<PAGE>
 
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                 FORM 10-K/A-1
(Mark One)
[X]     Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934

                  For the Fiscal Year Ended December 31, 1998

[_]     Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Period From _________ to __________.

                        Commission File Number:  0-27188
                                                 -------
                               PHARMACOPEIA, INC.
             (Exact name of Registrant as specified in its charter)

          DELAWARE                                33-0557266
(State or other jurisdiction of      (I.R.S. employer identification number)
 incorporation or organization)

                   CN 5350, PRINCETON, NEW JERSEY  08543-5350
             (Address of principal executive offices and zip code)

                                 (609) 452-3600
              (Registrant's telephone number, including area code)

       Securities registered pursuant to Section 12(b) of the Act:  None
                                                                    ----
Securities registered pursuant to Section 12(g) of the Act:  Common Stock $.0001
                                                             -------------------
Par Value
---------

     Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter periods as the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

                             YES   X      NO 
                                 -----       ------      

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

     The approximate aggregate market value of voting stock held by
nonaffiliates of the Registrant was $172,672,671 based on the last sale price of
Common Stock reported on The Nasdaq National Market on January 31, 1999.
3,472,804 shares of Common Stock held by  officers, directors, and holders of 5%
or more of the outstanding Common Stock have been excluded in that such persons
may be deemed to be affiliates.  This determination of affiliate status is not
necessarily a conclusive determination for other purposes.

     As of January 31, 1999, the number of outstanding shares of the
Registrant's Common Stock was 19,259,298.

                      DOCUMENTS INCORPORATED BY REFERENCE

     Certain information required by Part III of Form 10-K is incorporated by
reference from the Registrant's Proxy Statement for the Annual Stockholders
Meeting to be held May 4, 1999 (the "Proxy Statement), which will be filed with
the Securities and Exchange Commission within 120 days after the close of the
Registrant's fiscal year ended December 31, 1998.
<PAGE>
 
                                    PART IV
                                        
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)(1)  Financial Statements

        The following Consolidated Financial Statements are included:
        Report of  Independent Auditors
        Consolidated Balance Sheets as of December 31, 1997 and 1998
        Consolidated Statements of Operations for the years ended December 31,
          1996, 1997 and 1998
        Consolidated Statements of Stockholders' Equity for the years ended
          December 31, 1996, 1997 and 1998
        Consolidated Statements of Cash Flows for the years ended December 31,
          1996, 1997 and 1998
        Notes to Consolidated Financial Statements

(a)(2)  Financial Statement Schedules

        All financial statement schedules are omitted because they are not
        applicable, or not required, or because the required information is
        included in the financial statements or notes thereto.

<TABLE> 
<CAPTION> 
 
(a)(3)    Exhibits:
<S>                                <C> 
          3.1******                Restated Certificate of Incorporation of the Registrant.
          3.3******                Bylaws of the Registrant, as amended.
          3.3(a)********           Amendment to Bylaws of Pharmacopeia dated July 31, 1997.
          4.3*                     Stockholders Rights Agreement, dated February 15, 1995.
          10.1*                    Series A and Series B Preferred Stock Purchase Agreement, dated July 21,
                                   1993.
</TABLE> 

                                      -2-
<PAGE>
 
<TABLE> 
<CAPTION> 
<S>                                <C> 
          10.2*                    Series B Preferred Stock Purchase Agreement, dated March 11, 1994.
          10.3*                    Series C Preferred Stock Purchase Agreement, dated December 22, 1994.
          10.4*                    Series D Preferred Stock Purchase Agreement, dated February 15, 1995.
          10.5**#                  Amended 1994 Incentive Stock Plan.
          10.5(a)*******#          Amendment No. 3 to the 1994 Incentive Stock Plan dated May 9, 1997.
          10.6*#                   1995 Employee Stock Purchase Plan.
          10.7*#                   1995 Director Option Plan.
          10.8*+                   Library Collection Agreement, dated as of October 1, 1995, between
                                   Pharmacopeia and Novartis Corporation.
          10.9*+                   Research, License, and Royalty Agreement, dated as of February 15, 1995,
                                   between Pharmacopeia and Berlex Laboratories, Inc.
          10.9(a)*******+          Amendment No. 1 to Research, License and Royalty Agreement between the
                                   Company and Berlex Laboratories, Inc. dated November 27, 1996.
          10.9(b)*******+          Amendment No. 2 to Research, License and Royalty Agreement between the
                                   Company and Berlex Laboratories, Inc. dated June 30, 1997.
          10.9(c)*********+        Amendment No.3 to Research, License and Royalty Agreement between the
                                   Company and Berlex Laboratories, Inc. dated November 21, 1997.
          10.10*+                  License Agreement, dated as of October 6, 1995, among Pharmacopeia, the
                                   Trustees of Columbia University in the City of New York and Cold Spring
                                   Harbor Laboratory.
          10.11*+                  Collaboration Agreement, dated as of December 22, 1994, between
                                   Pharmacopeia and Schering Corporation and Schering-Plough, Ltd.
          10.11(b)*******+         Amendment No. 2 to Collaboration Agreement and Random Library Agreement
                                   between the Company and Schering Corporation and Schering-Plough, Ltd.
                                   dated as of April 22, 1996.
          10.11(c)*******+         Amendment No. 3 to Collaboration Agreement and Random Library Agreement
                                   between the Company and Schering Corporation and Schering-Plough, Ltd.
                                   dated as of April 21, 1997.
          10.12*+                  Random Library Agreement, dated as of December 22, 1994, between
                                   Pharmacopeia and Schering Corporation and Schering-Plough, Ltd.
          10.13*                   Lease Agreement between Pharmacopeia and Eastpark at 8A.
          10.13(a)**               Amendment dated as of January 22, 1996 to Lease Agreement between
                                   Pharmacopeia and Eastpark at 8A.
          10.13(b)****             Third Amendment to Lease Agreement dated March 31, 1996 between
                                   Pharmacopeia and Eastpark at 8A.
          10.14*                   Sublease, dated as of December 7, 1994, between Pharmacopeia and Enichem
                                   Americas, Inc.
          10.15*                   Lease, dated as of May 2, 1994, between Pharmacopeia and College Road
                                   Associates Limited, as amended.
          10.15(a)**               Lease dated as of December 1, 1995 between Pharmacopeia and College Road
                                   Associates, as amended.
          10.15(b)****             Third Execution and Modification of lease dated June 7, 1996, between
                                   Pharmacopeia and College Road Associates Limited.
          10.17*#                  Employment Agreement, dated October 4, 1994, between the Company and Lewis
                                   J. Shuster.
</TABLE> 

