**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 1O-Q**

**(MarkOne)**
| **ý**                                         | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|----------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
| ** **                                         | ** ** | ** **                                                                                              |
| **For the  quarterly period ended March 31, 2007** |
| ** **                                         |
| **Or**                                             |
| ** **                                         |
| **o**                                              | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission File Number: 0-50523**

**PHARMACOPEIA,INC.**

(Exact name ofregistrant as specified in its charter)

| **Delaware**                                                     |   | **51-0418085**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **P.O. Box  5350, Princeton, New Jersey**                   |   | **08543-5350**                        |
| (Address of  principal executive offices)                        |   | (Zip Code)                            |

 

**(609)452-3600**

(Registrant’stelephone number, including area code)

**PharmacopeiaDrug Discovery, Inc.**

(Former name,former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act.

Large accelerated filer   o   Acceleratedfiler   o   Non-acceleratedfiler  x

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).

Yes o    No x

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date:

| **Class**                      |   | **Outstanding at May 7, 2007** |
|--------------------------------|--------|--------------------------------|
| Common Stock,  $0.01 par value |   | **29,512,754**                 |

 

 

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**PHARMACOPEIA, INC.**

**Form 10-Q**

**Table of Contents**
| Item               | ** ** | ** **                                                                                  |
|--------------------|------------|---------------------------------------------------------------------------------------------|
|               |       |                                                                                        |
| PART I.       |       | FINANCIAL INFORMATION                                                                       |
|               |       |                                                                                        |
| Item 1.            |       | Consolidated  Financial Statements (Unaudited):                                             |
|               |       |                                                                                        |
|               |       | Consolidated  Balance Sheets as of March 31, 2007 and December 31, 2006                     |
|               |       |                                                                                        |
|               |       | Consolidated  Statements of Operations for the Three Months Ended March 31, 2007 and 2006   |
|               |       |                                                                                        |
|               |       | Consolidated  Statements of Cash Flows for the Three Months Ended March 31, 2007 and 2006   |
|               |       |                                                                                        |
|               |       | Notes to  Unaudited Consolidated Financial Statements                                       |
|               |       |                                                                                        |
| Item 2.            |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|               |       |                                                                                        |
| Item 3.            |       | Quantitative  and Qualitative Disclosures about Market Risk                                 |
|               |       |                                                                                        |
| Item 4.            |       | Controls and Procedures                                                                     |
|               |       |                                                                                        |
| PART II.      |       | OTHER  INFORMATION                                                                          |
|               |       |                                                                                        |
| Item 1.            |       | Legal  Proceedings                                                                          |
|               |       |                                                                                        |
| Item 1A.           |       | Risk Factors                                                                                |
|               |       |                                                                                        |
| Item 2.            |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                |
|               |       |                                                                                        |
| Item 3.            |       | Defaults upon  Senior Securities                                                            |
|               |       |                                                                                        |
| Item 4.            |       | Submission of  Matters to a Vote of Security Holders                                        |
|               |       |                                                                                        |
| Item 5.            |       | Other  Information                                                                          |
|               |       |                                                                                        |
| Item 6.            |       | Exhibits                                                                                    |
|               |       |                                                                                        |
| Signatures         |
|               |       |                                                                                        |
| Index to  Exhibits |

 

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**PART I - FINANCIAL INFORMATION**

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

**Pharmacopeia, Inc.Consolidated Balance Sheets**

**(Amounts in thousands, except share andper share data)**
| ** **                                                                                                                          | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                          | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| ** **                                                                                                                          | ** ** | **(unaudited)**    | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                          | ** ** | ** **         |       |                  |       |
| Current assets:                                                                                                                     |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                                          |       | $                  | 58,648     |                  | $          | 43,099 |   |
| Marketable  securities                                                                                                              |       | 1,010              |       | 3,041                 |       |
| Accounts  receivable, net                                                                                                           |       | —             |       | 5,006                 |       |
| Prepaid expenses  and other current assets                                                                                          |       | 1,103              |       | 1,498                 |       |
| Total current  assets                                                                                                               |       | 60,761             |       | 52,644                |       |
|                                                                                                                                |       |               |       |                  |       |
| Property and equipment,  net                                                                                                        |       | 11,241             |       | 11,287                |       |
| Deferred compensation  plan assets                                                                                                  |       | 1,958              |       | 2,022                 |       |
| Other assets                                                                                                                        |       | 174                |       | 174                   |       |
| Total assets                                                                                                                        |       | $                  | 74,134     |                  | $          | 66,127 |   |
|                                                                                                                                |       |               |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                      |       |               |       |                  |       |
| Current liabilities:                                                                                                                |       |               |       |                  |       |
| Accounts payable                                                                                                                    |       | $                  | 3,623      |                  | $          | 2,491 |   |
| Accrued  liabilities                                                                                                                |       | 4,067              |       | 3,346                 |       |
| Deferred  revenue, current portion                                                                                                  |       | 14,186             |       | 8,535                 |       |
| Warrant  liability                                                                                                                  |       | 6,084              |       | 4,378                 |       |
| Total current  liabilities                                                                                                          |       | 27,960             |       | 18,750                |       |
|                                                                                                                                |       |               |       |                  |       |
| Deferred revenue,  long-term                                                                                                        |       | 21,713             |       | 13,813                |       |
| Deferred compensation  plan                                                                                                         |       | 1,958              |       | 2,022                 |       |
| Other liabilities,  long-term                                                                                                       |       | 924                |       | 1,111                 |       |
|                                                                                                                                |       |               |       |                  |       |
| Commitments and  contingencies                                                                                                      |       | —             |       | —                |       |
|                                                                                                                                |       |               |       |                  |       |
| Stockholders’ equity:                                                                                                          |       |               |       |                  |       |
| Preferred stock,  $.01 par value, 2,500,000 shares authorized, none issued and outstanding                                          |       | —             |       | —                |       |
| Common stock,  $.01 par value, 50,000,000 shares authorized, 21,454,951 and 21,268,447  shares issued and outstanding, respectively |       | 215                |       | 213                   |       |
| Additional  paid-in capital                                                                                                         |       | 82,516             |       | 81,362                |       |
| Accumulated  deficit                                                                                                                |       | (61,141            | )          | (51,137               | )          |
| Accumulated  other comprehensive loss                                                                                               |       | (11                | )          | (7                    | )          |
| Total  stockholders’ equity                                                                                                    |       | 21,579             |       | 30,431                |       |
| Total  liabilities and stockholders’ equity                                                                                    |       | $                  | 74,134     |                  | $          | 66,127 |   |

 

See accompanyingnotes to these unaudited consolidated financial statements

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**Pharmacopeia, Inc.Consolidated Statements of Operations(Amounts in thousands, except share and per share data)**
| ** **                                            | ** ** | **For the Three Months** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                            | ** ** | **Ended March 31,**           | ** ** |
| ** **                                            | ** ** | **2007**                                | ** ** | **2006** | ** ** |
|                                                  |       |                                    |       |   |   |
| **Revenue**                                           |       |                                    |       |   |   |
| Net revenue                                           |       | $                                       | 6,349      |   | $ | 4,116 |   |
|                                                  |       |                                    |       |   |   |
| **Operating  Expenses**                               |       |                                    |       |   |   |
| Collaborative research and development expense        |       | 5,237                                   |       | 3,333 |   |
| Proprietary research and development expense          |       | 7,418                                   |       | 6,292 |   |
| General and administrative expense                    |       | 2,688                                   |       | 2,447 |   |
| Total operating  expenses                             |       | 15,343                                  |       | 12,072 |   |
| Operating loss                                        |       | (8,994                                  | )          | (7,956 | ) |
| Interest and other income, net                        |       | 696                                     |       | 281 |   |
| Increase in warrant liability                         |       | (1,706                                  | )          | — |   |
| Loss before  income taxes                             |       | (10,004                                 | )          | (7,675 | ) |
| Provision for income taxes                            |       | —                                  |       | 8 |   |
| Net loss                                              |       | $                                       | (10,004    | ) | $ | (7,683 | ) |
|                                                  |       |                                    |       |   |   |
| Net loss per  share:                                  |       |                                    |       |   |   |
| - Basic and diluted                                   |       | $                                       | (0.50      | ) | $ | (0.51 | ) |
|                                                  |       |                                    |       |   |   |
| Weighted average  number of common stock outstanding: |       |                                    |       |   |   |
| - Basic and  diluted                                  |       | 20,134,514                              |       | 15,102,499 |   |

