**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

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**Form 10-K**

**FORANNUAL AND TRANSITION REPORTSPURSUANT TO SECTIONS 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

**(Mark One)**

**x**           ANNUAL REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

**Forthe fiscal year ended March 31, 2006**

**or**

**£**            TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

**Forthe transition period from          to          **

**Commissionfile number: 0-27188**

**Accelrys, Inc.**

(Exact name of registrantas specified 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 National  Market                       |

 

Securities registered pursuant to Section 12(g) ofthe Act:

**None**

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes o   No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Exchange Act.Yes o   No x

Note—checking the box abovewill not relieve any registrant required to file reports pursuant to Section 13of 15(d) of the Exchange Act from their obligations under those Sections.

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x   No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§229.405 of this chapter) is not contained herein, and will not be contained,to the best of the registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K. x

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

| Large accelerated filer o |   | Accelerated filer x |   | Non-accelerated  filer o |
|---------------------------|--------|---------------------|--------|--------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o   No x

The aggregate market valueof the voting stock held by non-affiliates of the registrant as of September 30,2005 was $113.1 million (based upon the September 30, 2005 closing pricefor shares of the registrant’s common stock as reported by the NASDAQ NationalMarket). Shares of common stock held by each officer, director and holder of 5%or more of the outstanding common stock have been excluded in that such personsmay be deemed to be affiliates. This determination of affiliate status is notnecessarily a conclusive determination for other purposes.

The number of outstandingshares of the registrant’s common stock, par value $0.0001 per share, as of April 27,2006 was 26,211,888, net of treasury shares.

**DOCUMENTSINCORPORATED BY REFERENCE**

Portions of the registrant’sdefinitive Proxy Statement to be filed with the Securities and ExchangeCommission within 120 days after registrant’s fiscal year ended March 31,2006 are incorporated by reference into this report.

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

 

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**ACCELRYS, INC.FORM 10-K—ANNUAL REPORTFor the Fiscal Year Ended March 31, 2006Table of Contents**
|                   | ** ** | ** **                                                                                       | ** ** | **Page** |
|-------------------|------------|--------------------------------------------------------------------------------------------------|------------|----------|
| **PART I**   |       |                                                                                             |       |     |   |
| Item 1            |       | Business                                                                                         |       | 3        |   |
| Item 1A           |       | Risk Factors                                                                                     |       | 9        |   |
| Item  1B          |       | Unresolved  Staff Comments                                                                       |       | 19       |   |
| Item 2            |       | Properties                                                                                       |       | 19       |   |
| Item 3            |       | Legal  Proceedings                                                                               |       | 19       |   |
| Item  4           |       | Submission  of Matters to a Vote of Security Holders                                             |       | 19       |   |
| **PART II**  |       |                                                                                             |       |     |   |
| Item  5           |       | Market  for Registrant’s Common Equity and Related Stockholder Matters                      |       | 20       |   |
| Item 6            |       | Selected  Consolidated Financial Data                                                            |       | 21       |   |
| Item  7           |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations      |       | 23       |   |
| Item  7A          |       | Quantitative  and Qualitative Disclosures About Market Risk                                      |       | 39       |   |
| Item  8           |       | Financial  Statements and Supplementary Data                                                     |       | 40       |   |
| Item  9           |       | Changes  in and Disagreements With Accountants on Accounting and Financial Disclosure            |       | 78       |   |
| Item  9A          |       | Controls  and Procedures                                                                         |       | 78       |   |
| Item 9B           |       | Other  Information                                                                               |       | 82       |   |
| **PART III** |       |                                                                                             |       |     |   |
| Item  10          |       | Directors  and Executive Officers of the Registrant                                              |       | 84       |   |
| Item  11          |       | Executive  Compensation                                                                          |       | 84       |   |
| Item  12          |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters |       | 84       |   |
| Item  13          |       | Certain  Relationships and Related Transactions                                                  |       | 84       |   |
| Item  14          |       | Principal  Accounting Fees and Services                                                          |       | 84       |   |
| **PART IV**  |       |                                                                                             |       |     |   |
| Item  15          |       | Exhibits  and Financial Statement Schedules                                                      |       | 85       |   |
| **Signatures**    |       | 90                                                                                               |       |

 

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**Forward-LookingStatements**

When used anywhere in this Annual Report on Form 10-K(this “Report”), the words “expect”, “believe”, “anticipate”, “estimate”, “intend”,“plan” and similar expressions are intended to identify forward-lookingstatements. These forward-looking statements may include statements addressingour future financial and operating results. We have based these forward-lookingstatements on our current expectations about future events. Such statements aresubject to certain risks and uncertainties including those related to executionupon our strategic plans, the successful release and**acceptanceof new products, the demand for new and existing products, additionalcompetition, changes in economic conditions and those described in documents wehave filed with the Securities and Exchange Commission, including this Reportin “Management’s Discussion and Analysis of Financial Condition and Results ofOperations,” “Risk Factors,” and subsequent reports on Form 10-Q.All forward-looking statements in this document are qualified entirely by thecautionary statements included in this document and such other filings. Theserisks and uncertainties could cause actual results to differ materially fromresults expressed or implied by forward-looking statements contained in thisdocument. These forward-looking statements speak only as of the date of thisdocument. We disclaim any undertaking to publicly update or revise anyforward-looking statements contained herein to reflect any change in ourexpectations with regard thereto or any change in events, conditions orcircumstances on which any such statement is based.

Unless the contextrequires otherwise, in this report the terms “we,” “us” and “our” refer toAccelrys, Inc. and its wholly owned or indirect subsidiaries, and theirpredecessors.

**PART I**

**Item 1.   Business**

**Overview**

We develop andcommercialize software for computation, simulation, management and mining ofscientific data used by biologists, chemists and materials scientists,including nanotechnology researchers for product design as well as drug discoveryand development. Our technology and services are designed to meet the needs oftoday’s leading research organizations. We are headquartered in San Diego,California and were incorporated in Delaware in 1993. Our company website islocated at www.accelrys.com. Copies of our annual reports on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K,and amendments to those reports are available without charge on our website assoon as reasonably practicable after being filed with or furnished to the U.S.Securities and Exchange Commission (the “SEC”).

**Restatement ofFinancial Statements**

In this Report, we have restated our previously issuedconsolidated financial statements to reflect certain accounting adjustments. Thedecision to restate our consolidated financial statements was made by the AuditCommittee of our Board of Directors on December 16, 2005, followingconsultation with, and upon the recommendation of, management and Ernst &Young LLP (“E&Y”), our independent registered public accounting firm. Ourdecision to restate was made in connection with a review of our Annual Reporton Form 10-K for the year ended March 31, 2005 by theCorporation Finance Division of the SEC.

Our restated consolidated financial statementscontained in this Report reflect changes to the timing of revenue recognizedunder term-based and perpetual software license arrangements which includemultiple elements (typically software licenses and post-contract customersupport, referred to as “PCS”) and a change in accounting for softwaredevelopment costs. Our restated consolidated financial statements also reflectthe reclassification of general and administrative expenses and interest incomebetween continuing and discontinued operations, the reclassification of cashflows from discontinued operations as 

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net cash provided by (usedin) discontinued operating, investing and financing activities, as opposed to asingle line item as previously reported, and the reclassification ofinvestments in auction rate securities to marketable securities from cash andcash equivalents. The impact of the restatement on our previously issuedconsolidated financial statements is described more fully in “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andin Note 2 to our restated consolidated financial statements included elsewherein this Report.

In connection with the restatement, managementidentified and reported to the Audit Committee certain control deficienciesthat constituted material weaknesses in internal control over financialreporting. As a result of the identification of the material weaknesses, wehave identified certain control enhancements and improvements that, once fullyimplemented, will strengthen our internal control over financial reporting. Thematerial weaknesses and the identified control improvements and enhancements tobe implemented are described more fully in “Controls and Procedures” includedelsewhere in this Report.

We have not amended ourpreviously filed Annual Reports on Form 10-K or Quarterly Reports onForm 10-Q for the restatement, and the financial statements andrelated financial statement information contained in those reports should nolonger be relied upon. Throughout this Report, all amounts presented from priorperiods and prior period comparisons are labeled as “restated” and reflect thebalances and amounts on a restated basis.

**Description of OurIndustry**

For companies in thepharmaceutical, biotechnology, chemical, petrochemical and materialsindustries, innovation in the discovery and development of new products and therapid, cost-effective commercialization of these products can be crucial tosuccess. Companies in these industries invest considerable resources intechnologies that suggest productive new pathways for research projects,increase the efficiency of discovery and development processes, or enable themto maximize the use of corporate scientific data, information and knowledge. Onesuch set of technologies is software-based computation, analysis, informatics,workflow and knowledge management tools. These tools allow users to simulatekey chemical and biological systems, understand and predict fundamental properties,and assist in the design of new or improved products and processes. They alsomanage and mine scientific data, turning it into useful information andsupporting decision processes and research and development workflows.

**Description of OurBusiness**

We design, develop,market, and support software and related services that facilitate the discoveryand development of new and improved products and processes in thepharmaceutical, biotechnology, chemical, petrochemical and materialsindustries. Using our products, researchers may increase the speed andefficiency of the research and development cycle, thereby reducing productdevelopment costs and shortening the time to market for new productintroductions and process improvements. Our customers include leadingcommercial, government and academic organizations. Many of the largestpharmaceutical, biotechnology, chemical, petroleum and semiconductor companiesworldwide use our software. We market our products and services worldwide,principally through our direct sales force, augmented by the use of third-partydistributors.

**Business Strategy**

Our objective is tostrengthen our position as a leading provider of software-based scientificcomputation, analysis, informatics, knowledge management, workflow products andservices worldwide. We plan to accomplish this objective by providing acomprehensive set of integrated solutions that are central to theenterprise-wide research and development activities of our customers, and byconnecting 

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thesetools within an information technology framework that makes it easier forresearch and development organizations to manage data, information, knowledge,and collaborative processes.

**Products andServices**

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

*Modelingand Simulation Software.*   Many factors thataffect a molecule, including activity, bioavailability, toxicity, shelf lifeand environmental impact, are governed by fundamental properties such as shape,structure and reactivity that are determined at the sub-atomic, molecular, ornear-molecular levels. A spectrum of simulation technologies—quantum mechanicalsimulation, molecular simulation, and mesoscale simulation—predict theseproperties and help researchers discover new products, sharpen the focus ofexperimental activities and improve ultimate product performance. We are aleading provider of such modeling and simulation software.

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 plan to continue enhancing 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 by enabling straightforward access to our modeling and simulationsoftware from personal computers thereby making our products available to amuch larger population of biologists, chemists and engineers. This also helpsexpert modelers to connect and communicate more effectively to the widerresearch organization. Further, these products assist organizations incapturing, managing, and sharing the critical knowledge developed in modeling.

*InformaticsSoftware.**  *We are aleading provider of tools to capture, store, manage, and mine scientific dataand information. Informatics is a well-established technology in life sciences,where bioinformatics tools are integral to genetic and biological research, andcheminformatics applications are 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 data visualization and analysis software tosearch, retrieve, and use chemical structures, biological and chemical data,experimental data, and registration information. Many of these tools useindustry standard software components and are compliant with applications suchas Microsoft Excel®,allowing chemists to interact with chemical data within familiar productivitytools. We also use this component technology and our database architectures tobuild enterprise-wide systems for our clients.

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*WorkflowSoftware Solution.**  *Ourworkflow software solution allows customers to analyze and mine extremely largedata sets in real time. Informatics analyses generally require multiplecomputational steps. To address this issue, our solutions allow for automateddata analysis protocols to be saved for re-use or shared with a broad communityof users within the organization.

In addition to software modules, we also offer thefollowing services:

*CustomerSupport and Training.**  *Experttelephone support, an Internet-based knowledge-base and request-trackingsystem, and on-site training, web-based training, and scheduled trainingworkshops, are all designed to enhance customer success in the application ofour technologies.

*ContractResearch.**  *Ourscientists can be contracted to work on specific projects. These servicesprovide a high level of collaboration with the client and include mentoring andknowledge transfer related to the application of our modeling tools.

*Consulting Services.*   Weoffer consulting services including installation, non-complex implementationand integration.

**Customers**

Our customer base consists of commercial, governmentaland academic organizations. No single customer accounted for more than 10% ofour revenue during any of the three most recently completed fiscal years.

*CommercialCustomers.*   Our commercial customers include manyof the world’s largest pharmaceutical, biotechnology, chemical, petroleum andmaterial science companies. In each of the past three fiscal years, asignificant portion of our total revenue has been derived from pharmaceutical,biotechnology and chemical companies.

*GovernmentalCustomers.*   Many governmental institutions in theUnited States, Canada, Europe and the Asia/Pacific region use our products.

*Academic Customers.*   Manyuniversities in the United States, Europe and the Asia/Pacific region use ourproducts. This use historically has been for purposes of academic research, butwe believe our products increasingly may be used as a part of formal universityteaching curricula.

**Strategic andAcademic Alliances**

We have entered into anumber of strategic alliances relating to product development, productdistribution and joint marketing. We plan to continue to cultivaterelationships with academic, governmental and commercial research organizationsfor purposes of identifying and licensing new technology to use in productdevelopment. In addition, we plan to maintain and expand our alliances focusingon the compatibility of our products with databases and database managementsystems, other computational chemistry and molecular simulation products, andproducts in related markets such as imaging and clinical informatics. We alsointend to continue to enter into porting and joint marketing arrangements withhardware vendors on whose systems our products operate.

**Sales and Marketing**

We market our products and services worldwide.Historically, we have generated approximately 55%, 25% and 20% of our revenuesfrom the United States, Europe and Asia-Pacific, respectively. Please refer to Note 3 to our restated consolidatedfinancial statements included elsewhere in this Report for a breakdown ofrevenues and long-lived assets by geographic region. Our continuing reliance onsales in international markets exposes us to risks attendant to foreign sales,as described more fully in Item 1A of this Report.

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We sell our products and services through our directsales force, telesales and, in some markets, arrangements with distributors. Ourdirect sales representatives focus on a defined list of customers or cover anassigned 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 are primarily focused in the Asianmarket, primarily 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, generally a CD-ROM containing thepurchased software, together with the associated product literature, aregenerally shipped to our customers at the time of placing and processing theirorder. We recently initiated an electronic software distribution (“ESD”) pilotprogram, which, if implemented, will allow our customers to download ourproducts over the World Wide Web.

Our customers’ buyinghabits have historically resulted in a higher concentration of sales in thethird quarter of our fiscal year, due to traditionally higher purchasingactivity in the month of December in many commercial organizations.

**Customer Serviceand Support**

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 key to the adoption and successful utilization of our products.

Our support services givecustomers access to new releases, technical notes, documentation addenda andother support which enables customers to utilize our products more effectively,including access to our technical and scientific support personnel duringextended business hours. Both internally and through our distribution channels,we offer training conducted by staff knowledgeable in both the theory andapplication of our products. Technical newsletters and bulletins and advancenotification about future software releases are sent to customers to keep theminformed and to help them with resource allocation and scheduling. To maintainan ongoing understanding of customer requirements, we sponsor scientificsymposia and user group meetings throughout the year.

**Product Development**

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 ourproducts internally and, during the years ended March 31, 2006 and 2005and December 31, 2003, and the three months ended March 31, 2004, weincurred product development expenses totaling $21.7 million, $22.7 million,$22.4 million and $5.2 million, respectively. We have also licensed products orotherwise have acquired products, or portions of our products, from the opensource community, as well as corporate, governmental and academic institutions.These arrangements sometimes 

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involvejoint development efforts and frequently require the payment of royalties byus. The development and royalty obligations, scope of distribution rights,duration and other terms of these arrangements vary depending on the product,the market, resource requirements, the other parties with which we contract andother factors. We intend to continue to license or otherwise acquire technologyor products from third parties.

**Competitors**

The market for ourproducts is intensely competitive, subject to rapid change and significantlyaffected by new product introductions and other market activities of industryparticipants. Our competitors offer a variety of products and services toaddress this market. We believe that the principal competitive factors in thismarket are product quality, flexibility, ease-of-use, scientific validation andperformance, functionality and features, open architecture, quality of supportand service, reputation and price. Competition currently comes from thefollowing principal sources (and competitors that supply such sources listed inalphabetical order): other software packages for analysis of chemical andbiological data (ElsevierMDL, IDBS, LION bioscience);workflow and data-pipeline applications (Inforsense); desktop softwareapplications (CambridgeSoft, Tripos), including chemical drawing applications(CambridgeSoft, Elsevier MDL),molecular modeling and analytical data simulation applications (Chemical ComputingGroup, OpenEye, Schrodinger, Tripos); other typesof simulation software provided to engineers (Reactive Design); and firmssupplying databases, such as chemical or genomic information databases (Elsevier MDL, LION bioscience), and database management systems andinformation technology (Elsevier MDL,IDBS, LION bioscience).

**IntellectualProperty and Other Proprietary Rights**

We rely primarily on acombination of copyright, trademark and trade secret laws, confidentialityprocedures and contractual provisions to protect our proprietary rights. Wealso have 20 United States and foreign patents and several patent applications.We believe that factors such as the technological and creative skills of ourpersonnel, new product development, frequent product enhancements, namerecognition and reliable product maintenance are essential to establishing andmaintaining a technological leadership position. There can be no assurance thatour means of protecting our proprietary rights in the United States or abroad willbe adequate. 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, 2006,we had 479 full-time employees. None of our employees are covered by collectivebargaining agreements. Substantially all of our employees, other than certainof our executive officers and employees with customary employment arrangementswithin Europe, are at will employees, which means that each employee canterminate his or her relationship with us and we can terminate our relationshipwith him or her at any time. We offer industry competitive wages and benefitsand are committed to maintaining a workplace environment that promotes employeeproductivity and satisfaction. We believe our relations with our employees aregood.

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**Item 1A.     Risk Factors**

*You should carefully consider the risks describedbelow before investing in our publicly-traded securities. The risks describedbelow are not the only ones facing us. Our business is also subject to therisks that affect many other companies, such as competition, technologicalobsolescence, labor relations, general economic conditions, geopoliticalchanges and international operations. Additional risks not currently known tous or that we currently believe are immaterial also may impair our businessoperations and our liquidity.*The risks described below could cause our actual results to differmaterially from those contained in forward-looking statements we have made inthis Report, the information incorporated herein by reference and those we maymake from time to time.

**Certain RisksRelated to Our Marketplace and Environment**

***Our revenue fromthe sale of modeling, simulation and informatics software to the life sciencediscovery research marketplace, which has historically constituted asignificant portion of our overall revenue, has been declining over the pastseveral years and may continue to decline in future years.***   Historicallywe have derived a significant portion of our revenue from the sale of modeling,simulation and informatics software to the discovery research departments inpharmaceutical and biotechnology companies. Such revenues have been decliningover the past several years. We believe this decline is due to several factors,including industry consolidation, a general reduction in the level of discoveryresearch activity by our customers, increased competition, includingcompetition from open source software, and reductions in profit and relatedinformation technology spending by our customers, due in part to the expirationof patents on profitable drugs. 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 developing,marketing and selling software and service solutions to both our existingcustomers and to new customers.***   Our strategyinvolves transforming our product and service offerings by providing tools andcomponents to our customers which allow our customers to integrate softwareapplications and data more easily. A key enabler of this strategy is the datapipelining and workflow technology we acquired through the September 2004acquisition of SciTegic, Inc. We are utilizing SciTegic’s Pipeline Pilottechnology to enable our customers to build solutions which allow them toreceive greater value from their data, information and knowledge. Selling thistype of solution is fundamentally different than our historical sale ofmodeling and simulation products, and this type of offering is dependant uponour ability to build a successful services offering. Our sales and servicesmanagement are focused on transforming our sales process to allow us to besuccessful with this type of sale. In addition, we are adding personnel anddefining services offerings to enable our customers to successfully deploythese solutions. There can be no assurance that we will be successful in thistransformation of our sales processes and in the building of our servicescapabilities. If we are not successful, our ability to sustain or increaserevenue may be adversely impacted.

***Our ability to sustainor increase revenues will depend upon our success in entering new markets andin deriving additional revenues from our existing customers.***   Ourproducts are currently used primarily by molecular modeling and simulationspecialists in discovery research organizations. Our strategy is to expandusage of our products and services by marketing and distributing our softwareto a broader, more diversified group of biologists, chemists, engineers andinformaticians within our existing pharmaceutical and biotechnology customers,as well as to new customers in other industries. However, our products andservices may not achieve market acceptance or penetration in targeted newdepartments within our customers or in new industries. As a result, we may notbe able to sustain or increase revenue.

***We may be unable todevelop strategic relationships with our customers.******  ***Our strategy is to expandusage of our products and services by marketing and distributing solutions to abroader, 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 

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software and solutions. Becominga preferred vendor will require substantial re-training and new skillsdevelopment within our sales and service personnel and deployment of asuccessful account-management sales model. We believe that developing strategicrelationships with our customers may lead to additional revenue opportunities. However,there can be no assurance that any such relationships will develop or that suchrelationships will 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.

***Health care reformand restrictions on reimbursement may affect the ability of pharmaceutical,biotechnology and industrial chemical companies to purchase or license ourproducts or services, which may affect our results of operations and financialcondition.***   The continuing efforts ofgovernment and third-party payers in the markets we serve to contain or reducethe cost of health care may reduce the profitability of pharmaceutical,biotechnology and industrial chemical companies causing them to reduce researchand development expenditures. Because our products and services depend on suchresearch and development expenditures, our revenues may be significantlyreduced. We cannot predict what actions federal, state or private payers forhealth care goods and services may take in response to any health care reformproposals 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.

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

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

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***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, Cambridge, UnitedKingdom, and Bangalore, India. We also conduct sales and customer supportactivities at our facilities in Burlington, Massachusetts, Paris, France, andTokyo, Japan. Although we have contingency plans in effect for naturaldisasters or other catastrophic events, catastrophic events could still disruptour operations. For example, our San Diego and Tokyo facilities are located inareas that are particularly susceptible to earthquakes. Any natural disaster orcatastrophic event in our facilities or the areas in which they are locatedcould have a significant negative impact on our operations.

***Our insurance coverage may not be sufficient to avoidmaterial impact on our financial position or results of operations resultingfrom claims or liabilities against us, and we may not be able to obtaininsurance 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 wereunable to obtain such insurance on commercially reasonable terms.

**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 to risks associated with the operationof a global business.****  *Ournon-U.S. operations are subject to risks inherent in the conduct ofinternational business, including:

·  unexpected changes in regulatory requirements;

·  longer payment cycles;

·  currency exchange rate fluctuations;

·  import and export license requirements;

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·  tariffs and other barriers;

·  political unrest, terrorism and economicinstability;

·  disruption of our operations due to locallabor conditions;

·  limited intellectual property protection;

·  difficulties in collecting trade receivables;

·  difficulties in managing distributors orrepresentatives;

·  difficulties in managing an organizationspread over various countries;

·  difficulties in staffing foreign subsidiary orjoint venture operations; and

·  potentially adverse tax consequences.

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 to improveour financial position, we have reduced our headcount, which could negativelyimpact our business.******  ***Wehave undergone several reductions-in-force over the past few years, and ourworkforce has declined by approximately 200 people since March 2002. Whilewe believe we have sufficient staff to operate our business, we do not haveduplicative or redundant resources in many of our functions or operations. As aresult, there can be no assurance that further attrition will not impact ourability to operate our business, or adversely impact our revenues.

***Failure to attractand retain skilled personnel, including the personnel necessary to address theidentified material weaknesses in our internal control over financialreporting, 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 and results of operations. We do not intend tomaintain key person life insurance on the life of any employee.

In addition to the foregoing, as described in greaterdetail elsewhere in this Report, we recently concluded that we had materialweaknesses in our internal control over financial reporting as of March 31,2006. These material weaknesses, which principally arose due to our lack of asufficient number of employees with an appropriate level of accountingknowledge, experience and training in the application of generally acceptedaccounting principles relevant to our business, were at least partiallyresponsible for our need to restate our previously issued consolidatedfinancial statements as described elsewhere in this Report. While we haverecruited additional qualified personnel since March 31, 2006, one or moreof these qualified recruits or existing personnel could leave our employ withinthe foreseeable future. If not timely and adequately addressed, the loss of anyof these individuals could impair our ability to maintain effective internalcontrol over financial reporting and thereby cause a material adverse effect onour business.

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***If we choose to acquire businesses, products ortechnologies instead of developing them ourselves, we may be unable to completethese acquisitions or to successfully integrate an acquired business ortechnology in a cost-effective and non-disruptive manner.***   Fromtime to time, we may choose to acquire businesses, products or technologiesinstead of developing them ourselves. We do not know if we will be able tocomplete any acquisitions, or whether we will be able to successfully integrateany acquired businesses, operate them profitably or retain their key employees.Integrating any business, product or technology we acquire could be expensiveand time-consuming, disrupt our ongoing business and distract companymanagement. In addition, in order to finance any acquisition, we 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 will suffer. In addition, under certaincircumstances, amortization of assets or charges resulting from the costs ofacquisitions could harm our business and operating results.

**Certain RisksRelated To Our Financial Performance**

***We have a history of losses and our futureprofitability is uncertain.****  *Wegenerated net losses for the years ended March 31, 2006 and 2005 and December 31,2003, and the three months ended March 31, 2004. Continuing net losses maylimit our ability to fund our operations and we may not generate income fromoperations in the future. Our future profitability depends upon many factors,including several that are beyond our control. These factors include withoutlimitation:

·  changes in the demand for our products andservices;

·  the introduction of competitive software;

·  our ability to license desirable technologies;

·  changes in the research and developmentbudgets of our customers and potential customers; and

·  our ability to successfully, cost effectivelyand timely develop, introduce and market new products, services and productenhancements.

***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 unable tolicense software to, or collect receivables from our customers our operatingresults may be adversely affected.***   Themajority of our current customers are well-established, large pharmaceuticalcustomers and universities, and other customers include smaller biotechnologycompanies. We have not experienced significant customer defaults during thepast three fiscal years and have recorded a provision for bad debts of lessthan $0.5 million in each of those periods. Our financial success depends uponthe creditworthiness and ultimate collection of amounts due from our customers.If we are not able to collect from our customers, we may be required towrite-off significant accounts receivable and recognize bad debt expenses whichcould materially and adversely affect our operating results.

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***Our quarterlyoperating results, particularly our quarterly cash flows, will 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, we historically received approximately 40% of our annual orders inthe fiscal quarter ended December 31. As a result, our cash flows fromoperations generally are positive in the fiscal quarter ended March 31,and we generally experience negative cash flows from operations in the otherthree fiscal quarters. Due to the possibility of fluctuations in our revenue andexpenses, we believe that quarter-to-quarter comparisons of our operatingresults are not a good indication of our future performance.

***Changes in theaccounting treatment of employee stock-based compensation will adversely affectour results of operations.****  *InDecember 2004, the Financial Accounting Standards Board issued Statementof Financial Accounting Standard (“SFAS”) No. 123 (revised 2004), *Share-Based Payment* (“SFAS No. 123R”), whichrevises SFAS No. 123, *Accounting for Stock-BasedCompensation*. SFAS No. 123R requires that employeestock-based compensation is measured based on the grant-date fair value of therelated employee equity award and is treated as an expense that is reflected inthe financial statements over the related service period. SFAS No. 123Rapplies to all employee equity awards granted after adoption and to theunvested portion of employee equity awards outstanding as of adoption. Wecurrently anticipate adopting SFAS No. 123R using the modified-prospectivemethod effective April 1, 2006. Because employee stock-based compensationexpense will be reflected in our financial statements, the adoption of the SFASNo. 123R is anticipated to have a significant adverse impact on our futurereported results of operations, although at this time, we are unable toquantify such impact. However, the pro forma impact on our reported results ofoperations for prior periods of recognizing the fair value of employeestock-based compensation in accordance with SFAS No. 123 is described inNote 3 to our consolidated financial statements included elsewhere in thisReport.

***The recentlycompleted restatement of our historical financial statements has alreadyconsumed, and may continue to consume, a significant amount of our resourcesand may have a material adverse effect on our business and stock price.***   In December 2005, we announced that ourpreviously issued consolidated financial statements would be restated toreflect certain accounting adjustments. The restatement process was highly timeand resource-intensive and involved substantial attention from management andsignificant legal and accounting costs. Although we have now completed therestatement, we cannot guarantee that we will have no further inquiries fromthe SEC or NASDAQ regarding our restated financial statements or mattersrelating thereto. Likewise, many companies that have been required to restatetheir historical financial statements have subsequently experienced stockholderlawsuits relating to their restatements. Any future inquiries from the SEC orNASDAQ as a result of the restatement of our historical financial statementswill, regardless of the outcome, likely consume a significant amount of ourresources in addition to those resources already consumed in connection withthe restatement itself.

***If we fail tomaintain an effective system of internal control over financial reporting, wemay not be able to accurately report our financial results, and current andpotential stockholders may lose confidence in our financial reporting.****   We are required by the SEC toestablish and maintain adequate internal control over financial reporting thatprovides reasonable assurance regarding the reliability of our financialreporting and the preparation of financial statements in accordance withgenerally accepted accounting principles. We are likewise required, on aquarterly basis, to evaluate the effectiveness of our internal controls and todisclose any changes, significant deficiencies or material weaknesses in thoseinternal controls.*

As described in greater detail elsewhere in thisReport, in connection with the restatement process, we identified materialweaknesses in our internal control over financial reporting. These materialweaknesses 

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generally relate to ourhistorical lack of a sufficient number of employees with appropriate levels ofaccounting knowledge, experience and training in the application of generallyaccepted accounting principles relevant to our business. Given these materialweaknesses, management was unable to conclude that we maintained effectiveinternal control over financial reporting as of March 31, 2006. Further, these material weaknesses resultedin an adverse opinion by our independent registered public accounting firm asto the effectiveness of our internal control over financial reporting.

Since the determination regarding our materialweaknesses, we have devoted significant effort and resources to the remediationand improvement of our internal control over financial reporting. Inparticular, as described elsewhere in this Report, we have recruited a numberof qualified individuals to assist in maintaining adequate internal controls,we have initiated a revenue recognition training program and we haveimplemented an enhanced quarterly and annual financial statement close, reviewand reporting process. Although we believe that these efforts and resourceshave strengthened our internal control over financial reporting and address theconcerns that gave rise to the material weaknesses as of March 31, 2006,we cannot be certain that these measures will ensure that we maintain adequateinternal control over our financial reporting in future periods. Any failure tomaintain such internal controls could adversely impact our ability to reportour financial results on a timely and accurate basis. If our financialstatements are not accurate, investors may not have a complete understanding ofour operations. Likewise, if our financial statements are not filed on a timelybasis as required by the SEC and NASDAQ, we could face severe consequences fromthose authorities. In either case, there could result a material adverse affecton our business. Inferior internal controls could also cause investors to loseconfidence in our reported financial information, which could have a negativeeffect on the trading price of our stock.