                                      -3-
<PAGE>
 
<TABLE> 
<S>                                <C> 
          10.18*********#          Employment Agreement effective November 1, 1997 between the Company and
                                   Joseph A. Mollica, Ph.D.
          10.19************#       Employment Agreement, dated January 30, 1998, between the Company and
                                   Richard Walsh
          10.20*#                  Employment Agreement, dated June 3, 1993, between the Company and John J.
                                   Baldwin, Ph.D.
          10.21*#                  Employment Agreement, dated December 2, 1993, between the Company and
                                   Nolan H.
                                   Sigal, M.D., Ph.D.
          10.22*#                  Consulting Agreement, dated April 30, 1993, between the Company and W.
                                   Clark Still, Ph.D.
          10.23*                   Warrant to purchase Common Stock issued to Columbia University.
          10.24*                   Warrant to purchase Common Stock issued to Cold Spring Harbor Laboratory.
          10.25**+                 Collaboration Agreement effective as of December 31, 1995 between
                                   Pharmacopeia and Bayer.
          10.26**+                 Random Library Agreement effective as of December 31, 1995 between
                                   Pharmacopeia and Bayer.
          10.27***********#        Employment Agreement effective November 30, 1995 between Molecular
                                   Simulations Incorporated and Michael J. Savage
          10.27(a)************#    Amendment No. 1 to Employment Agreement between Molecular Simulations
                                   Incorporated and Michael J. Savage dated as of October 1, 1997
          10.28***********#        Employment Agreement effective November 30, 1995 between Molecular
                                   Simulations Incorporated and Saiid Zarrabian
          10.28(a)************#    Amendment No. 1 to Employment Agreement between Molecular Simulations
                                   Incorporated and Saiid Zarrabian dated as of October 1, 1997
          10.30***+                Collaborative Agreement dated as of March 29, 1996 with Daiichi
                                   Pharmaceutical Co., Ltd.
          10.30(a)*******+         Amendment No. 1 to Collaboration Agreement between the  Company and Daiichi
                                   Pharmaceutical Co., Ltd. dated April 14, 1997.
          10.31****+               Research Agreement, between Pharmacopeia, Inc. and N.V. Organon dated May
                                   31, 1996.
          10.32*****#              Employment Agreement, dated June 20, 1996, between the Company and Stephen
                                   A. Spearman, Ph.D.
          10.33*****               Lease Agreement, dated June 21, 1996, between Pharmacopeia and South
                                   Brunswick Rental I, Ltd.
          10.34**********+         Collaboration and License Agreement between Pharmacopeia, Inc. and
                                   Bristol-Myers Squibb Company dated November 26, 1997.
          10.35************+       Joint Venture Agreement dated February 14, 1992 between Polygen Corporation
                                   and Teijin Limited.
          10.36************        Amendment No. 1 to Joint Venture Agreement dated March 30, 1998 between
                                   Teijin Limited and Molecular Simulations Incorporated.
          10.37************+       Distributorship Agreement dated April 1, 1992 between Polygen 
</TABLE> 

                                      -4-
<PAGE>
 
<TABLE> 
<S>                                <C> 
                                   Corporation and Teijin Molecular Simulations Incorporated
          10.38************        Amendment to Distributorship Agreement dated October 17, 1994 between
                                   Molecular Simulations Incorporated and Teijin Molecular Simulations
                                   Incorporated.
          10.39************+       Amendment No. 2 to Distributorship Agreement dated September 30, 1996
                                   between Molecular Simulations Incorporated and Teijin Molecular Simulations
                                   Incorporated.
          10.40*************+      Amended and Restated Distributorship Agreement, dated March 1, 1998,
                                   between Molecular Simulations Incorporated and Teijin Molecular Simulations
                                   Incorporated
          10.41*************       Indemnity Agreement, dated March 1, 1998, between Molecular Simulations
                                   Incorporated and Teijin Molecular Simulations Incorporated
          10.42*************       Lease Agreement, dated February 26, 1987, as amended, between Sorrento Tech
                                   Limited and Biosym Technologies, Inc.
          10.43**************++    Collaboration and License Agreement, dated as of October 29, 1998, between
                                   Pharmacopeia, Inc. and Schering-Plough Ltd.
          10.44**************++    Collaboration and License Agreement, dated as of October 29, 1998, between
                                   Pharmacopeia, Inc. and Schering Corporation.
          10.45**************      Guarantee, dated as of October 29, 1998, between Pharmacopeia, Inc. and
                                   Schering-Plough Corporation
          10.46**************#     Employment Agreement, dated December 17, 1998, between the Company and
                                   Lewis Shuster
          10.47**************      Lease dated November 12, 1998 between Molecular Simulations Inc. and San
                                   Diego Tech Center, LLC
          10.48**************#     Indemnity Agreement dated July 21, 1997 between Molecular Simulations Inc.
                                   and C. Peter W. Booth
          11.1*                    Statement re Computation of Per Share Earnings.
          21.0**************       Subsidiaries of Pharmacopeia, Inc.
          23.1                     Consent of Ernst & Young LLP.
          23.2                     Consent of Arthur Andersen LLP.
          24.1**************       Powers of Attorney 
          27.1**************       Financial Data Schedule
          27.2*************        Restated Financial Data Schedule as of June 30, 1997
</TABLE>



* Incorporated by reference to the same numbered exhibit filed with the
Company's Registration Statement on Form S-1 No. 33-93460.
** Incorporated by reference to the same numbered exhibit filed with the
Company's Form 10-K for the year ended December 31, 1995.
*** Incorporated by reference to the same numbered exhibit filed with the
Company's Form 10-Q for the quarter ended March 31, 1996.
**** Incorporated by reference to the same numbered exhibit filed with the
Company's Form 10-Q for the quarter ended June 30, 1996.
***** Incorporated by reference to the same numbered exhibit filed with the

                                      -5-
<PAGE>
 
Company's Form 10-Q for the quarter ended September 30, 1996.
****** Incorporated by reference to the same numbered exhibit filed with the
Company's Form 10-K for the year ended December 31, 1996.
******* Incorporated by reference to the same numbered exhibit filed with the
Company's Form 10-Q for the quarter ended June 30, 1997.
******** Incorporated by reference to the same numbered exhibit filed with the
Company's form 10-Q for the quarter ended September 30, 1997.
********* Incorporated by reference to the same numbered exhibit filed with the
Company's Form 10-K for the year ended December 31, 1997.
********** Incorporated by reference to the same numbered exhibit filed with the
Company's Form 10-K/A-2 for the year ended December 31, 1997.
*********** Incorporated by reference to Exhibit 10.15 and 10.16 to Molecular
Simulations Incorporated's Registration Statement on Form S-1 (Registration No.
333-21427) listed on February 10, 1997.
************ Incorporated by reference to the same numbered exhibit filed with
the Company's Form 10-Q for the quarter ended June 30, 1998.
*************Incorporated by reference to the same numbered exhibit filed with
the Company's Form 10-Q for the quarter ended September 30, 1998.
************** Incorporated by reference to the same numbered exhibit filed 
with the Company's Form 10-K for the year ended December 31, 1998.
+ Confidential treatment granted.
++ Confidential treatment requested.
# Represents a management contract or compensatory plan or arrangement.

(b)  Reports on Form 8-K

     There were no reports on Form 8-K required to be filed for the quarter
     ended December 31, 1998.

(c)  Exhibits

     See Item 14 (a)(3) above.

(d)  Financial Statement Schedule

See Item 14(a)(2) above.

                                      -6-
<PAGE>
 
                                   SIGNATURES

      Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                               PHARMACOPEIA, INC.
 
 
                               By:  /s/ Lewis J. Shuster
                                  --------------------------------
                                    Lewis J. Shuster
                                    President and
                                    Chief Operating Officer - Pharmacopeia Labs
                                    (Principal Accounting Officer)
 
                               Date:  April 1, 1999


                    [Rest of Page intentionally left blank]


























                                      -7-
<PAGE>
 
      Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:

<TABLE>
<CAPTION>
Signatures                               Title                                   Date
----------                               -----                                   ----
<S>                                      <C>                                     <C>
 
/s/ Joseph A. Mollica, Ph.D.             Chairman of the Board, President and    April 1, 1999 
---------------------------------------  Chief Executive Officer (Principal
  Joseph A. Mollica, Ph.D.               Executive Officer)
 
/s/ Lewis J. Shuster                     President and Chief Operating Officer   April 1, 1999 
---------------------------------------  - Pharmacopeia Labs (Principal
   Lewis J. Shuster                      Financial and Accounting Officer)
 
                 *                       Director                                April 1, 1999 
---------------------------------------
   Gary E. Costley, Ph.D.