 

See accompanyingnotes to these unaudited consolidated financial statements

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**Pharmacopeia, Inc.Consolidated Statements of Cash Flows(Amounts in thousands)**
| ** **                                                                      | ** ** | **For the Three Months** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                      | ** ** | **Ended March 31,**           | ** ** |
| ** **                                                                      | ** ** | **2007**                                | ** ** | **2006** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                          |       |                                    |       |   |   |
| Net loss                                                                        |       | $                                       | (10,004    | ) | $ | (7,683 | ) |
| Adjustments to reconcile net loss to net cash provided  by operating activities |       |                                    |       |   |   |
| Depreciation and amortization                                                   |       | 506                                     |       | 517 |   |
| Increase of warrant liability                                                   |       | 1,706                                   |       | — |   |
| Contribution of stock to 401(k) Plan                                            |       | 126                                     |       | 124 |   |
| Share-based compensation                                                        |       | 513                                     |       | 415 |   |
| Changes in assets and liabilities:                                              |       |                                    |       |   |   |
| Accounts receivable                                                             |       | 5,006                                   |       | (4,371 | ) |
| Prepaid expenses and other current assets                                       |       | 395                                     |       | (111 | ) |
| Accounts payable                                                                |       | 1,132                                   |       | 662 |   |
| Accrued liabilities                                                             |       | 534                                     |       | 743 |   |
| Restructuring reserve                                                           |       | —                                  |       | (622 | ) |
| Deferred revenue                                                                |       | 13,551                                  |       | 5,065 |   |
| Net cash provided by (used in) operating activities                             |       | 13,465                                  |       | (5,261 | ) |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                          |       |                                    |       |   |   |
| Capital expenditures, net                                                       |       | (460                                    | )          | (329 | ) |
| Purchases of marketable securities                                              |       | —                                  |       | (1,000 | ) |
| Proceeds from sale and maturities of marketable  securities                     |       | 2,027                                   |       | 7,593 |   |
| Net cash provided by investing activities                                       |       | 1,567                                   |       | 6,264 |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                          |       |                                    |       |   |   |
| Proceeds from issuance of common stock                                          |       | 517                                     |       | 736 |   |
| Net cash provided by financing activities                                       |       | 517                                     |       | 736 |   |
| Net increase in  cash and equivalents                                           |       | 15,549                                  |       | 1,739 |   |
| Cash and  equivalents, beginning of period                                      |       | 43,099                                  |       | 11,680 |   |
| Cash and  equivalents, end of period                                            |       | $                                       | 58,648     |   | $ | 13,419 |   |

 

See accompanying notes to theseunaudited consolidated financial statements

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**Pharmacopeia, Inc.Notes to Unaudited Consolidated Financial Statements**

**1.   Background and Basis ofPresentation**

Pharmacopeia, Inc. (Pharmacopeia or the Company) was incorporatedin 2002 as Pharmacopeia Drug Discovery, Inc., a wholly owned subsidiary ofAccelrys, Inc. (Accelrys).  OnApril 30, 2004 (the distribution date), Accelrys spun-off 100 percent ofthe shares of Pharmacopeia Drug Discovery, Inc. in a pro rata tax-freedistribution and distributed to its stockholders of record one share ofPharmacopeia Drug Discovery, Inc. common stock for every two shares of Accelryscommon stock held.  A total of 12,181,471shares were distributed.  Effective May3, 2007, Pharmacopeia Drug Discovery, Inc. changed its name to Pharmacopeia,Inc.

Pharmacopeia is abiopharmaceutical company committed to discovering and developing noveltherapeutics to address significant medical needs. Using proprietarytechnologies and processes, the Company seeks to identify, optimize and developnovel drug candidates through our own internally-funded drug discovery programsand in collaborations with major pharmaceutical and biotechnologycompanies.  The Company has one internalprogram in Phase 1 clinical development and several internal programs inadvanced discovery.  Its collaborativeresearch efforts have resulted in a portfolio of five partnered programs inactive human clinical trials, with four additional partnered programs inpreclinical development.

The consolidated financial statementsinclude the accounts of the Company and its wholly owned subsidiaryPharmacopeia UK Holdings Limited (Pharmacopeia UK), which was formed in March2007. All significant intercompany accounts and transactions have beeneliminated in consolidation.

The accompanying unaudited consolidated financialstatements have been prepared in accordance with U. S. generally acceptedaccounting principles for interim financial information and with instructionsto Form 10-Q and Article 10 of Regulation S-X. Accordingly, theseunaudited consolidated financial statements do not include all of theinformation and disclosures required by U. S. generally accepted accountingprinciples for complete consolidated financial statements. In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation of the consolidated financialstatements have been included. Interim results are not necessarily indicativeof the results that may be expected for the year. The unaudited interimconsolidated financial statements should be read in conjunction with thefinancial statements and notes thereto included in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2006.

**2.**   **Significant Collaborations**

**Collaboration and LicenseAgreement with Cephalon**

In May 2006, the Companyentered into a Collaboration and License Agreement (the Cephalon Agreement)with Cephalon, Inc. (Cephalon) providing for the formation of a new drugdiscovery, development and commercialization alliance.  The Company received an up-front,non-refundable payment of $15.0 million in June 2006 to support the Company’sresearch efforts under the Cephalon Agreement.

As part of and during theinitial phase of the alliance, Cephalon is responsible for providing hit andlead compounds.  The Company and Cephalonwill then work collaboratively to advance the lead compounds to clinicalcandidates.  The Company is principallyresponsible for medicinal chemistry research and Cephalon provides biologysupport, including preclinical disease models, as required by the CephalonAgreement. The Company has agreed that, for a specified period, it will notscreen its compound library for other collaborators, or for its own account,against any target it works on under the Cephalon Agreemen.

Upon the nomination, ifany, of clinical candidates by the alliance, Cephalon will be primarilyresponsible for their development and commercialization.  The Company will retain an option to developcertain candidates from the alliance, subject to Cephalon’s agreeing to suchdevelopment.  For each clinicalcandidate, if any, advanced under the alliance, the developing company willmake clinical, regulatory and sales milestone payments to the non-developingcompany.  In addition, the companycommercializing each resulting product, if any, will pay thenon-commercializing company up to double-digit royalties based on the saleslevel achieved.

As stated above, under the Cephalon Agreement, the Companyreceived a non-refundable payment of $15.0 million and is principallyresponsible for performing medicinal chemistry research. The revenue for thisresearch is recognized on a proportional performance basis, which is expectedto approximate straight-line recognition of revenue during the three year termof the alliance.  The Company may receivemilestone payments, which would be recognized as revenue when the milestonesare achieved.  Included in deferredrevenue at March 31, 2007 was approximately $10.8 million related to theCephalon Agreement, of which $5.8 million 

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was classified as long-term.  For the three months ended March 31,2007, the Company’s net revenue under the Cephalon Agreement was 20% of totalrevenue for the period. The research activities under the Cephalon Agreementcommenced in June 2006 and therefore, there was no revenue recognized in thethree months ended March 31, 2006.

The Company and Cephaloneach have the right to terminate the Cephalon Agreement under certain specifiedcircumstances at any time during the term of the Cephalon Agreement.  In addition, Cephalon has the right toterminate the Cephalon Agreement in its sole discretion, upon ninety dayswritten notice to the Company, during the three-year research phase of thealliance, which phase may be extended by agreement of the parties.  No such termination shall require the Companyto refund to Cephalon any or all of the above funding.

One of the Company’sdirectors currently serves as the Chairman and Chief Executive Officer ofCephalon.