***We may be requiredto indemnify Pharmacopeia Drug Discovery, Inc. (“PDD”), or may not be ableto collect on indemnification rights from PDD.***   On April 30, 2004, we spun-offour drug discovery subsidiary, PDD, into an independent, separately traded,publicly held company through the distribution to our stockholders of adividend of one share of PDD common stock for every two shares of our commonstock. As part of the spin-off, we agreed to indemnify the indebtedness,liabilities and obligations of PDD. One such obligation includes a guarantee byus to the landlord of PDD’s obligations under the existing New Jerseylaboratory and headquarters leases, with respect to which PDD will indemnify usshould we be required to make any payment under the guarantee. Theseindemnification obligations could be as significant as the remaining futureminimum lease payments, which totaled approximately $25 million as of March 31,2006. PDD’s ability to satisfy any such indemnification obligations (including,without limitation, PDD’s commitment to indemnify us in the event of ourpayment under our guarantee of its leases) will depend upon PDD’s futurefinancial strength. We cannot assure you that, if PDD becomes obligated toindemnify us for any substantial obligations, PDD will have the ability to doso. There also can be no assurance that we will be able to satisfy anyindemnification obligations to PDD. Any failure by PDD to satisfy itsobligations and any required payment by us could have a material adverse effecton 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 

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continually evaluate andmonitor regulatory developments and cannot estimate the timing or magnitude ofadditional costs we may incur as a result.

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

***If we consume cash more quickly than expected, we maybe unable to raise additional capital and we may be forced to curtailoperations.***   We anticipate that our existingcapital resources will be adequate to fund our operations for at least the nexttwelve months. However, changes may occur that would consume available capitalresources before that time. Our capital requirements will depend on numerousfactors, including:

·       costsassociated with software sales;

·       thepurchase of additional capital equipment;

·       acquisitionsof other businesses or technologies;

·       costsassociated with the restatement of our historical financial statements asdescribed elsewhere in this Report; and

·       costsassociated with addressing the material weaknesses in our internal control overfinancial reporting as described elsewhere in this Report.

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

**Certain RisksRelated to Owning Our Stock**

***We expect that our stock price will fluctuatesignificantly, and you may not be able to resell your shares at or above yourinvestment price.***   The stock market, historically and in recent years, hasexperienced significant volatility particularly with technology company stocks.The volatility of technology company stock prices often does not relate to theoperating performance of the companies represented by the stock. Factors thatcould cause volatility in the price of our common stock include withoutlimitation:

·       actualand anticipated fluctuations in our quarterly financial and operating results;

·       marketconditions in the technology and software sectors;

·       issuanceof new or changed securities analysts’ reports or recommendations;

·       developmentsor disputes concerning our intellectual property or other proprietary rights orother legal claims;

·       introductionof technological innovations or new commercial products by us or ourcompetitors;

·       marketacceptance of our products and services;

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·       additionsor departures of key personnel;

·       publicperception of the impact of the restatement of our historical consolidatedfinancial statements as described elsewhere in this Report; and

·       thedisclosure of the material weaknesses in our internal control over financialreporting as described elsewhere in this Report.

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. Inaddition, in the past, when the market price of a stock has been volatile,holders of that stock have periodically instituted securities class actionlitigation against the issuer.

***As institutionshold the majority of our common stock in large blocks, substantial sales bythese stockholders could depress the market price for our shares.***   Asof April 11, 2006, the top ten institutional holders of our common stockheld approximately 48% of our outstanding common stock. As a result, if one ormore of these major stockholders were to sell all or a portion of theirholdings, or if the market were to perceive that such sale or sales may occur,the market price of our common stock may fall significantly.

***Because we do 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.

***Anti-takeover provisions under the Delaware GeneralCorporation Law, provisions in our certificate of incorporation and bylaws, andour adoption of a stockholder rights plan may render more difficult theaccomplishment of mergers or the assumption of control by a principal stockholder,making more difficult the removal of management.***   Certainprovisions of the Delaware General Corporation Law may delay or deter attemptsto secure control of our company without the consent of our management. Also,our governing documents provide for a staggered board of directors, which willmake it 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 

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confidential informationdeveloped by or made known to the employee or consultant during his, her or itsrelationship with us are to be kept confidential, and that all inventionsarising out of the employee’s or consultant’s relationship with us are ourexclusive property. Our employees and consultants may breach these agreements,and in some instances we may not have an adequate remedy. Additionally, in someinstances, we may have failed to require that employees and consultants executeconfidentiality and assignment-of-inventions agreements.

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

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

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

***Third-party software codes incorporated into ourproducts could subject us to liability or limit our ability to sell suchproducts.***   Some of our products includesoftware codes licensed from third parties, including the open source community.Some of these licenses impose certain obligations upon us, including royaltyand indemnification obligations. In the case of codes licensed from the opensource community, the licenses may also limit our ability to sell productscontaining such code. Though we generally review the applicable licenses priorto incorporating third party code into our software products, there can be noassurance that 

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such third partycodes incorporated into our products would not subject us to liability or limitour ability to sell the products containing such code, thereby having amaterial adverse affect upon our business.

**Item 1B.**               UnresolvedStaff Comments

None.

**Item 2.        Properties**

Thefollowing is a summary of our principal business locations:

| **Location**                    | ** ** | ** **                                                                                          | ** ** | **Principal activities** | ** ** | **Lease  Ends** | ** ** | **Square  Feet** | ** ** |
|---------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|-----------------|------------|------------------|------------|
| San Diego,  California, USA     |       | Corporate  headquarters, sales, customer support, marketing, administration and product development |       |                          | 2013       |            |       |             | 68,436     |   |   |
| Burlington,  Massachusetts, USA |       | Sales                                                                                               |       |                          | 2009       |            |       |             | 4,830      |   |   |
| Cambridge, UK                   |       | Sales,  support, marketing, product development and administration                                  |       |                          | 2022       |            |       |             | 24,451     |   |   |
| Paris, France                   |       | Sales                                                                                               |       |                          | 2013       |            |       |             | 4,500      |   |   |
| Tokyo, Japan                    |       | Sales  and customer support                                                                         |       |                          | 2008       |            |       |             | 6,000      |   |   |
| Bangalore, India                |       | Product development                                                                                 |       |                          | 2009       |            |       |             | 19,486     |   |   |

 

**Item 3.**                        LegalProceedings

We are not a party to anylegal proceedings the negative outcome of which would have a material adverseeffect on our business, financial condition or results of operations.

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

Not applicable.

 

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**PART II**

**Item 5.**                        Marketfor Registrant’s Common Equity and Related Stockholder Matters

**Market for CommonStock**

Ourcommon stock trades on the NASDAQ National Market tier of The NASDAQ StockMarket under the symbol ACCL. The following table sets forth, for the periodsindicated, the range of high and low sale prices per share of our common stock:

| ** **                         | ** ** | **High**   | ** ** | **Low**    | ** ** |
|------------------------------------|------------|------------|------------|------------|------------|
| **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 |   |
| **Year Ended March 31, 2005** |       |       |       |       |       |
| First Quarter                      |       | $          | 17.18      |       | $          | 7.91 |   |
| Second Quarter                     |       | $          | 10.06      |       | $          | 5.49 |   |
| Third Quarter                      |       | $          | 8.16       |       | $          | 5.55 |   |
| Fourth Quarter                     |       | $          | 7.94       |       | $          | 4.74 |   |

 

**Fromthe date of our initial public offering on December 5, 1995 until February 26,2004, our stock traded under the symbol PCOP. Since February 27, 2004, ourcommon stock has traded under the symbol ACCL.**

**Holders of Record**

As of April 27, 2006,there were 441 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.

**Equity CompensationPlan Information**

The information requiredby Item 201(d) of Regulation S-K will be included in our definitive proxystatement (“Proxy Statement”) to be filed with the SEC within 120 days afterour fiscal year ended March 31, 2006, and is incorporated in this Reportby reference.

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**Item 6.**                        SelectedConsolidated Financial Data

Thefollowing selected consolidated financial data have been derived from ouraudited consolidated financial statements and give effect to the restatementdescribed in “Management’s Discussion and Analysis of Financial Condition andResults of Operations” and in Note 2 to our consolidated financial statements. Thisdata should be read in conjunction with “Management’s Discussion and Analysisof Financial Condition and Results of Operations” and our consolidatedfinancial statements and related notes thereto included elsewhere in thisReport. On April 1, 2004, we changed our fiscal year end from December 31to March 31. The following table sets forth our selected consolidatedfinancial data as of and for the years ended March 31, 2006 and 2005, thethree months ended March 31, 2004, and the years ended December 31,2003, 2002 and 2001.

| ** **                                                                               | ** ** | **Years Ended**                                                  | ** ** | **Three  Months  Ended**    | ** ** |
|------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                               | ** ** | **March 31,  2006**                                              | ** ** | **March 31,  2005(1)** | ** ** | **December 31,  2003** | ** ** | **December 31,  2002** | ** ** | **December 31,  2001** | ** ** | **March 31,  2004** | ** ** |
| ** **                                                                               | ** ** | ** **                                                            | ** ** | **(Restated)**              | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **                                                                               | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **Consolidated Statement of  Operations Data:**                           |       |                                                                  |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                                                  |       |                                                                  | $          | 82,001                      |       |   | $ | 79,030 |   |   | $ | 86,209 |   |   |   | $ | 98,497 |   |   |   | $ | 90,314 |   |   | $ | 19,359 |   |
| Total operating  costs and expenses                                                      |       |                                                                  | 90,711     |                        |       | 96,800 |   |   | 91,116 |   |   |   | 108,319 |   |   |   | 110,894 |   |   | 28,876 |   |
| Operating loss  from continuing operations                                               |       |                                                                  | (8,710     | )                           |       | (17,770 | ) |   | (4,907 | ) |   |   | (9,822 | ) |   |   | (20,580 | ) |   | (9,517 | ) |
| Interest and  other income, net                                                          |       |                                                                  | 1,869      |                        |       | 1,738 |   |   | 4,160 |   |   |   | 3,894 |   |   |   | 6,097 |   |   | 921 |   |
| Loss from  continuing operations before income taxes                                     |       |                                                                  | (6,841     | )                           |       | (16,032 | ) |   | (747 | ) |   |   | (5,928 | ) |   |   | (14,483 | ) |   | (8,596 | ) |
| Income tax  expense (benefit)                                                            |       |                                                                  | 898        |                        |       | (571 | ) |   | 1,001 |   |   |   | 629 |   |   |   | 888 |   |   | 128 |   |
| Loss from  continuing operations                                                         |       |                                                                  | (7,739     | )                           |       | (15,461 | ) |   | (1,748 | ) |   |   | (6,557 | ) |   |   | (15,371 | ) |   | (8,724 | ) |
| Loss from  discontinued operations                                                       |       |                                                                  | —     |                        |       | (1,117 | ) |   | (2,848 | ) |   |   | (2,142 | ) |   |   | (6,178 | ) |   | (9,936 | ) |
| Net loss                                                                                 |       |                                                                  | $          | (7,739                      | )          |   | $ | (16,578 | ) |   | $ | (4,596 | ) |   |   | $ | (8,699 | ) |   |   | $ | (21,549 | ) |   | $ | (18,660 | ) |
| Basic and diluted loss per share amounts:                                                |       |                                                                  |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss from  continuing operations                                                         |       |                                                                  | $          | (0.30                       | )          |   | $ | (0.62 | ) |   | $ | (0.07 | ) |   |   | $ | (0.28 | ) |   |   | $ | (0.65 | ) |   | $ | (0.36 | ) |
| Loss from  discontinued operations                                                       |       |                                                                  | —     |                        |       | (0.04 | ) |   | (0.12 | ) |   |   | (0.09 | ) |   |   | (0.26 | ) |   | (0.41 | ) |
| Net loss                                                                                 |       |                                                                  | $          | (0.30                       | )          |   | $ | (0.66 | ) |   | $ | (0.19 | ) |   |   | $ | (0.37 | ) |   |   | $ | (0.91 | ) |   | $ | (0.77 | ) |
| Weighted average  shares used in computing basic and diluted loss per share amounts |       |                                                                  | 26,116     |                        |       | 25,137 |   |   | 23,752 |   |   |   | 23,512 |   |   |   | 23,729 |   |   | 24,090 |   |

 

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| ** **                                                         | ** ** | **As of**           | ** ** |
|--------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                         | ** ** | **March 31,  2006** | ** ** | **March 31,  2005(3)** | ** ** | **March 31,  2004** | ** ** | **December 31,  2003** | ** ** | **December 31,  2002** | ** ** | **December 31,  2001** | ** ** |
| ** **                                                         | ** ** | ** **               | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **                                                         | ** ** | **(In thousands)**  | ** ** |
| **Consolidated Balance Sheet  Data:**                              |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents, restricted cash and marketable securities |       | $                        | 66,022     |   | $ | 63,304 |   | $ | 141,261 |   |   | $ | 134,055 |   |   |   | $ | 141,071 |   |   |   | $ | 155,828 |   |   |
| Total assets                                                       |       | 146,755                  |       | 152,415 |   | 213,144 |   |   | 232,447 |   |   |   | 234,632 |   |   |   | 265,390 |   |   |
| Total deferred  revenue                                            |       | 61,269                   |       | 58,614 |   | 53,182 |   |   | 66,145 |   |   |   | 68,123 |   |   |   | 76,802 |   |   |
| Noncurrent  liabilities(2)                                         |       | 5,718                    |       | 5,131 |   | 3,770 |   |   | — |   |   |   | 8 |   |   |   | — |   |   |
| Accumulated  deficit                                               |       | (181,156                 | )          | (173,417 | ) | (156,839 | ) |   | (138,179 | ) |   |   | (133,583 | ) |   |   | (124,884 | ) |   |
| Total stockholders’  equity                                   |       | 63,208                   |       | 69,596 |   | 127,501 |   |   | 141,873 |   |   |   | 143,575 |   |   |   | 155,299 |   |   |
|                                                                    |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Amounts include theresults of SciTegic, Inc. from September 27, 2004, the date of theacquisition. See Note 5 to our consolidated financial statements includedelsewhere in this Report.

(2)          Noncurrent liabilitiesprimarily consist of non-cash long-term, lease-related liabilities.

(3)          The decrease in ourcash, cash equivalents, restricted cash and marketable securities and totalstockholders’ equity from March 31, 2004 to March 31, 2005 resultedfrom our April 30, 2004 spin-off of PDD. In connection with the spin-off,we distributed to our stockholders a dividend of one share of PDD common stockfor every two shares of our common stock and contributed to PDD $42.3 millionof marketable securities and $5.4 million in cash.

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**Item 7.**                        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.

Inaddition to historical information, the following discussion containsforward-looking statements that are subject to certain risks and uncertainties,including those risks and uncertainties described in Item 1A of thisReport. Actual results may differ substantially from those referred to hereindue to a number of factors, including but not limited to those risks anduncertainties.

**Restatement ofFinancial Statements**

We have restated our previously issued consolidatedfinancial statements to reflect certain accounting adjustments. Our restatedconsolidated financial statements reflect changes to the timing of revenuerecognized under term-based and perpetual software license arrangements whichinclude multiple elements (typically software licenses and PCS) and a change inaccounting for software development costs. Our restated consolidated financialstatements also reflect the reclassification of general and administrativeexpenses and interest income between continuing and discontinued operations,the reclassification of cash flows from discontinued operations as net cashprovided by (used in) discontinued operating activities, investing activitiesand financing activities, as opposed to a single line item as previouslyreported, and the reclassification of investments in auction rate securities tomarketable securities from cash and cash equivalents. The impact of therestatement on our previously issued financial statements is described morefully in Note 2 to our consolidated financial statements included elsewhere inthis Report.

Thefollowing table sets forth the effect of the restatement on our previouslyreported selected consolidated financial data:

| ** **                                           | ** ** | **Year Ended March 31, 2005**    | ** ** | **Three Months ended March 31, 2004** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                           | ** ** | **As  Previously    Reported  ** | ** ** | **  As Restated  **                   | ** ** | **As  Previously        Reported      ** | ** ** | **      As Restated      ** | ** ** |
| ** **                                           | ** ** | **(In  thousands, except per share amounts)**        | ** ** |
| **Consolidated Statement of  Operations Data:**      | ** ** |                                                 | ** ** | ** **                                                     |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Revenue                                              |       |                                                 | $          | 69,631                                                         |       |   |   | $ | 79,030 |   |   |   | $ | 11,135 |   |   |   | $ | 19,359 |   |   |
| Total operating  costs and expenses                  |       |                                                 | 95,995     |                                                           |       |   | 96,800 |   |   |   | 29,300 |   |   |   | 28,876 |   |   |
| Operating loss  from continuing operations           |       |                                                 | (26,364    | )                                                              |       |   | (17,770 | ) |   |   | (18,165 | ) |   |   | (9,517 | ) |   |
| Interest and  other income, net                      |       |                                                 | 1,738      |                                                           |       |   | 1,738 |   |   |   | 921 |   |   |   | 921 |   |   |
| Loss from  continuing operations before income taxes |       |                                                 | (24,626    | )                                                              |       |   | (16,032 | ) |   |   | (17,244 | ) |   |   | (8,596 | ) |   |
| Income tax  expense (benefit)                        |       |                                                 | (571       | )                                                              |       |   | (571 | ) |   |   | 128 |   |   |   | 128 |   |   |
| Loss from  continuing operations                     |       |                                                 | (24,055    | )                                                              |       |   | (15,461 | ) |   |   | (17,372 | ) |   |   | (8,724 | ) |   |
| Loss from  discontinued operations                   |       |                                                 | (1,117     | )                                                              |       |   | (1,117 | ) |   |   | (9,398 | ) |   |   | (9,936 | ) |   |
| Net loss                                             |       |                                                 | $          | (25,172                                                        | )          |   |   | $ | (16,578 | ) |   |   | $ | (26,770 | ) |   |   | $ | (18,660 | ) |   |
| Basic and diluted  loss per share amounts:           |       |                                                 |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss from  continuing operations                     |       |                                                 | $          | (0.96                                                          | )          |   |   | $ | (0.62 | ) |   |   | $ | (0.72 | ) |   |   | $ | (0.36 | ) |   |
| Loss from  discontinued operations                   |       |                                                 | (0.04      | )                                                              |       |   | (0.04 | ) |   |   | (0.39 | ) |   |   | (0.41 | ) |   |
| Net loss                                             |       |                                                 | $          | (1.00                                                          | )          |   |   | $ | (0.66 | ) |   |   | $ | (1.11 | ) |   |   | $ | (0.77 | ) |   |

 

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| ** **                                           | ** ** | **Years Ended December 31,**   | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                           | ** ** | **2003**                                      | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                           | ** ** | **As  Previously  Reported**                  | ** ** | **As Restated** | ** ** | **As  Previously    Reported  ** | ** ** | **  As Restated  ** | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** |
| ** **                                           | ** ** | **(In  thousands, except per share amounts)** | ** ** |
| **Consolidated  Statement of Operations Data:**      |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                              |       |                                          | $          | 85,561 |   |   |   | $ | 86,209 |   |   |   | $ | 95,104 |   |   |   | $ | 98,497 |   |   | $ | 95,107 |   |   | $ | 90,314 |   |   |
| Total operating  costs and expenses             |       |                                          | 90,919     |   |   |   | 91,116 |   |   |   | 105,631 |   |   |   | 108,319 |   |   | 108,458 |   |   | 110,894 |   |   |
| Operating loss  from continuing operations           |       |                                          | (5,358     | ) |   |   | (4,907 | ) |   |   | (10,527 | ) |   |   | (9,822 | ) |   | (13,351 | ) |   | (20,580 | ) |   |
| Interest and  other income, net                      |       |                                          | 4,160      |   |   |   | 4,160 |   |   |   | (203 | ) |   |   | 3,894 |   |   | 6,097 |   |   | 6,097 |   |   |
| Loss from  continuing operations before income taxes |       |                                          | (1,198     | ) |   |   | (747 | ) |   |   | (10,730 | ) |   |   | (5,928 | ) |   | (7,254 | ) |   | (14,483 | ) |   |
| Income tax  expense                                  |       |                                          | 1,001      |   |   |   | 1,001 |   |   |   | 515 |   |   |   | 629 |   |   | 888 |   |   | 888 |   |   |
| Loss from  continuing operations                     |       |                                          | (2,199     | ) |   |   | (1,748 | ) |   |   | (11,245 | ) |   |   | (6,557 | ) |   | (8,142 | ) |   | (15,371 | ) |   |
| Loss from  discontinued  operations                  |       |                                          | (1,298     | ) |   |   | (2,848 | ) |   |   | (382 | ) |   |   | (2,142 | ) |   | (6,178 | ) |   | (6,178 | ) |   |
| Net loss                                             |       |                                          | $          | (3,497 | ) |   |   | $ | (4,596 | ) |   |   | $ | (11,627 | ) |   |   | $ | (8,699 | ) |   | $ | (14,320 | ) |   | $ | (21,549 | ) |   |
| Basic and diluted loss per share amounts:            |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss from  continuing operations                     |       |                                          | $          | (0.09 | ) |   |   | $ | (0.07 | ) |   |   | $ | (0.48 | ) |   |   | $ | (0.28 | ) |   | $ | (0.34 | ) |   | $ | (0.65 | ) |   |
| Loss from  discontinued  operations                  |       |                                          | (0.06      | ) |   |   | (0.12 | ) |   |   | (0.01 | ) |   |   | (0.09 | ) |   | (0.26 | ) |   | (0.26 | ) |   |
| Net loss                                             |       |                                          | $          | (0.15 | ) |   |   | $ | (0.19 | ) |   |   | $ | (0.49 | ) |   |   | $ | (0.37 | ) |   | $ | (0.60 | ) |   | $ | (0.91 | ) |   |

 

| ** **                                                         | ** ** | **As of March 31,** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| ** **                                                         | ** ** | **As  Previously  Reported**       | ** ** | **As Restated** | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** |
| ** **                                                         | ** ** | **(In thousands)**            | ** ** |
| **Consolidated Balance Sheet  Data:**                              |       |                               |       |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents, restricted cash and marketable securities |       |                               | $          | 63,304 |   |   | $ | 63,304 |   | $ | 141,261 |   | $ | 141,261 |   |
| Total assets                                                       |       |                               | 160,554    |   |   | 152,415 |   | 220,478 |   | 213,144 |   |
| Total deferred  revenue                                            |       |                               | 42,596     |   |   | 58,614 |   | 27,765 |   | 53,182 |   |
| Noncurrent  liabilities                                            |       |                               | 5,131      |   |   | 5,131 |   | 3,770 |   | 3,770 |   |
| Accumulated  deficit                                               |       |                               | (149,260   | ) |   | (173,417 | ) | (124,088 | ) | (156,839 | ) |
| Total stockholders’  equity                                   |       |                               | 93,753     |   |   | 69,596 |   | 160,252 |   | 127,501 |   |
|                                                                    |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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| ** **                                                         | ** ** | **As of December 31,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                         | ** ** | **2003**                              | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                         | ** ** | **As  Previously  Reported**          | ** ** | **As Restated** | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** |
| ** **                                                         | ** ** | **(In thousands)**               | ** ** |
| **Consolidated Balance Sheet  Data:**                              | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash, cash  equivalents, restricted cash and marketable securities |       | $                                     | 134,055    |   | $ | 134,055 |   | $ | 141,071 |   | $ | 141,071 |   | $ | 155,828 |   | $ | 155,828 |   |
| Total assets                                                       |       | 239,667                               |       | 232,447 |   | 240,105 |   | 234,632 |   | 270,398 |   | 265,390 |   |
| Total deferred  revenue                                            |       | 32,504                                |       | 66,145 |   | 33,834 |   | 68,123 |   | 39,120 |   | 76,802 |   |
| Noncurrent  liabilities                                            |       | —                                |       | — |   | 8 |   | 8 |   | — |   | — |   |
| Accumulated  deficit                                               |       | (97,318                               | )          | (138,179 | ) | (93,821 | ) | (133,583 | ) | (82,194 | ) | (124,884 | ) |
| Total stockholders’  equity                                   |       | 182,734                               |       | 141,873 |   | 183,337 |   | 143,575 |   | 197,989 |   | 155,299 |   |
|                                                                    |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Overview**

***Our Business***

We design, develop,market, and support software and related services that facilitate the discoveryand development of new and improved products and processes in the pharmaceutical,biotechnology, chemical, petrochemical and materials industries. Using ourproducts, researchers may increase the speed and efficiency of the research anddevelopment cycle, thereby reducing product development costs and shorteningthe time to market for new product introductions and process improvements. 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 haveprimarily sold molecular modeling and simulation software. The market formolecular modeling and simulation products in the pharmaceutical andbiotechnology industries is challenging due to the maturity of the market,industry consolidation, reduction in the level of discovery research activity,and increased competition, including competition from open source software. Wealso sell modeling and simulation products to the chemical, petrochemical andmaterials industries. We believe these industries are in the early stages ofadoption of these technologies. Thus we believe the market for our productswithin these industries is nascent and has experienced modest growth over thepast several years. Following the acquisition of SciTegic, we began to offerdata-pipelining and workflow software. This technology is widely applicablewithin our target industries and represents a significant growth opportunity. Thereis currently limited competition to this technology in our targeted industries,and we are experiencing strong adoption rates within our customer base.

***Our Strategy***

Our objective is to strengthen our position as aleading provider of software-based scientific computation, analysis,informatics, knowledge management, workflow products and services. We plan toaccomplish our objective by providing a comprehensive set of integrated productsand services that are central to the enterprise-wide research and developmentactivities of our customers, and by connecting these tools within aninformation technology framework. This framework makes it easier for researchand development organizations to manage data, information, knowledge, andcollaborative processes.

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

In addition to the activities underway in our salesand service functions, we continue to focus on the componentization of ourentire suite of products on our Discovery Studio and Materials Studio platforms.In fiscal year 2007, we expect to continue the migration of our life sciencesapplications to the Discovery Studio platform with the expected launch ofDiscovery Studio 1.7 by the end of the fiscal year.

Finally, in addition toour focus on revenue growth, we continuously evaluate our personnelrequirements and cost structure. Over the past several years we havesignificantly reduced our operating costs through workforce reductions andother cost-savings measures. We will continue our focus on cost control, aswell as working capital management as we strive to improve our financialperformance.

**Critical AccountingPolicies**

Our discussion andanalysis of our financial condition and results of operations are based on ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof the consolidated financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses and the related disclosure of contingent assets and liabilities. Wereview our estimates on an on-going basis, including those related to revenuerecognition, income taxes and the valuation of goodwill, intangibles and otherlong-lived assets. We base our estimates on historical experience and onvarious other assumptions that we believe to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities. Actual results may differ fromthese estimates under different assumptions or conditions. Our accountingpolicies are described in more detail in Note 3 to our consolidated financialstatements included elsewhere in this annual report. We have identified thefollowing as the most critical accounting policies and estimates used in thepreparation of our consolidated financial statements.

*Revenue Recognition*

We recognize revenues in accordance with the AmericanInstitute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”)No. 97-2, *Software RevenueRecognition*, as amended, SEC Staff Accounting Bulletin (“SAB”) No. 104,*Revenue Recognition*, and Emerging IssuesTask Force (“EITF”) Issue No. 00-21, *RevenueArrangements with Multiple Deliverables*.

We generate revenuefrom the following primary sources:

·       softwarelicenses,

·       provisionof support and maintenance services on licensed software, referred to as PCS,and

·       training,installation and implementation services.

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Customer paymentsreceived in connection with our revenue-generating activities are recorded asdeferred revenue. We recognize revenue as set forth below and when all of thefollowing 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.

*Software Licenses*

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 licenses ratably over the term of the bundled PCS. Certainof our term-based licenses also allow the customer to substitute purchasedproducts for other products of equal value throughout the term. We account forthese arrangements as in-substance subscriptions and, accordingly, we recognizeas revenue the entire fee for such licenses ratably over the contractual termof the arrangement, which is typically the same as the term of the bundled PCS.

*Renewal of PCSunder Perpetual Software Licenses*

Our PCS includes the rightto receive unspecified upgrades or enhancements and technical support. Feesfrom customer renewals of PCS related to previously purchased perpetuallicenses are recognized ratably over the term of the PCS.

*Training,Installation and Implementation Services*

We provide certainservices to our customers, including product training, non-complex productinstallation and non-complex implementation services which are non-essential tothe operation of the software. When sold separately, revenue from theseservices is generally recognized as the services are delivered, according tothe contractual terms. Amounts billed but not yet recognized as revenue, and otherpayments received prior to the recognition of revenue, are recorded as deferredrevenue.

*Multi-ElementArrangements*

For multi-elementarrangements which include software licenses, PCS and non-complex training,installation and implementation 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.

*SoftwareDevelopment Costs*

We account for costsincurred to develop our software products in accordance with SFAS No. 86, *Accounting for the Cost of Computer Software to be Sold, Leased orOtherwise Marketed*. Accordingly, costs incurred in the research anddevelopment of new software products and significant enhancements to existingsoftware products are expensed as incurred, until the technological feasibilityof the product has been established. Technological feasibility occurs shortlybefore our software products are available for 

27

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generalrelease, and we have determined that costs eligible for capitalization are notmaterial. Accordingly, there were no capitalized software development costs asof March 31, 2006 and 2005.

*Valuation ofGoodwill*

Our goodwill resulted from acquisitions made in fiscalyears 1999, 2000, 2001 and 2005. In accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 142, *Goodwill and OtherIntangible Assets*, we review goodwill for impairment at leastannually in our fiscal fourth quarter and more frequently if events or changesin circumstances 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 assessment by a regulator, unanticipated competition, a loss of keypersonnel, or the presence of other indicators that would indicate a reductionin the fair value of 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 2006, 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 only 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 acomparison of our net assets as of March 31, 2006 to our marketcapitalization.

Because we determine thefair value of our reporting unit based on our market capitalization, our futurereviews of goodwill for impairment may be impacted by changes in the price ofour common stock. For example, a significant decline in the price of our commonstock may cause the fair value of our goodwill to fall below its carrying value.Therefore, we cannot assure you that when we complete our future reviews ofgoodwill for impairment that a material impairment charge will not be recorded.