                 *                       Director                                April 1, 1999 
---------------------------------------
   C. Peter W. Booth
                                         Director                                April 1, 1999 

                 *                       Director                                April 1, 1999 
---------------------------------------
   Charles A. Sanders, M.D.
                                         Director                                April 1, 1999 
                 *         
---------------------------------------
   Paul A. Bartlett, Ph.D.
</TABLE>

* By: /s/ Joseph A. Mollica
     -------------------------
     Joseph A. Mollica, Ph.D.
     Attorney-in-Fact
                                      -8-
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
                                        



                                    CONTENTS
 
 
Report of Independent Auditors ..........................................  F-1
Report of Independent Public Accountants.................................  F-2
Consolidated Balance Sheets .............................................  F-3
Consolidated Statements of Operations ...................................  F-4
Consolidated Statements of Stockholders' Equity .........................  F-5
Consolidated Statements of Cash Flows ...................................  F-6
Notes to Consolidated Financial Statements ..............................  F-7












                                      -9-
<PAGE>
 
                         Report of Independent Auditors
                                        

The Board of Directors and Stockholders
Pharmacopeia, Inc.

We have audited the accompanying consolidated balance sheet of Pharmacopeia,
Inc. and subsidiaries as of December 31, 1998, and the related consolidated
statements of operations, stockholders' equity and cash flows for the year then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free from
material misstatement.  An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements.  An audit
also includes assessing the accounting principles used and significant estimates
made by management, 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 to above present fairly, in
all material respects, the consolidated financial position of Pharmacopeia, Inc.
and subsidiaries at December 31, 1998 and the consolidated results of their
operations and their cash flows for the year then ended in conformity with
generally accepted accounting principles.

We previously audited and reported on the balance sheet as of December 31, 1997
and the related statements of operations, stockholders' equity, and cash flows
of Pharmacopeia, Inc. for the years ended December 31, 1996 and 1997, prior to
their restatement for the 1998 pooling of interests as described in Note 3. The
contribution of Pharmacopeia, Inc. to total assets represented 68.3% as of
December 31, 1997 and its contribution to revenues represented 23.8% and 30.2%
of the restated totals for 1996 and 1997, respectively.  Financial statements of
the other pooled company included in the 1996 and 1997 restated consolidated
statements were audited and reported on separately by other auditors.  We also
have audited, as to combination only, the accompanying consolidated balance
sheet as of December 31, 1997 and the related consolidated statements of
operations, stockholders' equity, and cash flows for the years ended December
31, 1996 and 1997, after restatement for the 1998 pooling of interests; in our
opinion, such consolidated financial statements have been properly combined on
the basis described in Note 3 to the consolidated financial statements.



                                              Ernst & Young LLP

Princeton, New Jersey
January 28, 1999

                                      F-1
<PAGE>
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
                                        

To Molecular Simulations Incorporated:

We have audited the accompanying consolidated balance sheets of Molecular 
Simulations Incorporated (a Delaware corporation) and subsidiaries as of 
December 31, 1997 and the related consolidated statements of income, 
stockholders' equity and cash flows for each of the two years in the period 
ended December 31, 1997 (not presented separately herein). These consolidated 
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, 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 consolidated financial statements referred to above present 
fairly, in all material respects, the financial position of Molecular 
Simulations Incorporated and subsidiaries as of December 31, 1997 and the 
results of their operations and their cash flows for each of the two years in 
the period ended December 31, 1997 (not presented separately herein) in 
conformity with generally accepted accounting principles.


                                        ARTHUR ANDERSEN LLP
                                             

San Diego, California
February 4, 1998


                                      F-2
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                          Consolidated Balance Sheets
                   (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
                                                                              December 31,
                                                                 -----------------------------------
                                                                         1997              1998
                                                                 -----------------------------------
<S>                                                                <C>               <C>
ASSETS
Current assets:
   Cash and cash equivalents                                              $ 24,609          $ 36,863
   Marketable securities                                                    60,166            44,235
   Trade receivables, net of allowance for doubtful accounts of             
    $466 and $609, respectively                                             19,424            22,771
   Prepaid expenses and other current assets                                 4,671             5,774
                                                                 -----------------------------------
Total current assets                                                       108,870           109,643
                                                                 -----------------------------------
 
Non-current investments in marketable securities                            12,865                 -
Property and equipment, net                                                 13,141            13,700
Software development costs, net of accumulated amortization of                   
    $5,813 and $2,725, respectively                                          3,437             3,492
Other assets                                                                 1,738             1,030
                                                                 -----------------------------------
                                                                          $140,051          $127,865
                                                                 ===================================
 
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Accounts payable                                                      $  4,232          $  5,158
    Accrued liabilities                                                     18,118            21,427
    Notes payable, current portion                                           1,566             1,316
    Deferred revenue, current portion                                       29,345            24,415
                                                                 -----------------------------------
 
Total current liabilities                                                   53,261            52,316
 
Notes payable, long-term portion                                             1,852               328
Deferred revenue, long-term portion                                          4,342             1,764
Other long-term liabilities                                                      -             1,240
 
Commitments and contingencies                                                    -                 -
 
Stockholders' equity:
    Preferred stock, $.0001 par value, 2,000,000 shares                          -                 -
       authorized; none issued and outstanding
    Common stock, $.0001 par value, 40,000,000 shares authorized;
       18,804,780 and 19,120,604 shares issued and outstanding
       at December 31, 1997 and 1998, respectively                               1                 1
    Additional paid-in capital                                             144,440           145,499
    Accumulated deficit                                                    (62,657)          (72,820)
    Accumulated other comprehensive loss                                    (1,188)             (463)
                                                                 -----------------------------------
Total stockholders' equity                                                  80,596            72,217
                                                                 -----------------------------------
                                                                          $140,051          $127,865
                                                                 ===================================
</TABLE>
       See accompanying notes to these consolidated financial statements.

                                      F-3
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
                                        
<TABLE>
<CAPTION>
                                                                 Year Ended December 31,
                                                       1996                1997                1998
                                              -----------------------------------------------------------
<S>                                             <C>                 <C>                 <C>
Revenue:
 Contract                                             $14,799             $24,523             $29,677
 Software license, service and other                   41,083              49,108              54,420
 Hardware                                               6,178               7,566               8,114
                                              -----------------------------------------------------------
Total revenue                                          62,060              81,197              92,211
 
Cost and Expense:
 Software, license and other                            2,517               3,512               3,476
 Hardware                                               5,242               6,720               7,061
 Research and development:
  Collaborative                                        13,129              16,931              20,307
  Proprietary                                          20,945              25,251              28,656
 Sales, general and administrative                     28,585              31,807              38,169
 Merger related costs                                       -                   -               7,998
                                              -----------------------------------------------------------
Total cost and expenses                                70,418              84,221             105,667
                                              -----------------------------------------------------------
 
Operating loss                                         (8,358)             (3,024)            (13,456)
 
Interest and other income, net                          4,043               4,292               4,202
                                              ----------------------------------------------------------- 
Income (loss) before provision for income                                                             
 taxes                                                 (4,315)              1,268              (9,254)
Provision for income taxes                              3,071               2,996                 909
                                              -----------------------------------------------------------
Net loss                                              $(7,386)            $(1,728)           $(10,163)
                                              ===========================================================
 
Basic net loss per share                                $(.42)              $(.09)              $(.54)
Diluted net loss per share                              $(.42)              $(.09)              $(.54)
Weighted average shares of common stock
 outstanding-basic                                     17,736              18,445              18,916
Weighted average shares of common stock
 outstanding-diluted                                   17,736              18,445              18,916
</TABLE>

       See accompanying notes to these consolidated financial statements.