**Product Development andCommercialization Agreement with GSK**

In March 2006, the Company and SmithKlineBeecham Corporation and Glaxo Group Limited (together GSK) entered into aproduct development and commercialization agreement (the GSK Agreement). Underthe terms of the GSK Agreement, the Company may receive up to $15.0 million incash payments from GSK related to the initial discovery activities to beconducted by the Company, including $5.0 million that the Company received inApril 2006. Up to the remaining $10.0 million will be payable to the Companyupon its fulfillment of certain conditions related to the initial discoveryactivities to be conducted by the Company. The Company’s role in the allianceis to (i) identify and (ii) advance molecules in chosen therapeutic programs todevelopment stage and (iii) subject to certain provisions in the GSK Agreement,further develop the candidates to clinical “proof of concept” (a demonstrationof efficacy in humans).

The GSK Agreement provides GSK anexclusive option, exercisable at defined points during the development processfor each program (up to the point of clinical proof of concept), to licensethat program. Upon licensing a program, GSK is obligated to conduct preclinicaldevelopment and/or clinical trials and commercialize pharmaceutical productsresulting from such licensed programs on a worldwide basis (the GSK LicenseObligations). In addition to the cash payments above, the Company is entitledto receive success-based milestone payments, starting in preclinical research,from GSK for each drug development program pursued by GSK under the allianceand the potential for double-digit royalties upon the successfulcommercialization by GSK of any product resulting therefrom.

In the event that GSK does not exerciseits option to license a program, the Company will retain all rights to thatprogram and may continue to develop the program and commercialize anyproducts resulting from the program, or it may elect to cease progressingthe program and/or seek other partners for further development andcommercialization.  Should the Companydevelop or partner such a program and commercialize any products resulting fromthat program, the Company will be obligated to pay GSK success-based milestonepayments and royalties upon successful commercialization, if any.

The Company has agreed that, for aspecified period, it will not screen its compound library for othercollaborators, or for its own account, against any target it screens under theGSK Agreement.

In April 2006, theCompany received $5.0 million in connection with the execution of the GSKAgreement. The Company recorded deferred revenue associated with the payment,net of the fair value of the warrants described below, of approximately $4.5million. As of March 31, 2007, approximately $1.0 million was classified indeferred revenue, current portion and approximately $2.9 million was classifiedin deferred revenue, long-term. The Company recognizes revenue on aproportional performance basis as it performs the required discovery activitiesin an amount from time to time less than or equal to the non-refundable portionof payments received in connection with the GSK Agreement.  For the three months ended March 31, 2007,the Company recognized revenue of approximately $238 thousand under the GSKAgreement. The research activities under the GSK Agreement commenced in April2006 and therefore, there was no revenue recognized in the three months endedMarch 31, 2006.

In connection with the GSK Agreement, theCompany issued two warrants to GSK for the purchase of up to anaggregate of 176,367 shares of its common stock at an exercise price of $5.67per share, which was a 25% premium over the trailing 30-day closing priceaverage preceding March 24, 2006. The warrants are exercisable at any timebefore the earlier to occur of (i) March 24, 2011 and (ii) theeffective date of certain types of terminations of the GSK Agreement. Thesewarrants were issued in a transaction not involving a public offering underSection 4(2) of the Securities Act of 1933, as amended. The fairvalue of the warrants has been determined to be $505 thousand. This amount wascalculated using the Black-Scholes pricing model with the followingassumptions: 80% volatility; expected term of 5 years; 4.66% risk-free rate;and 0% dividend.

The Company and GSK each have the right toterminate the GSK Agreement in its sole discretion under certain specified 

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circumstances at any time during the term of the GSK Agreement. Inaddition, the Company and GSK each have the right to terminate the GSKAgreement under other circumstances that are customary in these types ofagreements.  If the Company exercises itsdiscretionary termination right at any time during the first five years of theterm, under certain circumstances, it could be required to refund to GSK aportion of the up to $15.0 million related to initial discovery activities tobe conducted by the Company referred to above. The amount of any such refund will be calculated based upon when duringthe term of the GSK Agreement that termination occurs.  However, there are no instances where thedeferred revenue would be amortized below the amount that could be potentiallyrefundable pursuant to the terms of the GSK Agreement.  Further, shouldGSK exercise its discretionary termination rights, there are no provisions inthe GSK Agreement that would require the Company to refund payments receivedrelating to its performance of initial discovery activities or milestonepayments, if any, received under the GSK Agreement

**Collaboration and LicenseAgreement with Organon**

Under its February 2002 agreement with N.V. Organon(Organon), the Company received quarterly research funding to conduct its drugdiscovery activities to identify and optimize new drug candidates for multipletherapeutic targets provided by Organon (the 2002 Collaboration). The researchterm of 2002 Collaboration ended in February 2007.  Research funding from the 2002 Collaborationwas recognized as revenue on a proportional performance basis, whichapproximated straight-line recognition over the term of the agreement.  The 2002 Collaboration accounted for 8%, or$516 thousand, and 21%, or $863 thousand of total revenue for the three monthsended March 31, 2007 and 2006, respectively.

InFebruary 2007, the Company entered into an amended and restated collaborationand license agreement (the Organon Agreement) with Organon, providing for the formation of a newalliance to discover, develop and commercialize therapeutic products across abroad range of therapeutic indications. The new alliance builds on thecompanies’ past collaborations, including the 2002 Collaboration.

The Organon Agreementcalls for Pharmacopeia to receive an up-front payment of $15 million andup to $4 million per year ($20 million aggregate) in research fundingover the five-year term of the research portion of the alliance.  TheCompany received the $15 million up-front payment and the first quarterlyresearch funding payment of $1.0 million in March 2007.  The Organon Agreement also provides that theCompany waives its rights to receive further compensation (e.g. futuremilestone and royalty payments) with respect to programs resulting from leadseries identified by the Company and delivered to Organon under the 2002Collaboration and certain other programs from earlier agreements.

The Organon Agreementprovides Pharmacopeia the option to purchase the right to co-develop andco-commercialize therapeutic candidates discovered through the alliance. Fortherapeutic candidates the Company does not elect to co-develop andco-commercialize, Organon will retain exclusive development andcommercialization rights, and the Company will receive milestone payments as aresult of Organon’s successful advancement, if any, of each candidate throughclinical development, and up to double-digit royalties based oncommercialization of any resulting pharmaceutical products.

As mentioned above, inMarch 2007, the Company received $16.0 million in connection with OrganonAgreement, which the Company recorded as deferred revenue. As of March 31,2007, approximately $5.9 million was classified in deferred revenue, currentportion and approximately $10.1 million was classified in deferred revenue,long-term. The Company will recognize revenue on a proportional performancebasis as it performs research activities as provided in the Organon Agreement.For the three months ended March 31, 2007, the Company recognized $13 thousandin connection with the Organon Agreement.

BothPharmacopeia and Organon have the right to terminate the Organon Agreementunder certain specified circumstances at any time during the term of theOrganon Agreement.   In addition, the Company and Organon eachhave the right to terminate the Organon Agreement under other circumstancesthat are customary in these types of agreements. Further, each party has theright, upon six months prior written notice provided to the other party at anytime beginning two and one-half years after February 8, 2007, to terminate theresearch portion of the alliance and/or the Organon Agreement. Such atermination of the research portion of the alliance by Organon would not applyto Organon’s obligations with respect to any program developed by the alliancethat Organon is advancing or to therapeutic candidates with respect to whichthe Company has previously exercised its option to purchase the right toco-develop and co-commercialize. Should Organon exercise its discretionarytermination rights, there are no provisions in the Organon Agreement that wouldrequire the Company to refund payments received under the Organon Agreement. IfPharmacopeia exercises its discretionary termination right, under certaincircumstances, it could be subject to a termination fee of $5 million. Whetheror not the Company is subject to the termination fee is based upon when duringthe term of the Organon Agreement the Company’s discretionary termination rightis exercised. There will, however, be no instances where the deferred revenueassociated with the Organon Agreement would be amortized below $5 million untilsuch time as the Company is no longer subject to the termination fee.

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**Research and License Agreementwith Wyeth**

InDecember 2006, Pharmacopeia entered into a research and license agreement (theWyeth Agreement) with Wyeth, acting through its Wyeth Pharmaceuticals Division,providing for the formation of a new alliance based on the Company’s JanusKinase-3 (JAK3) inhibitor program.  The alliance’s goal is to identify, develop and commercializetherapeutic products for the treatment of certain immunological conditions inhumans.