*Valuation of Indefinite-Lived Intangible Asset*

In connection with our acquisition of SciTegic in September 2004,we acquired the SciTegic trade name which was determined to be indefinitelylived. In accordance with SFAS No. 142, *Goodwill andOther Intangible Assets*, we review our indefinite-lived intangibleasset for impairment at least annually in our fiscal fourth quarter and morefrequently if events or changes in circumstances occur that indicate apotential reduction in the fair value of the asset below its carrying value. Examplesof such events or circumstances include: a significant adverse change in legal factors or in the businessclimate, a significant decline in our stock price, a significant decline in ourprojected revenue or cash flows, an adverse action or assessment by aregulator, unanticipated competition, a loss of key personnel, or the presenceof other indicators that would indicate a reduction in the fair value of anasset.

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 2006, 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 potential royalties that would otherwise be paidto an independent third party for use of the trade name. Key assumptionsincluded in the discounted cash flow analysis include projections of futurerevenue growth, market royalty rates for similar assets and the after-tax rateof return on the asset.

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We cannot assure you thatthe underlying assumptions used to forecast the cash flows will materialize asestimated. For example, if our projections of future revenue growth do notmaterialize, the fair value of our indefinite-lived intangible asset may fallbelow its carrying value. Therefore, we cannot assure you that when we completeour future reviews of our indefinite-lived intangible asset for impairment thata material impairment charge 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, significant negative industry or economic trends or the presenceof other indicators that would indicate that the carrying amount of an asset orasset group is not recoverable.

A long-lived asset isconsidered to be impaired if the estimated undiscounted future cash flowsresulting from the use of the asset and its eventual disposition are notsufficient to recover the carrying value of the asset. In order to estimate anasset’s undiscounted future cash flows, we utilize our internal forecast of ourfuture operating results and cash flows, our strategic business plans andanticipated future economic and market conditions. There are inherent estimatesand assumptions underlying this information and management’s judgment isrequired in the application of this information to the determination of anasset’s undiscounted future cash flows. No assurance can be given that theunderlying estimates and assumptions utilized in our determination of an asset’sundiscounted future cash flows will materialize as anticipated. During fiscal year 2006, we did not identifyany conditions that would necessitate an impairment assessment of ourlong-lived assets.

*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 could ultimatelyresult in changes once the arrangements are reviewed by taxing authorities.Although we believe that our approach to determining the amount of sucharrangements is reasonable, no assurance can be given that the final resolutionof these matters will not be materially different than that which is reflectedin our historical income tax provisions and accruals. Such differences couldhave a material effect on our income tax expense or benefit in the period inwhich such determination is made.

We establish a valuation allowance againstour net deferred tax assets to reduce deferred tax assets to the amountexpected to be realized. The likelihood of a material change in theexpected realization of our deferred tax assets depends on our ability togenerate sufficient future taxable income. Our ability to generate enoughtaxable income to utilize our deferred tax assets depends on many factors,among which are our ability to deduct tax loss carryforwards against futuretaxable income, the effectiveness of our tax planning strategies, reversingdeferred tax liabilities and any significant changes in the tax treatmentreceived on our business combinations. Since our inception, we have provided afull valuation allowance against our net U.S. deferred tax assets as we do notbelieve the ultimate realization of our deferred tax assets is more likely thannot.

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**Results ofOperations**

Our results of operations give effect to therestatement of our previously issued consolidated financial statements as morefully described above.

On April 1, 2004, we changed our fiscal year endfrom December 31 to March 31. The first fiscal year affected by thischange ended on March 31, 2005. Included in Item 8 of this Report arethe consolidated balance sheets at March 31, 2006 and 2005 and theconsolidated statements of operations, consolidated statements of stockholders’equity and consolidated statements of cash flows for the years ended March 31,2006 and 2005 and December 31, 2003, and the three months ended March 31,2004. In order to provide the reader meaningful comparison, the followinganalysis provides comparison of our results of operations for the audited yearended March 31, 2006 with the audited year ended March 31, 2005, theaudited year ended March 31, 2005 with the audited year ended December 31,2003, and the audited three months ended March 31, 2004 with the unauditedthree months ended March 31, 2003.

Our results of operationsinclude the results of operations of SciTegic from September 27, 2004, thedate of the acquisition.

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

***Revenue***

Revenueincreased $3.0 million or 4% to $82.0 million for the year ended March 31,2006 compared to $79.0 million for the year ended March 31, 2005. Theincrease in revenue was primarily attributable to the additive effect of a fullyear of revenue recognized by our SciTegic subsidiary included in fiscal year2006, as compared to SciTegic revenues from the date of the acquisitionincluded in fiscal year 2005 and modest growth in product sales of materialsscience applications, partially offset by continued declines in sales ofmodeling and simulation products to biopharmaceutical companies.

***Operating Costs andExpenses***

| ** **                                 | ** ** | **Years Ended March 31,**              | ** ** | ** **                                 | ** ** |
|--------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                              | ** ** | **2005**                                   | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Amount**                                            | ** ** | **As a  Percentage  of Revenue** | ** ** | **Amount** | ** ** | **As a  Percentage  of Revenue** | ** ** | **Percentage  Change** | ** ** |
| ** **                                 | ** ** | **(In thousands, except percentages)** | ** ** |
| Cost of revenue                            |       | $                                                     | 17,095     |                                       |       | 21 | % |   | $ | 14,317 |   |   | 18 | % |   |   | 19 | % |   |
| Product  development                       |       | 21,721                                                |       |                                       | 26         | % |   | 22,717 |   |   | 29 | % |   |   | (4 | )% |   |
| Sales and  marketing                       |       | 32,657                                                |       |                                       | 40         | % |   | 36,916 |   |   | 47 | % |   |   | (12 | )% |   |
| General and  administrative                |       | 16,060                                                |       |                                       | 20         | % |   | 17,290 |   |   | 22 | % |   |   | (7 | )% |   |
| Severance and  lease abandonment charges   |       | 3,178                                                 |       |                                       | 4          | % |   | 5,110 |   |   | 6 | % |   |   | (38 | )% |   |
| Acquired  in-process product development   |       | —                                                |       |                                       | —     |   |   | 450 |   |   | 1 | % |   |   | (100 | )% |   |
| Total operating  expenses                  |       | 90,711                                                |       |                                       | 111        | % |   | 96,800 |   |   | 122 | % |   |   | (6 | )% |   |
| Operating loss from  continuing operations |       | $                                                     | (8,710     | )                                          |       | (11 | )% |   | $ | (17,770 | ) |   | (22 | )% |   |   | (51 | )% |   |

* *

*Costof Revenue.*   Costof revenue increased $2.8 million or 19% to $17.1 million for the year endedMarch 31, 2006, as compared to $14.3 million for the year endedMarch 31, 2005. As a percentage of revenue, cost of revenue increased to21% for the year ended March 31, 2006, as compared to 18% for the yearended March 31, 2005. The increase in cost of revenue was primarilyattributable to a $1.8 million increase in client services costs resulting froman increase in personnel as we transition to more of a solutions-based salesmodel that includes software and scientific services and a $0.6 millionincrease in intangible asset amortization resulting from a full year ofamortization of the intangible assets resulting from the acquisition ofSciTegic in September 2004.

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*ProductDevelopment Expenses.**  *Productdevelopment expenses decreased $1.0 million or 4% to $21.7 million for the yearended March 31, 2006, as compared to $22.7 million for the year ended March 31,2005. As a percentage of revenue, product development expenses decreased to 26%for the year ended March 31, 2006, as compared to 29% for the year ended March 31,2005. The decrease in product development expenses was primarily attributableto lower personnel expenses resulting from headcount reductions during fiscalyear 2006 and improved cost management.

*Salesand Marketing Expenses.**  *Sales andmarketing expenses decreased $4.2 million or 12% to $32.7 million for theyear ended March 31, 2006, as compared to $36.9 million for the year endedMarch 31, 2005. As a percentage of revenue, sales and marketing expensesdecreased to 40% for the year ended March 31, 2006, as compared to 47% forthe year ended March 31, 2005. The decrease in sales and marketingexpenses was primarily attributable to lower personnel expenses resulting fromheadcount reductions during fiscal year 2006 as we took measures to improve theefficiency of our salesforce.

*Generaland Administrative Expenses.**  *General andadministrative expenses decreased $1.2 million or 7% to $16.1 million for theyear ended March 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.

*Severanceand Lease Abandonment Charges.**  *Severanceand lease abandonment charges were $3.2 million for the year ended March 31,2006, as compared to $5.1 million for the year ended March 31, 2005. InMarch 2006, we implemented various actions designed to realign our resourceswith our portfolio of products and services, eliminate redundancies in ourworkforce and streamline our operations through workforce reductions andabandoning a portion of a leased facility in the United Kingdom. As a result ofthe implementation of these actions, we recognized a charge of $3.2 million,consisting of $1.8 million in severance benefits from the termination ofapproximately 50 employees and $1.4 million for our future lease obligationsrelated to the abandoned facility, net of estimated future sublease income. Weanticipate completing the workforce reductions and payment of severancebenefits in the first quarter of fiscal year 2007. The lease obligation for theabandoned facility terminates in fiscal year 2016.

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.

*Acquired In-ProcessProduct Development.**  *In connectionwith our acquisition of SciTegic on September 27, 2004, we recorded a non-cashcharge of $0.5 million for the estimated fair value of acquired in-processproduct development.

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***Net Interest and Other Income***

Netinterest and other income was $1.9 million for the year ended March 31,2006, as compared to $1.7 million for the year ended March 31, 2005. Theincrease in net interest and other income was primarily attributable to foreignexchange gains resulting from the strengthening of the U.S. dollar duringfiscal year 2006.

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

Werecognized income tax expense of $0.9 million for the year ended March 31,2006, as compared to an income tax benefit of $0.6 million for the year ended March 31,2005. The income tax expense recognized for fiscal year 2006 results fromtaxable income generated by certain of our foreign operations. The income taxbenefit recognized for fiscal year 2005 was primarily attributable to a $0.9million income tax benefit related to a refund of taxes previously withheld inJapan and 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.

***Loss from DiscontinuedOperations***

On April 30,2004, we spun-off our drug discovery subsidiary, PDD, into an independent,separately traded, publicly held company through the distribution to ourstockholders of a dividend of one share of PDD common stock for every twoshares of our common stock. In accordance with SFAS No. 144, we havereported PDD’s results of operations, assets and liabilities, and cash flows asdiscontinued operations in our consolidated financial statements for allperiods presented. There were no discontinued operations reported during theyear ended March 31, 2006 as PDD was spun-off prior to the start of thefiscal year. During the year ended March 31, 2005, we recognized a lossfrom discontinued operations of $1.1 million, or $0.04 per share, whichconsisted of revenue of $1.3 million and expenses of $2.4 million.

**Comparison of theYears Ended March 31, 2005 and December 31, 2003**

***Revenue***

Revenuedecreased $7.2 million or 8% to $79.0 million for the year ended March 31,2005, as compared to $86.2 million for the year ended December 31, 2003. Thedecrease in revenue was primarily attributable to continued declines in salesof modeling and simulation software to biopharmaceutical companies as well thecompletion of several consortia and consulting agreements during 2003.

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***Operating Costs andExpenses***

| ** **                                            | ** ** | **Years Ended**                                  | ** ** | ** **                                 | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                            | ** ** | **March 31, 2005**                          | ** ** | **December 31, 2003**            | ** ** | ** ** | ** ** |
| ** **                                            | ** ** | **Amount**                                            | ** ** | **As a  Percentage  of Revenue** | ** ** | **Amount** | ** ** | **As a  Percentage  of Revenue** | ** ** | **Percentage  Change** | ** ** |
| ** **                                            | ** ** | **(In thousands, except percentages)** | ** ** |
| Cost of revenue                                       |       | $                                                     | 14,317     |                                       |       | 18 | % |   | $ | 17,276 |   |   | 20 | % |   |   | (17 | )% |   |
| Product  development                                  |       | 22,717                                                |       |                                       | 29         | % |   | 22,394 |   |   | 26 | % |   |   | 1 | % |   |
| Sales and  marketing                                  |       | 36,916                                                |       |                                       | 47         | % |   | 34,493 |   |   | 40 | % |   |   | 7 | % |   |
| General and  administrative                           |       | 17,290                                                |       |                                       | 22         | % |   | 16,637 |   |   | 19 | % |   |   | 4 | % |   |
| Severance and  lease abandonment charges (recoveries) |       | 5,110                                                 |       |                                       | 6          | % |   | (384 | ) |   | 0 | % |   |   | (1,431 | )% |   |
| Acquired  in-process product development              |       | 450                                                   |       |                                       | 1          | % |   | — |   |   | — |   |   |   | 100 | % |   |
| Spin-off  transaction costs                           |       | —                                                |       |                                       | —     |   |   | 700 |   |   | 1 | % |   |   | (100 | )% |   |
| Total operating  costs and expenses                   |       | 96,800                                                |       |                                       | 122        | % |   | 91,116 |   |   | 106 | % |   |   | 6 | % |   |
| Operating loss from  continuing operations            |       | $                                                     | (17,770    | )                                          |       | (22 | )% |   | $ | (4,907 | ) |   | (6 | )% |   |   | 262 | % |   |

* *

*Costof Revenue.**  *Cost of revenue decreased $3.0 million or 17% to$14.3 million for the year ended March 31, 2005, as compared to $17.3million for the year ended December 31, 2003. As a percentage of revenue,cost of revenue decreased to 18% for the year ended March 31, 2005, ascompared to 20% for the year ended December 31, 2003. The decrease in costof revenue was primarily attributable to a $1.6 million decrease in intangibleasset amortization due to the full amortization during fiscal year 2003 ofintangible assets acquired in previous periods and a $1.1 million decrease inclient services costs resulting from workforce reductions.

*ProductDevelopment Expenses.**  *Productdevelopment expenses increased $0.3 million or 1% to $22.7 million for theyear ended March 31, 2005, as compared to $22.4 million for the year endedDecember 31, 2003. As a percentage of revenue, product developmentexpenses increased to 29% for the year ended March 31, 2005, as comparedto 26% for the year ended December 31, 2003. The increase inproduct development expenses was attributable to additional product developmentactivities resulting from our acquisition of SciTegic during fiscal year 2005,offset by decreases in personnel costs due to workforce reductions andadditional cost efficiencies realized during fiscal year 2005 as our Bangalore,India operations ramped-up.

*Salesand Marketing Expenses.**  *Sales andmarketing expenses increased $2.4 million or 7% to $36.9 million for theyear ended March 31, 2005, as compared to $34.5 million for the year endedDecember 31, 2003. As a percentage of revenue, sales and marketingexpenses increased to 47% for the year ended March 31, 2005, as comparedto 40% for the year ended December 31, 2003. The increase in sales andmarketing expenses was attributable to additional personnel and other costsresulting from the establishment of a business development function in fiscalyear 2005, and the increase in sales personnel resulting from our acquisitionof SciTegic in fiscal year 2005.

*Generaland Administrative Expenses.**  *General andadministrative expenses increased $0.7 million or 4% to $17.3 million for theyear ended March 31, 2005, as compared to $16.6 million for the year endedDecember 31, 2003. As a percentage of revenue, general and administrativeexpenses increased to 22% for the year ended March 31, 2005, as comparedto 19% for the year ended December 31, 2003. The increase in general andadministrative expenses was attributable to a $0.7 million increase in outsideconsulting and accounting fees incurred in relation to our initial compliancewith Section 404 of Sarbanes-Oxley, partially offset by decreased generaland administrative expenses due to headcount and other cost reductionsresulting from the spin-off of PDD.

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*Severanceand Lease Abandonment Charges (Recoveries).**  *Severance and lease abandonment charges were $5.1million for the year ended March 31, 2005, as compared to a recovery ofpreviously recognized severance and lease abandonment charges of $0.4 millionfor the year ended December 31, 2003. During fiscal year 2005, we incurreda severance charge of $1.4 million and a lease abandonment charge of $3.9 million,offset by the recovery of previously recognized lease abandonment charges of$0.2 million. During fiscal year 2005, we implemented various actions designedto improve the efficiency of our sales department and eliminate duplicativegeneral and administrative personnel through workforce reductions andabandoning a leased facility in Germany. As a result of the implementation ofthese 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.

During fiscal year 2003, we recovered $0.4 million ofpreviously recognized severance and lease abandonment charges initiallyrecognized in fiscal year 2002. The recovery consisted of $0.3 millionresulting from the termination of the lease on an abandoned facility, and $0.1million related to certain severance obligations.

*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.

*Spin-Off Transaction Costs.**  *During the year ended December 31, 2003, weincurred $0.7 million of transaction costs associated with our spin-off of PDD.

***Net Interest and Other Income***

Netinterest and other income was $1.7 million for the year ended March 31,2005, as compared to $4.2 million for the year ended December 31, 2003. Thedecrease in net interest and other income is attributable to lower interestincome resulting from lower average investment balances as well as higherforeign exchange gains recognized in fiscal year 2003 resulting from theweakening of the U.S. dollar in fiscal year 2005.

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

Werecognized an income tax benefit of $0.6 million for the year ended March 31,2005, as compared to income tax expense of $1.0 million for the year ended December 31,2003. The income tax benefit recognized for the year ended March 31, 2005was primarily attributable to a $0.9 million refund of taxes previouslywithheld in Japan and the release of $1.0 million of an income tax reserverelated to a transfer-pricing matter, offset by taxable income generated by ourforeign operations. The income tax expense recognized for fiscal year 2006results from taxable income generated by certain of our foreign operations.

***Loss From DiscontinuedOperations***

As aresult of our spin-off of PDD, we recognized a loss from discontinuedoperations of $1.1 million, or $0.04 per share, for the year ended March 31,2005, which consisted of revenue of $1.3 million and expenses of $2.4 million. Thisloss compared to a loss from discontinued operations of $2.8 million, or $0.12per share, for the year ended December 31, 2003, which consisted of $29.5million in revenue and $32.3 million in expenses.

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**Comparison of theThree—Month Periods Ended March 31, 2004 and March 31, 2003**

***Revenue***

Revenuedecreased $3.8 million or 16% to $19.4 million for the three months ended March 31,2004, as compared to $23.2 million for the three months ended March 31,2003. The decrease in revenue was primarily attributable to continueddeclines in sales of modeling and simulation software to biopharmaceuticalcompanies as well the completion of several consortia and consulting agreementsduring 2003.

***Operating Costs andExpenses***

| ** **                                          | ** ** | **Three Months Ended March 31,**  | ** ** | ** **                                 | ** ** |
|-----------------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                          | ** ** | **2004**                                              | ** ** | **2003**                                   | ** ** | ** ** | ** ** |
| ** **                                          | ** ** | **Amount**                                            | ** ** | **As a  Percentage  of Revenue** | ** ** | **Amount** | ** ** | **As a  Percentage  of Revenue** | ** ** | **Percentage  Change** | ** ** |
| ** **                                          | ** ** | **(In thousands, except percentages)** | ** ** |
| Cost of revenue                                     |       | $                                                     | 3,238      |                                       |       | 17 | % |   | $ | 4,590 |   |   | 20 | % |   |   | (29 | )% |   |
| Product  development                                |       | 5,248                                                 |       |                                       | 27         | % |   | 5,877 |   |   | 25 | % |   |   | (11 | )% |   |
| Sales and  marketing                                |       | 8,436                                                 |       |                                       | 44         | % |   | 8,864 |   |   | 38 | % |   |   | (5 | )% |   |
| General and administrative                          |       | 4,434                                                 |       |                                       | 23         | % |   | 4,250 |   |   | 18 | % |   |   | 4 | % |   |
| Severance and  lease abandonment charges            |       | 5,199                                                 |       |                                       | 27         | % |   | (384 | ) |   | (2 | )% |   |   | (1,454 | )% |   |
| Spin-off  transaction costs                         |       | 2,321                                                 |       |                                       | 12         | % |   | — |   |   | — |   |   |   | 100 | % |   |
| Total operating  costs and expenses                 |       | 28,876                                                |       |                                       | 149        | % |   | 23,197 |   |   | 100 | % |   |   | 24 | % |   |
| Operating income (loss)  from continuing operations |       | $                                                     | (9,517     | )                                          |       | (49 | )% |   | $ | 31 |   |   | 0 | % |   |   | (30,800 | )% |   |

* *

*Costof Revenue.**  *Cost of revenue decreased $1.4 million or 29% to$3.2 million for the three months ended March 31, 2004, as compared to$4.6 million for the three months ended March 31, 2003. As a percentage ofrevenue, cost of revenue decreased to 17% for the three months endedMarch 31, 2004, as compared to 20% for the three months endedMarch 31, 2003. The decrease in cost of revenue was primarily attributableto a $1.1 million decrease in intangible asset amortization due to the fullamortization in fiscal year 2003 of intangible assets acquired in previousperiods.

*ProductDevelopment Expenses.**  *Productdevelopment expenses decreased $0.7 million or 11% to $5.2 million for thethree months ended March 31, 2004, as compared to the $5.9 million for thethree months ended March 31, 2003. As a percentage of revenue, productdevelopment expenses increased to 27% for the three months ended March 31,2004, as compared to 25% for the three months ended March 31, 2003. Thedecrease in product development expenses was primarily attributable todecreased personnel expenses resulting from headcount reductions inJanuary 2004.

*Salesand Marketing Expenses.**  *Sales andmarketing expenses decreased $0.5 million or 5% to $8.4 million for thethree months ended March 31, 2004, as compared to $8.9 million for thethree months ended March 31, 2003. As a percentage of revenue, sales andmarketing expenses increased to 44% for the three months ended March 31,2004, as compared to 38% for the three months ended March 31, 2003. Thedecrease in sales and marketing expenses was primarily attributable to lowercommissions paid to sales personnel as a result of a decrease in orders.

 

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*Generaland Administrative Expenses.**  *General andadministrative expenses increased $0.1 million or 4% to $4.4 million for thethree months ended March 31, 2004, as compared to $4.3 million for thethree months ended March 31, 2003. As a percentage of revenue, general andadministrative expenses increased to 23% for the three months ended March 31,2004, as compared to 18% for the three months ended March 31, 2003. Theincrease in general and administrative costs was primarily attributable to anincrease in personnel costs and outside consulting and accounting fees incurredin relation to our initial compliance with Section 404 of Sarbanes-Oxley.

*Severanceand Lease Abandonment Charges (Recoveries).**  *Severance and lease abandonment charges were $5.2million for the three months ended March 31, 2004, as compared to arecovery of previously recognized severance and lease abandonment charges of$0.4 million for the three months ended March 31, 2003. During the threemonths ended March 31, 2004, we implemented a workforce reduction of 73employees designed to improve the efficiency of our product developmentactivities and reduce general and administrative costs. As a result of theimplementation of this workforce reduction, we incurred a charge of $2.8million for severance benefits for the terminated employees. The remainingseverance and lease abandonment expenses incurred during the three months endedMarch 31, 2004 related to costs arising from the retirement of our formerchief executive officer.

During the three months ended March 31, 2003, werecovered $0.4 million of severance and lease abandonment charges initiallyrecognized in fiscal year 2002, consisting of $0.3 million resulting from thetermination of the lease on an abandoned facility and $0.1 million related tocertain severance obligations.

*Spin-Off Transaction Costs.**  *During the three months ended March 31,2004, we incurred transaction costs of $2.3 million associated with ourspin-off of PDD.

***Net Interest and Other Income***

Netinterest and other income was $0.9 million for the three months ended March 31,2004, as compared to $1.1 million for the three months ended March 31,2003. The decrease was due to lower foreign exchange gains in the three monthsended March 31, 2004, as compared to the three months ended March 31,2003 resulting from the weakening of the U.S. dollar, partially offset by anincrease in interest income.

***Income Tax Expense***

Incometax expense was $0.1 million for the three months ended March 31, 2004, ascompared to $0.3 million for the three months ended March 31, 2003. Thedecrease in income tax expense was due to a decrease in taxable incomegenerated by our foreign operations.

***Loss From Discontinued Operations***

As aresult of our spin-off of PDD, we recognized a loss from discontinuedoperations of $9.9 million, or $0.41 per share, for the three months ended March 31,2004, which consisted of $5.4 million in revenue and $15.3 million in expenses.This compared to a loss from discontinued operations of $0.9 million, or $0.04per share, for the three months ended March 31, 2003, which consisted of$7.5 million in revenue and $8.4 million in expenses.

**Liquidity andCapital Resources**

We had cash, cash equivalents,restricted cash, and marketable securities of $66.0 million as of March 31,2006, as compared to $63.3 million as of March 31, 2005, an increase of$2.7 million. Significant components of this increase include cash provided byoperations of $5.8 million, offset by net purchases of property and equipmentof $3.0 million.

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Net cash provided by operating activities was $5.8million for the year ended March 31, 2006, as compared to net cash used inoperating activities of $14.2 million for the year ended March 31, 2005.The increase in cash flows from operating activities was primarily attributableto reduced operating expenditures, improved collections processes foroutstanding accounts receivable balances and the prepayment in fiscal year 2006by a significant customer of future software license fees of approximately $3 million.

Net cash used in investing activities was $2.1 millionfor the year ended March 31, 2006, as compared to net cash provided byinvesting activities of $0.1 million for the year ended March 31, 2005. Significantcomponents of cash flows from investing activities for the year ended March 31,2006 included net purchases of property and equipment of $3.0 million and a netdecrease in our marketable securities portfolio of $0.9 million. Significantcomponents of cash flows from investing activities for the year ended March 31,2005 included a $16.6 million net decrease in our marketable securitiesportfolio, $11.0 million in cash paid to acquire SciTegic and $5.1 million ofnet purchases of property and equipment. The $2.1 million decrease in netpurchases of property and equipment for the year ended March 31, 2006, ascompared to the year ended March 31, 2005, is primarily attributable toinvestments in leasehold improvements for our corporate headquarters in SanDiego, California in fiscal year 2005.

Net cash provided by financing activities was $0.9million for the year ended March 31, 2006, compared to net cash used infinancing activities of $3.8 million for the year ended March 31, 2005. Cashflows from financing activities for the year ended March 31, 2006consisted of proceeds from the issuance of our common stock under our employeestock plans. Significant components of cash flows from financing activities forthe year ended March 31, 2005 included $1.7 million in proceeds from theissuance of our common stock under our employee stock plans and $5.5 million incash contributed to PDD in the spin-off.

We have funded our activities todate primarily through the sales of software licenses and related services, theissuance of equity securities, and, prior to the spin-off of PDD, drugdiscovery services.

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 at least throughfiscal year 2007. However, there can be no assurance that changes will notoccur that would consume available capital resources before then. Our capitalrequirements depend on numerous factors, including our ability to continue togenerate software sales, the purchase of additional capital equipment andacquisitions of other businesses or technologies. There can be no assurancethat additional funding, if necessary, will be available to us on favorableterms, if at all. Our forecast for the period of time through which ourfinancial resources will be adequate to support our operations is forwardlooking information, and actual results could vary.

At March 31, 2006,our remaining liability for severance and lease abandonment charges was $4.3 million.Of the liability, $1.1 million represents severance benefits for terminatedemployees that will be paid in the first quarter of fiscal year 2007. Theremaining liability of $3.2 million represents lease abandonment obligationsthat will be paid through 2016. See Note 10 to our consolidated financial statementsincluded elsewhere in this Report for further information regarding ourseverance and lease abandonment liability.

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**Contractual Obligations**

Our long-term contractual obligations as of March 31,2006 are as follows (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    |       | $          | 40,790     |                                      |       | $ | 3,518 |   |   | $ | 7,627 |   | $ | 7,091 |   | $ | 22,554 |   |
| Estimated minimum  royalty payments(1) |       | 3,189      |       |                                      | 526        |   |   | 828 |   | 506 |   | 1,329 |   |
| Total                                  |       | $          | 43,979     |                                      |       | $ | 4,044 |   |   | $ | 8,455 |   | $ | 7,597 |   | $ | 23,883 |   |
|                                        |            |            |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          For purposes of the contractual obligations table, we have includedindefinite-lived contractual minimum royalty payments due in the ten fiscalyears following fiscal year 2006.

Weare obligated to pay royalties for licenses to enhance and market certainsoftware used in connection with our product offerings. In addition to thecontractual minimum royalties included in the table above, we have severalroyalty agreements that are long term or perpetual in nature and the royaltyobligations are generally based on a percentage of revenues derived fromcertain software license sales including associated sales of PCS. The royaltyagreements require quarterly payments and generally do not limit the maximumroyalties owed. During the years ended March 31, 2006 and 2005 and December 31,2003, we incurred royalty expenses of $3.0million, $2.8 million, and $2.8 million, respectively. Our future annualroyalty obligations will vary based on the volume and mix of our product salesand, as a result, may increase in the future.

On April 30, 2004,relating to the spin-off of PDD, the landlords of our New Jersey facilities,which were used by our PDD operations, consented to the assignment of theleases to PDD. Despite the assignment, the landlords required us to guaranteethe remaining lease obligations, which totaled approximately $25 million as of March 31,2006. In accordance with Financial Accounting Standards Board (“FASB”)Interpretation (“FIN”) No. 45, *Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others,* we recognized a liability andcorresponding charge to stockholders’ equity for the probability-weighted fairmarket value of the guarantee. Changes to the fair market value of theliability are recognized in stockholders’ equity. At March 31, 2006 and2005, the liability for our guarantee of the lease obligation was $0.6 millionand $0.7 million, respectively.

**Off-Balance Sheet Arrangements and Related PartyTransactions**

Asof March 31, 2006, 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 otherthan what is disclosed in Note 12 to our consolidated financial statementsincluded elsewhere in this Report.

**New Accounting Standards**

In November 2005, theFASB issued FASB Staff Position Nos. FAS 115-1 and FAS 124-1 (“FSP Nos. 115-1and 124-1”), *The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments*,which provide guidance on determining when investments in certain debt andequity securities are considered impaired and whether that impairment isother-than-temporary, and on the measurement of such impairment loss. FSP Nos.115-1 and 124-1 also include accounting considerations subsequentto the recognition of other-than-temporary impairments and require certaindisclosures about unrealized losses that have not been recognized asother-than-temporary impairments. We will adopt 

38

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FSP Nos.115-1 and 124-1 as of April 1, 2006. While we are currentlyevaluating the impact on our consolidated financial statements of the adoptionof FSP Nos. 115-1 and 124-1, we do not anticipate that they willhave a significant impact on our results of operations and financial position.

In May 2005, the FASBissued SFAS No. 154, *Accounting Changes andError Corrections, a replacement of APB Opinion No. 20 and SFAS No. 3*.Although SFAS No. 154 carries forward the guidance in APB No. 20 andSFAS No. 3 with respect to accounting for changes in estimates, changes inreporting entities, and the correction of errors, SFAS No. 154 establishesnew standards for accounting for changes in accounting principles, whereby allsuch changes must be accounted for by retrospective application to thefinancial statements of prior periods unless it is impracticable to do so. SFASNo. 154 is effective for accounting changes and error corrections made infiscal years beginning after December 15, 2005, with early adoptionpermitted for changes and corrections made in years beginning after May 2005.We will adopt SFAS No. 154 as of April 1, 2006. We are currentlyevaluating the impact of this new standard, but believe that it will not have amaterial impact on our financial position, results of operations or cash flows.