                                      F-4
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY
                   (Dollars in thousands, except share data)
                                        
<TABLE>
<CAPTION>
                                                    COMMON STOCK                        TREASURY STOCK
                                             ---------------------------              --------------------               
                                                                         ADDITIONAL                                    
                                              NUMBER OF SHARES             PAID-IN    NUMBER OF            ACCUMULATED 
                                                                 AMOUNT    CAPITAL      Shares    AMOUNT     DEFICIT   
                                           ----------------------------------------------------------------------------
<S>                                          <C>                 <C>     <C>          <C>         <C>      <C>         
Balance at December 31, 1995                      17,204,635         $1    $113,025           -   $   -       $(53,543)
Acquisition of treasury stock                                                             7,594       (2)              
Retirement of treasury stock                          (7,594)                    (2)     (7,594)       2               
Issuance of common stock in  private                                                                                   
 placements                                          973,206                 23,641                                    
Issuance of common stock for exercise                                                                                  
 of options                                           66,112                    153                                    
Issuance of common stock in employee                                                                                   
 stock purchase plan                                   7,171                    111                                    
Translation adjustment                                                                                                 
Net loss                                                                                                        (7,386)
                                           ----------------------------------------------------------------------------
Balance at December 31, 1996                      18,243,530          1     136,928           -        -       (60,929)
Acquisition of  treasury stock                                                            1,646       (1)              
Retirement of treasury stock                          (1,646)                    (1)     (1,646)       1               
Issuance of common stock in  private                                                                                   
 placements, net                                     438,323                  6,861                                    
Issuance of common stock for exercise of                                                                               
 options                                              93,477                    201                                    
Issuance of common stock in employee                                                                                   
 stock purchase plan                                  18,488                    235                                    
Issuance of common stock for 401k                                                                                      
 matching                                             12,608                    216                                    
Translation adjustment                                                                                                 
Net loss                                                                                                        (1,728)
                                           ----------------------------------------------------------------------------
Balance at December 31, 1997                      18,804,780          1     144,440           -        -       (62,657)
Acquisition of treasury stock                                                             3,584       (1)              
Retirement of treasury stock                          (3,584)                    (1)     (3,584)       1               
Issuance of common stock for exercise                                                                                  
 of options                                          263,481                    502                                    
Issuance of common stock in employee                                                                                   
 stock purchase plan                                  32,264                    298                                    
Issuance of common stock for 401k                                                                                      
 matching                                             23,663                    260                                    
Translation adjustment                                                                                                 
Net loss                                                                                                       (10,163)
                                           ----------------------------------------------------------------------------
Balance at December 31, 1998                      19,120,604         $1    $145,499           -   $    -      $(72,820)
                                           ============================================================================
</TABLE>

<TABLE> 
<CAPTION> 
                                              ACCUMULATED OTHER       TOTAL    
                                               COMPREHENSIVE     STOCKHOLDERS'
                                               INCOME (LOSS)         EQUITY   
                                             -----------------------------------
<S>                                          <C>                 <C>          
Balance at December 31, 1995                           $   (33)       $ 59,450
Acquisition of treasury stock                                               (2)
Retirement of treasury stock                                                  
Issuance of common stock in  private                                          
 placements                                                             23,641      
Issuance of common stock for exercise                                         
 of options                                                                153   
Issuance of common stock in employee                                          
 stock purchase plan                                                       111   
Translation adjustment                                    (466)           (466)
Net loss                                                                (7,386)
                                           -----------------------------------
Balance at December 31, 1996                              (499)         75,501
Acquisition of  treasury stock                                              (1)
Retirement of treasury stock                                                  
Issuance of common stock in  private                                          
 placements, net                                                         6,861     
Issuance of common stock for exercise of                                      
 options                                                                   201   
Issuance of common stock in employee                                       
 stock purchase plan                                                       235   
Issuance of common stock for 401k                                             
 matching                                                                  216
Translation adjustment                                    (689)           (689)
Net loss                                                                (1,728)
                                           -----------------------------------
Balance at December 31, 1997                            (1,188)         80,596
Acquisition of treasury stock                                               (1)
Retirement of treasury stock                                                  
Issuance of common stock for exercise                                         
 of options                                                                502 
Issuance of common stock in employee                                          
 stock purchase plan                                                       298   
Issuance of common stock for 401k                                             
 matching                                                                  260    
Translation adjustment                                     725             725
Net loss                                                               (10,163)
                                           -----------------------------------
Balance at December 31, 1998                             $(463)       $ 72,217
                                           =================================== 
</TABLE> 

       See accompanying notes to these consolidated financial statements.

                                      F-5
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                          Year Ended December 31,
                                                              1996                1997                 1998
                                                       ----------------------------------------------------------
<S>                                                      <C>              <C>                   <C>
Cash flows from operating activities
Net loss                                                       $ (7,386)             $ (1,728)           $(10,163)
Adjustments to reconcile net loss to net cash provided
   by (used in) operating activities:
  Depreciation                                                    2,833                 3,599               4,110
  Amortization                                                    1,205                 2,162               1,881
  Changes in operating assets and liabilities:
   Accounts receivable                                           (1,347)               (3,246)             (3,347)
   Prepaid expenses and other current assets                       (682)                 (258)             (1,103)
   Other assets                                                    (159)                  353                 708
   Accounts payable                                                (599)                1,856                 926
   Accrued liabilities                                            3,440                 3,316               3,309
   Deferred revenue                                              13,395                  (314)             (7,508)
   Other                                                            (84)                   37                 227
                                                       ----------------------------------------------------------
Net cash provided by (used in) operating activities              10,616                 5,777             (10,960)
 
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures                                             (7,590)               (7,549)             (5,283)
Increase in capitalized software development costs               (1,520)               (1,923)             (1,322)
Effect of TMSI consolidation                                          -                     -              (1,113)
Purchases of held to maturity securities                        (95,750)              (90,373)            (26,756)
Purchases of available for sale securities                            -                     -             (36,231)
Proceeds from sales of held to maturity securities               63,615                81,765              35,758
Proceeds from sales of available for sale securities                  -                     -              56,025
                                                       ----------------------------------------------------------
Net cash provided by (used in) investing activities             (41,245)              (18,080)             21,078
 
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from issuance of common stock                       23,905                 7,477               1,059
Payments on note payable                                         (1,196)               (1,313)             (1,590)
Additions to capital lease obligations                            1,344                     -                   -
Principal payments on capital leases                               (373)                 (193)               (184)
                                                       ----------------------------------------------------------
Net cash provided by (used in) financing activities              23,680                 5,971                (715)
Exchange rate effect on cash                                       (466)                 (627)                725
                                                       ----------------------------------------------------------
Net increase (decrease) in cash and cash equivalents             (7,415)               (6,959)             10,128
Cash and cash equivalents beginning of period 
  (including TMSI in 1998)                                       38,983                31,568              26,735
                                                       ----------------------------------------------------------
Cash and cash equivalents at end of period                     $ 31,568              $ 24,609            $ 36,863
                                                       ==========================================================
 
 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
 Interest                                                      $    307              $    379            $    333
 Income taxes                                                  $    817              $  1,555            $  1,277
</TABLE>
       See accompanying notes to these consolidated financial statements.

                                      F-6
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
            (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
                               DECEMBER 31, 1998
                                        
1.  ORGANIZATION AND DESCRIPTION OF BUSINESS

Pharmacopeia, Inc., ("Pharmacopeia") develops combinatorial chemistry libraries
and uses these libraries alone and through collaborations to discover new, low
molecular weight compounds principally for use as pharmaceuticals.
Pharmacopeia's wholly-owned subsidiary, Molecular Simulations Incorporated and
its subsidiaries ("MSI"), which was acquired on June 12, 1998 (see Note 3)
designs, develops, markets and supports software that facilitates the discovery
and development of new products and processes in the pharmaceutical,
biotechnology, chemical, petrochemical and materials industries and also offers
consulting, training and maintenance services in support of its customers' use
of its software products.  Pharmacopeia and MSI are collectively referred to
herein as the "Company".

