,204 |   | (883 | ) | (1,132 | ) |
| Income tax  expense (benefit)                  |       | 397                                                                   |       | 269 |   | 198 |   | (82 | ) |
| Net income  (loss)                             |       | (329                                                                  | )          | 935 |   | (1,081 | ) | (1,050 | ) |
|                                           |       |                                                                  |       |   |   |   |   |   |   |
| Basic and diluted net  income (loss) per share |       | $                                                                     | (0.01      | ) | $ | 0.04 |   | $ | (0.04 | ) | $ | (0.04 | ) |

 
| ** **                                     | ** ** | **Year Ended March 31, 2006**                     | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **First  Quarter**                                                    | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
| ** **                                     | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenue                                        |       | $                                                                     | 20,404     |   | $ | 21,736 |   | $ | 20,433 |   | $ | 19,429 |   |
| Cost of revenue                                |       | 3,908                                                                 |       | 3,892 |   | 4,045 |   | 4,183 |   |
| Gross margin                                   |       | 16,496                                                                |       | 17,844 |   | 16,388 |   | 15,246 |   |
|                                           |       |                                                                  |       |   |   |   |   |   |   |
| Operating  expenses:                           |       |                                                                  |       |   |   |   |   |   |   |
| Product development                            |       | 5,855                                                                 |       | 5,567 |   | 4,952 |   | 5,347 |   |
| Sales and marketing                            |       | 8,727                                                                 |       | 7,667 |   | 8,991 |   | 8,340 |   |
| General and administrative                     |       | 4,069                                                                 |       | 3,619 |   | 3,612 |   | 4,757 |   |
| Restructuring charges                          |       | —                                                                |       | — |   | — |   | 3,182 |   |
| Total operating  expenses                      |       | 18,651                                                                |       | 16,853 |   | 17,555 |   | 21,626 |   |
| Operating income  (loss)                       |       | (2,155                                                                | )          | 991 |   | (1,167 | ) | (6,380 | ) |
| Interest and  other income, net                |       | 698                                                                   |       | 402 |   | 530 |   | 239 |   |
| Income (loss)  before taxes                    |       | (1,457                                                                | )          | 1,393 |   | (637 | ) | (6,141 | ) |
| Income tax  expense (benefit)                  |       | 440                                                                   |       | 241 |   | (70 | ) | 286 |   |
| Net income  (loss)                             |       | (1,897                                                                | )          | 1,152 |   | (567 | ) | (6,427 | ) |
|                                           |       |                                                                  |       |   |   |   |   |   |   |
| Basic and diluted net  income (loss) per share |       | $                                                                     | (0.07      | ) | $ | 0.04 |   | $ | (0.02 | ) | $ | (0.25 | ) |

 

60

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**Item 9.   Changes inand Disagreements with Accountants on Accounting and Financial Disclosure**

None

**Item 9A.   Controlsand Procedures**

**Conclusion Regarding the Effectiveness of Disclosure Controls andProcedures**

We maintain disclosure controls and procedures, as such term is defined inRules 13a-15(e) and 15d-15(e) under the Securities ExchangeAct of 1934, as amended (the “Exchange Act”), that are designed to providereasonable assurance that information required to be disclosed by us in thereports that we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SECrules and forms, and that such information is accumulated and communicatedto our management, including our principal executive officer and principalfinancial officer, as appropriate, to allow timely decisions regarding requiredfinancial disclosures. Because of inherent limitations, our disclosure controlsand procedures, no matter how well designed and operated, can provide only reasonable,and not absolute, assurance that the objectives of such disclosure controls andprocedures are met.

As of the end of the period covered by this Report, we conducted anevaluation, under the supervision and with the participation of our management,including our principal executive officer and principal financial officer, ofthe effectiveness of the design and operation of our disclosure controls andprocedures pursuant to Exchange Act Rules 13a-15(b) and 15d-15(b).Based on this evaluation, our principal executive officer and principalfinancial officer concluded that our disclosure controls and procedures wereeffective as of March 31, 2007.