The companies each havecertain exclusive rights to develop and commercialize products resulting fromthe JAK3 program and the alliance.  Pharmacopeia retains the right todevelop and commercialize therapeutic products for the treatment ofdermatological and ocular diseases employing topical administration and Wyethhas the right to develop human therapeutic products for all other indicationsand routes of delivery.  Under the terms of the Wyeth Agreement, inaddition to an up-front non-refundable $5 million cash payment that the Companyreceived in January 2007, the Company may also receive, over the three yearresearch term that began in January 2007, up to $9.0 million in researchfunding.  In addition, the Company may receive up to $175.0 million ifWyeth achieves preclinical and clinical development and regulatory andcommercialization milestones, as well as double-digit royalties on the netsales of any products commercialized by Wyeth under the alliance. Each companyis responsible for all development, regulatory, manufacturing andcommercialization activities for the products it develops and commercializes inits field.

Each ofPharmacopeia and Wyeth have the right to terminate the Wyeth Agreement undercertain specified circumstances at any time during the term of the WyethAgreement.  In addition, Wyeth has the right, upon six months’ priorwritten notice provided to the Company at any time after December 22, 2007, toterminate the research collaboration and/or the Wyeth Agreement in its entiretyor in part.  Such right to termination would not apply to Wyeth’sobligations with respect to any program developed by the collaboration andlicensed by Wyeth. No termination will require the Company to refund to Wyethany or all of the above cash payments.

In January 2007, theCompany received the $5.0 million up-front non-refundable payment and the firstquarterly research funding of $750 thousand, both of which were recorded asdeferred revenue. The revenue for this research isrecognized on a proportional performance basis, which is expected toapproximate straight-line recognition of revenue over the initial three yearterm of the alliance. Forthe three months ended March 31, 2007, the Company recognized approximately$1.2 million, or 18% of its revenue, under the Wyeth Agreement, resulting indeferred revenue at March 31, 2007 of $4.6 million, of which $2.9 million wasclassified as long-term. The Company may receive milestone payments upon thesuccessful achievement, if any, of preclinical and clinical milestones. Thesemilestone payments will be recognized as revenue when the milestones areachieved.

**Collaboration and LicenseAgreements with Schering-Plough**

For the threemonths ended March 31, 2007 and 2006, the Company’s research collaborationswith Schering Corporation and Schering-Plough Ltd. (together Schering-Plough),accounted for 28% and 63%, respectively, of revenue, which includes $1.0million of milestone revenue in each respective period. Research funding from theSchering-Plough agreements is recognized as revenue as services are performed.Milestone payments are recognized as revenue when the milestones are achieved.For funding received in advance of the Company’s performance of research anddevelopment activities, the Company records deferred revenue. Included indeferred revenue at March 31, 2007 was approximately $62 thousand relating tothese collaborations. There was no deferred revenue recorded relating to these collaborationsat March 31, 2006. The Company received funding and recorded revenuefrom its collaborations with Schering-Plough through early April 2007, at whichtime the Company’s research activities under the collaborations ceased. Underthe terms of the Company’s agreements with Schering-Plough, the cessation ofthe Company’s research activities does not affect other areas of thecollaborations, including the ongoing Phase 2 and 1 clinical trials andmultiple preclinical programs that Schering-Plough is conducting. The Companywill continue to be entitled to payments resulting from the successfulachievement by Schering-Plough, if any, of preclinical and clinical milestonesas well as royalty payments from sales, if any, of products resulting from compoundsalready delivered by the Company and accepted by Schering-Plough under thecollaborations.

**Other Collaborations**

In the three months endedMarch 31, 2007, as part of its collaborations with Biovitrum, the Companyearned $1.0 million in milestone revenue for delivering an advanced leadcompound that Biovitrum has accepted. The milestone revenue, for which theCompany received payment in February 2007, accounted for 16% of revenue for thethree months ended March 31, 2007.

**Other Items**

No other collaboratoraccounted for more than 10% of total revenue in the three month periods endedMarch 31, 2007 and 2006.

8

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**3.**   **License Agreement with Bristol-Myers Squibb**

In March 2006, theCompany and Bristol-Myers Squibb Company (BMS) entered into an exclusivelicensing agreement providing the Company an exclusive license under certainBMS patents with respect to worldwide development and commercialization ofcertain compounds discovered by BMS that possess dual angiotensin andendothelin receptor antagonist (DARA) activity, including lead and backup DARAdevelopment candidates. In February 2007, the Company initiated Phase 1 clinicaltrials with its product candidate PS433540. The Company will pay BMS milestonepayments upon the achievement of successive clinical and regulatory events inthe United States and certain other jurisdictions, and royalties on sales ofproducts, if any, resulting from the DARA program. In connection with theinitiation of the Phase 1 clinical trials, the Company paid BMS $1.0 million inApril 2007. This amount was recorded as proprietary research and developmentexpense in the three months ended March 31, 2007 and is included in accruedliabilities as of March 31, 2007.

Under the terms of theagreement, in lieu of an up-front cash payment, the Company is providing BMS aset of compound libraries, over a period of approximately three years followingthe execution of the agreement. In the event the Company fails to deliver theaforementioned libraries to BMS, the Company would be required to make cashpayments to BMS on a pro rata basis of up to $1.9 million as of March 31, 2007.

The Company accounted forthis transaction in accordance with Accounting Principle Board Opinion 29, “Accountingfor Nonmonetary Transactions” as amended by Statement of Financial AccountingStandard (SFAS) No. 153 “Exchanges of Nonmonetary Assets.” The Companyestimated that the fair value of the compound library services to be providedto BMS is approximately $2.0 million. As such, and in accordance with SFAS No.2 “Accounting for Research and Development Costs,” the Company recorded anon-cash charge of $2.0 million to proprietary research and development expenseduring the three months ended March 31, 2006 and recorded a liability for theestimated fair value of the compound library services. As of March 31, 2007,the liability was approximately $1.8 million, of which approximately $0.9million is classified in other liabilities, long-term.

**4.**   **Net Loss Per Share**

The Company computes netloss per share in accordance with SFAS No. 128, “Earnings Per Share” (SFAS128). Under the provisions of SFAS 128, basic net loss per share is computed bydividing the net loss for the period by the weighted-average number of commonshares outstanding during the period. Diluted net loss per share is computed bydividing the net loss for the period by the weighted-average number of commonand dilutive common equivalent shares outstanding during the period. TheCompany had a net loss for the periods presented; accordingly, the inclusion ofcommon stock equivalents for outstanding stock options would be anti-dilutiveand, therefore, the weighted average shares used to calculate both basic anddiluted earnings per share are the same.

**5.**   **Segment Information**

The Companyclassifies its business operations in one operating segment. All of the Company’srevenues are generated from this segment. Revenue was derived from customerslocated in the following geographic regions:
|                        | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------|------------|------------------------------------------------------|------------|
| ** **             | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
|                   |       |                                                 |       |   |   |
| Customers  located in: |       |                                                 |       |   |   |
| United States          |       | 61                                                   | %          | 34 | % |
| Europe                 |       | 39                                                   | %          | 66 | % |

 

**6.**   **Share-Based Compensation**

Effective January 1, 2006, the Company adopted thefair value recognition provisions of SFAS No. 123 (revised 2004), “Share-BasedPayment” (SFAS 123R), using the modified-prospective transition method. Thisstatement is a revision to SFAS 123, supersedes APB 25 and amends SFASNo. 95, “Statement of Cash Flows.” Under this transition method, compensation cost recognized includescompensation costs for all share-based payments granted prior to, but not yetvested as of December 31, 2005 based on the grant date fair value estimated inaccordance with the original provisions of SFAS 123, and compensation cost forall share-based payments granted subsequent to December 31, 2005 based on thegrant date fair value estimated in accordance with provisions of SFAS 123R.