2.  SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

These consolidated financial statements include the accounts of Pharmacopeia,
its wholly-owned subsidiaries and, beginning in 1998, its 50% owned joint
venture (see Note 10).  All significant intercompany balances and transactions
have been eliminated in consolidation.

USE OF ESTIMATES

The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes.  Actual results could differ from those estimates.

CASH EQUIVALENTS

The Company considers all highly liquid investments with an original maturity of
three months or less to be cash equivalents.  The Company invests its cash in
deposits with major financial institutions, money market funds, U.S. Treasury
securities and other investment grade securities such as prime rated commercial
paper.

MARKETABLE SECURITIES

Marketable securities consist of fixed income investments with a maturity of
greater than three months such as United States treasury securities, obligations
of United States government agencies, other investment grade securities such as
prime rated commercial paper and corporate bonds.  As a result of the Company's
strategic acquisition intentions, initiated with the merger of MSI (see Note 3),
the Company as of June 30, 1998, transferred the classification of its
marketable securities of $64,029 from held-to-maturity to available-for-sale.
Available-for-sale securities are carried at market which approximates cost as
of December 31, 1998.

Property and Equipment

Property and equipment is stated at cost.  Depreciation is provided over the
estimated useful lives of the related assets, which range from three to ten
years using the straight-line method. Assets under capital leases are amortized
over the lesser of the useful life of the assets or the applicable lease terms,
whichever is shorter, which approximates 5 years.

                                      F-7
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
            (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
                               DECEMBER 31, 1998
                                        
2.  SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

SOFTWARE DEVELOPMENT COSTS

Development costs incurred in the research and development of new software
products and enhancements to existing software products are expensed as incurred
until technological feasibility has been established. Thereafter, the Company
capitalizes software development costs in accordance with Statement of Financial
Accounting Standards No. 86 (SFAS 86), "Accounting for the Cost of Computer
Software to be Sold, Leased or Otherwise Marketed".  The Company amortizes such
capitalized costs over the estimated product life, not to exceed three years
from the date on which the product is available for general release.  The
Company capitalized approximately $1,520, $1,923 and $1,394 in 1996, 1997 and
1998, respectively.  Included in the accompanying consolidated statements of
operations for 1996, 1997 and 1998, respectively, is approximately $902, $1,585,
and $1,339 of amortization expense related to capitalized software.

REALIZATION OF ASSETS

The Company periodically re-evaluates the original assumptions and rationale
utilized in the establishment of the carrying value and estimated life of its
assets.  The criteria used for these evaluations include management's estimates
of the assets continuing ability to generate income from operations and positive
cash flow in future periods, as well as the strategic significance of its assets
to the Company's business objectives.

FOREIGN CURRENCY TRANSLATION

The Company translates certain of its accounts and the financial statements of
its foreign operations in accordance with Statement of Financial Accounting
Standards No. 52 (SFAS No. 52), "Foreign Currency Translation".  Assets and
liabilities are translated into U.S. dollars at the rate of exchange at the end
of the period.  Resulting translation adjustments are reflected as a cumulative
translation adjustment which is included in accumulated other comprehensive
income (loss) within stockholders' equity.  Revenue and expense accounts are
translated using the weighted average exchange rate for the period.  Transaction
gains and losses are reflected in the results of operations.

CONCENTRATIONS OF RISK

The Company purchases substantially all hardware products that it resells to its
licensees from a single vendor.  Management believes that other vendors could be
identified who could provide the Company and its licensees with similar hardware
products at comparable terms.  However, any disruption of supply could cause a
temporary adverse effect in the Company's revenues during any period requiring
porting of the Company's software products to alternative hardware platforms or
negotiation of alternative supply and distribution agreements.

The Company licenses its products primarily to corporations, including value
added resellers and academic institutions, serving a wide variety of domestic
and foreign markets.  The Company extends credit to its licensees based on its
evaluation of the customer's financial condition, generally without requiring a
deposit or collateral.  Exposure to losses on receivables is principally
dependent on each customer's financial condition.  The Company monitors its
exposure for credit losses and maintains allowances for estimated losses.

                                      F-8
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
            (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
                               DECEMBER 31, 1998

                                        
2.  SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

The Company's international sales are generally denominated in foreign
currencies.  Losses on the conversion of foreign-denominated receivables into
U.S. dollars could have a material adverse effect on the Company's financial
statements.  The Company conducts business in the Asia/Pacific region primarily
in Japan. Any significant decline in the Japanese economy or the value of its
currency could have a material adverse impact on the Company.

REVENUE RECOGNITION

Contract revenue from collaborative agreements relates to research and
development work and is recognized primarily using the percentage of completion
method.  The application of this revenue recognition method is dependent on the
contractual arrangement of each agreement.  Accordingly, revenue is recognized
as research and development labor (based on a contractually agreed upon dollar
amount per person) is expended against a total research and development plan
(based on a total amount of labor as defined in each agreement).  Payments
received under these agreements prior to the completion of the related work are
recorded as deferred revenue.  Non-refundable milestone payments and up-front
fees are recognized as contract revenue when received as the Company has no
other performance obligations.

The Company recognizes revenue from licenses of computer software provided that
the customer has signed a non-cancelable license agreement, the software and
related documentation has been shipped, no material uncertainties regarding
customer acceptance exist, collection of the resulting receivable is deemed
probable and no other significant obligations by the Company exist.  Prepaid
post contract support and maintenance ("PCS") revenue bundled with software
license agreements is unbundled using objective, vendor specific evidence.  PCS
revenue is recognized pro-rata over the related license period, which is
generally one year.  Revenue generated from consulting, training and software
customization sold separately from license agreements are recognized as the
services are performed.

The Company earns revenue under product development and consortia agreements
wherein several unrelated parties enter into a joint product development
agreement with the Company.  The Company's product development and consortia
agreements are generally one to three years in length, require an annual fee and
contain progressive milestones.  In exchange for a consortia fee, customers
receive consortia membership, a software library of certain Company products and
related software maintenance support.  The portion of consortia fees associated
with the initial software library is recognized by the Company in the first
month of membership, while consortia fees associated with consortia membership
and software maintenance are recognized by the Company on a straight-line basis
over the term of the agreement.  The Company is not required to deliver
specified products under the agreements and the consortia fees are non-
refundable.  If the Company is successful in developing products under the
product development and consortia agreements described above, a non-transferable
license is typically awarded to the consortia members.

                                      F-9
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
            (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
                               DECEMBER 31, 1998
                                        
2.    SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Under certain circumstances, the Company sells computer hardware to a licensee
of the Company's software products.  In these instances, the Company typically
orders the hardware from an unrelated vendor and records revenue upon shipment
of the hardware to the licensee by the vendor.

RESEARCH AND DEVELOPMENT

All research and development costs are charged to operations as incurred.

STOCK BASED COMPENSATION

As permitted by FASB Statement No. 123, "Accounting for Stock-Based
Compensation" (FASB 123), the Company has elected to follow Accounting Principal
Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and
related interpretations in accounting for its employee stock option plans.
Under APB 25, no compensation expense is recognized at the time of option grant
because the exercise price of the Company's employee stock option equals the
fair market value of the underlying common stock on the date of grant.