**Management’s Report on Internal Control Over Financial Reporting**

Our management is responsible for establishing and maintaining adequateinternal control over financial reporting, as such term is defined in ExchangeAct Rules 13a-15(f) and 15d-15(f). Our internal controlover financial reporting is a process designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation of thefinancial statements for external purposes in accordance with generallyaccepted accounting principles. Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that internal controls may become inadequate because of changes inconditions, or that the degree of compliance with policies and procedures maydeteriorate.

Under the supervision and with the participation of our management,including our principal executive officer and principal financial officer, weconducted an evaluation of the effectiveness of our internal control overfinancial reporting based on the framework set forth in *Internal Control—Integrated Framework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission. Basedon our evaluation under the framework in *InternalControl — Integrated Framework*, our management concluded that ourinternal control over financial reporting was effective as of March 31, 2007.

Ernst & Young LLP, the independent registeredpublic accounting firm that audited the consolidated financial statementsincluded in this Annual Report on Form 10-K, has also audited management’sassessment of our internal control over financial reporting and theeffectiveness of our internal control over financial reporting as of March 31,2007, as stated in their report which is included herein.

61

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**Changes in Internal Control Over Financial Reporting**

There have been no changes in our internal controlover financial reporting during the fourth quarter of fiscal year ended March31, 2007 that have or are reasonably likely to materially affect our internalcontrol over financial reporting identified in connection with the previouslymentioned evaluation.

62

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**Report of Independent Registered Public AccountingFirm on Internal Control Over Financial Reporting**

The Board of Directors and StockholdersAccelrys, Inc.

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Control Over FinancialReporting, that Accelrys, Inc. maintained effective internal control overfinancial reporting as of March 31, 2007, based on criteria established in*Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(the COSO criteria). Accelrys Inc.’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the company’s internal control over financialreporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

In our opinion, management’s assessment thatAccelrys, Inc. maintained effective internal control over financialreporting as of March 31, 2007, is fairly stated, in all materialrespects, based on the COSO control criteria. Also, in our opinion,Accelrys, Inc. has maintained effective internal control over financialreporting as of March 31, 2007, based on the COSO control criteria.

We have also audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), the 2007consolidated financial statements of Accelrys, Inc. and our report dated June1, 2007 expressed an unqualified opinion thereon.
|                        | /s/ Ernst & Young LLP |   |
|------------------------|---------------------------|--------|
|                   |                      |
| San Diego,  California |                      |
| June 1, 2007           |                      |

 

63

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**Item 9B.   OtherInformation**

On May 29, 2007, the Human Resources Committee ofour Board of Directors approved our management incentive plan for fiscal year2008 (the “2008 Management Incentive Plan”), pursuant to which ourmanagement-level employees will be eligible to receive cash bonuses based onour achievement of certain corporate goals specified in the 2008 ManagementIncentive Plan, including achieving certain non-GAAP operating income andproduct orders targets, and individual performance objectives. These bonusesare designed to attract, motivate, retain and reward our management-levelemployees. Under the 2008 Management Incentive Plan, the Chief ExecutiveOfficer has an annual bonus target equal to 100% of his base salary, the ChiefFinancial Officer has an annual bonus target equal to 50% of his base salary,the Senior Vice President, Worldwide Sales and Support has an annual bonustarget of 60% of his base salary, and all other executive officers have anannual bonus target equal to 40% of their respective base salaries. Payoutsunder the 2008 Management Incentive Plan will vary dependant upon the level ofachievement of the specified corporate and individual goals, and will rangefrom zero to two times the targeted bonus amount. The Human Resources Committeewill make all final determinations regarding the achievement of goals and thepayment of bonuses pursuant to the 2008 Management Incentive Plan. The HumanResources Committee has the ability to modify, suspend or terminate the 2008Management Incentive Plan at any time.

64

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**PART III**

**Item 10.**                   Directors,Executive Officers and Corporate Governance

The information required by this item is incorporatedby reference from the Proxy Statement.

**Item 11.**                   ExecutiveCompensation

The information required by this item is incorporatedby reference from the Proxy Statement.

**Item 12.**                   SecurityOwnership of Certain Beneficial Owners and Management and Related StockholdersMatters

The information required by this item is incorporatedby reference from the Proxy Statement.

**Item 13.**                   CertainRelationships and Related Transactions, and Director Independence

The information required by this item is incorporatedby reference from the Proxy Statement.