9

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The fair value of theseequity awards was estimated at the date of grant using the Black-Scholes optionpricing model with the following weighted average assumptions for the threemonths ended March 31, 2007 and 2006, respectively:
|                          | ** ** | **2007**               | ** ** | **2006**               | ** ** |
|--------------------------|------------|------------------------|------------|------------------------|------------|
| Dividend yield           |       | 0%                     |       | 0%                     |       |
| Expected  volatility     |       | 90.00%                 |       | 80.00%                 |       |
| Risk-free interest  rate |       | 4.51%                  |       | 4.66%                  |       |
| Expected life  (years)   |       | 6.25    |       | 6.25    |       |

 

For the three monthsended March 31, 2007 and 2006, total share-based compensation costs associatedwith the adoption of SFAS 123R was approximately $490 thousand and $394thousand, respectively. In addition to the expense incurred related to stockoption grants to employees, the Company also incurred share-based compensationcosts of approximately $13 thousand and $21 thousand related to the vesting ofrestricted stock grants for the three months ended March 31, 2007 and 2006,respectively, and approximately $10 thousand related to stock options grantedto consultants for the three months ended March 31, 2007.

As of March 31, 2007,there was approximately $4.1 million of unrecognized compensation costs, net ofestimated forfeitures, related to share-based payments which are expected to berecognized over a weighted average period of 2.74 years.  Cash proceeds from stock options exercisedduring the three months ended March 31, 2007 and 2006 was approximately $517thousand and $736 thousand, respectively.

**7.  Warrant Liability**

The Companyfollows Emerging Issues Task Force (EITF) No. 00-19, “Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock” (EITF 00-19) which provides guidance for distinguishing betweenpermanent equity, temporary equity and assets and liabilities. Under EITF00-19, to qualify as permanent equity, an equity derivative, includingwarrants, must permit the Company to settle in unregistered shares. Undersecurities law, if the warrants were issued in connection with a publicoffering and have a cash settlement feature at the holder’s option, the Companydoes not have the ability to settle in unregistered shares. Therefore, thewarrants cannot be classified as permanent equity and are instead classified asa liability. The approximately 1,450,000 warrants that the Company issued aspart of its equity financing in October 2006 meet this criteria and their fairvalue has been recorded as a liability in the accompanying balance sheets.Other warrants the Company had previously issued qualify as permanent equityand do not require remeasurement.

The Companyrecords its warrant liabilities at fair value using a Black-Scholes option-pricingmodel and remeasures at each reporting date until the warrants are exercised orhave expired. Changes in the fair value of the warrants are reported in thestatements of operations as income or expense. The fair value of the warrantscould be subject to significant fluctuation based on changes in the Company’sstock price, expected volatility, expected life, the risk-free interest rateand dividend yield. As of March 31, 2007, the fair value of the warrantliability increased to approximately $6.1 million from approximately $4.4million as of December 31, 2006, and as such, approximately $1.7 million wasrecorded as a non-operating expense in the three months ended March 31, 2006.The assumptions used in the Black-Scholes option-pricing model as of March 31,2007 and December 31, 2006, respectively, were as follows:

|                          | ** ** | **March 31,**     | ** **             | **December 31,** | ** ** |
|--------------------------|------------|------------------------|------------------------|-----------------------|------------|
| ** **               | ** ** | **2007**               | ** **             | **2006**              | ** ** |
| Dividend yield           |       | 0%                     |                   | 0%                    |       |
| Expected  volatility     |       | 90.00%                 |                   | 90.00%                |       |
| Risk-free  interest rate |       | 4.54%                  |                   | 4.70%                 |       |
| Expected life  (years)   |       | 5.05    |                   | 5.30%                 |       |
| Stock Price              |       | $                      | 5.69    |                  | $          | 4.26    |   |
| Exercise Price           |       | $                      | 5.14    |                  | $          | 5.14    |   |

 

**8.**   **Restructuring and severance obligations**

During the year ended December 31, 2004, the Companyexecuted a restructuring plan for the purpose of making its research anddevelopment activities more efficient by eliminating unnecessary facilities. Areduction in force of six administrative Pharmacopeia 

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employees also occurred during that year. As a result,restructuring related charges of approximately $5.9 million, as outlined below,were recognized as operating expense during the year endedDecember 31, 2004.

The following table summarizes theactivity and balance of the restructuring reserve at March 31, 2006 (inthousands):
|                                  | ** ** | **Severance Cost for** | ** ** | ** **                              | ** ** | ** ** | ** ** |
|----------------------------------|------------|----------------------------------|------------|-----------------------------------------|------------|------------|------------|
| ** **                       | ** ** | **Involuntary Employee**    | ** ** | **Costs to Exit Leased** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | **Terminations**                 | ** ** | **Facility**                            | ** ** | **Total**  | ** ** |
| Restructuring  charges           |       | $                                | 132        |                                    | $          | 5,718      |       | $ | 5,850 |   |
| Utilization of  Reserves:        |       |                             |       |                                    |       |       |       |
| Cash payments                    |       | (132                             | )          | (4,974                                  | )          | (5,106     | )          |
| Write-off Leasehold Improvements |       | —                           |       | (458                                    | )          | (458       | )          |
| Balance at March 31,  2006       |       | $                                | —     |                                    | $          | 286        |       | $ | 286 |   |

 

In the threemonths ended June 30, 2006, the Company made cash payments of approximately$198 thousand relating to a former facility it leased through April 2006.  Additionally, the Company made an adjustmentof approximately $88 thousand to reduce its restructuring cost estimate toreflect actual restructuring costs and as such, as of June 30, 2006 there wereno liabilities relating to restructuring costs.

**9**.   Commitments andContingencies

**Product Development and Commercialization Agreementwith GSK**

Under the terms of theGSK Agreement, the Company and GSKeach have the right to terminate the GSK Agreement in its sole discretion undercertain specified circumstances at any time during the term of the GSKAgreement. In addition, the Company and GSK each have the right to terminatethe GSK Agreement under circumstances that are customary in these types ofagreements.  If the Company exercises itsdiscretionary termination right at any time during the first five years of theterm, under certain circumstances, it could be required to refund to GSK aportion of the up to $15.0 million related to initial discovery activities tobe conducted by the Company under the GSK Agreement. The amount of any suchrefund will be calculated based upon when during the term of the GSK Agreementthat termination occurs.  However, thereare no instances where the deferred revenue would be amortized below the amountthat could be potentially refundable pursuant to the terms of the GSKAgreement.  Further, should GSK exercise its discretionary terminationrights, there are no provisions in the GSK Agreement that would require theCompany to refund payments received relating to its performance of initialdiscovery activities or milestone payments, if any, under the GSK Agreement.

The Company’s role in the alliance is to(i) identify and (ii) advance molecules in chosen therapeutic programs todevelopment stage and (iii) subject to certain provisions in the GSK Agreement,further develop the candidates to clinical “proof of concept” (a demonstrationof efficacy in humans). As of March 31, 2007, the Company had approximately$3.9 million of deferred revenue related to services that are to be provided toGSK by the Company subsequent to March 31, 2007.

**License Agreement with BMS**

Under the terms of itsagreement with BMS, in lieu of an up-front cash payment, the Company isproviding BMS a set of compound libraries, over a period of approximately threeyears following the execution of the agreement. The Company recorded a liability for the estimated fair value of thecompound library services, which was approximately $1.8 million as of March 31,2007. In the event the Company fails to deliver the aforementioned libraries toBMS, the Company would be required to make cash payments on a pro rata basis ofup to approximately $1.9 million as of March 31, 2007.

In addition, the Companywill pay BMS milestone payments upon the achievement of successive clinical andregulatory events in the United States and certain other jurisdictions, androyalties on sales of products, if any, resulting from the DARA program. InFebruary 2007, the Company initiated Phase 1 clinical trials for its productcandidate, PS433540. In connection with the initiation of the Phase 1 clinicaltrials, the Company paid BMS $1.0 million in April 2007. This amount wasrecorded in accrued liabilities as of March 31, 2007.