EARNINGS PER SHARE

Basic and diluted earnings per share is calculated in accordance with FASB 
Statement No. 128, earnings per share. All earnings per share amounts for all 
periods have been presented, and where appropriate, restated to conform to the 
requirements of Statement 128.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

As of January 1, 1998, the Company adopted SFAS No. 130, Reporting Comprehensive
Income   ("SFAS No. 130").  SFAS No. 130 establishes new rules for the reporting
and display of comprehensive income (loss) and its components; however, the
adoption of this Statement had no impact on the Company's net loss or
stockholders' equity. SFAS No. 130 requires that foreign currency translation
adjustments, which prior to adoption were reported separately in stockholders'
equity, be included in accumulated other comprehensive income.  Prior year
financial statements have been reclassified to conform to the requirements of
SFAS No. 130.  All of the Company's amounts in accumulated other comprehensive
income (loss) are attributable to translation adjustments.

In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, which is effective for years beginning after
December 15, 1997.  SFAS No. 131 establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports.  It also
establishes standards for related disclosures about products and services,
geographic areas and major customers.  The Company adopted the new requirements
retroactively in 1998.

                                     F-10
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
            (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
                               DECEMBER 31, 1998
                                        
2.  SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

In March 1998, the AICPA issued SOP 98-1, Accounting For the Costs of Computer
Software Developed For or Obtained for Internal use.  The Company is required to
adopt the SOP effective January 1, 1999.  The SOP will require the
capitalization of certain costs incurred after the date of adoption in
connection with developing or obtaining software for internal use.  The Company
currently expenses such costs as incurred.  The Company has determined the
historical impact of adopting this SOP to be immaterial.

3.  ACQUISITION

On June 12, 1998 Pharmacopeia completed its merger with MSI through the issuance
of approximately 7.1 million shares of Pharmacopeia common stock for all of the
issued and outstanding MSI Common Stock, MSI Class B Common Stock and MSI Series
A Convertible Preferred Stock.  The merger has been accounted for as a pooling
of interests and accordingly, the financial statements for the periods prior to
the merger have been restated to include MSI.  In connection with the merger,
the Company recorded merger-related charges of approximately $8.0 million.  Such
charges consist of transaction costs, principally investment banking and
professional fees.

The following table summarizes 1998 information on a separate company basis for
Pharmacopeia and MSI prior to the completion of the merger:

<TABLE>
<CAPTION>
                                                 PERIOD FROM
                                             JANUARY 1, 1998 TO
                                                JUNE 12, 1998
                                         ------------------------
Total revenue:
<S>                                        <C>
     Pharmacopeia                                  $12,322
     MSI                                            20,437
                                                          
Net income (loss):                                        
     Pharmacopeia                                  $(3,588)
     MSI                                            (1,483)
</TABLE>                                                       
                                                               
4.    MARKETABLE SECURITIES                                    
                                                               
      Marketable securities consist of the following as of
      December 31,

<TABLE>
<CAPTION>
                                                                1997                     1998
                                                  --------------------------------  --------------
                                                      CURRENT         NONCURRENT       Current
                                                  ----------------  --------------  --------------
<S>                                               <C>               <C>             <C>
U.S. treasury securities and obligations of
 U.S. government agencies                              $31,732         $ 8,501         $36,245
                                                       
U.S. corporate debt securities                          28,434           4,364           7,990
                                                       -------         -------         -------
                                                       $60,166         $12,865         $44,235
                                                       =======         =======         =======
</TABLE>

At December 31, 1997 and 1998 the fair value of the Company's marketable
securities approximated cost and therefore, there were no unrealizable gains or
losses.

                                     F-11

<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
            (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
                               DECEMBER 31, 1998
                                        
5.  PROPERTY AND EQUIPMENT

Property and equipment consist of the following:
<TABLE>
<CAPTION>
                                                                            DECEMBER 31,
                                                                       1997              1998
                                                               -----------------------------------
<S>                                                              <C>               <C>
Laboratory equipment                                                  $ 7,388          $  8,477
Furniture, fixtures and equipment                                       4,076             4,553
Computers and software                                                  5,633             8,287
Leasehold improvements                                                  4,213             5,780
Other                                                                     954               453
                                                               -----------------------------------
                                                                       22,264            27,550
Accumulated depreciation and amortization                              (9,123)          (13,850)
                                                               -----------------------------------
Property and equipment, net                                           $13,141          $ 13,700
                                                               ===================================
</TABLE>

6.  ACCRUED LIABILITIES

Accrued liabilities consist of the following:
<TABLE>
<CAPTION>
                                                                            DECEMBER 31,
                                                                       1997              1998
                                                               -----------------------------------
<S>                                                                 <C>            <C>
Accrued payroll and other compensation                                $ 7,796           $ 8,529
Royalties                                                               1,041               946
Merger related costs                                                        -             3,867
Accrued taxes                                                           4,975             5,108
Other                                                                   4,306             2,977
                                                               -----------------------------------
                                                                      $18,118           $21,427
                                                              ====================================
</TABLE>

7.  INCOME TAXES

The Company accounts for income taxes under Statement of Financial Accounting
Standards ("SFAS") No. 109, "Accounting for Income Taxes" which requires the
asset and liability method of accounting for income taxes.  Under the asset and
liability method, deferred income taxes are recognized for the tax consequences
of "temporary differences" by applying enacted statutory tax rates applicable to
future years to differences between the financial carrying amounts and the tax
basis of existing assets and liabilities.


                                     F-12
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
            (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
                               DECEMBER 31, 1998
 
7.  Income Taxes    (continued)

Significant components of the Company's deferred tax assets and liabilities as
of December 31 are as follows:

<TABLE>
<CAPTION>
                                                                 1997               1998
                                                         -----------------------------------
Deferred tax assets:
<S>                                                        <C>                <C>
Net operating loss carryforwards                               $ 16,541             $ 17,873
Unused tax credits                                                2,134                2,261
Accruals and reserves                                             2,203                2,628
Other                                                                 -                  258
                                                         --------------     ----------------
Gross deferred tax asset                                         20,878               23,020
 
Deferred tax liabilities:
  Fixed assets and intangibles                                      825                  948
                                                         --------------     ----------------
 
Net asset before valuation allowance                             20,053               22,072
Valuation allowance                                             (20,053)             (22,072)
                                                         --------------     ----------------
 
Net deferred tax asset (liability)                         $         -        $        -
                                                         ==============     ================
</TABLE>

Under SFAS No. 109, a valuation allowance is established, if based on the weight
of available evidence, it is more likely than not that a portion of the deferred
tax asset will not be realized.  Accordingly, a full valuation allowance has
been provided to offset the Company's net deferred tax assets.

The provision for income taxes consists of the following for the years ended
December 31,:

<TABLE>
<CAPTION>
                                   1996        1997        1998
                                 ---------  ----------  ----------
<S>                              <C>        <C>         <C>
Current:
 
  Federal                         $   47      $1,603       $   -
  State                               59         480         310
  Foreign                          1,365         913         599
 
Deferred:
 
  Federal                          1,600           -           -
  State                                -           -           -
  Foreign                              -           -           -
                                 ---------------------------------
Total                             $3,071      $2,996       $ 909
                               ===================================
</TABLE>

                                     F-13
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
            (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
                               DECEMBER 31, 1998

7.  Income Taxes   (continued)

The reconciliation of income taxes computed at the U.S. statutory federal tax
rate to income tax expense for the years ended December 31 are:
<TABLE>
<CAPTION>
                                                   1996              1997               1998
                                             -------------     -------------     ---------------
<S>                                            <C>               <C>               <C>
Tax expense (benefit) at U.S.
  statutory rate                                 $(1,467)           $  431             $(3,146)
State income taxes, net of
  federal income tax benefit                          39               317                 205
Nondeductible merger costs                             -                 -               1,788
Change in valuation allowance                      2,941             1,537               1,986
Foreign Taxes                                      1,534               975              (   12)
Other  Items                                          24              (264)                 88
                                             -------------     -------------     ---------------
 
Income tax expense                               $ 3,071            $2,996             $   909
                                             =============     =============     ===============
</TABLE>

Pretax income (loss) before extraordinary item from the Company's domestic
operations totaled approximately ($3,800), $1,400 and ($10,900) for the years
ended December 31, 1996, 1997 and 1998, respectively. Pretax income (loss) from
the Company's foreign operations totaled approximately ($500), ($200) and
$1,800 for the years ended December 31, 1996, 1997 and 1998, respectively.