**Item 14.**                   PrincipalAccountant Fees and Services

The information required by this item is incorporatedby reference from the Proxy Statement.

65

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**PART IV**

**Item 15.**                   Exhibits andFinancial Statement Schedules

(a)(1) Financial Statements

The following Consolidated Financial Statements areincluded:
| Report of Ernst &  Young LLP, Independent Registered Public Accounting Firm                          |   |
|---------------------------------------------------------------------------------------------------------------|--------|
| Consolidated  Balance Sheets as of March 31, 2007 and 2006                                               |   |
| Consolidated  Statements of Operations for the years ended March 31, 2007, 2006 and  2005                |   |
| Consolidated  Statements of Stockholders’ Equity for the years ended March 31, 2007,  2006 and 2005 |   |
| Consolidated  Statements of Cash Flows for the years ended March 31, 2007, 2006 and  2005                |   |
| Notes to  Consolidated Financial Statements                                                                   |   |

 

(a)(2) Financial Statement Schedules

Schedule II—Valuation and Qualifying Accounts
| **Description**                   | ** ** | **Balance at  Beginning of  Year** | ** ** | **Additions  Charged to  Costs and  Expenses** | ** ** | **Deductions(1)** | ** ** | **Balance at  End of  Year** | ** ** |
|-----------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------|------------|-------------------|------------|----------------------------------------|------------|
| ** **                        | ** ** | **(In thousands)**                      | ** ** |
| Allowance for  doubtful accounts: |       |                                         |       |                                                     |       |              |       |                                   |       |
| Year ended March 31, 2007    |       | $                                            | 351        |                                                     | $          | —            |       | $                                      | 138        |   | $ | 213 |   |
| Year ended March 31, 2006    |       | $                                            | 315        |                                                     | $          | —            |       | $                                      | (36        | ) | $ | 351 |   |
| Year ended  March 31, 2005   |       | $                                            | 191        |                                                     | $          | 394               |       | $                                      | 270        |   | $ | 315 |   |

 

----

(1)             Representswrite-offs, net of recoveries.

All other schedules are omitted because they are notapplicable, or not required, or because the required information is included inthe financial statements or notes thereto.

(a)(3) Exhibits:
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1             |       | Agreement and Plan of Merger and Reorganization  dated September 13, 2004 by and among Accelrys, Inc., Nashville  Acquisition Corporation, SciTegic, Inc., Mathew Hahn and David Rogers as  Principal Shareholders, and Mathew Hahn as Shareholder Representative  (incorporated by reference to Exhibit 2.1 to Accelrys, Inc.’s Report on  Form 8-K dated September 16, 2004).                                                                                                          |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3.1             |       | Restated Certificate of Incorporation of  Pharmacopeia, Inc. (incorporated by reference to Exhibit 3.1 to  Accelrys, Inc.’s Report on Form 10-K for the year ended  December 31, 1996).                                                                                                                                                                                                                                                                                                            |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3.2             |       | Certificate of Amendment of the Restated Certificate  of Incorporation of Pharmacopeia, Inc. (incorporated by reference to  Exhibit 3.2 to Accelrys, Inc.’s Report on Form 10-K for the year ended March  31, 2005).                                                                                                                                                                                                                                                                                              |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3.3             |       | Amended and Restated Bylaws of Accelrys, Inc.  as amended. (incorporated by reference to Exhibit 3.3 to Accelrys, Inc.’s  Report on Form 10-K for the year ended March 31, 2005).                                                                                                                                                                                                                                                                                                                                 |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.1             |       | Rights Agreement, dated as of September 6,  2002, between Pharmacopeia, Inc. and American Stock Transfer &  Trust Company, as Rights Agent, which includes as Exhibit A thereto the  Certificate of Designation, Preferences and Rights of Series A Junior  Participating Preferred Stock and Exhibit B thereto the Form of  Right Certificate (incorporated by reference to Exhibit 4.1 to  Accelrys, Inc.’s Report on Form 8-K dated September 4,  2002). |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.1#           |       | Amended 1994 Incentive Stock Plan (incorporated by  reference to Exhibit 10.5 to Accelrys, Inc.’s Report on  Form 10-K for the year ended December 31, 1995).                                                                                                                                                                                                                                                                                                                                      |