In December 2004, theFASB issued SFAS No. 123R. SFAS No. 123R requires that employeestock-based compensation is measured based on the grant date fair value of therelated employee equity awards and is treated as an expense that is reflectedin the financial statements over the related service period. SFAS No. 123Rapplies to all employee equity awards granted after adoption and to theunvested portion of employee equity awards outstanding as of adoption. We willadopt SFAS No. 123R using the modified-prospective method effective April 1,2006. While we are currently evaluating the impact on our consolidatedfinancial statements of the adoption of SFAS No. 123R, we anticipate thatit will have a significant adverse impact on our future reported results ofoperations because employee stock-based compensation expense will be chargeddirectly against our reported results, but will not affect our financialposition or cash flows.

**Item7A.**                Quantitative andQualitative Disclosures About Market Risk

We have operations inEurope and Asia-Pacific. As a result, our financial position, results ofoperations and cash flows can be affected by fluctuations in foreign currencyexchange rates, particularly fluctuations in the pound sterling, euro and yenexchange rates. Many of our reporting entities conduct a portion of theirbusiness 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 areincluded in the determination of net income. We analyze our exposure tocurrency fluctuations and may engage in financial hedging techniques in thefuture to reduce the effect of these potential fluctuations. We do notcurrently have hedging contracts in effect since exchange rate fluctuationshave had little impact on our operating results and cash flows. The majority ofour subscription agreements are denominated in U.S. dollars.

Our investment portfoliois maintained in accordance with our investment policy that defines allowableinvestments, specifies credit quality standards and limits the credit exposureof any single issuer. None of our investments are held for trading orspeculative purposes. The fair value of our cash equivalents and marketablesecurities is subject to change as a result of changes in market interest ratesand investment risk related to the issuers’ credit worthiness. We do notutilize financial contracts to manage our exposure in our investment portfolioto changes in interest rates. A hypothetical 100 basis point increase ordecrease in market interest rates would not have a material impact on the fairvalue of our cash equivalents and marketable securities due to the relativelyshort maturities of these investments. While changes in interest rates mayaffect the fair value of our investment portfolio, any gains or losses will notbe recognized in our results of operations until the investment is sold or if thereduction in fair value was determined to be a permanent impairment.

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**Item 8.**                        FinancialStatements and Supplementary Data

**REPORT OFINDEPENDENT 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, 2006 and March 31, 2005(restated), and the related consolidated statements of operations, stockholders’equity, and cash flows for each of the years ended March 31, 2006 and March 31,2005 (restated) and December 31, 2003 (restated), and the three monthperiod ended March 31, 2004 (restated). Our audits also included thefinancial statement schedule listed in the index at Item 15(a)(2). Thesefinancial statements and schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements and schedule based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards 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, 2006 and March 31, 2005(restated), and the consolidated results of its operations and its cash flowsfor each of the years ended March 31, 2006 and March 31, 2005(restated) and December 31, 2003 (restated), and the three month periodended March 31, 2004 (restated), in conformity with U.S. generallyaccepted accounting principles. Also, in our opinion, the related financialstatement schedule, when considered in relation to the basic financialstatements taken as a whole, presents fairly in all material respects theinformation set forth therein.

As described in Note 2, Restatement of Prior PeriodsPresented, the Company has restated its previously issued consolidatedfinancial statements as of March 31, 2005 and for the years endedMarch 31, 2005 and December 31, 2003 and the three month period endedMarch 31, 2004, to correct the accounting for revenue recognition andsoftware development costs, and to correct the classification of expenses,interest income, cash flows from discontinued operations and investments in auctionrate securities.

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of Accelrys, Inc.’sinternal control over financial reporting as of March 31, 2006, based on thecriteria established in Internal Control-Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission and our reportdated May 5, 2006, expressed an unqualified opinion on management’sassessment and an adverse opinion on the effectiveness of internal control overfinancial reporting thereon.
|                        | /s/ ERNST & YOUNG Llp |
|------------------------|--------------------------------|
| San Diego,  California |                           |
| May 5, 2006       |                           |

 

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**Accelrys, Inc.Consolidated Balance Sheets(In thousands, except per share amounts)**

| ** **                                                                                                                                                | ** ** | **March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                                                                                                | ** ** | **2006**           | ** ** | **2005(1)** | ** ** |
| ** **                                                                                                                                                | ** ** | ** **         | ** ** | **(Restated)** | ** ** |
| **Assets**                                                                                                                                                |       |               |       |   |   |
| Current assets:                                                                                                                                           |       |               |       |   |   |
| Cash and cash equivalents                                                                                                                                 |       | $                  | 24,656     |   | $ | 21,256 |   |
| Marketable securities                                                                                                                                     |       | 34,733             |       | 35,416 |   |
| Trade receivables, net of allowance for doubtful  accounts of $351 and $315 as of March 31, 2006 and 2005,  respectively                        |       | 17,289             |       | 20,006 |   |
| Prepaid expenses and other current assets                                                                                                                 |       | 3,438              |       | 6,249 |   |
| Total current assets                                                                                                                                      |       | 80,116             |       | 82,927 |   |
| Restricted cash                                                                                                                                           |       | 6,633              |       | 6,632 |   |
| Property and equipment, net                                                                                                                               |       | 7,860              |       | 9,043 |   |
| Goodwill                                                                                                                                                  |       | 42,663             |       | 42,609 |   |
| Intangible assets, net                                                                                                                                    |       | 8,671              |       | 10,369 |   |
| Other assets                                                                                                                                              |       | 812                |       | 835 |   |
| Total assets                                                                                                                                              |       | $                  | 146,755    |   | $ | 152,415 |   |
| **Liabilities  and stockholders’ equity**                                                                                                            |       |               |       |   |   |
| Current liabilities:                                                                                                                                      |       |               |       |   |   |
| Accounts payable                                                                                                                                          |       | $                  | 1,676      |   | $ | 1,821 |   |
| Accrued liabilities                                                                                                                                       |       | 4,939              |       | 5,570 |   |
| Accrued compensation and benefits                                                                                                                         |       | 7,009              |       | 8,874 |   |
| Current portion of accrued severance and lease  abandonment                                                                                               |       | 2,936              |       | 2,809 |   |
| Current portion of deferred revenue                                                                                                                       |       | 51,710             |       | 49,083 |   |
| Total current liabilities                                                                                                                                 |       | 68,270             |       | 68,157 |   |
| Deferred revenue, net of current portion                                                                                                                  |       | 9,559              |       | 9,531 |   |
| Accrued severance and lease abandonment, net of  current portion                                                                                          |       | 1,338              |       | 1,784 |   |
| Deferred rent, lease concessions and lease guarantee,  net of current portion                                                                             |       | 4,380              |       | 3,347 |   |
| 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; 26,856 and 26,643 shares issued and outstanding at March 31,  2006 and 2005, respectively |       | 3                  |       | 3 |   |
| Additional paid-in capital                                                                                                                                |       | 254,224            |       | 253,327 |   |
| Deferred compensation                                                                                                                                     |       | (522               | )          | (1,469 | ) |
| Lease guarantee                                                                                                                                           |       | (635               | )          | (698 | ) |
| Treasury stock; 644 shares at each of March 31,  2006 and 2005, respectively                                                                         |       | (8,340             | )          | (8,340 | ) |
| Accumulated deficit                                                                                                                                       |       | (181,156           | )          | (173,417 | ) |
| Accumulated other comprehensive income (loss)                                                                                                             |       | (366               | )          | 190 |   |
| Total stockholders’ equity                                                                                                                           |       | 63,208             |       | 69,596 |   |
| Total liabilities  and stockholders’ equity                                                                                                          |       | $                  | 146,755    |   | $ | 152,415 |   |

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(1)          We have restated our previously issued consolidatedfinancial statements for all reporting periods beginning January 1, 2000through September 30, 2005 to reflect certain accounting adjustments, asdescribed more fully in Note 2.

See accompanying notes to these consolidated financial statements.

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Accelrys, Inc.Consolidated Statements of Operations(In thousands, except per share amounts)

| ** **                                                                                  | ** ** | **Years Ended**     | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------|------------|--------------------------|------------|----------------------------------|------------|
| ** **                                                                                  | ** ** | **March 31,  2006** | ** ** | **March 31,  2005(1)**      | ** ** | **December 31,  2003(1)** | ** ** | **March 31,  2004(1)** | ** ** | **March 31,  2003(1)** | ** ** |
| ** **                                                                                  | ** ** | ** **               | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |
| ** **                                                                                  | ** ** | ** **               | ** ** | **(Restated)**                   | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Revenue                                                                                     |       |                     | $          | 82,001                           |       |   | $ | 79,030 |   |   | $ | 86,209 |   |   | $ | 19,359 |   |   | $ | 23,228 |   |   |
| Operating costs and  expenses:                                                              |       |                     |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of revenue                                                                             |       |                     | 17,095     |                             |       | 14,317 |   |   | 17,276 |   |   | 3,238 |   |   | 4,590 |   |   |
| Product development                                                                         |       |                     | 21,721     |                             |       | 22,717 |   |   | 22,394 |   |   | 5,248 |   |   | 5,877 |   |   |
| Sales and marketing                                                                         |       |                     | 32,657     |                             |       | 36,916 |   |   | 34,493 |   |   | 8,436 |   |   | 8,864 |   |   |
| General and administrative                                                                  |       |                     | 16,060     |                             |       | 17,290 |   |   | 16,637 |   |   | 4,434 |   |   | 4,250 |   |   |
| Severance and lease abandonment charges (recoveries)                                        |       |                     | 3,178      |                             |       | 5,110 |   |   | (384 | ) |   | 5,199 |   |   | (384 | ) |   |
| Acquired in-process product development                                                     |       |                     | —     |                             |       | 450 |   |   | — |   |   | — |   |   | — |   |   |
| Spin-off transaction costs                                                                  |       |                     | —     |                             |       | — |   |   | 700 |   |   | 2,321 |   |   | — |   |   |
| Total operating  costs and expenses                                                         |       |                     | 90,711     |                             |       | 96,800 |   |   | 91,116 |   |   | 28,876 |   |   | 23,197 |   |   |
| Operating income  (loss) from continuing operations                                         |       |                     | (8,710     | )                                |       | (17,770 | ) |   | (4,907 | ) |   | (9,517 | ) |   | 31 |   |   |
| Interest and  other income, net                                                             |       |                     | 1,869      |                             |       | 1,738 |   |   | 4,160 |   |   | 921 |   |   | 1,127 |   |   |
| Income (loss)  from continuing operations before taxes                                      |       |                     | (6,841     | )                                |       | (16,032 | ) |   | (747 | ) |   | (8,596 | ) |   | 1,158 |   |   |
| Income tax  expense (benefit)                                                               |       |                     | 898        |                             |       | (571 | ) |   | 1,001 |   |   | 128 |   |   | 270 |   |   |
| Income (loss)  from continuing operations                                                   |       |                     | (7,739     | )                                |       | (15,461 | ) |   | (1,748 | ) |   | (8,724 | ) |   | 888 |   |   |
| Loss from  discontinued operations                                                          |       |                     | —     |                             |       | (1,117 | ) |   | (2,848 | ) |   | (9,936 | ) |   | (938 | ) |   |
| Net loss                                                                                    |       |                     | $          | (7,739                           | )          |   | $ | (16,578 | ) |   | $ | (4,596 | ) |   | $ | (18,660 | ) |   | $ | (50 | ) |   |
| Basic and diluted  income (loss) per share amounts:                                         |       |                     |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss)  from continuing operations                                                   |       |                     | $          | (0.30                            | )          |   | $ | (0.62 | ) |   | $ | (0.07 | ) |   | $ | (0.36 | ) |   | $ | 0.04 |   |   |
| Loss from  discontinued operations                                                          |       |                     | —     |                             |       | (0.04 | ) |   | (0.12 | ) |   | (0.41 | ) |   | (0.04 | ) |   |
| Net loss                                                                                    |       |                     | $          | (0.30                            | )          |   | $ | (0.66 | ) |   | $ | (0.19 | ) |   | $ | (0.77 | ) |   | $ | (0.00 | ) |   |
| Weighted averaged  shares used to compute basic and diluted income (loss) per share amounts |       |                     | 26,116     |                             |       | 25,137 |   |   | 23,752 |   |   | 24,090 |   |   | 23,617 |   |   |

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(1)          We have restated ourpreviously issued consolidated financial statements for all reporting periodsbeginning January 1, 2000 through September 30, 2005 to reflect certainaccounting adjustments, as described more fully in Note 2.

See accompanying notes to these consolidated financial statements.

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**Accelrys, Inc. Consolidated Statements of Stockholders’ 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(1)**         | ** ** | **(Loss)**        | ** **                | **Equity(1)**  | ** ** |
| ** **                                                                                                            | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **       | ** ** | ** **              | ** **     | ** **      | ** ** | ** ** | ** **                                  | **(Restated)**         | ** ** | ** **        | ** **                | **(Restated)** | ** ** |
| Balance at December 31, 2002 (Previously  Reported)                                                              |       |                  | 24,241     |        |       |           | $ 2   |             |       |                    | $ 284,733 |            |       |       | $      — |                   |       |              | $   — |           |       |   | 644 |   |   |   | $ (8,340 | ) |   |   | $ (93,821 | ) |   |   | $    763 |   |   |   | $ 183,337 |   |   |
| Cumulative effect of restatement on prior years(1)                                                                    |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | (39,762 | ) |   |   | — |   |   |   | (39,762 | ) |   |
| Balance at December 31, 2002 (Restated)(1)                                                                       |       |                  | 24,241     |        |       |           | 2          |             |       |                    | 284,733        |            |       |       | —                                      |                   |       |              | —                    |           |       |   | 644 |   |   |   | (8,340 | ) |   |   | (133,583 | ) |   |   | 763 |   |   |   | 143,575 |   |   |
| Comprehensive  loss:                                                                                                  |       |                  |       |        |       |           |       |             |       |                    |           |            |       |       |                                        |                   |       |              |                      |           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss (Restated)(1)                                                                                                |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | (4,596 | ) |   |   | — |   |   |   | (4,596 | ) |   |
| Foreign currency translation adjustment                                                                               |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 1,147 |   |   |   | 1,147 |   |   |
| Unrealized loss on marketable securities                                                                              |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   |   |   |   |   | (576 | ) |   |   | (576 | ) |   |
| Total comprehensive loss (Restated)(1)                                                                                |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (4,025 | ) |   |
| Deferred compensation bonus, subject to vesting                                                                       |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | (536                                        | )                      |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (536 | ) |   |
| Non-cash stock-based compensation expense                                                                             |       |                  | —     |        |       |           | —     |             |       |                    | 93             |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 93 |   |   |
| Issuance of common stock upon exercise of stock  options and under employee stock purchase plan                  |       |                  | 219        |        |       |           | —     |             |       |                    | 1,723          |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 1,723 |   |   |
| Issuance of common stock for 401(K) plan  matching contribution                                                  |       |                  | 108        |        |       |           | —     |             |       |                    | 1,043          |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 1,043 |   |   |
| Balance at December 31, 2003 (Restated)(1)                                                                       |       |                  | 24,568     |        |       |           | 2          |             |       |                    | 287,592        |            |       |       | (536                                        | )                      |       |              | —                    |           |       |   | 644 |   |   |   | (8,340 | ) |   |   | (138,179 | ) |   |   | 1,334 |   |   |   | 141,873 |   |   |
| Comprehensive  loss:                                                                                                  |       |                  |       |        |       |           |       |             |       |                    |           |            |       |       |                                        |                   |       |              |                      |           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss (Restated)(1)                                                                                                |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | (18,660 | ) |   |   | — |   |   |   | (18,660 | ) |   |
| Foreign currency translation adjustment                                                                               |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 280 |   |   |   | 280 |   |   |
| Unrealized loss on marketable securities                                                                              |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   |   |   |   |   | (52 | ) |   |   | (52 | ) |   |
| Total comprehensive loss (Restated)(1)                                                                                |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (18,432 | ) |   |
| Issuance of restricted stock                                                                                          |       |                  | 52         |        |       |           | —     |             |       |                    | 891            |            |       |       | (891                                        | )                      |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Amortization of deferred stock-based compensation  related to restricted stock                                        |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | 29                                          |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 29 |   |   |
| Amortization and vesting of deferred compensation  bonus                                                              |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | 537                                         |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 537 |   |   |
| Non-cash stock-based compensation expense                                                                             |       |                  | —     |        |       |           | —     |             |       |                    | 8              |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 8 |   |   |
| Issuance of common stock upon exercise of stock  options                                                              |       |                  | 316        |        |       |           | —     |             |       |                    | 3,229          |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 3,229 |   |   |
| Issuance of common stock for 401(K) plan  matching contribution                                                  |       |                  | 13         |        |       |           | —     |             |       |                    | 257            |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 257 |   |   |
| Balance at March 31, 2004 (Restated)(1)                                                                          |       |                  | 24,949     |        |       |           | 2          |             |       |                    | 291,977        |            |       |       | (861                                        | )                      |       |              | —                    |           |       |   | 644 |   |   |   | (8,340 | ) |   |   | (156,839 | ) |   |   | 1,562 |   |   |   | 127,501 |   |   |
| Comprehensive  loss:                                                                                                  |       |                  |       |        |       |           |       |             |       |                    |           |            |       |       |                                        |                   |       |              |                      |           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss (Restated)(1)                                                                                                |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | (16,578 | ) |   |   | — |   |   |   | (16,578 | ) |   |
| Foreign currency translation adjustment                                                                               |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 115 |   |   |   | 115 |   |   |
| Unrealized loss on marketable securities                                                                              |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   |   |   |   |   | (1,487 | ) |   |   | (1,487 | ) |   |
| Total comprehensive loss (Restated)(1)                                                                                |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | —                                      |                   |       |              | —                    |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (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 |   |   |

43

 

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**Accelrys, Inc. Consolidated Statements of Stockholders’ Equity (Continued) (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(1)**         | ** ** | **(Loss)**        | ** **  | **Equity(1)**  | ** ** |
| ** **                                                                                                                | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **       | ** ** | ** **              | ** **     | ** **      | ** ** | ** ** | ** **        | **(Restated)**         | ** ** | ** **        | ** **  | **(Restated)** | ** ** |
| Balance at March 31, 2005 (Restated)(1)                                                                              |       |                  | 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                                                                                   |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | —            |                   |       |              | —      |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (784 | ) |   |   | (784 | ) |   |
| Unrealized gain on marketable securities                                                                                  |       |                  | —     |        |       |           | —     |             |       |                    | —         |            |       |       | —            |                   |       |              | —      |           |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 228 |   |   |   | 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 |   |   |

----

(1)                 We have restated our previously issued consolidatedfinancial statements for all reporting periods beginning January 1, 2000through September 30, 2005 to reflect certain accounting adjustments, asdescribed more fully in Note 2.

See accompanying notes to these consolidated financial statements.

44

 

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**Accelrys, Inc.Consolidated Statements of Cash Flows(In thousands)**

| ** **                                                                                  | ** ** | **Years Ended**          | ** ** | **Three Months Ended**      | ** ** |
|---------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                  | ** ** | **March 31,  2006** | ** ** | **March 31,  2005(1)** | ** ** | **December 31,  2003(1)** | ** ** | **March 31,  2004(1)** | ** ** | **March 31,  2003(1)** | ** ** |
| ** **                                                                                  | ** ** | ** **               | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |
| ** **                                                                                  | ** ** | ** **               | ** ** | **(Restated)**              | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| **Cash flows from operating activities:**                                                   | ** ** |                     | ** ** | ** **                  |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net loss                                                                                    |       |                     | $          | (7,739                      | )          |   |   | $ | (16,578 | ) |   |   | $ | (4,596 | ) |   |   | $ | (18,660 | ) |   |   | $ | (50 | ) |   |
| Less: Loss from  discontinued operations                                                    |       |                     | —     |                        |       |   | (1,117 | ) |   |   | (2,848 | ) |   |   | (9,936 | ) |   |   | (938 | ) |   |
| Income (loss) from  continuing operations                                                   |       |                     | (7,739     | )                           |       |   | (15,461 | ) |   |   | (1,748 | ) |   |   | (8,724 | ) |   |   | 888 |   |   |
| Adjustments to reconcile  net loss to net cash  provided by (used in) operating activities: |       |                     |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Depreciation                                                                                |       |                     | 3,813      |                        |       |   | 4,528 |   |   |   | 4,493 |   |   |   | 1,134 |   |   |   | 1,130 |   |   |
| Amortization of  acquired intangible assets                                                 |       |                     | 1,698      |                        |       |   | 1,131 |   |   |   | 2,885 |   |   |   | — |   |   |   | 1,260 |   |   |
| Non-cash  stock-based compensation                                                          |       |                     | 853        |                        |       |   | 689 |   |   |   | 93 |   |   |   | 37 |   |   |   | 10 |   |   |
| Contribution of  common stock to 401(K) plan                                           |       |                     | 134        |                        |       |   | 612 |   |   |   | 1,043 |   |   |   | 257 |   |   |   | 281 |   |   |
| Non-cash rent  expense                                                                      |       |                     | 1,359      |                        |       |   | 914 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Acquired  in-process product development                                                    |       |                     | —     |                        |       |   | 450 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Changes in operating  assets and liabilities:                                               |       |                     |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Trade receivables                                                                           |       |                     | 2,040      |                        |       |   | (8,119 | ) |   |   | (2,133 | ) |   |   | 28,978 |   |   |   | 20,642 |   |   |
| Prepaid expenses  and other current assets                                                  |       |                     | 2,280      |                        |       |   | 477 |   |   |   | 131 |   |   |   | (144 | ) |   |   | 1 |   |   |
| Other assets                                                                                |       |                     | (309       | )                           |       |   | 42 |   |   |   | (523 | ) |   |   | 99 |   |   |   | 132 |   |   |
| Accounts payable                                                                            |       |                     | (69        | )                           |       |   | (3,927 | ) |   |   | 388 |   |   |   | 2,814 |   |   |   | 389 |   |   |
| Accrued  liabilities                                                                        |       |                     | (2,181     | )                           |       |   | 512 |   |   |   | (1,737 | ) |   |   | (2,116 | ) |   |   | (4,515 | ) |   |
| Deferred revenue                                                                            |       |                     | 3,893      |                        |       |   | 3,037 |   |   |   | (44 | ) |   |   | (10,048 | ) |   |   | (9,454 | ) |   |
| Net cash provided by  (used in) continuing operating activities                             |       |                     | 5,772      |                        |       |   | (15,115 | ) |   |   | 2,848 |   |   |   | 12,287 |   |   |   | 10,764 |   |   |
| Net cash provided by  (used in) discontinued operating activities                           |       |                     | —     |                        |       |   | 958 |   |   |   | (4,780 | ) |   |   | (3,364 | ) |   |   | (4,768 | ) |   |
| Net cash provided by  (used in) operating activities                                        |       |                     | 5,772      |                        |       |   | (14,157 | ) |   |   | (1,932 | ) |   |   | 8,923 |   |   |   | 5,996 |   |   |
| **Cash flows from investing activities:**                                                   | ** ** |                     | ** ** | ** **                  |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Purchases of  property and equipment, net                                                   |       |                     | (3,043     | )                           |       |   | (5,053 | ) |   |   | (2,850 | ) |   |   | (803 | ) |   |   | (714 | ) |   |
| Purchases of  marketable securities                                                         |       |                     | (11,146    | )                           |       |   | (52,661 | ) |   |   | (93,861 | ) |   |   | (61,319 | ) |   |   | (18,552 | ) |   |
| Proceeds from  maturities of marketable securities                                          |       |                     | 12,055     |                        |       |   | 69,273 |   |   |   | 99,574 |   |   |   | 66,256 |   |   |   | 16,638 |   |   |
| Acquisition of  business, net of cash acquired                                              |       |                     | —     |                        |       |   | (10,989 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Net cash provided  by (used in) continuing investing activities                             |       |                     | (2,134     | )                           |       |   | 570 |   |   |   | 2,863 |   |   |   | 4,134 |   |   |   | (2,628 | ) |   |
| Net cash used in  discontinued investing activities                                         |       |                     | —     |                        |       |   | (436 | ) |   |   | (4,163 | ) |   |   | (4,613 | ) |   |   | (86 | ) |   |
| Net cash provided  by (used in) investing activities                                        |       |                     | (2,134     | )                           |       |   | 134 |   |   |   | (1,300 | ) |   |   | (479 | ) |   |   | (2,714 | ) |   |
| **Cash flows from financing activities:**                                                   | ** ** |                     | ** ** | ** **                  |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Proceeds from  issuance of common stock                                                     |       |                     | 857        |                        |       |   | 1,682 |   |   |   | 1,723 |   |   |   | 3,229 |   |   |   | 57 |   |   |
| Cash remitted to  PDD                                                                       |       |                     | —     |                        |       |   | (5,445 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Payments on  capital leases                                                                 |       |                     | —     |                        |       |   | — |   |   |   | (12 | ) |   |   | (4 | ) |   |   | (3 | ) |   |
| Net cash provided  by (used in) financing activities                                        |       |                     | 857        |                        |       |   | (3,763 | ) |   |   | 1,711 |   |   |   | 3,225 |   |   |   | 54 |   |   |
| Exchange rate  effect on cash and cash equivalents                                          |       |                     | (1,095     | )                           |       |   | 81 |   |   |   | 794 |   |   |   | 236 |   |   |   | 7 |   |   |
| Change in cash and  cash equivalents of discontinued operations                             |       |                     | —     |                        |       |   | (743 | ) |   |   | 6,213 |   |   |   | 814 |   |   |   | 4,950 |   |   |
| Increase  (decrease) in cash and cash equivalents                                           |       |                     | 3,400      |                        |       |   | (18,448 | ) |   |   | 5,486 |   |   |   | 12,719 |   |   |   | 8,293 |   |   |
| Cash and cash  equivalents at beginning of period                                           |       |                     | 21,256     |                        |       |   | 39,704 |   |   |   | 21,499 |   |   |   | 26,985 |   |   |   | 21,499 |   |   |
| Cash and cash  equivalents at end of period                                                 |       |                     | $          | 24,656                      |       |   |   | $ | 21,256 |   |   |   | $ | 26,985 |   |   |   | $ | 39,704 |   |   |   | $ | 29,792 |   |   |
| **Supplemental cash flow information:**                                                     | ** ** |                     | ** ** | ** **                  |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Cash paid during  the year for income taxes                                                 |       |                     | $          | 515                         |       |   |   | $ | 693 |   |   |   | $ | 296 |   |   |   | $ | 163 |   |   |   | $ | 141 |   |   |

----

(1)             We have restated our previously issued consolidatedfinancial statements for all reporting periods beginning January 1, 2000through September 30, 2005 to reflect certain accounting adjustments, asdescribed more fully in Note 2.

See accompanying notes to these consolidated financial statements.

45

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

**1.   Organizationand Description of Business**

We develop and commercialize software for computation,simulation, management and mining of scientific data used by biologists,chemists and materials scientists, including nanotechnology researchers forproduct design as well as drug discovery and development.

On April 1, 2004, wechanged our fiscal year end from December 31 to March 31. Forcomparative purposes, we have included in our accompanying consolidatedfinancial statements the consolidated statements of operations, consolidatedstatements of stockholders’ equity and consolidated statements of cash flowsfor the years ended March 31, 2006 and 2005 and December 31, 2003,and the three months ended March 31, 2004.

**2.**   Restatementof Prior Periods Presented

We have restated our previously issued consolidatedfinancial statements to reflect certain accounting adjustments. The decision torestate our consolidated financial statements was made by the Audit Committeeof our Board of Directors on December 16, 2005, following consultationwith, and upon the recommendation of, management and Ernst & Young LLP(“E&Y”), our independent registered public accounting firm. Our decision torestate was made in connection with a review of our Annual Report on Form 10-Kfor the year ended March 31, 2005 by the Corporate Finance Division of theSecurities and Exchange Commission (the “SEC”).

Our restated consolidated financial statements reflectthe following accounting adjustments:

*Timingof Revenue Recognition.**  *Priorto January 2004, we generally recognized revenues from our term-basedsoftware license arrangements, which include both a software license and post-contractcustomer support (“PCS”), as follows: 64% of the total sales value attributedto the software license was recognized as revenue upon product shipment and theremaining 36%, which was associated with PCS, was recognized as revenue overthe PCS term. We have since determined that the fee for such arrangementscannot be unbundled and accounted for separately because we do not havevendor-specific objective evidence (“VSOE”) of the fair value of the PCS. Rather,the entire arrangement fee should be recognized as revenue ratably over theterm of the PCS.

Historically, we generally recognized revenues fromour perpetual software license arrangements, which include both a softwarelicense and PCS, as follows: 85% of the total sales value attributed to thesoftware license was recognized as revenue upon product shipment and theremaining 15%, which was attributed to PCS, was recognized as revenue over thePCS term. We have since determined that the fee for such arrangements cannot beunbundled and accounted for separately because we do not have VSOE of the fairvalue of the PCS. Rather, the entire arrangement fee should be recognized asrevenue ratably over the term of the PCS.

Accordingly, we have restated our previously issuedconsolidated financial statements to reflect these changes in the timing of therevenue recognized associated with these software license arrangements.

*Accountingfor Software Development Costs.**  *Historically,we capitalized a portion of our product development costs in accordance withStatement of Financial Accounting Standards (“SFAS”) No. 86, *Accounting for the Cost of Computer Software to be Sold, Leased orOtherwise Marketed*. As a result of an internal review of ourhistorical accounting for software development costs, we determined that we didnot have contemporaneous evidence of the achievement of technologicalfeasibility of our software development projects as required for capitalizationunder SFAS No. 86. As a result, we historically 

46

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

capitalized softwaredevelopment costs prior to the achievement of technological feasibility. Basedon this review, we have determined that technological feasibility occursshortly before our software products are available for general release. Usingthis revised methodology, we have determined that costs eligible forcapitalization under SFAS No. 86 would not be material. Therefore, we haverestated our previously issued consolidated financial statements to remove allhistorical capitalization of product development costs and related assets andamortization.

*Classificationof Expenses, Interest Income and Cash Flows From Discontinued Operations.**  *We have restated our previously issued consolidatedstatements of operations to correct certain misclassifications of general andadministrative expenses and interest income between continuing and discontinuedoperations. These misclassifications resulted in an understatement of our lossfrom discontinued operations and a corresponding overstatement of our loss fromcontinuing operations. We have also restated our previously issued consolidatedstatements of cash flows to report net cash provided by operating, investingand financing activities related to discontinued operations as separate lineitems in the statements of cash flows, as opposed to a single line item aspreviously reported.