As of December 31, 1998, the Company has federal net operating loss
carryforwards of approximately $45.8 million. The federal net operating losses
and credits begin to expire in 2008 through 2018, if not fully utilized.
Realization is dependent on generating sufficient taxable income prior to
expiration of the loss carryforwards.

As a result of certain transactions involving the Company's stock, the Company
believes an ownership change, as defined in Section 382 of the Internal Revenue
Code, has occurred.  Consequently, future utilization of the Company's federal
net operating loss carryforwards may be subject to limitations.

8.  STOCK PLANS

The Company has three Stock Plans, the 1994 Incentive Stock Plan, the 1995
Employee Stock Purchase Plan and the 1995 Director Option Plan.

In accordance with the 1994 Incentive Stock Plan (the "Plan"), the Company may
grant up to 2,750,000 shares of both incentive or non-qualified stock options or
stock purchase rights to officers, directors, employees, sales representatives
and consultants of the Company. The term of each incentive and non-qualified
stock option and stock purchase right is ten years or ten years and one day from
the date of grant. Vesting generally occurs over a period of not greater than
five years.

                                     F-14
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
            (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
                               DECEMBER 31, 1998

                                        
8.  STOCK PLANS   (CONTINUED)

Under the 1994 Incentive Stock Plan, 1,819,408 outstanding options and stock
purchase rights were exercisable at December 31, 1998 and there were 409,324
shares available for future grants.  In addition,1,181,484 of the outstanding
options issued and exercisable were from various former MSI plans.  All stock
purchase rights which are not vested are subject to repurchase by the Company.

In 1995, the Company adopted the 1995 Employee Stock Purchase Plan ("ESPP")
under Section 423 of the Internal Revenue Code.  An aggregate of 250,000 shares
of common stock are reserved for offering under the ESPP.  In 1998, 32,204
shares of common stock were purchased at prices ranging from $7.01 to $12.54 per
share, as determined by the ESPP.  At December 31, 1998, there were 192,077
shares available for future purchase.

In accordance with the 1995 Directors Option Plan, the Company may grant up to
150,000 options to purchase shares of common stock to non-employee members of
the Board.  The exercise price of the stock options shall be equal to the fair
market value per share of common stock on the option grant date.  Each option
has a term of ten years from the option grant date and shall become exercisable
in a series of three equal and successive annual installments.  In 1998 45,000
options were granted at an exercise price of $17.125. At December 31, 1998,
33,336 of the outstanding options were exercisable and there were 45,000 shares
available for future grants.

FASB 123 requires pro forma information regarding net income and earnings per
share as if the Company has accounted for its employee stock options and
warrants granted subsequent to December 31, 1994 and shares of common stock
purchased by employees in connection with the ESPP ("equity awards") under the
fair value method of FASB 123.  The fair value of these equity awards was
estimated at the date of grant using a Black-Scholes option pricing model with
the following weighted average assumptions for 1996, 1997 and 1998,
respectively: risk-free interest rates of 6.17%, 5.44% and 4.49%; expected
volatility of 59.70, 47.00 and 81.00; expected option life of 5.6, 5.8 and 5.9
years from vesting and an expected dividend yield of 0.0%.

For purposes of pro forma disclosures, the estimated fair value of the equity
awards is amortized to expense over the options' vesting period.  The Company's
pro forma information is as follows:

<TABLE>
<CAPTION>
                                                         1996             1997             1998
                                                   -------------    -------------    -------------
<S>                                                 <C>              <C>              <C>
Pro forma net loss.................................    $(9,014)         $(5,224)        $(17,209)
Pro forma basic net loss per share.................    $  (.51)         $  (.28)        $   (.91)
</TABLE>

                                     F-15
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
            (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
                               DECEMBER 31, 1998

                                        
8.  STOCK PLANS   (CONTINUED)

     A summary of the Company's stock option activity, and related information
for the years ended December 31, 1996, 1997, and 1998 follows:

<TABLE>
<CAPTION>
                                -------------------------------     ------------------------------    ------------------------------
                                             1996                                1997                              1998
                                -------------------------------     ------------------------------    ------------------------------

                                                    Weighted                          Weighted                          Weighted
                                  Common Stock      Average             Common        Average         Common Stock      Average
                                     Options        Exercise            Stock         Exercise           Options        Exercise
                                                     Price             Options         Price                             Price
                                                                                                                   
                                --------------  --------------     -------------  --------------    --------------  --------------
<S>                               <C>             <C>                <C>            <C>               <C>             <C>
Outstanding at beginning of year     2,152,343          $ 1.91         2,650,397          $ 6.41         3,164,229          $ 8.19
  Granted.......................       722,906           19.22           778,524           13.94         1,217,504           12.45
  Exercised.....................       (81,700)           2.91          (109,169)           3.32          (295,578)           2.42
  Forfeited.....................      (143,152)           2.26          (155,523)           9.01          (361,133)          13.01
                                --------------                     -------------                    -------------- 
                                                                                                                   
Outstanding at end of year           2,650,397            6.41         3,164,229            8.19         3,725,022            9.54
                                ==============                     =============                    ============== 
                                                                                                                   
Exercisable at end of year             843,258                         1,450,000                         1,852,744 
                                ==============                     =============                    ============== 
Weighted average fair value of                                                                                     
 options granted during the year                          8.03                             10.58                              6.52
 
</TABLE>

     Stock options outstanding at December 31, 1998 are summarized as follows:

<TABLE>
<CAPTION>
                                                                                       Weighted Average
                               Outstanding                 Weighted Average                Exercise
     Range of                   Options at                     Remaining                     Price
  Exercise Prices           December 31, 1998              Contractual Life
-------------------    --------------------------    ---------------------------    ---------------------
<S>                     <C>                           <C>                            <C>
    $           .48                68,991                            5.9                   $  .46
    $ 1.24 - $19.00             3,331,049                            6.5                     8.66
    $19.38 - $26.75               324,982                            7.7                    21.81
                       --------------------------
    $  .48 - $26.75             3,725,022                            6.6                     9.66
                       --------------------------
</TABLE>

                                     F-16
<PAGE>
 
                      Pharmacopeia, Inc. and Subsidiaries
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
            (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATE)
                               DECEMBER 31, 1998
9.   Segment information

Pharmacopeia operates in two business segments.  The Company's Laboratory
Services segment develops combinatorial chemistry libraries and uses these
libraries alone and through funded collaborations to discover new, low molecular
weight compounds principally for use as pharmaceuticals.  The Company's Software
segment designs, develops, markets and supports software that facilitates the
discovery and development of new products and processes in the pharmaceutical,
biotechnology, chemical petrochemical and materials industries.  Summarized
financial information concerning the industry segments and geographic areas in
which the Company operated at December 31, 1996, 1997 and 1998 and for each of
the years then ended is presented in the following tables:

<TABLE>
<CAPTION>

BUSINESS SEGMENTS                                          1996                                           1997                    
                                      --------------------------------------------     -------------------------------------------- 

                                                        Laboratory                                    Laboratory                  
                                        SOFTWARE         Services           TOTAL      SOFTWARE        Services           TOTAL   
                                                                                                                                  
                                      --------------------------------------------------------------------------------------------
<S>                                     <C>         <C>                   <C>          <C>         <C>                  <C>       
Revenue:                                                                                                                          
  Contract                               $    -             $  14,799     $ 14,799     $      -           $  24,523     $ 24,523  
  Software licenses, service and                                                                                                  
     Other                                41,083                    -       41,083       49,108                   -       49,108  
  Hardware                                 6,178                    -        6,178        7,566                   -        7,566  
                                      --------------------------------------------------------------------------------------------- 
Total Revenue                            $47,261            $  14,799     $ 62,060      $56,674           $  24,523     $ 81,197  
                                      ============================================================================================
                                                                                                                                  
Operating income (loss)                  $ 3,700             ($12,058)     ($8,358)     $ 7,820            ($10,844)     ($3,024) 
                                      ============================================================================================
                                                                                                                                  
Total Assets                             $39,665            $  91,979     $131,644      $44,364           $  95,687     $140,051  
                                      ============================================================================================
                                                                                                                                  
GEOGRAPHIC INFORMATION                                                                                                            
Revenues (2)(3):                                                                                                                  
  U.S.                                                                    $ 48,910                                      $ 62,444  
  Europe                                                                    13,150                                        18,753  
                                                                     -------------                                 -------------
  Asia-Pacific                                                                   -                                             -  
Total:                                                                    $ 62,060                                      $ 81,197  
                                                                     =============                                 =============  
</TABLE>
<TABLE> 
<CAPTION> 

BUSINESS SEGMENTS                                             1998                     
                                      -------------------------------------------------
                                                         Laboratory                    
                                         SOFTWARE         Services             Total   
                                      -------------------------------------------------
<S>                                      <C>         <C>                   <C>         
Revenue:                                                                               
  Contract                               $      -            $  29,677     $     29,677
  Software licenses, service and                                                       
     Other                                 54,420                    -           54,420     
  Hardware                                  8,114                    -            8,114
                                      -------------------------------------------------
Total Revenue                             $62,534            $  29,677     $     92,211
                                      =================================================
                                                                                       
Operating income (loss)                   $ 1,090             ($14,546)     (1)($13,456)
                                      =================================================
                                                                                       
Total Assets                              $52,889            $  74,976     $    127,865
                                      =================================================
                                                                                       
GEOGRAPHIC INFORMATION                                                                 
Revenues (2)(3):                                                                       
  U.S.                                                                     $     58,601
  Europe                                                                         22,739
  Asia-Pacific                                                                   10,871
                                                                      -----------------
Total:                                                                     $     92,211
                                                                      ================= 
</TABLE> 
(1)  Includes $8.0 million of merger related costs.
(2)  Revenue in the U.S. category for 1996 and 1997 includes export sales
     primarily to TMSI, the Company's sales and distribution entity for Asia
     Pacific region. TMSI was accounted for under the equity method during 1996
     and 1997, and was consolidated in 1998.
(3)  Export sales totaled $28,944, $21,811 and $18,489 in 1996, 1997 and 1998,
     respectively.

                                     F-17
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
            (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATE)
                               DECEMBER 31, 1998

10.   Joint Venture Agreement

The Company owns a 50% interest in Teijin Molecular Simulations Incorporated
(TMSI), a Japan corporation formed for the purpose of marketing, distribution,
licensing, selling and supporting the Company's products in Asia.  For periods
through December 31, 1997 the Company used the equity method of accounting for
the joint venture.  The Company had product sales to TMSI of approximately
$5,924 and $8,478 in 1996 and 1997, respectively.  The products are typically
shipped directly to the end user by the Company.

Condensed financial information of TMSI as of and for the years ended December
31, 1996 and 1997 is as follows:
<TABLE>
<CAPTION>
                                                            1996                 1997
                                                      -----------------     ---------------
                                                          (unaudited)        (unaudited) 
<S>                                                   <C>                   <C>
Current assets......................................         $5,425             $ 4,790
Non-current assets..................................            642                 583
Current liabilities.................................          4,028               3,353
Stockholders' Equity................................          2,039               2,020
Revenue.............................................          6,490              11,067
Operating income....................................            267                 848
Net income..........................................            110                 343
</TABLE>

As a result of certain changes to the joint venture agreement related to the
management and control of the joint venture, in 1998 the Company began to
consolidate its interest in TMSI.

As of December 31, 1998 the Company has a remaining obligation to Teijin Limited
of $700 which will be paid in 1999.

11.   COMMITMENTS AND CONTINGENCIES

OPERATING LEASES

The Company has several operating leases or sub-leases for office and laboratory
space, which expire at various dates through December 31, 2008.

     The future minimum lease commitments at December 31, 1998 are as follows:

<TABLE>
                   <S>                     <C>
                        1999                    $ 4,361
                        2000                      4,370
                        2001                      4,359
                        2002                      4,322
                        2003                      4,365
                        Thereafter               11,339
</TABLE>

Rent expense for the years ended December 31, 1996, 1997 and 1998 was $2,846,
$3,793 and $4,435, respectively.

                                     F-18
<PAGE>
 
                      PHARMACOPEIA, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
            (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATE)
                               DECEMBER 31, 1998


11.   Commitments and Contingencies (continued)

ROYALTIES

The Company pays royalties to approximately forty-five partners for the
worldwide licenses to enhance and market certain software developed at
universities, corporations and other institutions.  A majority of the royalty
agreements are long term or perpetual in nature and the royalty obligations
thereunder are generally based on a percentage of revenues derived from certain
software licenses plus associated revenues from post contract support and
maintenance. The royalty agreements require quarterly payments and generally do
not limit the maximum royalty amount under the agreement.  Certain agreements
contain provisions for quarterly and annual minimum royalties of approximately
$457.  The Company paid royalties under these agreements of approximately $606,
$1,333 and $2,110 in 1996, 1997 and 1998, respectively.  Approximately $701,
$1,304 and  $1,623 of royalty expense related to royalty agreements is included
in license cost of revenue for the year ended December 31, 1996, 1997 and 1998,
respectively.  Based on existing royalty agreements the Company expects to incur
significant future royalty obligations.

On July 16, 1993, the Company entered into a license agreement with the Trustees
of Columbia University and Cold Spring Harbor Laboratory.  The agreement grants
to the Company an exclusive, worldwide license to certain technology for making
and using combinatorial chemical libraries.  The agreement includes annual
license fees and certain royalties to be made by the Company.  In October 1995,
the Company amended this license agreement and issued warrants to purchase
100,000 shares of common stock at $10.00 per share, exercisable through October
5, 2000 or earlier as defined in the warrants the years ended December 31, 1996,
1997, and 1998 the Company paid royalties and license fees to Columbia
University of  $590, $550 and $514, respectively.

Litigation

In the ordinary course of business, the Company is subject to claims and, from
time to time, is named in various legal proceedings. In the opinion of
management, the amount of ultimate liability, if any, with respect to any
pending actions will not materially affect the financial position or results of
operations of the Company.

                                     F-19
<PAGE>
 
                      Pharmacopeia, Inc. and Subsidiaries
                          Report on Form 10-K for the
                          Year ended December 31, 1998

                               INDEX TO EXHIBITS

 
Exhibit                                                   Sequentially 
Number                          Exhibit Name                Numbered      
                                                             Page     

23.1        Consent of Ernst & Young LLP
 
23.2        Consent of Arthur Andersen LLP