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**Collaboration and License Agreement with Cephalon**

**Under the Cephalon Agreement, the Company received anup-front, non-refundable payment of $15.0 million in June 2006 to support theCompany’s research efforts.  The Companyis principally responsible for performing medicinal chemistry research over thealliance term, as required by the Cephalon Agreement. As of March 31, 2007, theCompany had approximately $10.8 million of deferred revenue related to servicesthat are to be provided to Cephalon by the Company subsequent to March 31,2007.**

**Collaboration and License Agreement with Organon**

Under the Organon Agreement, the Company received anup-front, non-refundable payment of $15.0 million and $1.0 million in researchfunding in March 2007 to support the Company’s research efforts.  As of March 31, 2007, the Company hadapproximately $16.0 million of deferred revenue related to services that are tobe provided to Organon by the Company subsequent to March 31, 2007.

In addition, if the Company exercises itsdiscretionary termination right, under certain circumstances, it could besubject to a termination fee of $5.0 million. Whether or not the Company issubject to the termination fee is based upon when during the term of theOrganon Agreement the Company exercises its discretionary termination right.There will, however, be no instances where the deferred revenue associated withthe Organon Agreement would be amortized below $5.0 million until such time asthe Company is no longer subject to the termination fee.

**Research and License Agreement with Wyeth**

Under the Wyeth Agreement, the Company received anup-front, non-refundable payment of $5.0 million in January 2007 to support theCompany’s research efforts.  As of March31, 2007, the Company had approximately $4.6 million of deferred revenuerelated to services that are to be provided to Wyeth by the Company subsequentto March 31, 2007.

**Milestone andRoyalty Commitments**

**Under the terms of certain agreements to which the Companyis a party, it is possible that the Company may become obligated to payaggregate milestone payments totaling up to $238 million upon the achievementof successive clinical and regulatory events and royalties on sales ofproducts, if any, resulting from programs for which the Company has developmentresponsibility under such agreements. The Company will not be responsible for the payment of future milestoneand/or royalty payments in the event that development of such a program is discontinued.  Preclinical and clinical development of drugcandidates is a long, expensive and uncertain process.  At any stage of the preclinical or clinicaldevelopment process, the Company may decide to discontinue the development ofits product candidates.  To date, none ofthe compounds to which the Company holds complete or partial rights has reachedthe stage of commercial product.  TheCompany expects that its product candidates will not be commercially availablefor many years, if ever.**

**10**.   Related PartyTransaction

In May 2006, the Companyentered into the Cephalon Agreement.One of the Company’s directorscurrently serves as the Chairman and Chief Executive Officer of Cephalon.During the three months ended March 31, 2007, the Company recognized revenue ofapproximately $1.3 million relating to this collaboration.

**11.**          New AccountingPronouncements

**Fair Value Measurements**

In September 2006, the FinancialAccounting Standards Board (FASB) issued SFAS No. 157, “Fair ValueMeasurements,” (SFAS 157). SFAS 157 establishes a framework for measuring fairvalue in accordance with generally accepted accounting principles and expandsdisclosures about fair value measurements. SFAS 157 is effective for fiscalyears beginning after November 15, 2007 and interim periods within those fiscalyears. The Company is currently evaluating the impact that SFAS No. 157 willhave on its consolidated financial statements.

**12**.   Subsequent Event – Sale of Securities

**On May 7, 2007, the Company issued andsold approximately 8.1 million shares of the Company’s common stock at apurchase price per share of $5.00 as part of a public underwrittenoffering.  The aggregate gross proceedsof the transaction were approximately $40.3 million. The proceeds the Companyreceived from the transaction, net of transaction costs, were approximately$37.1 million.  The shares of commonstock were sold through a prospectus supplement pursuant to one of the Company’seffective shelf registration**

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**statements.**

**Item 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations.**

**FORWARD-LOOKINGSTATEMENTS**

This Report on Form 10-Q containsforward-looking statements regarding us and our business, financial condition,results of operations and prospects within the meaning of the PrivateSecurities Litigation Reform Act of 1995.  Such forward-looking statementsinclude those that express plans, anticipation, intent, contingency, goals,targets or future development and/or otherwise are not statements of historicalfact.  These forward-looking statements are based on our currentexpectations and projections about future events and they are subject to risksand uncertainties known and unknown that could cause actual results anddevelopments to differ materially from those expressed or implied in suchstatements.  These forward-looking statements include statements about thefollowing:

·                  our plansto develop PS433540, a product candidate from our DARA program;

·                  our Phase1 clinical studies and proposed Phase 2 clinical studies with respect toPS433540, including timing and expected outcomes of such studies;

·                  ourestimates of the market opportunity for our product candidates, including PS433540;

·                  our abilityto successfully perform under our collaborations with Cephalon,GlaxoSmithKline, Organon and Wyeth;

·                  ourability to build our pipeline of novel drug candidates through our owninternally-funded drug discovery and development programs, third partycollaborations and in-licensing;

·                  our abilityto raise additional capital;

·                  ourexpectations concerning the development priorities of our collaborators, theirability to successfully develop compounds and our receipt of milestones and royalties;

·                  ouranticipated operating results, financial condition, liquidity and capitalresources;

·                  ourexpectations concerning the legal protections afforded by U.S. andinternational patent laws;

·                  ourability to pursue the development of new compounds and other business matterswithout infringing the patent rights of others;

·                  our abilityto acquire or invest in complementary businesses or technologies; and

·                  additionalcompetition and changes in economic conditions.

In some cases, you can identify forward-lookingstatements by terminology, such as “goals,” or “expects,” “anticipates,” “intends,”“plans,” “believes,” “seeks,” “estimates,” or the negative of such terms orother similar expressions.  You are urged not to place undue reliance onany such forward-looking statements, any of which may turn out to be wrong dueto inaccurate assumptions, unknown risks, uncertainties or other factors.  Factors that could cause or contribute todifferences in results and outcomes from those in our forward-looking statementsinclude, without limitation, those discussed elsewhere in this Report in PartII, Item 1A. “Risk Factors” and in this Part I, Item 2, as well as thosediscussed in our other Securities and Exchange Commission (SEC) filings.

We urge you to carefully read and considerthe disclosures found in these filings, all of which are available in the SECEDGAR database at www.sec.gov.  Weundertake no obligation to (and expressly disclaim any such obligation to)revise or update the statements made herein or the risk factors that may relatethereto whether as a result of new information, future events or otherwise.

The following discussionsshould be read in conjunction with the section of this Report entitled “RiskFactors”.

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**TheCompany**

**Overview**

We are a biopharmaceuticalcompany committed to discovering and developing novel therapeutics to addresssignificant medical needs. Using proprietary technologies and processes, weseek to identify, optimize and develop novel drug candidates through our owninternally-funded drug discovery and development programs and in collaborationswith major pharmaceutical and biotechnology companies.  We have one internal program in Phase 1clinical development and several internal programs in advanced discovery.  Our collaborative research efforts haveresulted in a portfolio of five partnered programs in active human clinicaltrials, with four additional partnered programs in preclinical development.

PS433540, a product candidate we aredeveloping internally, is in Phase 1 clinical development. PS433540 is aDual-Acting angiotensin and endothelin Receptor Antagonist (DARA) that wein-licensed from BMS and that is being developed as a potential treatment forcardiovascular diseases, including most importantly hypertension and diabeticnephropathy.  Our licensing agreementwith BMS provides us with an exclusive license under certain BMS patents withrespect to worldwide development and commercialization of PS433540, as well ascertain other compounds discovered by BMS that possess DARA activity.  We believe that PS433540 administered as asingle agent has the potential to have a superior efficacy profile tomonotherapy with an angiotensin receptor blocker for the treatment ofhypertension and diabetic nephropathy. In April 2007, we announced positive results from our first Phase 1clinical study with PS433540.  In theevent that we achieve positive results in our additional Phase 1 studies, webelieve we will initiate a Phase 2 clinical trial for PS433540 in hypertensionin the first half of 2008 and complete a Phase 2 proof of concept study inhypertension in the second half of 2008.