*Classificationof Investments in Auction Rate Securities.**  *We have restated our previously issued consolidatedbalance sheets and statements of cash flows to reflect the reclassification ofinvestments in auction rate securities to marketable securities from cash andcash equivalents.

The financial information presented in theaccompanying consolidated financial statements and these notes to theconsolidated financial statements give effect to the restatement.

Theeffect of the restatement on our previously reported revenue, operatingexpenses, net loss and basic and diluted net loss per share for the historicalperiods presented in the accompanying consolidated financial statements was asfollows:

| ** **                                                   | ** ** | **Years Ended**                                                  | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                   | ** ** | **March 31,  2005**                                              | ** ** | **December 31,  2003**      | ** ** | **March 31,  2004** | ** ** | **March 31,  2003** | ** ** |
| ** **                                                   | ** ** | ** **                                                            | ** ** | ** **                       | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |
| ** **                                                   | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Increase in  revenue                                         |       |                                                                  | $          | 9,399                            |       |   |   | $ | 648 |   |   |   | $ | 8,224 |   |   |   | $ | 6,009 |   |   |
| Increase  (decrease) in total costs and operating  expenses  |       |                                                                  | 805        |                             |       |   | 197 |   |   |   | (424 | ) |   |   | 248 |   |   |
| Decrease  (increase) in net loss                             |       |                                                                  | 8,594      |                             |       |   | (1,099 | ) |   |   | 8,110 |   |   |   | 5,403 |   |   |
| Decrease (increase) in  basic and diluted net loss per share |       |                                                                  | 0.34       |                             |       |   | (0.04 | ) |   |   | 0.34 |   |   |   | 0.23 |   |   |

 

47

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

The following tablessummarizes the effect of the restatement on line items presented in ourconsolidated financial statements included in our Annual Report on Form 10-Kfor the fiscal year ended March 31, 2006:

**ConsolidatedBalance Sheets as of March 31, 2005 and 2004**

| ** **                                       | ** ** | **As of March 31,** | ** ** |
|--------------------------------------------------|------------|------------------------------------|------------|
| ** **                                       | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| ** **                                       | ** ** | **As  Previously  Reported**       | ** ** | **As Restated** | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** |
| ** **                                       | ** ** | **(In thousands)**            | ** ** |
| Cash and cash  equivalents                       |       | $                                  | 24,010     |   | $ | 21,256 |   | $ | 39,704 |   | $ | 39,704 |   |
| Marketable  securities                           |       | 32,662                             |       | 35,416 |   | 101,557 |   | 101,557 |   |
| Software  development costs, net                 |       | 8,553                              |       | — |   | 7,748 |   | — |   |
| Total assets                                     |       | 160,554                            |       | 152,415 |   | 220,478 |   | 213,144 |   |
| Current portion  of deferred revenue             |       | 35,005                             |       | 49,083 |   | 22,272 |   | 42,252 |   |
| Total current  liabilities                       |       | 54,079                             |       | 68,157 |   | 50,963 |   | 70,943 |   |
| Deferred revenue,  net of current portion        |       | 7,591                              |       | 9,531 |   | 5,493 |   | 10,930 |   |
| Accumulated  deficit                             |       | (149,260                           | )          | (173,417 | ) | (124,088 | ) | (156,839 | ) |
| Total  stockholders’ equity                 |       | 93,753                             |       | 69,596 |   | 160,252 |   | 127,501 |   |
| Total liabilities and  stockholders’ equity |       | 160,554                            |       | 152,415 |   | 220,478 |   | 213,144 |   |
|                                                  |            |                                    |            |  |  |  |  |  |  |  |  |  |  |

 

48

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

**ConsolidatedStatements of Operations for the years ended March 31, 2005 and December 31,2003, and the three months ended March 31, 2004 and 2003**

| ** **                                            | ** ** | **Years Ended**                                                  | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **March 31, 2005**                                          | ** ** | **December 31, 2003** | ** ** |
| ** **                                            | ** ** | **As  Previously  Reported**                                          | ** ** | **As Restated** | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** |
| ** **                                            | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenue                                               |       | $                                                                     | 69,631     |   |   | $ | 79,030 |   |   |   | $ | 85,561 |   |   |   | $ | 86,209 |   |   |
| Operating costs  and expenses:                        |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of revenue                                       |       | 17,905                                                                |       |   | 14,317 |   |   |   | 19,845 |   |   |   | 17,276 |   |   |
| Product development                                   |       | 18,324                                                                |       |   | 22,717 |   |   |   | 18,078 |   |   |   | 22,394 |   |   |
| Sales and marketing                                   |       | 36,916                                                                |       |   | 36,916 |   |   |   | 34,493 |   |   |   | 34,493 |   |   |
| General and administrative                            |       | 17,290                                                                |       |   | 17,290 |   |   |   | 18,187 |   |   |   | 16,637 |   |   |
| Severance and lease abandonment charges (recoveries)  |       | 5,110                                                                 |       |   | 5,110 |   |   |   | (384 | ) |   |   | (384 | ) |   |
| Acquired in-process product development               |       | 450                                                                   |       |   | 450 |   |   |   | — |   |   |   | — |   |   |
| Spin-off transaction costs                            |       | —                                                                |       |   | — |   |   |   | 700 |   |   |   | 700 |   |   |
| Total operating  costs and expenses                   |       | 95,995                                                                |       |   | 96,800 |   |   |   | 90,919 |   |   |   | 91,116 |   |   |
| Operating loss  from continuing operations            |       | (26,364                                                               | )          |   | (17,770 | ) |   |   | (5,358 | ) |   |   | (4,907 | ) |   |
| Interest and  other income, net                       |       | 1,738                                                                 |       |   | 1,738 |   |   |   | 4,160 |   |   |   | 4,160 |   |   |
| Loss from  continuing operations before income  taxes |       | (24,626                                                               | )          |   | (16,032 | ) |   |   | (1,198 | ) |   |   | (747 | ) |   |
| Income tax  expense (benefit)                         |       | (571                                                                  | )          |   | (571 | ) |   |   | 1,001 |   |   |   | 1,001 |   |   |
| Loss from  continuing operations                      |       | (24,055                                                               | )          |   | (15,461 | ) |   |   | (2,199 | ) |   |   | (1,748 | ) |   |
| Loss from  discontinued operations                    |       | (1,117                                                                | )          |   | (1,117 | ) |   |   | (1,298 | ) |   |   | (2,848 | ) |   |
| Net loss                                              |       | $                                                                     | (25,172    | ) |   | $ | (16,578 | ) |   |   | $ | (3,497 | ) |   |   | $ | (4,596 | ) |   |
| Basic and diluted loss per share amounts:             |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss from  continuing operations                      |       | $                                                                     | (0.96      | ) |   | $ | (0.62 | ) |   |   | $ | (0.09 | ) |   |   | $ | (0.07 | ) |   |
| Loss from  discontinued operations                    |       | (0.04                                                                 | )          |   | (0.04 | ) |   |   | (0.06 | ) |   |   | (0.12 | ) |   |
| Net loss                                              |       | $                                                                     | (1.00      | ) |   | $ | (0.66 | ) |   |   | $ | (0.15 | ) |   |   | $ | (0.19 | ) |   |

 

49

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

 

| ** **                                                    | ** ** | **Three Months Ended March 31,**                  | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2004**                                                              | ** ** | **2003** | ** ** |
| ** **                                                    | ** ** | **As  Previously  Reported**                                          | ** ** | **As Restated** | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** |
| ** **                                                    | ** ** | ** **                                                            | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** |
| ** **                                                    | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenue                                                       |       | $                                                                     | 11,135     |   |   | $ | 19,359 |   |   |   | $ | 17,219 |   |   |   | $ | 23,228 |   |   |
| Operating costs  and expenses:                                |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of revenue                                               |       | 4,107                                                                 |       |   | 3,238 |   |   |   | 5,169 |   |   |   | 4,590 |   |   |
| Product development                                           |       | 4,265                                                                 |       |   | 5,248 |   |   |   | 4,692 |   |   |   | 5,877 |   |   |
| Sales and marketing                                           |       | 8,436                                                                 |       |   | 8,436 |   |   |   | 8,864 |   |   |   | 8,864 |   |   |
| General and administrative                                    |       | 4,972                                                                 |       |   | 4,434 |   |   |   | 4,608 |   |   |   | 4,250 |   |   |
| Severance and lease abandonment charges (recoveries)          |       | 5,199                                                                 |       |   | 5,199 |   |   |   | (384 | ) |   |   | (384 | ) |   |
| Spin-off transaction costs                                    |       | 2,321                                                                 |       |   | 2,321 |   |   |   | — |   |   |   | — |   |   |
| Total operating  costs and expenses                           |       | 29,300                                                                |       |   | 28,876 |   |   |   | 22,949 |   |   |   | 23,197 |   |   |
| Operating income  (loss) from continuing  operations          |       | (18,165                                                               | )          |   | (9,517 | ) |   |   | (5,730 | ) |   |   | 31 |   |   |
| Interest and  other income, net                               |       | 921                                                                   |       |   | 921 |   |   |   | 1,127 |   |   |   | 1,127 |   |   |
| Income (loss)  from continuing operations before income taxes |       | (17,244                                                               | )          |   | (8,596 | ) |   |   | (4,603 | ) |   |   | 1,158 |   |   |
| Income tax  expense                                           |       | 128                                                                   |       |   | 128 |   |   |   | 270 |   |   |   | 270 |   |   |
| Income (loss)  from continuing operations                     |       | (17,372                                                               | )          |   | (8,724 | ) |   |   | (4,873 | ) |   |   | 888 |   |   |
| Loss from  discontinued operations                            |       | (9,398                                                                | )          |   | (9,936 | ) |   |   | (580 | ) |   |   | (938 | ) |   |
| Net loss                                                      |       | $                                                                     | (26,770    | ) |   | $ | (18,660 | ) |   |   | $ | (5,453 | ) |   |   | $ | (50 | ) |   |
| Basic and diluted loss per share amounts:                     |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss)  from continuing operations                     |       | $                                                                     | (0.72      | ) |   | $ | (0.36 | ) |   |   | $ | (0.21 | ) |   |   | $ | 0.04 |   |   |
| Loss from  discontinued operations                            |       | (0.39                                                                 | )          |   | (0.41 | ) |   |   | (0.02 | ) |   |   | (0.04 | ) |   |
| Net loss                                                      |       | $                                                                     | (1.11      | ) |   | $ | (0.77 | ) |   |   | $ | (0.23 | ) |   |   | $ | (0.00 | ) |   |

 

**ConsolidatedStatements of Cash Flows for the years ended March 31, 2005 and December 31,2003, and the threemonths ended March 31, 2004 and 2003**

| ** **                                                      | ** ** | **Years Ended**         | ** ** |
|-----------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                      | ** ** | **March 31, 2005** | ** ** | **December 31, 2003** | ** ** |
| ** **                                                      | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** |
| ** **                                                      | ** ** | **(In thousands)**      | ** ** |
| Net cash provided  by (used in) operating activities            |       | $                            | (11,909    | ) |   | $ | (14,157 | ) |   |   | $ | 4,823 |   |   |   | $ | (1,932 | ) |   |
| Net cash provided  by (used in) investing activities            |       | (1,058                       | )          |   | 134 |   |   |   | (1,371 | ) |   |   | (1,300 | ) |   |
| Net cash provided  by (used in) financing activities            |       | 1,682                        |       |   | (3,763 | ) |   |   | 1,711 |   |   |   | 1,711 |   |   |
| Change in cash  and cash equivalents of discontinued operations |       | 896                          |       |   | (743 | ) |   |   | (6,533 | ) |   |   | 6,213 |   |   |
| Net increase  (decrease) in cash and cash equivalents           |       | (15,694                      | )          |   | (18,448 | ) |   |   | (727 | ) |   |   | 5,486 |   |   |
| Cash and cash  equivalents, beginning of period                 |       | 39,704                       |       |   | 39,704 |   |   |   | 28,236 |   |   |   | 21,499 |   |   |
| Cash and cash  equivalents, end of period                       |       | 24,010                       |       |   | 21,256 |   |   |   | 27,509 |   |   |   | 26,985 |   |   |
|                                                                 |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

50

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

 

| ** **                                                      | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                      | ** ** | **2004**                                             | ** ** | **2003** | ** ** |
| ** **                                                      | ** ** | **As  Previously  Reported**                         | ** ** | **As Restated** | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** |
| ** **                                                      | ** ** | ** **                                           | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** |
| ** **                                                      | ** ** | **(In thousands)**                              | ** ** |
| Net cash provided  by operating activities                      |       |                                                 | $          | 3,802 |   |   |   | $ | 8,923 |   |   |   | $ | 10,964 |   |   |   | $ | 5,996 |   |   |
| Net cash provided  by (used in) investing activities            |       |                                                 | 3,178      |   |   |   | (479 | ) |   |   | (3,786 | ) |   |   | (2,714 | ) |   |
| Net cash provided  by financing activities                      |       |                                                 | 3,225      |   |   |   | 3,225 |   |   |   | 54 |   |   |   | 54 |   |   |
| Change in cash and  cash equivalents of discontinued operations |       |                                                 | 1,795      |   |   |   | 814 |   |   |   | (3,826 | ) |   |   | 4,950 |   |   |
| Net increase  (decrease) in cash and cash equivalents           |       |                                                 | 12,195     |   |   |   | 12,719 |   |   |   | 3,343 |   |   |   | 8,293 |   |   |
| Cash and cash  equivalents, beginning of period                 |       |                                                 | 27,509     |   |   |   | 26,985 |   |   |   | 28,236 |   |   |   | 21,499 |   |   |
| Cash and cash  equivalents, end of period                       |       |                                                 | 39,704     |   |   |   | 39,704 |   |   |   | 31,579 |   |   |   | 29,792 |   |   |

 

The following tablessummarizes the effect of the restatement on line items presented in ourunaudited condensed consolidated financial statements included in our QuarterlyReports on Form 10-Q for the three months ended September 30,2005 and June 30, 2005:

**UnauditedCondensed Consolidated Balance Sheets as of September 30, 2005 andJune 30, 2005**

| ** **                                       | ** ** | **As of**                   | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|
| ** **                                       | ** ** | **September 30, 2005** | ** ** | **June 30, 2005** | ** ** |
| ** **                                       | ** ** | **As  Previously  Reported**     | ** ** | **As Restated** | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** |
| ** **                                       | ** ** | **(In thousands)**          | ** ** |
| Cash and cash equivalents                        |       | $                                | 18,371     |   | $ | 18,371 |   | $ | 16,981 |   | $ | 15,978 |   |
| Marketable  securities                           |       | 27,840                           |       | 27,840 |   | 32,713 |   | 33,716 |   |
| Software  development costs, net                 |       | 8,234                            |       | — |   | 8,583 |   | — |   |
| Total assets                                     |       | 138,350                          |       | 130,530 |   | 147,413 |   | 139,244 |   |
| Current portion  of deferred revenue             |       | 25,883                           |       | 35,391 |   | 29,707 |   | 42,075 |   |
| Total current  liabilities                       |       | 39,353                           |       | 48,861 |   | 44,182 |   | 56,550 |   |
| Deferred revenue,  net of current portion        |       | 5,629                            |       | 7,146 |   | 7,690 |   | 9,491 |   |
| Accumulated  deficit                             |       | (155,317                         | )          | (174,162 | ) | (152,976 | ) | (175,314 | ) |
| Total  stockholders’ equity                 |       | 88,198                           |       | 69,353 |   | 90,563 |   | 68,225 |   |
| Total liabilities and  stockholders’ equity |       | 138,350                          |       | 130,530 |   | 147,413 |   | 139,244 |   |
|                                                  |            |                                  |            |  |  |  |  |  |  |  |  |  |  |

 

51

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

**UnauditedCondensed Consolidated Statements of Operations for the three and six monthsended September 30,2005 and 2004, and the three months ended June 30, 2005 and 2004**

| ** **                                                    | ** ** | **Three Months Ended September 30,**              | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                                                              | ** ** | **2004** | ** ** |
| ** **                                                    | ** ** | **As  Previously  Reported**                                          | ** ** | **As Restated** | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** |
| ** **                                                    | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenue                                                       |       |                                                                  | $          | 18,592 |   |   |   | $ | 21,736 |   |   |   | $ | 14,277 |   |   |   | $ | 19,734 |   |   |
| Operating costs  and expenses:                                |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of revenue                                               |       |                                                                  | 5,400      |   |   |   | 4,171 |   |   |   | 3,137 |   |   |   | 2,352 |   |   |
| Product development                                           |       |                                                                  | 4,687      |   |   |   | 5,567 |   |   |   | 4,382 |   |   |   | 5,112 |   |   |
| Sales and marketing                                           |       |                                                                  | 7,388      |   |   |   | 7,388 |   |   |   | 7,471 |   |   |   | 7,471 |   |   |
| General and administrative                                    |       |                                                                  | 3,619      |   |   |   | 3,619 |   |   |   | 3,680 |   |   |   | 3,680 |   |   |
| Acquired in-process product development                       |       |                                                                  | —     |   |   |   | — |   |   |   | 700 |   |   |   | 700 |   |   |
| Total operating  costs and expenses                           |       |                                                                  | 21,094     |   |   |   | 20,745 |   |   |   | 19,370 |   |   |   | 19,315 |   |   |
| Operating income  (loss) from continuing operations           |       |                                                                  | (2,502     | ) |   |   | 991 |   |   |   | (5,093 | ) |   |   | 419 |   |   |
| Interest and  other income, net                               |       |                                                                  | 402        |   |   |   | 402 |   |   |   | 489 |   |   |   | 489 |   |   |
| Income (loss)  from continuing operations before income taxes |       |                                                                  | (2,100     | ) |   |   | 1,393 |   |   |   | (4,604 | ) |   |   | 908 |   |   |
| Income tax  expense                                           |       |                                                                  | 241        |   |   |   | 241 |   |   |   | 479 |   |   |   | 479 |   |   |
| Net income (loss)                                             |       |                                                                  | $          | (2,341 | ) |   |   | $ | 1,152 |   |   |   | $ | (5,083 | ) |   |   | $ | 429 |   |   |
| Basic net income (loss) per share                             |       |                                                                  | $          | (0.09 | ) |   |   | $ | 0.04 |   |   |   | $ | (0.21 | ) |   |   | $ | 0.02 |   |   |
| Diluted net income  (loss) per share                          |       |                                                                  | $          | (0.09 | ) |   |   | $ | 0.04 |   |   |   | $ | (0.21 | ) |   |   | $ | 0.02 |   |   |

 

52

----

**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

 

| ** **                                                    | ** ** | **Six Months Ended September 30,**                | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                                                              | ** ** | **2004** | ** ** |
| ** **                                                    | ** ** | **As  Previously  Reported**                                          | ** ** | **As Restated** | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** |
| ** **                                                    | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenue                                                       |       |                                                                  | $          | 37,146 |   |   |   | $ | 42,139 |   |   | $ | 28,458 |   |   | $ | 38,538 |   |   |
| Operating costs  and expenses:                                |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of revenue                                               |       |                                                                  | 10,431     |   |   |   | 8,308 |   |   | 6,923 |   |   | 5,273 |   |   |
| Product development                                           |       |                                                                  | 9,617      |   |   |   | 11,421 |   |   | 8,505 |   |   | 10,173 |   |   |
| Sales and marketing                                           |       |                                                                  | 15,885     |   |   |   | 15,885 |   |   | 15,240 |   |   | 15,240 |   |   |
| General and administrative                                    |       |                                                                  | 7,688      |   |   |   | 7,688 |   |   | 7,689 |   |   | 7,689 |   |   |
| Acquired in-process product development                       |       |                                                                  | —     |   |   |   | — |   |   | 700 |   |   | 700 |   |   |
| Total operating  costs and expenses                           |       |                                                                  | 43,621     |   |   |   | 43,302 |   |   | 39,057 |   |   | 39,075 |   |   |
| Operating loss  from continuing operations                    |       |                                                                  | (6,475     | ) |   |   | (1,163 | ) |   | (10,599 | ) |   | (537 | ) |   |
| Interest and  other income, net                               |       |                                                                  | 1,100      |   |   |   | 1,100 |   |   | 1,074 |   |   | 1,074 |   |   |
| Income (loss)  from continuing operations before income taxes |       |                                                                  | (5,375     | ) |   |   | (63 | ) |   | (9,525 | ) |   | 537 |   |   |
| Income tax expense                                            |       |                                                                  | 682        |   |   |   | 682 |   |   | 614 |   |   | 614 |   |   |
| Loss from  continuing operations                              |       |                                                                  | (6,057     | ) |   |   | (745 | ) |   | (10,139 | ) |   | (77 | ) |   |
| Loss from  discontinued operations                            |       |                                                                  | —     |   |   |   | — |   |   | (1,117 | ) |   | (1,117 | ) |   |
| Net loss                                                      |       |                                                                  | $          | (6,057 | ) |   |   | $ | (745 | ) |   | $ | (11,256 | ) |   | $ | (1,194 | ) |   |
| Basic and diluted loss per share amounts:                     |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss from  continuing operations                              |       |                                                                  | $          | (0.23 | ) |   |   | $ | (0.03 | ) |   | $ | (0.41 | ) |   | $ | (0.00 | ) |   |
| Loss from  discontinued operations                            |       |                                                                  | —     |   |   |   | — |   |   | (0.05 | ) |   | (0.05 | ) |   |
| Net loss                                                      |       |                                                                  | $          | (0.23 | ) |   |   | $ | (0.03 | ) |   | $ | (0.46 | ) |   | $ | (0.05 | ) |   |

 

53

----

**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

 

| ** **                                            | ** ** | **Three Months Ended June 30,**                   | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **2005**                                                              | ** ** | **2004** | ** ** |
| ** **                                            | ** ** | **As  Previously  Reported**                                          | ** ** | **As Restated** | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** |
| ** **                                            | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenue                                               |       |                                                                  | $          | 18,555 |   |   |   | $ | 20,404 |   |   |   | $ | 14,181 |   |   |   | $ | 18,804 |   |   |
| Operating costs  and expenses:                        |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of revenue                                       |       |                                                                  | 5,030      |   |   |   | 4,136 |   |   |   | 3,786 |   |   |   | 2,921 |   |   |
| Product development                                   |       |                                                                  | 4,931      |   |   |   | 5,855 |   |   |   | 4,123 |   |   |   | 5,061 |   |   |
| Sales and marketing                                   |       |                                                                  | 8,499      |   |   |   | 8,499 |   |   |   | 7,769 |   |   |   | 7,769 |   |   |
| General and administrative                            |       |                                                                  | 4,069      |   |   |   | 4,069 |   |   |   | 4,009 |   |   |   | 4,009 |   |   |
| Total operating  costs and expenses                   |       |                                                                  | 22,529     |   |   |   | 22,559 |   |   |   | 19,687 |   |   |   | 19,760 |   |   |
| Operating loss  from continuing operations            |       |                                                                  | (3,974     | ) |   |   | (2,155 | ) |   |   | (5,506 | ) |   |   | (956 | ) |   |
| Interest and  other income, net                       |       |                                                                  | 698        |   |   |   | 698 |   |   |   | 585 |   |   |   | 585 |   |   |
| Loss from  continuing operations before income  taxes |       |                                                                  | (3,276     | ) |   |   | (1,457 | ) |   |   | (4,921 | ) |   |   | (371 | ) |   |
| Income tax  expense                                   |       |                                                                  | 440        |   |   |   | 440 |   |   |   | 135 |   |   |   | 135 |   |   |
| Loss from  continuing operations                      |       |                                                                  | (3,716     | ) |   |   | (1,897 | ) |   |   | (5,056 | ) |   |   | (506 | ) |   |
| Loss from  discontinued operations                    |       |                                                                  | —     |   |   |   | — |   |   |   | (1,117 | ) |   |   | (1,117 | ) |   |
| Net loss                                              |       |                                                                  | $          | (3,716 | ) |   |   | $ | (1,897 | ) |   |   | $ | (6,173 | ) |   |   | $ | (1,623 | ) |   |
| Basic and diluted loss per share amounts:             |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss from  continuing operations                      |       |                                                                  | $          | (0.14 | ) |   |   | $ | (0.07 | ) |   |   | $ | (0.21 | ) |   |   | $ | (0.02 | ) |   |
| Loss from  discontinued operations                    |       |                                                                  | —     |   |   |   | — |   |   |   | (0.04 | ) |   |   | (0.05 | ) |   |
| Net loss                                              |       |                                                                  | $          | (0.14 | ) |   |   | $ | (0.07 | ) |   |   | $ | (0.25 | ) |   |   | $ | (0.07 | ) |   |

 

**UnauditedCondensed Consolidated Statements of Cash Flows for the six months ended September 30, 2005 and2004, and the three months ended June 30, 2005 and 2004**

| ** **                                                      | ** ** | **Six Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                                               | ** ** | **2004** | ** ** |
| ** **                                                      | ** ** | **As  Previously  Reported**                           | ** ** | **As Restated** | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** |
| ** **                                                      | ** ** | **(In thousands)**                                | ** ** |
| Net cash used in  operating activities                          |       |                                                   | $          | (6,326 | ) |   |   | $ | (7,913 | ) |   | $ | (13,536 | ) |   | $ | (13,322 | ) |   |
| Net cash provided  by (used in) investing activities            |       |                                                   | 974        |   |   |   | 2,667 |   |   | (1,325 | ) |   | (10,667 | ) |   |
| Net cash provided  by (used in) financing activities            |       |                                                   | 521        |   |   |   | 521 |   |   | (4,635 | ) |   | (4,119 | ) |   |
| Change in cash  and cash equivalents of discontinued operations |       |                                                   | —     |   |   |   | — |   |   | — |   |   | 5,426 |   |   |
| Net decrease in  cash and cash equivalents                      |       |                                                   | (5,639     | ) |   |   | (5,639 | ) |   | (19,769 | ) |   | (22,972 | ) |   |
| Cash and cash  equivalents, beginning of period                 |       |                                                   | 24,010     |   |   |   | 24,010 |   |   | 39,704 |   |   | 39,704 |   |   |
| Cash and cash  equivalents, end of period                       |       |                                                   | 18,371     |   |   |   | 18,371 |   |   | 19,935 |   |   | 16,732 |   |   |
|                                                                 |            |                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

54

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

 

| ** **                                                      | ** ** | **Three Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                                            | ** ** | **2004** | ** ** |
| ** **                                                      | ** ** | **As  Previously  Reported**                        | ** ** | **As Restated** | ** ** | **As  Previously  Reported** | ** ** | **As Restated** | ** ** |
| ** **                                                      | ** ** | **(In thousands)**                             | ** ** |
| Net cash used in  operating activities                          |       |                                                | $          | (4,918 | ) |   |   | $ | (5,884 | ) |   |   | $ | (7,852 | ) |   |   | $ | (6,734 | ) |   |
| Net cash provided  by (used in) investing activities            |       |                                                | (1,976     | ) |   |   | 61 |   |   |   | 3,078 |   |   |   | (5,723 | ) |   |
| Net cash provided  by (used in) financing activities            |       |                                                | 479        |   |   |   | 479 |   |   |   | 1,364 |   |   |   | (4,081 | ) |   |
| Change in cash  and cash equivalents of discontinued operations |       |                                                | —     |   |   |   | — |   |   |   | (147 | ) |   |   | 5,426 |   |   |
| Net decrease in  cash and cash equivalents                      |       |                                                | (7,029     | ) |   |   | (6,026 | ) |   |   | (9,352 | ) |   |   | (11,353 | ) |   |
| Cash and cash  equivalents, beginning of period                 |       |                                                | 24,010     |   |   |   | 24,010 |   |   |   | 40,072 |   |   |   | 40,072 |   |   |
| Cash and cash  equivalents, end of period                       |       |                                                | 16,981     |   |   |   | 15,978 |   |   |   | 30,720 |   |   |   | 28,719 |   |   |

 

**3.   SignificantAccounting Policies**

*Principles ofConsolidation*

These consolidatedfinancial statements include our accounts and those of our wholly ownedsubsidiaries. All intercompany balances and transactions have been eliminatedin consolidation.

*Use of Estimates*

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the U.S. requires management to make estimates and assumptions thataffect the reported amounts of assets, liabilities, revenues and expenses, andthe disclosure of contingent assets and liabilities. On an on-going basis, weevaluate our estimates, including those related to revenue recognition, incometaxes and the valuation of goodwill, intangibles and other long-lived assets.We base our estimates on historical experience and on various other assumptionsthat we believe to be reasonable under the circumstances. Actual future resultscould differ from those estimates.

*Cash and CashEquivalents*

We consider all highlyliquid investments with a maturity at purchase of three months or less to becash equivalents. We invest our cash with financial institutions in moneymarket funds, U.S. Treasury securities and other investment grade securitiessuch as prime-rated commercial paper.

*MarketableSecurities*

Our marketable securities consist of debt securitieswith maturities at purchase of greater than three months and include U.S.Treasury securities, obligations of U.S. government agencies, corporate bondsand auction rate municipal bonds. We account for our investments in marketablesecurities in accordance with SFAS No. 115, *Accountingfor Certain Investments in Debt and Equity Securities*. Accordingly,our marketable securities have been classified as available-for-sale and arerecorded at their estimated fair value. Changes in fair value are recorded asunrealized gains or losses which are included in accumulated othercomprehensive income (loss) in stockholders’ equity. The cost of marketablesecurities sold is determined based on the specific identification method.

55

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

We review the fair value of our marketable securitiesat least quarterly to determine if declines in the fair value of individualsecurities are other-than-temporary in nature. If we believe the decline in thefair value of an individual security is other-than-temporary, we write-down thecarrying value of the security to its estimated fair value, generallydetermined using quoted market prices. To determine if a decline in the fairvalue of an investment is other-than-temporary, we consider several factorsincluding, among others, the period of time and extent to which the estimatedfair value has been less than cost, overall market conditions, the historicaland projected 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.