 

66

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| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                                                                 |
|-----------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1(a)#        |       | Amendment No. 1 to the 1994 Incentive Stock  Plan (incorporated by reference to Exhibit 10.1(a) to  Accelrys, Inc.’s Report on Form 10-K for the year ended  December 31, 2000).                                                                        |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.1(b)#        |       | Amendment No. 2 to the 1994 Incentive Stock  Plan (incorporated by reference to Exhibit 10.1(b) to  Accelrys, Inc.’s Report on Form 10-K for the year ended  December 31, 2000).                                                                        |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.1(c)#        |       | Amendment No. 3 to the 1994 Incentive Stock  Plan (incorporated by reference to Exhibit 10.5(a) to  Accelrys, Inc.’s Report on Form 10-Q for the quarter ended  June 30, 1997).                                                                         |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.1(d)#        |       | Amendment No. 4 to the 1994 Incentive Stock  Plan (incorporated by reference to Exhibit 10.1(d) to  Accelrys, Inc.’s Report on Form 10-K for the year ended  December 31, 2000).                                                                        |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.1(e)#        |       | Amendment No. 5 to the 1994 Incentive Stock  Plan (incorporated by reference to Exhibit 10.1(e) to  Accelrys, Inc.’s Report on Form 10-K for the year ended  December 31, 2000).                                                                        |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.1(f)#        |       | Amendment No. 6 to the 1994 Incentive Stock  Plan (incorporated by reference to Exhibit 10.1(f) to  Accelrys, Inc.’s Report on Form 10-K for the year ended  December 31, 2000).                                                                        |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.1(g)#        |       | Amendment No. 7 to the 1994 Incentive Stock  Plan (incorporated by reference to Exhibit 10.1(g) to  Accelrys, Inc.’s Report on Form 10-K for the year ended  December 31, 2000).                                                                        |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.1(h)#        |       | Amendment No. 8 to the 1994 Incentive Stock  Plan (incorporated by reference to Exhibit 10.54 to  Accelrys, Inc.’s Report on Form 10-Q for the quarter ended  June 30, 2000).                                                                                     |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.1(i)#        |       | Amendment No. 9 to the 1994 Incentive Stock  Plan (incorporated by reference to Exhibit 10.1(i) to  Accelrys, Inc.’s Report on Form 10-Q for the quarter ended  March 31, 2002).                                                                        |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.2#           |       | 1995 Director Option Plan (incorporated by reference  to Exhibit 10.7 to Accelrys, Inc.’s Registration Statement on  Form S-1 (Reg. No. 33-98246)).                                                                                                                    |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.2(a)#        |       | Amendment No. 1 to 1995 Director Option Plan  (incorporated by reference to Exhibit 10.3(a) to  Accelrys, Inc.’s report on form 10-K for the year ended  December 31, 2000).                                                                                 |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.2(b)#        |       | Amendment No. 2 to the 1995 Director Option  Plan (incorporated by reference to Exhibit 10.3(b) to  Accelrys, Inc.’s report on Form 10-Q for the quarter ended  March 31, 2001).                                                                        |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.2 (c)        |       | Accelrys, Inc. 2004 New Hire Equity Incentive  Plan (incorporated by reference to Exhibit 10.3(c) to Accelrys, Inc.’s  Report on Form 10-K for the year ended March 31, 2005).                                                                                                   |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.3#           |       | Amendment to employment agreement, effective as of  May 1, 2003, between the Company and Joseph A. Mollica, Ph.D.  (incorporated by reference to exhibit 10.9(a) to Accelrys, Inc.’s  report on Form 10-Q for the quarter ended March 31, 2003.)                  |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.4#           |       | Form of Indemnity Agreement for Directors and  Executive Officers (incorporated by reference to Exhibit 10.48 to  Accelrys, Inc.’s Report on Form 10-K for the year ended  December 31, 1998).                                                                    |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.5#           |       | Accelrys, Inc. 2000 Stock Option Plan  (incorporated by reference to Exhibit 10.23 to Accelrys, Inc.’s  Report on form 10-K for the year ended December 31, 2000).                                                                                                     |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.6#           |       | Accelrys, Inc. Executive Non-Qualified Deferred  Compensation Plan (incorporated by reference to Exhibit 10.52 to  Accelrys, Inc.’s Report on Form 10-Q for the quarter ended  March 31, 2000).                                                                   |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.7#           |       | Separation Agreement and Release of Claims dated  September 30, 2002, by and between Accelrys, Inc. and Michael R.  Stapleton (incorporated by reference to Exhibit 10.25/a to  Accelrys, Inc.’s Report on Form 10-K for the year ended  December 31, 2002). |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.8            |       | Lease, dated August 20, 2003, between  Accelrys, Inc. and Eastpark at 8A (Building 1000) (incorporated by  reference to Exhibit 10.35 to Accelrys, Inc.’s Report on Form 10-Q  for the quarter ended September 30, 2003).                                         |
|            |       |                                                                                                                                                                                                                                                                                            |
| 10.9            |       | Lease, dated August 20, 2003, between  Accelrys, Inc. and Eastpark at 8A (Building 3000) (incorporated by  reference to Exhibit 10.36 to Accelrys, Inc.’s Report on Form 10-Q  for the quarter ended September 30, 2003).                                         |