We have concentrated ourinternal discovery programs primarily on diseases related to immunoregulation. Immunoregulatory indications could include rheumatoid arthritis, psoriasis,inflammatory bowel disease, multiple sclerosis and others. This focus builds onour expertise in the area, and also takes advantage of attractive commercialopportunities we believe exist. Our internal discovery efforts includedeveloping CCR1 antagonists to treat inflammatory diseases including rheumatoidarthritis and multiple sclerosis as well as programs directed at generatingJAK3 inhibitors for topical use in dermatological and ocular diseases. We havepartnered our JAK3 Inhibitors program with Wyeth for all indications and routesof delivery other than topical administration for dermatological and oculardiseases. We also have a discovery program focused on A2a antagonists to treatParkinson’s disease.  We fully fund theseprograms and retain intellectual property and ownership rights to any compoundsdiscovered. At an appropriate point, we may license one or more of thesecompounds or programs to a partner.

In addition to ourproprietary research and development, we currently have collaborations underwhich we are actively performing research and development activities withleading pharmaceutical and biotechnology companies, including Cephalon,GlaxoSmithKline, Organon and Wyeth.  Whileour collaborations with each of these companies vary, in each one we may havecertain development or commercialization rights. We also have othercollaborations with leading pharmaceutical and biotechnology companies,including Schering Corporation and Schering-Plough Ltd. (together Schering-Plough)and BMS, where we have completed our activities and the collaborator is nowresponsible for the development of potential therapeutic products. Ourcollaborative research efforts with Schering Plough and BMS have resulted in aportfolio that includes one partnered program currently in Phase 2 clinicaltrials targeting chronic obstructive pulmonary disease (COPD) and fourpartnered programs in active Phase 1 clinical trials targeting rheumatoidarthritis, oncology, metabolic and inflammatory diseases.

Associated with theseclinical development programs, we have received milestone payments fromSchering-Plough and BMS and, to the extent the compounds successfully progressthrough clinical development and registration, we will be entitled to receiveadditional milestone payments. We are also entitled to receive royalties on thecommercial sale, if any, of drugs resulting from these collaborations. However,numerous additional studies are required to fully assess the potential of theseclinical candidates before they reach the marketplace, and the results frompreclinical studies and clinical studies conducted to date with these compoundsare not necessarily indicative of the results that may be obtained in futureclinical studies.

In addition to thecompounds in clinical development, four more partnered programs are at variousstages of preclinical development, the point at which compounds are tested forsafety in animals and are subjected to other studies required prior to testingcompounds in humans.

Preclinical and clinicaldevelopment of drug candidates is a long, expensive and uncertain process. Wecontinue to pursue the discovery and development of product candidates in bothour internal and collaborative programs. The drug candidates described above areat early stages, and none have received regulatory approval for commercialsale. All of the compounds face the substantial risk of failure inherent indrug discovery and development. At any stage of the clinical developmentprocess, we or our collaborators may decide to discontinue development of ourproduct candidates. To date, none of the compounds in which we hold complete orpartial rights has reached the stage of a commercial product and, although wehave received license and milestone fees, we may never receive any salesrevenues, royalty payments, or any additional license and milestone fees, underour current or any future 

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collaborations. We do not expect that our productcandidates will be commercially available for many years, if ever.

From time to timewe have considered, and we will continue to consider strategic initiativesintended to further the development of our business. In addition, we consideropportunities to expand our product pipeline through the acquisition orin-licensing of, or investment in, product development candidates, and weintend to continue to explore those opportunities.

We were incorporated asPharmacopeia Drug Discovery, Inc. in February 2002 as a wholly ownedsubsidiary of Accelrys.  OnDecember 18, 2003, Accelrys announced its plans to spin-off 100 percent ofour shares in a pro rata tax-free distribution to its stockholders, subject tothe satisfaction of certain conditions.  On April 30, 2004,Accelrys completed the spin-off of us into an independent, separately tradedand publicly held company through the distribution to its stockholders of adividend of one share of our common stock for every two shares of Accelryscommon stock held.  Effective May 3,2007, we changed our name to Pharmacopeia, Inc.

**Liquidity and Capital Resources**

As of March 31, 2007, we had cash, cash equivalents andmarketable securities of $59.7 million compared to $46.1 million at December31, 2006, representing 80% and 70% of our total assets, respectively. We makeinvestments in highly liquid investment-grade marketable securities, includingcorporate bonds and United States government and agency securities. Inaddition, as of March 31, 2007, we had deferred revenue and other liabilitiesof approximately $37.7 million relating to research and development activitiesthat are to be provided by us subsequent to March 31, 2007, of which $22.6million was classified as long-term.

The following is a summary of selected cash flowinformation for the three months ended March 31, 2007 and 2006 (in thousands):
|                                                      | ** ** | **For the Three Months Ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                           | ** ** | **March 31,**                                 | ** ** |
| ** **                                           | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| Net loss                                             |       | $                                                  | (10,004    | ) | $ | (7,683 | ) |
| Adjustments for  noncash operating items             |       | 2,851                                              |       | 1,056 |   |
|                                                 |       |                                               |       |   |   |
| Net cash  operating loss                             |       | (7,153                                             | )          | (6,627 | ) |
| Net change in  assets and liabilities                |       | 20,618                                             |       | 1,366 |   |
|                                                 |       |                                               |       |   |   |
| Net provided by  (cash used) in operating activities |       | $                                                  | 13,465     |   | $ | (5,261 | ) |
|                                                 |       |                                               |       |   |   |
| Net cash  provided by investing activities           |       | 1,567                                              |       | 6,264 |   |
|                                                 |       |                                               |       |   |   |
| Net cash  provided by financing activities           |       | $                                                  | 517        |   | $ | 736 |   |

 

**Net cash provided by (used in) operatingactivities**

Net cash provided by operating activities for the threemonths ended March 31, 2007 resulted primarily from the receipt of a $5.0million upfront non-refundable payment received in January 2007 relating to theWyeth Agreement and a $15.0 million upfront non-refundable payment received inMarch 2007 relating to the Organon Agreement, offset by cash used to fund bothour proprietary internal drug research and development efforts, including ourPhase 1 clinical trials for PS433540, and the fulfillment of our research anddevelopment performance obligations under our collaborations. Absent thereceipt of the $20.0 million from Wyeth and Organon, our net cash used inoperating activities would have been approximately $6.5 million.  Net cash used in operating activities for thethree months ended March 31, 2006 was primarily due to cash used to fund ourproprietary and collaborative research and development efforts and the paymentof restructuring expenses related to the 2004 consolidation of our facilities.

**Net cash provided by investing activities**

Net cash provided by investing activities for the threemonths ended March 31, 2007 and 2006 related primarily to the net sales andmaturities of marketable securities, partially offset by capital expendituresfor laboratory and information technology equipment and software

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**Net cash provided by financingactivities**

Net cash provided by financing activities for the threemonths ended March 31, 2007 and 2006 consisted primarily of proceeds from theissuance of common stock in connection with exercises of stock options.

**Liquidity and Capital Resources Outlook**

We expect tocontinue to use our capital to fund our operations. We expect that our researchand development expenditures will continue to increase in the future as weincrease our internal drug research and development efforts. Conducting our owndrug research and development is a key component of our business model.PS433540, a product candidate from our DARA program that we are developinginternally, is currently in Phase 1 clinical trials.  Preclinical development studies and clinicaltrials are significant, time-consuming and costly processes. In addition, aspart of our collaborative agreements with Cephalon, GSK, Organon and Wyeth, wehave received up-front payments. In connection with these agreements, we areobligated to perform significant research and development activities overmultiple years and as such, expect to incur significant costs performing suchactivities.

**On May 7, 2007, we issued and soldapproximately 8.1 million shares of our common stock at a purchase price pershare of $5.00 as part of a public underwritten offering. The aggregate grossproceeds of the transaction were approximately $40.3 million.  The proceeds we received from thetransaction, net of transaction costs, were approximately $37.1 million.  The shares of common stock were sold througha prospectus supplement pursuant to one of our effective shelf registrationstatements.**

In connection withthe GSK Agreement, we may receive up to an additional $10.0 million from GSK,should we fulfill certain conditions related to initial discovery activitiesthat we will perform.