Marketablesecurities, including marketable securities classified as restricted cash (seeNote 9), consist of the following:

| ** **                                                                 | ** ** | **Amortized  Cost**     | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------|------------|
| ** **                                                                 | ** ** | **(In thousands)** | ** ** |
| **March 31,  2006:**                                                  |       |                    |       |                         |       |                          |       |                |       |   |   |   |   |   |   |   |   |
| U.S. Treasury  securities and obligations of U.S. government agencies |       |                    | $          | 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 |   |   |
| **March 31,  2005 (Restated):**                                       |       |                    |       |                         |       |                          |       |                |       |   |   |   |   |   |   |   |   |
| U.S. Treasury  securities and obligations of U.S. government agencies |       |                    | $          | 29,070                       |       |                          |       | $                   | —     |   |   |   | $ | (688 | ) |   |   | $ | 28,382 |   |   |
| U.S. corporate  debt securities                                            |       |                    | 10,667     |                         |       |                          | —     |                |       |   | (237 | ) |   |   | 10,430 |   |   |
| Auction rate  municipal bonds                                              |       |                    | 2,750      |                         |       |                          | —     |                |       |   | — |   |   |   | 2,750 |   |   |
|                                                                       |       |                    | $          | 42,487                       |       |                          |       | $                   | —     |   |   |   | $ | (925 | ) |   |   | $ | 41,562 |   |   |

 

Included in marketable securities in the accompanyingconsolidated balance sheets is accrued interest receivable on marketablesecurities of $0.3 million and $0.5 million as of March 31, 2006 and 2005,respectively.

Thecontractual maturities of our marketable securities at March 31, 2006 areas follows (in thousands):

| Due within one  year      |   | $      | 13,396 |   |
|---------------------------|--------|--------|--------|--------|
| Due in one to  five years |   | 19,112 |   |
| Due after five  years     |   | 8,550  |   |
|                      |   | $      | 41,058 |   |

 

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

56

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

The following tablesummarizes the gross unrealized losses and fair value of our marketablesecurities with unrealized losses that are not deemed to beother-than-temporarily impaired, aggregated by investment category and lengthof time that individual securities that have been in a continuous unrealizedloss position, at March 31, 2006:

| ** **                                                            | ** ** | **Less Than 12 Months** | ** ** | **12 Months or Greater** | ** ** | **Total**           | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------|------------|---------------------|------------|
| ** **                                                            | ** ** | **Fair Value**                    | ** ** | **Unrealized  Losses**                  | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** |
| ** **                                                            | ** ** | **(In thousands)**                | ** ** |
| U.S. Treasury  securities and obligations of U.S. government agencies |       |                                   | $          | —                                  |       |                |       | $ | — |   |   |   | $ | 23,507 |   |   |   | $ | (544 | ) |   |   | $ | 23,507 |   |   |   | $ | (544 | ) |   |
| U.S. corporate  debt securities                                       |       |                                   | —     |                                    |       |                | —     |   |   |   | 9,001 |   |   |   | (154 | ) |   |   | 9,001 |   |   |   | (154 | ) |   |
|                                                                  |       |                                   | $          | —                                  |       |                |       | $ | — |   |   |   | $ | 32,508 |   |   |   | $ | (698 | ) |   |   | $ | 32,508 |   |   |   | $ | (698 | ) |   |

 

The unrealized losses onthese securities were primarily caused by recent increases in market interestrates, and not the credit quality of the issuer, and we have the ability andintent to hold these securities until a recovery of fair value, which may be atmaturity. As a result, we do not believe these securities to beother-than-temporarily impaired as of March 31, 2006.

*Allowance forDoubtful Accounts*

We maintain an allowancefor doubtful accounts for estimated losses resulting from the inability of ourcustomers to make required payments on accounts receivable. This estimate isbased on a specific customer analysis and an analysis of our historicalwrite-offs as a percent of outstanding accounts receivable balances. If thefinancial condition of a customer were to deteriorate, resulting in animpairment of its ability to make payments against outstanding balances owed tous, an additional allowance may be required.

*Fair Value ofFinancial Instruments*

We carry our cash and cashequivalents, marketable securities and restricted cash at market value. Thecarrying amount of accounts receivable, accounts payable and accruedliabilities are considered to be representative of their respective fair valuesdue to their short-term nature.

*Property andEquipment*

Propertyand equipment, stated at cost, consists of the following:

| ** **                                      | ** ** | ** **                       | ** ** | **March 31,**      | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **Useful Lives (Yrs)** | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                      | ** ** | ** **                       | ** ** | **(In thousands)** | ** ** |
| Computers and  software                         |       |                             | 2-3        |                    |       | $ | 14,957 |   | $ | 22,931 |   |
| Furniture and  fixtures                         |       |                             | 3          |                    |       | 1,131 |   | 2,180 |   |
| Leasehold  improvements                         |       |                             | 5-10       |                    |       | 3,554 |   | 3,728 |   |
|                                            |       |                             |       |                    |       | 19,642 |   | 28,839 |   |
| Less accumulated  depreciation and amortization |       |                             |       |                    |       | (11,782 | ) | (19,796 | ) |
|                                            |       |                             |       |                    |       | $ | 7,860 |   | $ | 9,043 |   |

 

57

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

Depreciation is providedon the straight-line method over the estimated useful lives of the relatedassets. Assets under capital leases, if any, are amortized over the shorter oftheir estimated useful life or the applicable lease period. 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.

*SoftwareDevelopment Costs*

We account for costsincurred to develop our software products in accordance with SFAS No. 86, *Accounting for the Cost of Computer Software to be Sold, Leased orOtherwise Marketed*. Accordingly, costs incurred in the research anddevelopment of new software products and significant enhancements to existingsoftware products are expensed as incurred, until the technological feasibilityof the product has been established. Technological feasibility occurs shortlybefore our software products are available for general release, and we havedetermined that costs eligible for capitalization are not material.Accordingly, there were no capitalized software development costs as of March 31,2006 and 2005.

*Goodwill andAcquired Intangible Assets*

Changesin the carrying amount of goodwill are as follows (in thousands):

| Balance at March 31,  2004                                          |   | $      | 34,072 |   |
|--------------------------------------------------------------------------|--------|--------|--------|--------|
| Goodwill from acquisition of SciTegic, Inc.  (Note 5)               |   | 9,726  |   |
| Purchase adjustment for the settlement of a  pre-acquisition contingency |   | 58     |   |
| Purchase adjustment for reversal of tax reserve                          |   | (500   | )      |
| Purchase adjustment for use of pre-acquisition  deferred tax assets      |   | (747   | )      |
| Balance  March 31, 2005                                             |   | 42,609 |   |
| Additional purchase consideration from escrow                            |   | 54     |   |
| Balance at  March 31, 2006                                          |   | $      | 42,663 |   |

 

Intangible assets consistof the following:

| ** **                                      | ** ** | **March 31, 2006**       | ** ** | **March 31, 2005** | ** ** |
|-------------------------------------------------|------------|------------------------------------|------------|------------------------------|------------|
| ** **                                      | ** ** | **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 |   |   |   | $ | 2,025 |   |   |   | 5 |   |   |   | $ | 6,750 |   |   |   | $ | 675 |   |   |
| Purchased  customer relationships               |       |                               | 10         |                         |       |   | 1,650 |   |   |   | 248 |   |   |   | 10 |   |   |   | 1,650 |   |   |   | 83 |   |   |
| Purchased backlog                               |       |                               | 2.25       |                         |       |   | 550 |   |   |   | 541 |   |   |   | 2.25 |   |   |   | 550 |   |   |   | 368 |   |   |
| Purchased  contract based                       |       |                               | 5          |                         |       |   | 50 |   |   |   | 15 |   |   |   | 5 |   |   |   | 50 |   |   |   | 5 |   |   |
|                                            |       |                               |       |                         |       |   | $ | 9,000 |   |   |   | $ | 2,829 |   |   |   |   |   |   |   | $ | 9,000 |   |   |   | $ | 1,131 |   |   |
| 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 ended March 31,2006 and 2005 and December 31, 2003, and the three months ended 

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

March 31, 2004and 2003 (unaudited), intangible asset amortization expense totaled $1.7million, $1.1 million, $2.8 million, $0 and $1.3 million,respectively.

Futureestimated amortization expense for intangible assets as of March 31, 2006for each of the succeeding five years is as follows (in thousands):

| Fiscal Year 2007 |   | $     | 1,534  |   |
|------------------|--------|-------|--------|--------|
| Fiscal Year 2008 |   | 1,525 |   |
| Fiscal Year 2009 |   | 1,398 |   |
| Fiscal Year 2010 |   | 958   |   |
| Fiscal Year 2011 |   | 165   |   |

 

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 respective carryingvalues. Examples of such events or circumstances include: a significant adversechange in legal factors or in the business climate, a significant decline inour stock price, a significant decline in our projected revenue or cash flows,an adverse action or assessment by a regulator, unanticipated competition, aloss of key personnel, or the presence of other indicators that would indicatea reduction in the fair value of 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 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 only one reporting unitgiven the similarities of economic characteristics between the operations andthe common nature of the products, services and customers. Because we have onlyone reporting unit, and we are publicly traded, we determine the fair value ofthe reporting unit based on our market capitalization as we believe this  represents the best evidence of fair value. Inthe fourth quarter of fiscal year 2006, we completed our annual goodwillimpairment test for fiscal year 2006 in accordance with SFAS No. 142 andconcluded that our goodwill was not impaired. Our conclusion that goodwill wasnot impaired was based on a comparison of our net assets as of March 31,2006 to our market capitalization.

Our indefinite-livedintangible asset is considered to be impaired if we determine that the carryingvalue of the asset exceeds its estimated fair value. In the fourth quarter offiscal year 2006, we completed our annual indefinite-lived intangible assetimpairment test and concluded that our indefinite-lived intangible asset wasnot impaired. We estimated the fair value of our indefinite-lived intangibleasset utilizing a discounted cash flow analysis which considers the potentialroyalties that would otherwise be paid to an independent third party for use ofthe trade name. Key assumptions included in the discounted cash flow analysisinclude projections of future revenue growth, market royalty rates for similarassets and the after-tax rate of return on the asset.

*Impairment ofLong-Lived Assets*

In accordance with SFAS No. 144,*Accounting for the Impairment or Disposal ofLong-Lived Assets*, we review long-lived assets to be held and used,including acquired intangible assets subject to amortization 

59

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

andproperty and equipment, for impairment whenever events or changes incircumstances indicate that the carrying amount of the assets may not be fullyrecoverable. Conditions that would necessitate an impairment assessment includea significant decline in the market price of an asset or asset group, asignificant adverse change in the extent or manner in which an asset or assetgroup is being used, the loss of legal ownership or title to the asset,significant negative industry or economic trends or the presence of otherindicators that would indicate that the carrying amount of an asset or assetgroup is not recoverable. An asset is considered to be impaired if management’sestimate of the undiscounted future cash flows anticipated to result from theuse of the asset and its eventual disposition are not sufficient to recover thecarrying value of the asset. Duringfiscal years 2006 and 2005, we did not identify any conditions that wouldnecessitate an impairment assessment of our long-lived assets.

*Revenue Recognition*

We recognize revenues in accordance with the AmericanInstitute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”)97-2, *Software Revenue Recognition*, asamended, SEC Staff Accounting Bulletin (“SAB”) No. 104, *Revenue Recognition*, and Emerging Issues Task Force (“EITF”)Issue No. 00-21, *Revenue Arrangements withMultiple Deliverables*.

We generate revenuefrom the following primary sources:

·       softwarelicenses,

·       provisionof support and maintenance services on licensed software, referred to as PCS,and

·       training,installation and implementation services.

Customer payments received in connection with ourrevenue-generating activities are recorded as deferred revenue. We recognizerevenue as set forth below and when 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.

*Software Licenses*

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 VSOE of the fair value ofthese elements, we recognize as revenue the entire fee for such licensesratably over the term of the bundled PCS. Certain of our term-based licensesalso allow the customer to substitute purchased products for other products ofequal value throughout the term. We account for these arrangements asin-substance subscriptions and, accordingly, we recognize as revenue the entirefee for such licenses ratably over the contractual term of the arrangement,which is typically the same as the term of the bundled PCS.

60

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

*Renewal of PCSunder Perpetual Software Licenses*

Our PCS includes the rightto receive unspecified upgrades or enhancements and technical support. Feesfrom customer renewals of PCS related to previously purchased perpetuallicenses are recognized ratably over the term of the PCS.

*Training,Installation and Implementation Services*

We provide certainservices to our customers, including product training, non-complex productinstallation and non-complex implementation services which are non-essential tothe operation of the software. When sold separately, revenue from theseservices is generally recognized as the services are delivered, according tothe contractual terms. Amounts billed but not yet recognized as revenue, andother payments received prior to the recognition of revenue, are recorded asdeferred revenue.

*Multi-Element Arrangements*

For multi-elementarrangements which include software licenses, PCS and non-complex training,installation and implementation 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.

*Shipping Costs*

The costs of shippingproducts to our customers are expensed as incurred and are included in cost ofrevenue in our consolidated statements of operations. We incurred $0.8 million,$0.7 million, $0.9 million, $0.2 million and $0.3 million in shipping costsduring the years ended March 31, 2006 and 2005 and December 31, 2003,and the three months ended March 31, 2004 and 2003 (unaudited),respectively.

*Advertising Costs*

The costs of advertisingare expensed as incurred and are included in sales and marketing expenses inour consolidated statements of operations. We incurred $45,000, $0.1 million$0.3 million, $43,000 and $44,000 in advertising costs during the years ended March 31,2006 and 2005 and December 31, 2003, and the three months ended March 31,2004 and 2003 (unaudited), 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.

In certain instances, weand our subsidiaries conduct business with customers and vendors in currenciesother than the functional currency of each entity. Foreign exchange gains(losses) resulting from these transactions are included in interest and otherincome, net in our consolidated statements of operations and totaled $0.3million, $(0.1) million, $0.6 million, $(0.1) million and $0.3 million for theyears ended March 31, 2006 and 2005 and December 31, 2003, and thethree months ended March 31, 2004 and 2003 (unaudited), respectively.

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

*Concentrations ofRisk*

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 portfolioand maturities of investments, which are designed to maintain the safety andliquidity of our deposits and investments.

Our international salesare generally denominated in foreign currencies. Conversion offoreign-denominated receivables into U.S. dollars could have a material adverseeffect on our results of operations. We conduct business in Europe and in theAsia/Pacific region, primarily in Japan. Any significant decline in theeconomies or the value of the currencies in these regions could have a materialadverse impact on us.

*Income Taxes*

We account for income taxes using the liabilitymethod. Under the liability method, deferred income taxes are recognized forthe tax consequences of temporary differences between the financial carryingamounts and the tax basis of existing assets and liabilities by applyingenacted statutory tax rates applicable to future years. The provision forincome taxes is based on our estimates for taxable income of the various legalentities and jurisdictions in which we operate. As such, income tax expense mayvary from the customary relationship between income tax expense and pre-taxaccounting income. We establish a valuation allowance against our netdeferred tax assets to reduce deferred tax assets to the amount expected to berealized.

*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 common stock equivalents.

Potentially dilutivecommon stock equivalents consist of common stock options and restricted stockthat has not yet fully vested and totaled approximately 3.5 million, 3.2million, 3.5 million, 1.7 million and 7.0 million shares for the years endedMarch 31, 2006 and 2005 and December 31, 2003, and the three monthsended March 31, 2004 and 2003 (unaudited), respectively. Potentiallydilutive common stock equivalents were excluded from the diluted earnings pershare calculations for all periods presented as their effect would beanti-dilutive.

*Stock-BasedCompensation*

As permitted by SFAS No. 123, *Accounting for Stock-Based Compensation*, we account foremployee stock-based compensation in accordance with Accounting PrinciplesBoard Opinion No. 25, *Accounting for StockIssued to Employees,* and related interpretations. Accordingly,stock-based compensation expense related to employee stock options isrecognized if, on the date of grant, the exercise price of employee stockoption is less than the fair market value of the underlying common stock.

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

The following tableillustrates the effect on net loss and net loss per share if we had applied thefair value recognition provisions of SFAS No. 123 to our employee stockawards. For purposes of the SFAS No. 123 pro forma disclosures, theestimated fair value of employee stock awards has been amortized to expenseover the related vesting period of the award on a straight-line basis.

| ** **                                                                                                      | ** ** | **Years Ended**                                                  | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                      | ** ** | **March 31,  2006**                                              | ** ** | **March 31,  2005**         | ** ** | **December 31,  2003** | ** ** | **March 31,  2004** | ** ** | **March 31,  2003** | ** ** |
| ** **                                                                                                      | ** ** | ** **                                                            | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |
| ** **                                                                                                      | ** ** | ** **                                                            | ** ** | **(Restated)**                   | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **                                                                                                      | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Net loss, as reported                                                                            |       | $                                                                     | (7,739     | )                                | $          | (16,578 | ) |   | $ | (4,596 | ) |   | $ | (18,660 | ) |   | $ | (50 | ) |   |
| Add: Stock-based  employee compensation expense included in net loss, as reported                               |       | 853                                                                   |       | 358                              |       |   | 93 |   |   | 574 |   |   | 23 |   |   |
| Deduct:  Stock-based employee compensation expense determined under the fair value  based method for all awards |       | (5,200                                                                | )          | (7,218                           | )          |   | (12,065 | ) |   | (3,806 | ) |   | (5,400 | ) |   |
| Pro forma net  loss                                                                                             |       | $                                                                     | (12,086    | )                                | $          | (23,438 | ) |   | $ | (16,568 | ) |   | $ | 21,892 | ) |   | $ | (5,427 | ) |   |
| Basic and diluted net  loss per share:                                                                          |       |                                                                  |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| As reported                                                                                                     |       | $                                                                     | (0.30      | )                                | $          | (0.66 | ) |   | $ | (0.19 | ) |   | $ | (0.77 | ) |   | $ | (0.00 | ) |   |
| Pro forma                                                                                                       |       | $                                                                     | (0.46      | )                                | $          | (0.93 | ) |   | $ | (0.70 | ) |   | $ | (0.91 | ) |   | $ | (0.23 | ) |   |

 

Thefair value of employee stock awards was estimated at the date of grant usingthe Black-Scholes option pricing model with the following weighted averageassumptions:

| ** **                                        | ** ** | **Years Ended**     | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------|------------|--------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | **March 31,  2006** | ** ** | **March 31,  2005**         | ** ** | **December 31,  2003** | ** ** | **March 31,  2004** | ** ** | **March 31,  2003** | ** ** |
| ** **                                        | ** ** | ** **               | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |
| Expected  volatility                              |       |                     | 66         | %                                |       |   | 69 | % |   |   | 86 | % |   |   | 85 | % |   |   | 88 | % |   |
| Risk-free  interest rate                          |       |                     | 4.1        | %                                |       |   | 3.8 | % |   |   | 3.7 | % |   |   | 3.4 | % |   |   | 3.5 | % |   |
| Expected option  life in years                    |       |                     | 4.0        |                             |       |   | 3.5 |   |   |   | 6.3 |   |   |   | 5.8 |   |   |   | 6.5 |   |   |
| Expected dividend  yield                          |       |                     | 0          | %                                |       |   | 0 | % |   |   | 0 | % |   |   | 0 | % |   |   | 0 | % |   |
| Weighted average per  share grant date fair value |       |                     | $          | 3.08                             |       |   |   | $ | 3.99 |   |   |   | $ | 5.46 |   |   |   | $ | 13.92 |   |   |   | $ | 4.98 |   |   |
|                                                   |            |                          |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Segment andGeographic Information*

In accordance with SFAS No. 131, *Disclosures about Segments of an Enterprise and Related Information*,our operations have been aggregated into one reportable segment given thesimilarities of economic characteristics between the operations and the commonnature of the products, services and customers.

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

Financial information bygeographic region is as follows:

| ** **   | ** ** | **Years Ended**                                  | ** ** |
|--------------|------------|-------------------------------------------------------|------------|
| ** **   | ** ** | **March 31, 2006**                          | ** ** | **March 31, 2005** | ** ** | **December 31, 2003** | ** ** |
| ** **   | ** ** | **Amount**                                            | ** ** | **Percentage  of  Total** | ** ** | **Amount** | ** ** | **Percentage  of  Total** | ** ** | **Amount** | ** ** | **Percentage  of  Total** | ** ** |
| ** **   | ** ** | ** **                                            | ** ** | ** ** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **   | ** ** | **(In thousands, except percentages)** | ** ** |
| Revenues:    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S.         |       | $                                                     | 47,599     |   |   | 58 | % |   |   | $ | 42,022 |   |   |   | 53 | % |   | $ | 44,421 |   |   | 51 | % |   |
| Europe       |       | 18,645                                                |       |   | 23 | % |   |   | 20,353 |   |   |   | 26 | % |   | 25,756 |   |   | 30 | % |   |
| Asia-Pacific |       | 15,757                                                |       |   | 19 | % |   |   | 16,655 |   |   |   | 21 | % |   | 16,032 |   |   | 19 | % |   |
| Total        |       | $                                                     | 82,001     |   |   | 100 | % |   |   | $ | 79,030 |   |   |   | 100 | % |   | $ | 86,209 |   |   | 100 | % |   |

 

| ** **   | ** ** | **Three Months Ended**                      | ** ** |
|--------------|------------|-------------------------------------------------------|------------|
| ** **   | ** ** | **March 31, 2004**                          | ** ** | **March 31, 2003** | ** ** |
| ** **   | ** ** | **Amount**                                            | ** ** | **Percentage  of  Total** | ** ** | **Amount** | ** ** | **Percentage  of  Total** | ** ** |
| ** **   | ** ** | ** **                                            | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |
| ** **   | ** ** | **(Restated)**                                        | ** ** | **(Restated)** | ** ** |
| ** **   | ** ** | **(In thousands, except percentages)** | ** ** |
| Revenues:    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S.         |       |                                                  | $          | 9,615 |   |   |   | 50 | % |   | $ | 11,360 |   |   | 49 | % |   |
| Europe       |       |                                                  | 5,441      |   |   |   | 28 | % |   | 6,697 |   |   | 29 | % |   |
| Asia-Pacific |       |                                                  | 4,303      |   |   |   | 22 | % |   | 5,171 |   |   | 22 | % |   |
| Total        |       |                                                  | $          | 19,359 |   |   |   | 100 | % |   | $ | 23,228 |   |   | 100 | % |   |

 

| ** **          | ** ** | **As of March 31**                     | ** ** | **As of   December 31** | ** ** |
|---------------------|------------|-------------------------------------------------------|------------|----------------------------------------|------------|
| ** **          | ** ** | **2006**                                              | ** ** | **2005**                               | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **          | ** ** | **Amount**                                            | ** ** | **Percentage  of  Total**              | ** ** | **Amount** | ** ** | **Percentage  of  Total** | ** ** | **Amount** | ** ** | **Percentage  of  Total** | ** ** | **Amount** | ** ** | **Percentage  of  Total** | ** ** |
| ** **          | ** ** | ** **                                            | ** ** | ** **                             | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **          | ** ** | **(In thousands, except percentages)** | ** ** |
| Long-lived  assets: |       |                                                  |       |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S.                |       | $                                                     | 56,445     |                                   |       | 94 | % |   |   | $ | 58,484 |   |   |   | 93 | % |   |   | $ | 38,210 |   |   |   | 89 | % |   | $ | 38,645 |   |   | 89 | % |   |
| Europe              |       | 2,406                                                 |       |                                   | 4          | % |   |   | 2,805 |   |   |   | 5 | % |   |   | 3,487 |   |   |   | 8 | % |   | 3,481 |   |   | 8 | % |   |
| Asia-Pacific        |       | 1,155                                                 |       |                                   | 2          | % |   |   | 1,567 |   |   |   | 2 | % |   |   | 1,453 |   |   |   | 3 | % |   | 1,348 |   |   | 3 | % |   |
| Total               |       | $                                                     | 60,006     |                                   |       | 100 | % |   |   | $ | 62,856 |   |   |   | 100 | % |   |   | $ | 43,150 |   |   |   | 100 | % |   | $ | 43,474 |   |   | 100 | % |   |

 

*ComprehensiveIncome (Loss)*

In accordance with SFAS No. 130,*Reporting Comprehensive Income*, wereport the components of comprehensive income (loss), including net income(loss), in the financial statements in the period in which they are recognized.Comprehensive income (loss) is defined as all changes in equity during a periodfrom non-owner sources, including foreign currency translation adjustment andunrealized gains and losses on marketable securities. We present comprehensiveincome (loss) in our consolidated statements of 

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

stockholders’ equity. Accumulated other comprehensiveincome (loss) in stockholders’ equity consists of the following:

| ** **                                | ** ** | **March 31,**      | ** ** |
|-------------------------------------------|------------|-------------------------|------------|
| ** **                                | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                | ** ** | **(In thousands)** | ** ** |
| Foreign currency  translation adjustment  |       | $                       | 332        |   | $ | 1,115 |   |
| Unrealized loss  on marketable securities |       | (698                    | )          | (925 | ) |
|                                      |       | $                       | (366       | ) | $ | 190 |   |

 

*Guarantees*

We account for guaranteesin accordance with Financial Accounting Standards Board Interpretation (“FASB”)Interpretation (“FIN”) No. 45, *Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others*. FIN No. 45 requires thata guarantor recognize, at the inception of a guarantee, a liability for thefair value of certain guarantees and requires certain disclosures to be made bya guarantor about its obligations under certain guarantees that it has issued.

*Effect of New AccountingStandards*

In November 2005, the FASB issued Staff PositionNos. FAS 115-1 and FAS 124-1, *TheMeaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments*(“FSP Nos. 115-1 and 124-1”), which provideguidance on determining when investments in certain debt and equity securitiesare considered impaired and whether that impairment is other-than-temporary,and on the measurement of such impairment loss. FSP Nos. 115-1 and 124-1also include accounting considerations subsequent to the recognition ofother-than-temporary impairments and require certain disclosures aboutunrealized losses that have not been recognized as other-than-temporaryimpairments. We will adopt FSP Nos. 115-1 and 124-1 in thefirst quarter of fiscal year 2007. While we are currently evaluating the impacton our consolidated financial statements of the adoption of FSP Nos. 115-1and 124-1, we do not anticipate that they will have a significant impacton our results of operations and financial position.

In May 2005, the FASB issued SFAS No. 154, *Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20and SFAS No. 3*. Although SFAS No. 154 carries forward theguidance in APB No. 20 and SFAS No. 3 with respect to accounting forchanges in estimates, changes in reporting entities, and the correction oferrors, SFAS No. 154 establishes new standards for accounting for changesin accounting principles, whereby all such changes must be accounted for byretrospective application to the financial statements of prior periods unlessit is impracticable to do so. SFAS No. 154 is effective for accountingchanges and error corrections made in fiscal years beginning after December 15,2005, with early adoption permitted for changes and corrections made in yearsbeginning after May 2005. We will adopt SFAS No. 154 as of April 1,2006. We are currently evaluating the impact of this new standard, but believethat it will not have a material impact on our financial position, results ofoperations or cash flows.

In December 2004, theFASB issued SFAS No. 123 (revised 2004), *Share-BasedPayment* (“SFAS No. 123R”). SFAS No. 123R requiresthat employee stock-based compensation is measured based on the grant date fairvalue of the related employee equity awards and is treated as an expense thatis reflected in the financial statements over the related service period. SFAS No. 123Rapplies to all 

65

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

employeeequity awards granted after adoption and to the unvested portion of employeeequity awards outstanding as of adoption. We will adopt SFAS No. 123Rusing the modified-prospective method effective April 1, 2006. While weare currently evaluating the impact on our consolidated financial statements ofthe adoption of SFAS No. 123R, we anticipate that it will have a significantadverse impact on our future reported results of operations because employeestock-based compensation expense will be charged directly against our reportedresults, but will not affect our financial position or cash flows.

**4.   Divestiture ofPharmacopeia Drug Discovery, Inc. (“PDD”)**

On April 30, 2004, we completed the spin-off ofPDD 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. As part of this transaction, wecontributed $42.3 million in marketable securities and $5.4 million in cash toPDD and incurred transaction costs of approximately $3.0 million.

We have reclassified PDD’s prior period results of operations,assets and liabilities, and cash flows as discontinued operations in ourconsolidated financial statements. Further, the notes to our consolidatedfinancial statements exclude the results of operations, assets and liabilitiesof PDD.

In connection with the spin-off of PDD, we enteredinto a transition services agreement with PDD, under which we agreed to providecertain services to PDD through the first anniversary of the spin-off. Accordingly,during fiscal year 2005, we provided PDD with $0.5 million for purchase of afinancial system and $0.7 million related to the consolidation of itsfacilities. As of March 31, 2006, we have no further obligations to PDDunder the transition services agreement.

We also entered into a tax sharing and indemnification agreement with PDD,under which we are responsible for filing all federal, state and local incometax returns including PDD for all periods through the distribution date, andfor paying all taxes related to those returns.

We also guaranteed the remaining leaseobligations on certain of PDD’s facilities, as more fully described in Note 9.

**5.**   Acquisitionof SciTegic, Inc.

On September 27, 2004, we acquired all of theoutstanding common shares of SciTegic, Inc., a leading provider ofworkflow software solutions for the scientific research market, in atransaction accounted for as a purchase. The results of SciTegic’s operationshave been included in our consolidated financial statements since theacquisition date. The primary reason for the acquisition was to complement ourexisting product offerings.

The aggregate purchase price was $20.8 million,consisting of $13.4 million of cash paid and the issuance of 1,166,218 sharesof our common stock valued at $7.4 million. The per share value of the stockissued was $6.37 determined based on the average market price of our commonshares over the five-day period including two days before, the day of and twodays after the terms of the acquisition were agreed to and announced. On theclosing date of acquisition, 1,040,119 shares of our common stock were issuedto SciTegic stockholders and the remaining 126,099 shares (the “earn-out shares”)were deposited into an escrow account. Further, we deposited $3.2 million ofthe cash consideration into an escrow account.

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

The following tablesummarizes the estimated fair values of the assets acquired and liabilitiesassumed at the date of acquisition (in thousands):

| Fair value of net  tangible assets acquired and liabilities assumed:    |   |   |   |   |   |
|-------------------------------------------------------------------------|--------|--------|--------|--------|--------|
| Current assets                                                          |   | $      | 3,471  |   |   |   |
| Property and equipment                                                  |   | 163    |   |   |   |
| Other long-term assets                                                  |   | 21     |   |   |   |
| Current liabilities                                                     |   | (2,297 | )      |   |   |
| Deferred revenue                                                        |   | (2,172 | )      |   |   |
| Long-term liabilities                                                   |   | (15    | )      |   |   |
| Total                                                                   |   |   |   | (829   | )      |
| Fair value of identifiable intangible assets  acquired:                 |   |   |   |   |   |
| In-process product development                                          |   | 450    |   |   |   |
| Intangible assets not subject to  amortization—Trademark/tradename |   | 2,500  |   |   |   |
| Intangible assets subject to amortization:                              |   |   |   |   |   |
| Developed technology (5 year estimated useful life)                     |   | 6,750  |   |   |   |
| Customer relationships (10 year estimated useful  life)                 |   | 1,650  |   |   |   |
| Backlog (2.25 year estimated useful life)                               |   | 550    |   |   |   |
| Contracted based (5 year estimated useful life)                         |   | 50     |   |   |   |
| Total                                                                   |   |   |   | 11,950 |   |
| Goodwill                                                                |   |   |   | 9,726  |   |
| Net assets  acquired                                                    |   |   |   | $      | 20,847 |   |
|                                                                         |        |        |        |        |        |  |  |

 

The $450,000 of acquired in-process product developmentwas written-off at the date of acquisition in accordance with FASBInterpretation No. 4, *Applicability of FASBStatement No. 2 to Business Combinations Accounted for by the PurchaseMethod*. The goodwill resulting from the acquisition is not anticipatedto be deductible for tax purposes.