 

67

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| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                         |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.10           |       | Sublease, dated May 18, 2004, between  Accelrys, Inc. and Pfizer Inc. (incorporated by reference to Exhibit  10.18 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended December  31, 2004).                                    |
|            |       |                                                                                                                                                                                                                                                    |
| 10.11           |       | Lease, dated May 18, 2004, between  Accelrys, Inc. and AGRRI Seaview, L.LC. (incorporated by reference to  Exhibit 10.19 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended  December 31, 2004).                              |
|            |       |                                                                                                                                                                                                                                                    |
| 10.12           |       | Sublease, dated January 27, 2005, between  Accelrys, Inc. and QUALCOMM Incorporated (incorporated by reference to  Exhibit 10.20 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended  December 31, 2004).                      |
|            |       |                                                                                                                                                                                                                                                    |
| 10.13#          |       | R. William Taylor employment letter (incorporated by  reference to Exhibit 10.23 to Accelrys, Inc.’s Report on Form 10-Q for  the quarter ended December 31, 2004).                                                                           |
|            |       |                                                                                                                                                                                                                                                    |
| 10.14#          |       | Separation Agreement and Release for John J. Hanlon  (incorporated by reference to Exhibit 10.24 to Accelrys, Inc.’s Report on  Form 10-Q for the quarter ended December 31, 2004).                                                                |
|            |       |                                                                                                                                                                                                                                                    |
| 10.15#          |       | Separation Agreement and Mutual Release, dated  October 4, 2005, between Accelrys, Inc. and Mahesh Krishnamurthy  (incorporated by reference to Exhibit 10.11 to Accelrys, Inc.’s  Form 8-K dated October 11, 2005). |
|            |       |                                                                                                                                                                                                                                                    |
| 10.16#          |       | Letter of Employment, dated September 29, 2005,  between Accelrys, Inc. and Richard Murphy (incorporated by reference to  Exhibit 99.1 to Accelrys, Inc.’s Form 8-K dated October 19,  2005).                        |
|            |       |                                                                                                                                                                                                                                                    |
| 10.17#          |       | Accelrys, Inc. Amended and Restated 2004 Stock  Incentive Plan (incorporated by reference to Exhibit 4.2 to Accelrys, Inc.’s  Report on Form S-8 filed on August 26, 2005).                                                                        |
|            |       |                                                                                                                                                                                                                                                    |
| 10.18#          |       | Form of Stock Option Award Agreement pursuant to  Amended and Restated 2004 Stock Incentive Plan (incorporated by reference to  Exhibit 4.3 to Accelrys, Inc.’s Report on Form S-8 filed on August 26,  2005).                                |
|            |       |                                                                                                                                                                                                                                                    |
| 10.19#          |       | Form of SAR Award Agreement pursuant to Amended and  Restated 2004 Stock Incentive Plan (incorporated by reference to Exhibit 4.4  to Accelrys, Inc.’s Report on Form S-8 filed on August 26, 2005).                                               |
|            |       |                                                                                                                                                                                                                                                    |
| 10.20#          |       | Form of Restricted Stock Award Agreement pursuant to  Amended and Restated 2004 Stock Incentive Plan (incorporated by reference to Exhibit  4.5 to Accelrys, Inc.’s Report on Form S-8 filed on August 26, 2005).                             |
|            |       |                                                                                                                                                                                                                                                    |
| 10.21#          |       | Form of Restricted Stock Unit Award Agreement  pursuant to Amended and Restated 2004 Stock Incentive Plan (incorporated by  reference to Exhibit 4.6 to Accelrys, Inc.’s Report on Form S-8 filed on  August 26, 2005).                            |
|            |       |                                                                                                                                                                                                                                                    |
| 10.22#          |       | Terms of continuing employment of Matthew Hahn,  dated as of August 12, 2005 (incorporated by reference to Exhibit 10.3 to  Accelrys, Inc.’s Report on Form 10-Q for the quarter ended September 30, 2005).                                        |
|            |       |                                                                                                                                                                                                                                                    |
| 10.23           |       | Sublease, dated May 10, 2006, between Accelrys,  Inc., Accelrys, Ltd., QUALCOMM Inc., and QUALCOMM UK Ltd. (incorporated by  reference to Exhibit 10.33 to Accelrys, Inc.’s Report on Form 10-K for the  year ended March 31, 2006).               |
|            |       |                                                                                                                                                                                                                                                    |
| 10.24#          |       | Employment Agreement dated May 21, 2006 by and  between Accelrys, Inc. and Mark J. Emkjer. (incorporated by  reference to Exhibit 10.34 to Accelrys, Inc.’s Report on Form 10-K for the  year ended March 31, 2006).           |
|            |       |                                                                                                                                                                                                                                                    |
| 10.25#          |       | Fiscal year 2007 Management Incentive Plan.  (incorporated by reference to Exhibit 10.35 to Accelrys, Inc.’s Report on  Form 10-K for the year ended March 31, 2006).                                                                              |
|            |       |                                                                                                                                                                                                                                                    |
| 10.26           |       | Employment Transition and Separation Agreement,  dated June 14, 2006, between Accelrys, Inc. and David M. Sankaran  (incorporated by reference to Exhibit 99.1 to Accelrys, Inc.’s Form 8-K dated  June 15, 2006)                                  |