Pursuant to the terms of the merger agreement, thecash escrow was released to the former SciTegic stockholders on January 31,2005 and September 27, 2005. The earn-out shares held in escrow will bereleased in four semi-annual installments to former SciTegic stockholderssubject to, among other things, the continued employment by us of two foundersof SciTegic through September 27, 2006.

In addition to the earn-out shares described above,208,225 shares of our common stock were deposited in the escrow account for thetwo founders of SciTegic. In fiscal year 2005, we recorded deferred stock-basedcompensation of $1.3 million for the value of these shares. Additionally, infiscal year 2005, we recorded deferred stock-based compensation of $0.2 millionfor the value of our unvested stock options issued to SciTegic employees in theacquisition. The deferred stock-based compensation is being recognized over therespective vesting periods of the earn-out shares and stock options. As of March 31,2006, the remaining deferred stock-based compensation balance was $0.4 million.

67

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

Assumingthe acquisition had occurred on the first day of the following respectiveperiods, our unaudited pro forma consolidated results of operations would be asfollows:

| ** **                                                                      | ** ** | **Years Ended**                                                  | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                      | ** ** | **March 31,  2005**                                              | ** ** | **December 31,  2003**      | ** ** | **March 31,  2004** | ** ** | **March 31,  2003** | ** ** |
| ** **                                                                      | ** ** | ** **                                                            | ** ** | ** **                       | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |
| ** **                                                                      | ** ** | **(Restated)**                                                        | ** ** | **(Restated)**                   | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **                                                                      | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenue                                                                         |       | $                                                                     | 82,844     |                             |       | $ | 93,395 |   |   | $ | 21,165 |   |   | $ | 24,586 |   |   |
| Net loss                                                                        |       | (16,822                                                               | )          |                             | (4,450     | ) |   | (18,660 | ) |   | (307 | ) |   |
| Basic and diluted  net loss per share                                           |       | $                                                                     | (0.67      | )                                |       | $ | (0.18 | ) |   | $ | (0.73 | ) |   | $ | (0.01 | ) |   |
| Weighted average  shares used to calculate basic and diluted net loss per share |       | 25,137                                                                |       |                             | 25,126     |   |   | 25,464 |   |   | 24,991 |   |   |

 

**6.   Income Taxes**

Income(loss) from continuing operations before taxes was as follows:

| ** ** | ** ** | **Years Ended**     | ** ** | **Three Months Ended** | ** ** |
|------------|------------|--------------------------|------------|----------------------------------|------------|
| ** ** | ** ** | **March 31,  2006** | ** ** | **March 31,  2005**         | ** ** | **December 31,  2003** | ** ** | **March 31,  2004** | ** ** | **March 31,  2003** | ** ** |
| ** ** | ** ** | ** **               | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |
| ** ** | ** ** | ** **               | ** ** | **(Restated)**                   | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** ** | ** ** | **(In thousands)**  | ** ** |
| U.S.       |       |                     | $          | (6,897                           | )          |   | $ | (19,762 | ) |   | $ | (5,947 | ) |   |   | $ | (8,796 | ) |   |   | $ | 161 |   |   |
| Foreign    |       |                     | 56         |                             |       | 3,730 |   |   | 5,200 |   |   |   | 200 |   |   |   | 997 |   |   |
| Total      |       |                     | $          | (6,841                           | )          |   | $ | (16,032 | ) |   | $ | (747 | ) |   |   | $ | (8,596 | ) |   |   | $ | 1,158 |   |   |

 

Incometax expense (benefit) consists of the following:

| ** **                                 | ** ** | **Years Ended**     | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------|------------|--------------------------|------------|----------------------------------|------------|
| ** **                                 | ** ** | **March 31,  2006** | ** ** | **March 31,  2005**         | ** ** | **December 31,  2003** | ** ** | **March 31,**

**2004** | ** ** | **March 31,  2003** | ** ** |
| ** **                                 | ** ** | ** **               | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |
| ** **                                 | ** ** | ** **               | ** ** | **(Restated)**                   | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **                                 | ** ** | **(In thousands)**  | ** ** |
| Current:                                   |       |                     |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Federal                                    |       |                     | $          | —                           |       |   |   | $ | (952 | ) |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   |
| State                                      |       |                     | 102        |                             |       |   | 125 |   |   |   | 70 |   |   |   | 62 |   |   |   | 5 |   |   |
| Foreign                                    |       |                     | 725        |                             |       |   | 256 |   |   |   | 931 |   |   |   | 66 |   |   |   | 265 |   |   |
| Total current income tax expense (benefit) |       |                     | 827        |                             |       |   | (571 | ) |   |   | 1,001 |   |   |   | 128 |   |   |   | 270 |   |   |
| Deferred:                                  |       |                     |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Federal                                    |       |                     | —     |                             |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| State                                      |       |                     | —     |                             |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Foreign                                    |       |                     | 71         |                             |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Total deferred income tax expense          |       |                     | 71         |                             |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Total income tax expense  (benefit)        |       |                     | $          | 898                              |       |   |   | $ | (571 | ) |   |   | $ | 1,001 |   |   |   | $ | 128 |   |   |   | $ | 270 |   |   |

 

68

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

The following reconcilesincome taxes computed at the U.S. statutory federal tax rate to income taxexpense (benefit):

| ** **                                  | ** ** | **Years Ended**     | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------|------------|--------------------------|------------|----------------------------------|------------|
| ** **                                  | ** ** | **March 31,  2006** | ** ** | **March 31,  2005**         | ** ** | **December 31,  2003** | ** ** | **March 31,  2004** | ** ** | **March 31,  2003** | ** ** |
| ** **                                  | ** ** | ** **               | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | **(Unaudited)** | ** ** |
| ** **                                  | ** ** | ** **               | ** ** | **(Restated)**                   | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **                                  | ** ** | **(In thousands)**  | ** ** |
| Income tax at  U.S. statutory rate          |       |                     | $          | (2,327                           | )          |   |   | $ | (5,451 | ) |   |   | $ | (254 | ) |   |   | $ | (2,923 | ) |   |   | $ | 394 |   |   |
| State income  taxes, net of federal benefit |       |                     | (309       | )                                |       |   | (837 | ) |   |   | (45 | ) |   |   | (516 | ) |   |   | 69 |   |   |
| Reversal of tax  reserve                    |       |                     | —     |                             |       |   | (952 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Receivable for  withholding tax from Japan  |       |                     | —     |                             |       |   | (880 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Foreign taxes                               |       |                     | 568        |                             |       |   | (100 | ) |   |   | 600 |   |   |   | 66 |   |   |   | 265 |   |   |
| Change in  valuation allowance and other    |       |                     | 2,966      |                             |       |   | 7,649 |   |   |   | 700 |   |   |   | 3,501 |   |   |   | (458 | ) |   |
| Income tax expense  (benefit)               |       |                     | $          | 898                              |       |   |   | $ | (571 | ) |   |   | $ | 1,001 |   |   |   | $ | 128 |   |   |   | $ | 270 |   |   |

 

Significantcomponents of our deferred tax assets and liabilities are as follows:

| ** **                                   | ** ** | **March 31,**      | ** ** |
|----------------------------------------------|------------|-------------------------|------------|
| ** **                                   | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | ** **              | ** ** | **(Restated)** | ** ** |
| ** **                                   | ** ** | **(In thousands)** | ** ** |
| Deferred tax assets:                         |       |                    |       |   |   |
| Net operating loss carryforwards             |       | $                       | 53,380     |   | $ | 51,616 |   |
| Goodwill and intangibles                     |       | 7,941                   |       | 9,383 |   |
| Unused tax credits                           |       | 4,456                   |       | 4,018 |   |
| Accruals and reserves                        |       | 4,674                   |       | 3,763 |   |
| Gross deferred tax assets                    |       | 70,451                  |       | 68,780 |   |
| Deferred tax  liabilities:                   |       |                    |       |   |   |
| Property and equipment                       |       | 9                       |       | 543 |   |
| Intangible assets                            |       | 3,468                   |       | 4,148 |   |
| Gross deferred tax liabilities               |       | 3,477                   |       | 4,691 |   |
| Total net deferred tax assets                |       | 66,974                  |       | 64,089 |   |
| Valuation  allowance for deferred tax assets |       | (66,631                 | )          | (63,675 | ) |
| Net deferred taxes                           |       | $                       | 343        |   | $ | 414 |   |

 

We have provided a full valuation allowance for our 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, 2006 and 2005, we had$0.3 million and $0.4 million, respectively, of foreign deferred taxassets. The increase in the valuation allowance for deferred tax assetsfor the years ended March 31, 2006 and 2005 of $3.0 million and $7.4 million,respectively, was due primarily to the inability to utilize net operating losscarryforwards.

As of March 31, 2006, we had U.S. federal netoperating loss carryforwards of approximately $138.2 million, and taxcredit carryforwards of approximately $1.9 million. Our U.S. federal netoperating loss and tax credit carryforwards expire beginning in 2008 through2026, if not fully utilized. Realization is dependent on generating sufficienttaxable income prior to expiration of the loss and credit carryforwards. 

69

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

Approximately $46.7million of the net operating loss carryforwards relate to stock optiondeductions which, when realized, will result in an increase to paid-in capitaland a decrease in income taxes payable.

In addition to the net operating loss carryforwards inthe table above, as of March 31, 2006, we had pre-acquisition netoperating loss carryforwards of $57.0 million from acquisitions outsidethe U.S. which have been fully reserved. During the years ended March 31,2006 and 2005 and December 31, 2003, we utilized $0 million, $0.7 millionand $0.3 million, respectively, of pre-acquisition net operating losscarryforwards that resulted in a corresponding reduction to goodwill. Therealization of our remaining pre-acquisition net operating loss carryforwardsas of March 31, 2006 will result in additional reductions of goodwill.

As of March 31, 2006 and 2005, we had a taxreserve of $0.7 million and $0.6 million, respectively, related to a potentialtransfer pricing issue.

In April 2003, we established a wholly-ownedsubsidiary, Accelrys Software Solutions Pvt. Ltd., in Bangalore, India, thatqualifies under applicable Indian law for a tax holiday through March 2009.The aggregate dollar amount of the tax holiday was $0.3 million, or $0.01 pershare, as of March 31, 2006.

A portion of our U.S.federal and state net operating loss and tax credit carryforwards may besubject to annual usage limitations under Sections 382 and 383 of theInternal Revenue Code. Use of the U.K. net operating loss carryforwards may belimited upon the occurrence of certain events such as the discontinuation orchange in the nature or conduct of our business.

**7.   Stock Plans**

On August 2, 2005, our stockholders approved theAmended and Restated 2004 Stock Incentive Plan (“2004 Plan”). The 2004 Planauthorizes the grant of equity awards to purchase the number of shares of ourcommon stock equal to the sum of (i) 1,900,000 shares and (ii) thenumber of shares of common stock underlying any stock awards granted undercertain prior equity plans (the 1994 Incentive Stock Plan, the 1996 EquityIncentive Plan, the 2000 Stock Option Plan and the 2004 New-Hire Equity IncentivePlan) that expire or are canceled or forfeited without having been exercised infull or that are repurchased by us. Potential types of equity awards that maybe granted under the 2004 Plan to our officers, directors, employees andconsultants include stock options, restricted stock awards, common stockawards, stock appreciation rights, performance awards and deferred stock units.Pursuant to the 2004 Plan, any shares of common stock that are awarded underthe 2004 Plan as restricted stock awards, common stock awards, performanceawards or deferred stock units (but not as stock options or stock appreciationrights) are counted against the maximum number of shares of common stockavailable 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 stock.At March 31, 2006, approximately 2,045,000 shares of our common stockremain available for issuance pursuant to awards granted under the 2004 Plan.

On August 2, 2005, our stockholders also approvedthe 2005 Employee Stock Purchase Plan (“2005 ESPP”), under which we havereserved 1,000,000 shares of our common stock for issuance. Under the 2005 ESPP, employees may defer upto 10% of their base salary to purchase shares of our common stock. Thepurchase price of the common stock is equal to 85% of the lower of the fairmarket value per share of our common stock on the commencement date of theapplicable offering period or the purchase date. To date, 

70

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

wehave not issued shares under the 2005 ESPP and 1,000,000 shares remainavailable for future issuance under the 2005 ESPP as of March 31, 2006.

The 2005 ESPP replaced our 1995 Employee StockPurchase Plan (“1995 ESPP”) which expired in fiscal year 2006. During the yearsended March 31, 2006 and 2005 and December 31, 2003, 75,080 shares,95,720 shares and 112,439 shares, respectively, of our common stock were issuedunder the 1995 ESPP. No shares of our common stock were issued under the 1995ESPP during the three months ended March 31, 2004 and 2003 (unaudited), respectively.

Asummary of activity under our stock plans, excluding the 2005 ESPP and 1995ESPP, is as follows (in thousands, except per share amounts):

| ** **                          | ** ** | **Years Ended**                                                  | ** ** |
|-------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                          | ** ** | **March 31, 2006**                                          | ** ** | **March 31, 2005** | ** ** |
| ** **                          | ** ** | **Number of  Shares**                                            | ** ** | **Weighted  Average  Exercise**

**Price** | ** ** | **Number  of Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| ** **                          | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Outstanding at  beginning of period |       |                                                                  | 5,343      |   |   |   | $ | 10.56 |   |   |   | 9,796 |   |   |   | $ | 13.87 |   |   |
| Granted                             |       |                                                                  | 389        |   |   |   | 5.80 |   |   |   | 1,592 |   |   |   | 7.06 |   |   |
| Exercised                           |       |                                                                  | (120       | ) |   |   | 4.33 |   |   |   | (142 | ) |   |   | 7.48 |   |   |
| Expired                             |       |                                                                  | (1,306     | ) |   |   | 12.26 |   |   |   | (5,903 | ) |   |   | 15.18 |   |   |
| Outstanding at  end of period       |       |                                                                  | 4,306      |   |   |   | $ | 9.78 |   |   |   | 5,343 |   |   |   | $ | 10.56 |   |   |
| Exercisable at  end of period       |       |                                                                  | 2,954      |   |   |   | $ | 11.09 |   |   |   | 3,108 |   |   |   | $ | 12.70 |   |   |

 

| ** **                          | ** ** | **Three Months Ended  March 31, 2004**            | ** ** | **Year Ended  December 31, 2003** | ** ** |
|-------------------------------------|------------|-----------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                          | ** ** | **Number of  Shares**                                            | ** ** | **Weighted  Average  Exercise  Price**           | ** ** | **Number  of Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| ** **                          | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Outstanding at  beginning of period |       |                                                                  | 9,722      |                                             |       |   | $ | 13.78 |   |   |   | 8,379 |   |   |   | $ | 15.62 |   |   |
| Granted                             |       |                                                                  | 673        |                                             |       |   | 16.80 |   |   |   | 1,849 |   |   |   | 6.31 |   |   |
| Exercised                           |       |                                                                  | (305       | )                                                |       |   | 10.58 |   |   |   | (107 | ) |   |   | 7.27 |   |   |
| Expired                             |       |                                                                  | (294       | )                                                |       |   | 21.09 |   |   |   | (399 | ) |   |   | 19.55 |   |   |
| Outstanding at  end of period       |       |                                                                  | 9,796      |                                             |       |   | $ | 13.87 |   |   |   | 9,722 |   |   |   | $ | 13.78 |   |   |
| Exercisable at  end of period       |       |                                                                  | 5,392      |                                             |       |   | $ | 16.71 |   |   |   | 5,094 |   |   |   | $ | 17.55 |   |   |

 

71

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

A summary of stock optionsoutstanding and exercisable as of March 31, 2006 is as follows:

| **Options Outstanding**                  | ** **                          | **Options Exercisable**                                                              | ** ** |
|-----------------------------------------------|-------------------------------------|-------------------------------------------------------------------------------------------|------------|
| ** **                                    | **Range of  Exercise  Prices** | ** **                                                                                | ** ** | **Number  Outstanding** | ** ** | **Weighted Average  Remaining  Contractual Life  (years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| ** **                                    | ** **                          | **(In thousands, except per share amounts and years)** | ** ** |
| $  0.38-  4.00            |                                |                                                                                      | 51         |   |   |   | 6.8 |   |   |   | $ | 0.36 |   |   |   | 36 |   |   |   | $ | 0.45 |   |   |
|     4.01-  7.00 |                                |                                                                                      | 1,895      |   |   |   | 6.5 |   |   |   | 5.99 |   |   |   | 1,091 |   |   |   | 6.12 |   |   |
|     7.01-10.00            |                                |                                                                                      | 1,393      |   |   |   | 5.8 |   |   |   | 8.25 |   |   |   | 938 |   |   |   | 8.43 |   |   |
|   10.01-15.00                       |                                |                                                                                      | 476        |   |   |   | 3.1 |   |   |   | 13.25 |   |   |   | 418 |   |   |   | 13.13 |   |   |
|   15.01-20.00                       |                                |                                                                                      | 170        |   |   |   | 3.7 |   |   |   | 18.05 |   |   |   | 150 |   |   |   | 18.07 |   |   |
|   20.01-40.00                       |                                |                                                                                      | 318        |   |   |   | 3.1 |   |   |   | 31.02 |   |   |   | 318 |   |   |   | 31.02 |   |   |
|   40.01-85.00                       |                                |                                                                                      | 3          |   |   |   | 3.9 |   |   |   | 49.89 |   |   |   | 3 |   |   |   | 49.89 |   |   |
| $  0.38-85.00                       |                                |                                                                                      | 4,306      |   |   |   | 5.6 |   |   |   | $ | 9.78 |   |   |   | 2,954 |   |   |   | $ | 11.06 |   |   |

 

**8.   RetirementSavings Plans**

*U.S. BasedEmployees*

We have an employee savings and retirement plan (“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 the 401(K) Plan,employees may elect to contribute up to 20% of their compensation, or thestatutory prescribed limit, if less. We may, at our discretion, match employeecontributions up to a maximum of 3% of the employee’s compensation. Employermatching contributions totaled $0.4 million, $0.6 million, $0.7 million, $0.2 millionand $0.2 million for the years ended March 31, 2006 and 2005 and December 31,2003, and the three months ending March 31, 2004 and 2003 (unaudited),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 Plancontains a bonus employer contribution. The bonus employer contribution isdetermined based on each percent that our stock outperforms the Russell 2000Index, up to a maximum of 20% of the participant’s annual retainer or basesalary, as appropriate. Bonus employer contributions totaled $0.5 million forthe year ended December 31, 2003. No bonus employer contributions weremade for all other periods presented.

*Non-U.S. BasedEmployees*

We provide retirementbenefits for employees located outside the U.S. commensurate with other similarcompanies in those respective locations. Employer contributions, in the form ofcash, totaled $0.7 million, $0.7 million, $0.6 million, $0.2 million and$0.1 million for the years ended March 31, 2006 and 2005 andDecember 31, 2003, and the three months ending March 31, 2004 and2003 (unaudited), respectively.

72

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

**9.   Commitments andContingencies**

*Operating Leases*

We lease office space in several facilities underoperating leases that expire through 2022. For accounting purposes, werecognize rent expense on a straight-line basis over the term of the relatedoperating leases. Rent expense recognized in excess of rent paid is reflectedas a deferred rent liability, which is included in deferred rent, leaseconcessions and lease guarantee in the accompanying consolidated balancesheets. Rent expense under our operating leases for the years endedMarch 31, 2006 and 2005 and December 31, 2003, and the three monthsended March 31, 2004 and 2003 (unaudited), was approximately $4.2 million,$4.6 million, $4.3 million, $1.2 million and $1.0 million, respectively.

The terms of our lease for our corporate office in SanDiego, California include a tenant improvement allowance of up to $1.8 million.We initially recorded the entire tenant improvement allowance as a receivablefrom the landlord and as a corresponding lease concessions liability. We areamortizing the liability ratably over the term of the related lease as areduction to rent expense.During the year ended March 31, 2006, we determined that the remainingtenant improvement allowance receivable from the landlord of $0.4 million wasuncollectible and accordingly we wrote-off the remaining receivable against thelease concessions liability.

Additionally, under the terms of the lease for our SanDiego, California corporate office, we were required to place $6.6 million in arestricted cash account to ensure our performance under the lease agreement. Ifwe are not in default under the lease, the cash restriction will decrease to$4.4 million on September 1, 2009, $3.0 million on September 1, 2011and will expire upon termination of the lease on September 1, 2013. At March 31,2006 and 2005, we had a restricted cash balance of $6.6 million and $6.6 million,respectively, which consisted entirely of marketable securities.

We attempt to sublease any unoccupied office space. Werecognized sublease income of $0.4 million, $0.5 million, $0.3 million, $0.1million and $5,000 for the years ended March 31, 2006 and 2005 and December 31,2003, and for the three months ended March 31, 2004 and 2003 (unaudited),respectively.

Future minimum leasecommitments and future committed sublease income as of March 31, 2006 areas follows:

| ** **       | ** ** | **Operating  Lease  Commitments** | ** ** | **Sublease  Income** | ** ** | **Net** | ** ** |
|------------------|------------|-----------------------------------|------------|----------------------|------------|---------|------------|
| ** **       | ** ** | **(In thousands)**           | ** ** |
| Fiscal year 2007 |       |                              | $          | 4,285                |       |    |       | $ | 767 |   |   | $ | 3,518 |   |
| Fiscal year 2008 |       |                              | 4,417      |                 |       |    | 534        |   |   | 3,883 |   |
| Fiscal year 2009 |       |                              | 4,241      |                 |       |    | 497        |   |   | 3,744 |   |
| Fiscal year 2010 |       |                              | 4,090      |                 |       |    | 487        |   |   | 3,603 |   |
| Fiscal year 2011 |       |                              | 3,975      |                 |       |    | 487        |   |   | 3,488 |   |
| Thereafter       |       |                              | 22,635     |                 |       |    | 81         |   |   | 22,554 |   |
|             |       |                              | $          | 43,643               |       |    |       | $ | 2,853 |   |   | $ | 40,790 |   |

 

*Guarantee of LeaseObligation of Others*

On April 30, 2004,relating to the spin-off of PDD, the landlords of our New Jersey facilities,which were used by our PDD operations, consented to the assignment of theleases to PDD. Despite the 

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

assignment,the landlords required us to guarantee the remaining lease obligations, whichtotaled approximately $25 million as of March 31, 2006. In accordance withFIN No. 45, we recognized a liability and corresponding charge tostockholders’ equity for the probability-weighted fair market value of theguarantee. Changes to the fair market value of the liability are recognized instockholders’ equity. At March 31, 2006 and 2005, the liability for ourguarantee of the lease obligation was $0.6 million and $0.7 million,respectively.

*Royalties*

We are obligated to pay royalties for licenses toenhance and market certain software used in connection with our productofferings. Annual contractual minimum royalty payments as of March 31,2006 are as follows (in thousands):

| Fiscal year 2007 |   | $     | 526    |   |
|------------------|--------|-------|--------|--------|
| Fiscal year 2008 |   | 496   |   |
| Fiscal year 2009 |   | 332   |   |
| Fiscal year 2010 |   | 253   |   |
| Fiscal year 2011 |   | 253   |   |
| Thereafter(1)    |   | 1,329 |   |
|             |   | $     | 3,189  |   |

----

(1)          Forpurposes of the contractual minimum royalty payments table, we have includedindefinite-lived contractual minimum royalty payments due in the ten fiscalyears following fiscal year 2006.

Inaddition to the contractual minimum royalties included in the table above, wehave several royalty agreements that are long term or perpetual innature and the royalty obligations are generally based on a percentage ofrevenues derived from certain software license sales including associated salesof PCS. The royalty agreements require quarterly payments and generally do notlimit the maximum royalties owed. During the years ended March 31, 2006 and2005 and December 31, 2003, and the three months ended March 31, 2004 and 2003(unaudited), we incurred related royalty expense of $3.0 million, $2.8 million,$2.8 million, $0.4 million and $0.5 million, respectively.

*Litigation*

In the ordinary course ofbusiness, we may be subject to claims and, from time to time, named in variouslegal proceedings. We are currently not involved in any matters of materiallitigation.

*Other Guaranteesand Indemnifications*

We provideindemnifications of varying scope and size to certain customers against claimsof intellectual property infringement made by third parties arising from theuse of our products. We have also entered into indemnification agreements withour officers and directors. Although the maximum potential amount of futurepayments we could be required to make under these indemnifications isunlimited, to date we have not incurred material costs to defend lawsuits orsettle claims related to these indemnification provisions. Additionally, wehave insurance policies that, in most cases, would limit our exposure andenable us to recover a portion of any amounts paid. Therefore, we believe theestimated fair 

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

value ofthese agreements is minimal and likelihood of incurring an obligation is remote.Accordingly, we have not accrued any liabilities in connection with theseindemnification obligations as of March 31, 2006.

**10.   Severance andLease Abandonment**

Thefollowing summarizes the changes in our severance and lease abandonmentliability:

| ** **                                         | ** ** | **Severance Costs  for Involuntary  Employee  Terminations** | ** ** | **Costs to  Exit Lease  Obligations** | ** ** | **Total** | ** ** |
|----------------------------------------------------|------------|------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------|------------|
| ** **                                         | ** ** | **(In thousands)**                                                | ** ** |
| Balance at  December 31, 2002                 |       |                                                                   | $          | 544                                             |       |      |       | $ | 1,731 |   |   | $ | 2,275 |   |
| Cash payments                                      |       |                                                                   | (449       | )                                               |       |      | (281       | ) |   | (730 | ) |
| Adjustment to liability                            |       |                                                                   | (95        | )                                               |       |      | (289       | ) |   | (384 | ) |
| Balance at  December 31, 2003                 |       |                                                                   | —     |                                            |       |      | 1,161      |   |   | 1,161 |   |
| Additional severance charges                       |       |                                                                   | 2,813      |                                            |       |      | —     |   |   | 2,813 |   |
| Cash payments                                      |       |                                                                   | (2,197     | )                                               |       |      | (65        | ) |   | (2,262 | ) |
| Balance at  March 31, 2004                    |       |                                                                   | 616        |                                            |       |      | 1,096      |   |   | 1,712 |   |
| Additional severance and lease abandonment charges |       |                                                                   | 1,358      |                                            |       |      | 3,956      |   |   | 5,314 |   |
| Cash payments                                      |       |                                                                   | (907       | )                                               |       |      | (1,342     | ) |   | (2,249 | ) |
| Adjustment to liability                            |       |                                                                   | —     |                                            |       |      | (167       | ) |   | (167 | ) |
| Effect of foreign exchange                         |       |                                                                   | —     |                                            |       |      | (17        | ) |   | (17 | ) |
| 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 |   |

 

During fiscal year 2002, we implemented variousactions designed to improve our operations and overall financial performancethrough workforce reductions and the abandonment of two leased facilities. As aresult of the implementation of these actions, we recognized a charge of $4.3million, consisting of $2.3 million in severance benefits from the terminationof 71 employees and $2.0 million related to the abandonment of the two leasedfacilities. The severance benefits were paid in full in fiscal year 2003. Duringfiscal year 2003, we negotiated the termination of the operating lease for oneof the abandoned leased facilities and finalized certain remaining severanceobligations which resulted in a $0.4 million reduction to the original $2.0million liability. Additionally, during fiscal year 2005, we subleased theother abandoned leased facility which resulted in a $0.2 million reduction tothe original $2.0 million liability. Our lease obligation for this facilityterminates in fiscal year 2008.

During the three months ended March 31, 2004, weimplemented a workforce reduction of 73 employees designed to improve theefficiency of our product development activities and reduce general andadministrative costs. As a result of the implementation of this workforcereduction, we incurred a charge of $2.8 million for severance benefits for theterminated employees. The severance benefits were paid in full in fiscal year2005.

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

During fiscal year 2005, as a result of the relocationof our corporate headquarters, we recorded a lease abandonment charge of $3.6million representing the future lease obligations, net of estimated futuresublease income. Our lease obligation for this facility terminates in fiscalyear 2007.

Additionally, during fiscal year 2005, we implementedvarious actions designed to improve the efficiency of our sales department andeliminate duplicative general and administrative personnel through workforcereductions and the abandonment of a leased facility in Germany. As a result ofthe implementation of these actions, we recognized a charge of $1.7 million,consisting of $1.4 million in severance benefits from the termination of 42employees and $0.3 million related to the abandonment of the leased facility. Theseverance benefits were paid in full in fiscal year 2006. Our lease obligationfor the abandoned facility terminates in fiscal year 2010.

In March 2006, weimplemented 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 millionin severance benefits from the termination of approximately 50 employees and$1.4 million for our future lease obligations related to the abandonedfacility, net of estimated future sublease income. We anticipate completing theworkforce reductions and payment of severance benefits in the first quarter offiscal year 2007. The lease obligation for the abandoned facility terminates infiscal year 2016.

**11.   VariableInterest Entity**

In March 2000, weestablished a rabbi trust for the benefit of our directors and officers underthe EDC Plan. In accordance with FIN No. 46, *Consolidationof Variable Interest Entities, an Interpretation of ARB No. 51*,we have included the assets of the rabbi trust in our consolidated balancesheets since the trust’s inception. As of March 31, 2006 and 2005, theasset and liabilities of the trust were $0.4 million and $0.8 million,respectively. Changes in the values of the assets held by the rabbi trustaccrue to the directors and officers and not to us.

**12.   Related PartyTransactions**

A former member of our board of directors is a partnerin the former principal outside law firm that provided legal services to usthrough April 30, 2004. For the years ended March 31, 2005 and December 31,2003, and the three months ended March 31, 2004, we incurred a total of$0.2 million, $0.5 million and $0.4 million, respectively, in fees relatedto services provided by the legal firm.

Our former chairman,president and chief executive officer is also the chairman of the board ofdirectors of a customer. For the years ended March 31, 2006 and 2005 and December 31,2003, and the three months ended March 31, 2004, we received $4,000, $0.1million, $0.7 million and $2,000, respectively, in payment for products andservices provided to the customer.