 

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| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                            |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.27#          |       | Letter of Employment, dated September 1, 2006,  between Accelrys, Inc. and Rick E. Russo (incorporated by reference to  Exhibit 99.1 to Accelrys, Inc.’s Form 8-K dated September 6, 2006)                                            |
|            |       |                                                                                                                                                                                                                                       |
| 10.28#          |       | Letter of Employment, dated September 6, 2006,  between Accelrys, Inc. and Frank K. Brown, Ph.D. (incorporated by reference  to Exhibit 99.3 to Accelrys, Inc.’s Form 8-K dated September 28, 2006)                                   |
|            |       |                                                                                                                                                                                                                                       |
| 10.29#          |       | Second Amendment to Employment Agreement, dated  September 26, 2006, between Accelrys, Inc. and Mathew Hahn, Ph.D.  (incorporated by reference to Exhibit 99.2 to Accelrys, Inc.’s Form 8-K dated  September 28, 2006)                |
|            |       |                                                                                                                                                                                                                                       |
| 10.30#          |       | Form of Employment Agreement between Accelrys, Inc.  and certain of its executives (incorporated by reference to Exhibit 10.5 to  Accelrys, Inc.’s Form 10-Q for the quarter ended September 30, 2006)                                |
|            |       |                                                                                                                                                                                                                                       |
| 10.31#          |       | Amendment to Employment Agreement, dated February 1,  2007, between Accelrys, Inc. and Nicholas Austin (incorporated by reference  to Exhibit 10.2 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended  December 31, 2006). |
|            |       |                                                                                                                                                                                                                                       |
| 10.32#*         |       | Fiscal year 2008 Management Incentive Plan.                                                                                                                                                                                                |
|            |       |                                                                                                                                                                                                                                       |
| 14.1            |       | Code of Ethics (incorporated by reference to Exhibit  14.1 to Accelrys, Inc.’s Report on Form 8-K filed on February 5, 2005.)                                                                                                         |
|            |       |                                                                                                                                                                                                                                       |
| 21.1*           |       | Subsidiaries of Accelrys, Inc.                                                                                                                                                                                                             |
|            |       |                                                                                                                                                                                                                                       |
| 23.1*           |       | Consent of Independent Registered Public Accounting  Firm                                                                                                                                                                                  |
|            |       |                                                                                                                                                                                                                                       |
| 31.1*           |       | Section 302 Certification of the Principal  Executive Officer                                                                                                                                                                         |
|            |       |                                                                                                                                                                                                                                       |
| 31.2*           |       | Section 302 Certification of the Principal  Financial Officer                                                                                                                                                                         |
|            |       |                                                                                                                                                                                                                                       |
| 32.1*           |       | Section 906 Certification of the Chief  Executive Officer and Chief Financial Officer                                                                                                                                                 |