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**Accelrys, Inc. Notes to Consolidated Financial Statements (Continued)**

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

Thefollowing quarterly financial data, in the opinion of management, reflects alladjustments, consisting of normal recurring adjustments and the restatementadjustments more fully described in Note 2, necessary for a fairpresentation of results for the periods presented:

| ** **                                          | ** ** | **Year Ended March 31, 2006**                     | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **First  Quarter**                                                    | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
| ** **                                          | ** ** | **(Restated)**                                                        | ** ** | **(Restated)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                          | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenue                                             |       |                                                                  | $          | 20,404 |   |   |   | $ | 21,736 |   |   | $ | 20,433 |   | $ | 19,429 |   |
| Total operating  costs and expenses                 |       |                                                                  | 22,559     |   |   |   | 20,745 |   |   | 21,600 |   | 25,809 |   |
| Operating  (income) loss from continuing operations |       |                                                                  | (2,155     | ) |   |   | 991 |   |   | (1,167 | ) | (6,380 | ) |
| Net income (loss)                                   |       |                                                                  | (1,897     | ) |   |   | 1,152 |   |   | (567 | ) | (6,427 | ) |
| Basic net income (loss) per share                   |       |                                                                  | $          | (0.07 | ) |   |   | $ | 0.04 |   |   | $ | (0.02 | ) | $ | (0.25 | ) |
| Diluted net income  (loss) per share                |       |                                                                  | $          | (0.07 | ) |   |   | $ | 0.04 |   |   | $ | (0.02 | ) | $ | (0.25 | ) |

 

| ** **                                          | ** ** | **Year Ended March 31, 2005**                     | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **First  Quarter**                                                    | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
| ** **                                          | ** ** | **(Restated)**                                                        | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **                                          | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenue                                             |       |                                                                  | $          | 18,804 |   |   |   | $ | 19,734 |   |   |   | $ | 19,600 |   |   |   | $ | 20,892 |   |   |
| Total operating  costs and expenses(1)              |       |                                                                  | 19,760     |   |   |   | 19,315 |   |   |   | 28,229 |   |   |   | 29,497 |   |   |
| Operating income  (loss) from continuing operations |       |                                                                  | (956       | ) |   |   | 419 |   |   |   | (8,629 | ) |   |   | (8,605 | ) |   |
| Income (loss)  from continuing operations           |       |                                                                  | (506       | ) |   |   | 429 |   |   |   | (8,083 | ) |   |   | (7,301 | ) |   |
| Loss from  discontinued operations(2)               |       |                                                                  | (1,117     | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Net income (loss)                                   |       |                                                                  | (1,623     | ) |   |   | 429 |   |   |   | (8,083 | ) |   |   | (7,301 | ) |   |
| Basic loss per share amounts:                       |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss)  from continuing operations           |       |                                                                  | $          | (0.02 | ) |   |   | $ | 0.02 |   |   |   | $ | (0.31 | ) |   |   | $ | (0.28 | ) |   |
| Loss from  discontinued operations                  |       |                                                                  | (0.05      | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Net income (loss)                                   |       |                                                                  | $          | (0.07 | ) |   |   | $ | 0.02 |   |   |   | $ | (0.31 | ) |   |   | $ | (0.28 | ) |   |
| Diluted net  income (loss) per share                |       |                                                                  | $          | (0.07 | ) |   |   | $ | 0.02 |   |   |   | $ | (0.31 | ) |   |   | $ | (0.28 | ) |   |

 

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(1)   Theincrease in total operating costs and expenses in the third quarter of fiscalyear 2005 as compared to the second quarter of fiscal year 2005 is partiallydue to costs from our SciTegic subsidiary, which was acquired on September 27,2004, as more fully described in Note 5. The results of SciTegic’s operationshave been included in our consolidated financial statements since theacquisition date.

(2)   As morefully described in Note 4, on April 30, 2004, we completed the spin-off of PDDinto an independent, separately traded, publicly held company. Accordingly, wehave reclassified PDD’s prior period results of operations, assets andliabilities, and cash flows as discontinued operations in our consolidated financialstatements.

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

None

**Item 9A.**                Controlsand Procedures

**Conclusion Regarding the Effectiveness ofDisclosure Controls and Procedures**

We maintain disclosure controls and procedures, as such term is defined in Rules13a-15(e) and 15d-15(e) under the Securities Exchange Act of1934, as amended (the “Exchange Act”), that are designed to provide reasonableassurance that information required to be disclosed by us in the reports thatwe file or submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the SEC rules and forms, andthat such information is accumulated and communicated to our management,including our principal executive officer and principal financial officer, asappropriate, to allow timely decisions regarding required financial disclosures.Because of inherent limitations, our disclosure controls and procedures, nomatter how well designed and operated, can provide only reasonable, and notabsolute, 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 werenot effective as of March 31, 2006. In particular, in connection with therestatement of our previously issued financial statements, managementidentified certain control deficiencies that represent material weaknesses inour internal control over financial reporting, as more fully described below. Asa result of the restatement of our previously issued financial statements andnotwithstanding the material weaknesses described below, management believesthat the consolidated financial statements included in this Report fairlypresent, in all material respects, our financial position, results ofoperations and cash flows for the periods presented.

**Management’s Report on Internal ControlOver 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 generally acceptedaccounting principles. 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 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 set forth in *Internal Control—Integrated Framework*, our managementidentified certain control deficiencies that represent material weaknesses inour internal control over financial reporting as of March 31, 2006. Amaterial weakness is defined as a control deficiency, or combination of controldeficiencies, that results in more than a remote likelihood that a material 

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misstatement of the annual or interimfinancial statements will not be prevented or detected. The material weaknessesidentified by management are as follows:

*Timing of Revenue Recognition.**  *We did not maintain effective controls over theapplication of software revenue recognition principles to our term-based andperpetual software license arrangements. In connection with a review of ourAnnual Report on Form 10-K for the year ended March 31, 2005 bythe Corporate Finance Division of the SEC, we determined that we had failed toproperly recognize revenue from software arrangements which include multipleelements (typically software licenses and PCS) in the correct reportingperiods, although the total revenue recognized over the term of thearrangements was appropriate. Therefore, we have restated our previously issuedconsolidated financial statements to correct revenue and deferred revenue. Ourfailure to properly apply software revenue recognition principles to ourterm-based and perpetual software license arrangements resulted from a lack ofa sufficient number of employees with appropriate levels of knowledge,expertise and training in the application of generally accepted accountingprinciples relevant to software revenue recognition.

*Accounting for SoftwareDevelopment Costs.*   We did not maintain effectivecontrols over the application of SFAS No. 86, *Accountingfor the Cost of Computer Software to be Sold, Leased or Otherwise Marketed,*to our software development projects. As a result of an internal review of ourhistorical accounting for software development costs, we determined that we didnot have contemporaneous evidence of the achievement of technologicalfeasibility of our software development projects as required for capitalizationunder SFAS No. 86. As a result, we historically capitalized softwaredevelopment costs prior to the achievement of technological feasibility. Basedon this review, we have determined that technological feasibility occursshortly before our software products are available for general release. Usingthis revised methodology, we have determined that costs eligible forcapitalization under SFAS No. 86 would not be material. Therefore, we haverestated our previously issued consolidated financial statements to remove allhistorical capitalization of product development costs and related assets andamortization. Our failure to properly apply SFAS No. 86 resulted from alack of a sufficient number of employees with appropriate levels of knowledge,expertise and training in the application of generally accepted accountingprinciples relevant to software development costs.

Because of the materialweaknesses described above, which resulted in material misstatements of ourpreviously issued consolidated financial statements, our management concludedthat we did not maintain effective internal control over financial reporting asof March 31, 2006 based on the criteria in *InternalControl—Integrated Framework*. Ourmanagement’s assessment of the effectiveness of our internal control overfinancial reporting as of March 31, 2006 has been audited by Ernst &Young LLP, an independent registered public accounting firm, as stated in theirreport which is included herein.

**Changes in Internal Control Over Financial Reporting**

There have been no changesin our internal control over financial reporting that occurred in our lastfiscal quarter that have or are reasonably likely to materially affect ourinternal control over financial reporting identified in connection with thepreviously mentioned evaluation other than those described below.

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With oversightfrom our Audit Committee, we have formulated a remediation plan intended toaddress the control deficiencies identified above and we are committed toeffectively implementing the plan as expeditiously as possible. Notwithstandingthe remediation initiatives described below, the control deficiencies will notbe considered remediated until new controls are implemented, in operation for asufficient period of time, are tested and our management concludes that the newcontrols are operating effectively. Specifically, the following actions havebeen taken as part of the remediation activities:

(1)         Wehired three senior-level accounting employees in March and April 2006who have significant expertise in financial controls and the application ofgenerally accepted accounting principles relevant to our business, includingsoftware revenue recognition.

(2)         Weinitiated a program of additional training regarding our revenue recognitionpolicies designed to ensure all relevant personnel involved in software revenuerecognition transactions understand and apply applicable generally acceptedaccounting principles, and have set an annual minimum training requirement.

(3)         Weimplemented an enhanced quarterly and annual financial statement close, reviewand reporting process to include additional levels of analysis and review.

We continue to take remedial steps tostrengthen our internal controls and enhance our financial reporting processes.Our ongoing review of our internal controls and financial reporting processesmay result in further remediation efforts in addition to those listed above.

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

The Board of Directors and StockholdersAccelrys, Inc.

We have audited management’sassessment, included in the accompanying Management’s Report on InternalControl Over Financial Reporting, that Accelrys, Inc. did not maintaineffective internal control over financial reporting as of March 31, 2006,because of the effect of the material weaknesses identified in the Company’ssystem of internal control related to the analysis and recording of revenue andsoftware development costs that resulted in the restatement of prior year’sfinancial statements, 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 inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

A company’s internal controlover financial reporting is a process designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation offinancial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the 

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assetsof the company; (2) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

Amaterial weakness is a control deficiency, or combination of controldeficiencies, that results in more than a remote likelihood that a materialmisstatement of the annual or interim financial statements will not beprevented or detected. The following material weaknesses have been identifiedand included in management’s assessment:

·  Failure to properly apply software revenuerecognition principles to term-based and perpetual software licensearrangements resulted from the Company’s historical lack of a sufficient numberof employees with appropriate levels of knowledge, expertise and training in theapplication of generally accepted accounting principles relevant to softwarerevenue recognition.

·  Failure to properly apply applicableaccounting literature to the Company’s software development projects resultedfrom the Company’s lack of a sufficient number of employees with appropriatelevels of knowledge, expertise and training in the application of generallyaccepted accounting principles relevant to software development costs.

These material weaknesses resulted in the Companyrestating certain of its previously issued financial statements as of March 31,2005 and for the years ended March 31, 2005 and December 31, 2003 and thethree-month period ended March 31, 2004 to reflect the appropriate accountingfor revenue, cost of revenues, operating expenses, long-lived assets anddeferred revenue. The Company was required to record revenue based on the termof the license rather than recognizing a portion of the fee up-front and aportion over the post contract support term, which changed the timing of revenuerecognition. In addition, the Company was required to expense previouslycapitalized costs associated with software development in the period originallyincurred, which has the effect of increasing research and development expenseand decreasing cost of revenues for the related amortization. These materialweaknesses were considered in determining the nature, timing, and extent ofaudit tests applied in our audit of the 2006 financial statements, and thisreport does not affect our report dated May 5, 2006 on those financialstatements.

In ouropinion, management’s assessment that Accelrys, Inc. did not maintaineffective internal control over financial reporting as of March 31, 2006,is fairly stated, in all material respects, based on the COSO control criteria.Also, in our opinion, because of the effect of the material weaknessesdescribed above on the achievement of objectives of the control criteria,Accelrys, Inc. has not maintained effective internal control overfinancial reporting as of March 31, 2006, based on the COSO control criteria.

|                        |   | /s/ Ernst & Young LLP |
|------------------------|--------|---------------------------|
|                   |   |                      |
| San Diego,  California |   |                      |
| May 5, 2006            |   |                      |

 

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**Item 9B.**               Other Information

*Employment Agreement with Mark J. Emkjer*

On May 22, 2006, we entered into an employmentagreement (the “Emkjer Employment Agreement”) with Mark J. Emkjer, our currentpresident and chief executive officer. Pursuant to the terms of the employmentagreement, Mr. Emkjer is entitled to receive an annual base salary in theamount of $400,000, which amount is subject to annual review by the HumanResources Committee of the Board of Directors (the “HR Committee”). Mr. Emkjeris also entitled to participate in our management incentive plan, which allowshim to receive, subject to the criteria set forth in the management incentiveplan, an incentive bonus in an amount equal to up to 85% of his annual basesalary for each year he remains employed with us.

We may terminate the agreement upon two years notice. Suchnotice may be given commencing twelve months after execution of the agreement. However,even during the term of the agreement, Mr. Emkjer’s employment with uswill be at-will, meaning that either we or Mr. Emkjer may terminate theemployment relationship at any time. If Mr. Emkjer’s employment with us isterminated by us during the term without “cause” or by Mr. Emkjer for “goodreason” (each as defined in the Emkjer Employment Agreement), Mr. Emkjerwill be entitled to receive, subject to his continued compliance with certainnon-competition, non-solictation and non-disparagement provisions contained inthe Emkjer Employment Agreement, severance payments and benefits consisting of:(1) an amount equal to twice the amount of his then-current base salary,payable in equal monthly installments over a period of two years following thedate of termination; (2) a pro-rated amount equal to the incentive bonusthat he would otherwise have been entitled to receive under the managementincentive plan for the then-current fiscal year, payable as a lump sum; (3) anamount equal to twice the amount of his then-current target bonus amount underthe management incentive plan, payable in equal monthly installments over aperiod of two years following the date of termination; and (4) reimbursementsfor COBRA payments made under our medical and dental insurance plans for aperiod of up to two years following the date of termination.

In addition, if Mr. Emkjer’s employment with usis terminated within the period commencing two months prior to, and extendingeighteen months following, the occurrence of a “change of control” (as definedin the Emkjer Employment Agreement) which takes place during the term of theEmkjer Employment Agreement, Mr. Emkjer will be entitled to receive,subject to his continued compliance with certain non-competition,non-solictation and non-disparagement provisions contained in the EmkjerEmployment Agreement, severance payments and benefits consisting of: (1) anamount equal to twice the amount of his then-current base salary, payable inequal monthly installments over a period of one year following the date oftermination; (2) a pro-rated amount equal to the incentive bonus that hewould otherwise have been entitled to receive under the management incentiveplan for the then-current fiscal year, payable as a lump sum; (3) anamount equal to twice the amount of his then-current target bonus amount underthe management incentive plan, payable in equal monthly installments over aperiod of one year following the date of termination; and (4) reimbursementsfor COBRA payments made under our medical and dental insurance plans for aperiod of up to two years following the date of termination. In addition, allstock awards issued to Mr. Emkjer pursuant to our stock incentive planswill automatically accelerate and become vested in full as of the date oftermination.

The timing of payments to Mr. Emkjerof his severance payments and benefits under the Emkjer Employment Agreementmay be deferred to avoid incurring additional taxes and penalties pursuant to Section 409Aof the Internal Revenue Code of 1986 (the “Code”). All payments are subjectcertain gross-up provisions in the event that they are characterized as “excessparachute payments” within the meaning of Section 280G of the Code.

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*AnnualManagement Bonuses*

On May18, 2006, the HR Committee authorized the payment of a bonus to our managementlevel employees. Under the terms of our fiscal year 2006 Management IncentivePlan, the HR Committee had discretion to award bonuses ranging from zero to upto six times the actual amounts paid. The amounts paid are set forth below:

| **Name**          | ** ** | ** **                                            | ** ** | **Position** | ** ** | **Amount** | ** ** |
|-------------------|------------|-------------------------------------------------------|------------|--------------|------------|------------|------------|
| Mark J. Emkjer    |       | Chief  Executive Officer and President                |       | $            | 100,000    |       |
| David M. Sankaran |       | Chief  Financial Officer, Senior Vice President       |       | 30,000       |       |
| David R. Mersten  |       | Senior  Vice President, General Counsel and Secretary |       | 30,000       |       |
| R. William Taylor |       | Vice  President, Marketing and Corporate Development  |       | 30,000       |       |
| Nicholas Austin   |       | Vice  President, Research and Development             |       | 30,000       |       |
| Judith Ohrn-Hicks |       | Vice  President, Human Resources                      |       | 25,000       |       |
| Kathy Hollister   |       | Vice  President, Client Services                      |       | 25,000       |       |
| J. James Mihlik   |       | Vice President,  Corporate Controller                 |       | 20,000       |       |
|                   |            |                                                       |            |              |            |            |            |  |

 

In addition, RichardMurphy, our Senior Vice President, Worldwide Sales and Services, received abonus payment of $57,188 in accordance with the terms of Mr. Murphy’semployment letter, dated September 29, 2005, and Matthew Hahn, Ph.D., ourChief Science and Technology Officer, received a bonus payment of $48,020 inaccordance with the terms of Dr. Hahn’s employment letter, datedAugust 12, 2005.

*Approval of 2007Management Incentive Plan*

On May 18, 2006, the HR Committee approved ourmanagement incentive plan for fiscal year 2007 (the “2007 Bonus Plan”),pursuant to which our management-level employees will be eligible to receivecash bonuses based on our achievement of certain corporate goals specified inthe 2007 Bonus Plan, including achieving certain earnings before interest andtaxes, revenue levels and product orders. These bonuses are designed toattract, motivate, retain and reward our management-level employees. Under the2007 Bonus Plan, the Chief Executive Officer has an annual bonus target equalto 85% of base salary, the Senior Vice President of Worldwide Sales and Supporthas an annual bonus target of 60% of base salary, and Vice Presidents have anannual bonus target equal to 40% of base salary. Payouts under the 2007 BonusPlan will vary dependant upon the level of achievement of the specifiedcorporate goals, and will range from zero to two times the targeted bonusamount in the event that the 2007 Bonus Plan’s goals are significantlyexceeded. The HR Committee will make all final determinations regarding theachievement of goals and the payment of bonuses pursuant to the 2007 Bonus Plan.The HR Committee has the ability to modify, suspend or terminate the 2007 Bonusplan at any time.

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**PART III**

**Item 10.**                 Directorsand Executive Officers of the Registrant

The information requiredby this item concerning our directors and executive officers is incorporated byreference from the Proxy Statement.

**Item 11.**                 ExecutiveCompensation

The information requiredby this item is incorporated by reference from the section entitled “AdditionalInformation” in the Proxy Statement.

**Item 12.**                 SecurityOwnership of Certain Benefical Owners and Management and Related Stockholders Matters

The information requiredby this item is incorporated by reference from the section entitled “AdditionalInformation” in the Proxy Statement.

**Item 13.**                 CetainRelationships and Related Transactions

The information requiredby this item is incorporated by reference from the section entitled “AdditionalInformation” in the Proxy Statement.

**Item 14.**                 PrincipalAccountant Fees and Services

The information requiredby this item is incorporated by reference from the sections entitled “Proposal No. 2—Ratificationof the Selection of Independent Registered Public Accounting Firm” and “AdditionalInformation” in the Proxy Statement.

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**PART IV**

**Item 15.**                 Exhibitsand Financial Statement Schedules

(a)(1) Financial Statements

The following Consolidated Financial Statements areincluded:

| Report of Ernst &  Young LLP, Independent Registered Public Accounting Firm                                                                                                |   | 40 |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----|
| Consolidated  Balance Sheets as of March 31, 2006 and 2005                                                                                                                     |   | 41 |
| Consolidated  Statements of Operations for the years ended March 31, 2006 and 2005 and  December 31, 2003, and the three months ended March 31, 2004                 |   | 42 |
| Consolidated  Statements of Stockholders’ Equity for the years ended March 31, 2006  and 2005 and December 31, 2003, and the three months ended  March 31, 2004 |   | 43 |
| Consolidated  Statements of Cash Flows for the years ended March 31, 2006 and 2005 and  December 31, 2003, and the three months ended March 31, 2004                 |   | 45 |
| Notes  to Consolidated Financial Statements                                                                                                                                         |   | 46 |

 

(a)(2) Financial Statement Schedules

ScheduleII—Valuation and Qualifying Accounts

| **Description**                        | ** ** | ** **              | ** ** | **Balance at  Beginning of  Period** | ** ** | **Additions  Charged to  Costs and  Expenses** | ** ** | **Deductions(1)** | ** ** | **Balance at  End of  Period** | ** ** |
|----------------------------------------|------------|-------------------------|------------|------------------------------------------------|------------|----------------------------------------------------------|------------|-------------------|------------|------------------------------------------|------------|
| ** **                             | ** ** | **(In thousands)** | ** ** |
| Allowance for  doubtful accounts:      |       |                    |       |                                           |       |                                                     |       |              |       |                                     |       |   |   |   |   |   |   |
| Year ended March 31, 2006         |       |                    | $          | 315                                            |       |                                                     |       | $                 | —     |                                     |       |   | $ | (36 | ) |   |   | $ | 351 |   |   |
| Year ended March 31, 2005         |       |                    | $          | 191                                            |       |                                                     |       | $                 | 394        |                                     |       |   | $ | 270 |   |   |   | $ | 315 |   |   |
| Three months ended March 31, 2004 |       |                    | $          | 505                                            |       |                                                     |       | $                 | 43         |                                     |       |   | $ | 357 |   |   |   | $ | 191 |   |   |
| Year ended  December 31, 2003     |       |                    | $          | 1,634                                          |       |                                                     |       | $                 | 425        |                                     |       |   | $ | 1,554 |   |   |   | $ | 505 |   |   |

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(1)          Represents write-offs,net of recoveries.

All other schedules areomitted because they are not applicable, or not required, or because therequired information is included in the 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 the Company’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 the Company’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).                                                                                                                                                                                                              |

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| 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).                                                                                                                                                                                                                                                                                                                                     |
| 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 Employee Stock  Purchase Plan (incorporated by reference to Exhibit 10.6 to Accelrys, Inc.’s  Registration Statement on Form S-1 (Reg. No. 33-98246)).                                                                                                                                                                                                                                                                                                                                       |
| 10.2(a)# |   | Amendment No. 1 to  the Employee Stock Purchase Plan (incorporated by reference to  Exhibit 10.2(a) to Accelrys, Inc.’s Report on Form 10-Q  for the quarter ended March 31, 2001).                                                                                                                                                                                                                                                                                                |
| 10.3#    |   | 1995 Director Option  Plan (incorporated by reference to Exhibit 10.7 to Accelrys, Inc.’s  Registration Statement on Form S-1 (Reg. No. 33-98246)).                                                                                                                                                                                                                                                                                                                                               |
| 10.3(a)# |   | Amendment No. 1 to  1995 Director Option Plan (incorporated by reference to  Exhibit 10.3(a) to Accelrys, Inc.’s report on form 10-K  for the year ended December 31, 2000).                                                                                                                                                                                                                                                                                                            |

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| 10.3(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).                                                                         |
|-----------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.3 (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).                                                                                                   |
| 10.4      |   | Lease Agreement between  Accelrys, Inc. and Eastpark at 8A (incorporated by Reference to  Exhibit 10.13 to Accelrys, Inc.’s Registration Statement on  Form S-1 (Reg. No. 33-98246)).                                                                                  |
| 10.4(a)   |   | Amendment dated as of  January 22, 1996 to Lease Agreement between Accelrys, Inc. and Eastpark  at 8A (incorporated by reference to Exhibit 10.13(a) to Accelrys, Inc.’s  Report on Form 10-K for the year ended December 31, 1995).                         |
| 10.4(b)   |   | Third Amendment to Lease Agreement dated  March 31, 1996 between Pharmacopeia, Inc. and Eastpark at 8A  (incorporated by reference to Exhibit 10.13(b) to Accelrys, Inc.’s  Report on Form 10-Q for the quarter ended June 30, 1996).                   |
| 10.5#     |   | Employment Agreement  dated as of February 26, 2001 between the Company and Joseph A. Mollica,  Ph.D. (incorporated by reference to Exhibit 10.9 to Accelrys, Inc.’s  Report on form 10-K for the year ended December 31, 2000).                                       |
| 10.5(a)#  |   | 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.)                  |
| 10.6      |   | Lease dated  November 12, 1998 between Molecular Simulations Inc. and San Diego Tech  Center, LLC (incorporated by reference to Exhibit 10.47 to Accelrys, Inc.’s  Report on Form 10-K for the year ended December 31, 1998).                                     |
| 10.7#     |   | Form of Indemnity  Agreement for Directors and Executive Officers (incorporated by reference to  Exhibit 10.48 to Accelrys, Inc.’s Report on Form 10-K  for the year ended December 31, 1998).                                                                    |
| 10.8      |   | Lease Agreement, dated  May 1, 1999, between Accelrys, Inc. and South Brunswick Rental I, LTD  (incorporated by reference to Exhibit 10.49 to Accelrys, Inc.’s  Report on Form 10-Q for the quarter ended June 30, 1999).                                         |
| 10.9#     |   | 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).                                                                                                     |
| 10.10#    |   | 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).                                                                   |
| 10.11     |   | Form of Stock  Purchase Agreement, dated as of March 8, 2000, among the company and the  investors set forth therein (incorporated by reference to Exhibit 10.53  to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended  March 31, 2000)             |
| 10.12     |   | Employment Agreement  dated May 1, 2001 between the Company and Michael R. Stapleton.  (incorporated by reference to Exhibit 10.28 to Accelrys, Inc.’s  Report on form 10-Q for the quarter ended September 30,  2001).                                           |
| 10.12(a)# |   | Separation Agreement and  Release of Claims dated September 30, 2002, by and between  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). |

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| 10.13  |   | Lease Agreement dated  July 29, 2001 among the Master, Fellows and Scholars of Trinity College,  Cambridge, Accelrys Limited, and Accelrys Inc. and Trinity College (CSP)  Limited (incorporated by reference to Exhibit 10.30 to Accelrys, Inc.’s  Report on form 10-Q for the quarter ended September 30, 2001). |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.14# |   | Employment Agreement  dated December 3, 2002 by and between Accelrys, Inc. and Mark J.  Emkjer (incorporated by reference to Exhibit 10.28 to Accelrys, Inc.’s  Report on Form 10-K for the year ended December 31, 2002).                                                                          |
| 10.15  |   | 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).                                                                                     |
| 10.16  |   | 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).                                                                                     |
| 10.17  |   | 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).                                                                                                                        |
| 10.18  |   | 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).                                                                                                                  |
| 10.19  |   | 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).                                                                                                          |
| 10.20# |   | David M. Sankaran  employment letter (incorporated by reference to Exhibit 10.21 to Accelrys,  Inc.’s Report on Form 10-Q for the quarter ended December 31, 2004).                                                                                                                                                                    |
| 10.21# |   | Mahesh Krishnamurthy  employment letter (incorporated by reference to Exhibit 10.22 to Accelrys,  Inc.’s Report on Form 10-Q for the quarter ended December 31, 2004).                                                                                                                                                                 |
| 10.22# |   | 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).                                                                                                                                                                    |
| 10.23# |   | 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).                                                                                                                                                   |
| 10.24# |   | Separation Agreement and  Mutual Release, dated October 4, 2005, between Accelrys, Inc. and  Mahesh Krishnamurthy (incorporated by reference to Exhibit 1.011 to  Accelrys, Inc.’s Form 8-K dated October 11, 2005).                                                                                     |
| 10.25# |   | 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).                                                                                                            |
| 10.26# |   | FY2006 Management  Incentive Plan Form (incorporated by reference to Exhibit 10.26 to Accelrys,  Inc.’s Report on Form 10-Q for the quarter ended June 30, 2005).                                                                                                                                                                      |
| 10.27# |   | 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).                                                                                                                                                            |

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| 10.28#  |   | 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).     |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.29#  |   | 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).                   |
| 10.30#  |   | 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). |
| 10.31#  |   | 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). |
| 10.32#  |   | 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).            |
| 10.33*  |   | Sublease, dated May 10,  2006, between Accelrys, Inc., Accelrys, Ltd., QUALCOMM Inc., and QUALCOMM UK  Ltd.                                                                                                                  |
| 10.34*# |   | Employment Agreement  dated May 21, 2006 by and between Accelrys, Inc. and Mark J. Emkjer.                                                                                                               |
| 10.35*# |   | Fiscal year 2007  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  registrant                                                                                                                                                                                                  |
| 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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+                Confidentialtreatment granted.

++     Confidential treatmentrequested.

#                 Represents amanagement contract or compensatory plan or arrangement.

*                    Filedherewith

(b)   Exhibits

SeeItem 15(a)(3) above.

(c)    FinancialStatement Schedules

See Item 15(a)(2) above.

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**SIGNATURE**

Pursuantto the requirements of section 13 or 15(d) of the Securities Exchange Actof 1934, the registrant has duly caused this report to be signed on its behalfby the undersigned, thereunto duly authorized.
|        | ACCELRYS, INC. |
|--------|----------------|
|   | By:            | /s/ DAVID M. SANKARAN |   |
|   |           | David M. Sankaran |
|   | * *       | *Senior Vice President and* |
|   | * *       | *Chief Financial Officer* |
|   | * *       | *(Duly Authorized Officer and* |
|   | * *       | *Chief Financial Officer)* |
|   | * *       | Date: May 24, 2006 |

 

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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 DavidM. Sankaran, jointly and severally, as his or her attorney-in-fact, each withfull power of substitution, for him or her, in any and all capacities, to signeach amendment to this report on Form 10-K, and to file the same,with exhibits 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.

Pursuantto the requirements of the Securities Exchange Act of 1934, this Report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated:
|                             | **Signatures** | ** **                                         | ** ** |                   | **Title** | ** ** | ** ** |  | **Date** | ** ** |
|-----------------------------|----------------|----------------------------------------------------|------------|-------------------|-----------|------------|------------|--|----------|------------|
| /s/ MARK  J. EMKJER         |           | Director, President  and Chief Executive Officer   |       | May 24, 2006 |
| Mark  J. Emkjer             |           | (Principal Executive Officer)                      |       |              |
| /s/ DAVID M. SANKARAN       |           | Senior Vice  President and Chief Financial Officer |       | May 24, 2006 |
| David  M. Sankaran          |           | (Principal Financial Officer)                      |       |              |
| /s/ KENNETH  L. COLEMAN     |           | Chairman of the  Board of Directors                |       | May 24, 2006 |
| Kenneth  L. Coleman         |           |                                               |       |              |
| /s/ GARY  E. COSTLEY, Ph.D. |           | Director                                           |       | May 24, 2006 |
| Gary  E. Costley, Ph.D.     |           |                                               |       |              |
| /s/ RICARDO  B. LEVY, Ph.D. |           | Director                                           |       | May 24, 2006 |
| Ricardo  B. Levy, Ph.D.     |           |                                               |       |              |
| /s/ CHRISTOPHER  J. STEFFEN |           | Director                                           |       | May 24, 2006 |
| Christopher J.  Steffen     |           |                                               |       |              |

 

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