 

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#                    Representsa management contract or compensatory plan or arrangement.

*                    Filedherewith

(b)                                 Exhibits

See Item 15(a)(3) above.

(c)                                  FinancialStatement Schedules

See Item 15(a)(2) above.

69

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**SIGNATURE**

Pursuant to the requirements of section 13 or15(d) of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.
|        | Accelrys, Inc. |
|--------|----------------|
|   |           |
|   | By:            | /s/ RICK E. RUSSO |   |
|   |           | RICK E. RUSSO |
|   | * *       | *Senior Vice President and* |
|   | * *       | *Chief Financial Officer* |
|   | * *       | *(Duly Authorized Officer and* |
|   | * *       | *Chief Financial Officer)* |
|   | * *       | * * |
|   |           | Date: June 4, 2007 |

 

70

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**POWER OF ATTORNEY**

KNOW ALL PERSONS BY THESE PRESENTS, that each personwhose signature appears below constitutes and appoints Mark J. Emkjer and RickE. Russo, jointly and severally, as his or her attorney-in-fact, each with fullpower of substitution, for him or her, in any and all capacities, to sign eachamendment to this report on Form 10-K, and to file the same, withexhibits thereto and other documents in connection therewith, with theSecurities and Exchange Commission, hereby ratifying and confirming all thateach of said attorneys-in-fact or his or her substitute or substitutes maylawfully do or cause to be done by virtue hereof.

Pursuant to therequirements of the Securities Exchange Act of 1934, this Report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated:
| Signatures                  | ** ** | **Title**                                         | ** ** | **Date**     |
|-----------------------------|------------|---------------------------------------------------|------------|--------------|
|                        |       |                                              |       |         |
| /s/ MARK J.  EMKJER         |       | Director, President and Chief Executive Officer   |       | June 4, 2007 |
| Mark J. Emkjer              |       | (Principal Executive Officer)                     |       |         |
|                        |       |                                              |       |         |
|                        |       |                                              |       |         |
| /s/ RICK E. RUSSO           |       | Senior Vice President and Chief Financial Officer |       | June 4, 2007 |
| Rick E. Russo               |       | (Principal Financial Officer)                     |       |         |
|                        |       |                                              |       |         |
|                        |       |                                              |       |         |
| /s/ KENNETH L.  COLEMAN     |       | Chairman of the Board of Directors                |       | June 4, 2007 |
| Kenneth L.  Coleman         |       |                                              |       |         |
|                        |       |                                              |       |         |
|                        |       |                                              |       |         |
| /s/ GARY E. COSTLEY, Ph.D.  |       | Director                                          |       | June 4, 2007 |
| Gary E. Costley,  Ph.D.     |       |                                              |       |         |
|                        |       |                                              |       |         |
|                        |       |                                              |       |         |
| /s/ RICARDO B. LEVY, Ph.D.  |       | Director                                          |       | June 4, 2007 |
| Ricardo B. Levy,  Ph.D.     |       |                                              |       |         |
|                        |       |                                              |       |         |
|                        |       |                                              |       |         |
| /s/ CHRISTOPHER  J. STEFFEN |       | Director                                          |       | June 4, 2007 |
| Christopher J.  Steffen     |       |                                              |       |         |

 

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