We anticipate thatour capital resources, including the net proceeds we received in connectionwith our May 2007 financing, will be adequate to fund our operations at theircurrent levels at least through December 31, 2008. However, there can be noassurance that changes will not occur that would consume available capitalresources before then.

Our capitalrequirements depend on competing technological and market developments, changesin our existing collaborative relationships, progress of PS433540 in clinicaltrials, the cost of filing, prosecuting, defending, and enforcing patent claimsand other intellectual property rights and the outcome of related litigation,the purchase of additional capital equipment, acquisitions of other businessesor technologies, and the progress of our collaborators’ milestone and royaltyproducing activities. We will need to raise additional funds to finance ouroperating activities or enter into strategic initiatives intended to furtherthe development of our business. There can be no assurance that additionalfunding, if necessary, will be available to us on favorable terms, if at all.Our forecasts of the period of time through which our financial resources willbe adequate to support our operations are forward-looking information andactual results could vary. The factors described earlier in this section willimpact our future capital requirements and the adequacy of our available funds.

**Resultsof Operations**

This sectionshould be read in conjunction with the discussion under “Liquidity and CapitalResources”.

**Three months ended March31, 2007 and 2006**

Our net revenue increased 54% to $6.3 million in the three months ended March 31, 2007 compared to $4.1 million in the three monthsended March 31,2006. Net revenue consists ofresearch and development efforts we perform under our various collaboration agreements,as well as our earning of milestones, success fees and license revenue if andas our discoveries progress through our collaborators’ development processes.Net revenue for the three months ended March 31, 2007 and 2006 is summarized as follows (in thousands):
|                                               | ** ** | **For the three months ended March 31,** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                                                               | ** ** | **2006** | ** ** |
|                                          |       |                                                                   |       |   |   |
| Collaborative  research revenue               |       | $                                                                      | 4,199      |   | $ | 2,991 |   |
| Milestones,  success fees and license revenue |       | 2,150                                                                  |       | 1,125 |   |
|                                          |       | $                                                                      | 6,349      |   | $ | 4,116 |   |

 

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Schering-Plough accounted for 28% and 63% of our net revenue in the threemonths ended March31, 2007 and 2006, respectively,including $1.0 million of our milestone and success fees revenue recorded ineach respective period.  Organonaccounted for 8% and 21% of our net revenue in the three months ended March 31,2007 and 2006, respectively.  Cephalonaccounted for 20% of our net revenue in the three months ended March 31, 2007.Our alliance with Cephalon commenced in May 2006 and therefore there was nocorresponding revenue in the three months ended March 31, 2006. Our alliancewith Wyeth began in January 2007, and accounted for 18% of our revenue in theperiod. Lastly, in the three months ended March 31, 2007, we earned $1.0million in milestone revenue from one of our collaborations with Biovitrum,which accounted for 16% of our revenue in the period.

The increase in collaborative research revenue in the three months endedMarch 31, 2007 was largely due to our new alliances with Cephalon, Wyeth, andGSK, partially offset by further reductions in the scope of our collaborationswith Schering-Plough and reduced research efforts on our Organon collaborationin March 2007 as the development of a new research plan for the OrganonAgreement, which was executed in February 2007, was in process.

Collaborativeresearch and development expense includes the labor, material, equipment andallocated facilities cost of our scientific staff that is working oncollaborative partnerships. Collaborative research and development expensesincreased 57% to $5.2 million in the three months ended March 31, 2007compared to $3.3 million in the three months ended March 31, 2006. This increase relates to an increasein resources allocated to our new collaborations with GSK, Cephalon and Wyeth.In December 2006, we entered into the Wyeth agreement in which we licensedcertain rights to our JAK3 program to Wyeth. Prior to January 2007, theresources that were deployed on the JAK3 program were accounted for inproprietary research and development expense. Resources deployed on our JAK3program, as they relate to programs for employing topical administration forocular and dermatological diseases, have been and will continue to be accountedfor in proprietary research and development as retain all rights to theseprograms. This increase was offset by reductions in resources allocated to ourcollaborations with Schering-Plough and reductions in resources deployed to ourOrganon collaboration in March 2007 as the development of a new research planfor the Organon Agreement was in process. Share-based compensation costsassociated with our adoption of SFAS 123R for the three months ended March 31,2007 and 2006 were $125 thousand and $78 thousand, respectively.

Proprietaryresearch and development expense includes research and development acquisitioncosts, labor, material, equipment and allocated facilities cost of scientificstaff working on self-funded internal drug discovery and development programs. Our mostadvanced internal program is our DARA program, which is in Phase 1 clinicaltrials. We licensed our DARA program from BMS in March 2006. In addition, wecurrently have several internal programs in advanced preclinical discovery.Proprietary research and development expenses increased 18% to $7.4 million inthe three months ended March 31, 2007 compared to $6.3 million in the threemonths ended March 31, 2006. Proprietary research and development expense forthe three months ended March 31, 2006 included a $2.0 million charge relatingto acquisition costs of the DARA program from BMS. Exclusive of this charge,the increase for the three months ended March 31, 2007 over the three monthsended March 31, 2006 was 73%, or $3.1 million. This increase was primarilyattributable to costs relating to the Phase 1 clinical trials for PS433540,including a $1.0 million milestone payment payable to BMS, and costs expendedon our CCR1 discovery program. The increase was offset by a decrease in costsrelated to our JAK3 program. As previously mentioned, certain aspects of ourJAK3 program were partnered with Wyeth in December 2006. The majority of thecosts previously incurred in proprietary research and development expense inprior periods, are now categorized as collaborative research and development.  Share-based compensation costs associatedwith our adoption of SFAS 123R for the three months ended March 31, 2007 and2006 were $73 thousand and $91 thousand, respectively. Because of thespeculative nature of these internal drug discovery and development projects,it is not possible to estimate completion dates or costs of completion.Additionally, from time to time, certain staff and other research anddevelopment resources may be temporarily redirected from one project toanother, which redirection may also delay or impact the cost of internal drugdiscovery and development projects.

General andadministrative expense increased by 10% to $2.7 million in the three monthsended March31, 2007 compared to $2.4 million in the three months ended March 31,2006.  The increase in general and administrative expense is attributableto increased legal, consulting, and share-based compensation costs during thethree months ending March 31, 2007. Share-based compensation costs associated with our adoption of SFAS 123Rfor the three months ended March 31, 2007 and 2006 were $292 thousand and $226thousand, respectively.

Interest and otherincome, net increased to $696 thousand in the three months ended March 31, 2007compared to $281 thousand in the three months ended March 31, 2006.  This increase is primarily dueto higher yields on our increased cash, cash equivalents, and marketablesecurities balances during the three months ended March 31, 2007 as compared tothe three months ended March 31,2006.

Increase inwarrant liability represents the increase in the fair value of the warrants weissued in connection with our equity financing in October 2006. The fair valueof the warrants is determined using the Black-Scholes option-pricing model.

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We recorded noincome tax provision for the three months ended March 31, 2007 as the minimumstate income taxes that we previously were subject to no longer apply due tostate legislative changes. For the three months ended March 31, 2006, werecorded an income tax provision of $9 thousand related to these minimum stateincome taxes.

As a result of thenet revenues and expenses described above, we generated a net loss of $10.0million ($0.50 per basic and diluted share) in the three months ended March 31, 2007,compared to a net loss of $7.7 million ($0.51 per basic and diluted share) inthe three months ended March31, 2006.

**Contractual Obligations**

For a discussionof our contractual obligations, see “Item 7. Management’s Discussion andAnalysis of Financial Condition and Results of Operations” in our report onForm 10-K for the year ended December 31, 2006. See discussion of theCollaboration and License Agreement with Organon in Note 2, as well as thecommitments and contingencies in Note 9, respectively to the unaudited consolidatedfinancial statements for new contractual obligations as of March 31, 2007.

**Net Loss Outlook**

We have had net losses in recent years and we expect to incur losses infuture periods. These losses are expected to increase as compared to priorperiods as a result of the increased level of investment we plan to make in ourinternal proprietary programs in the future. Our internal proprietary researchand development costs are expected to continue to increase due to our effortsto progress the DARA program, specifically our product candidate PS433540,through clinical trials.

Our net loss is highly dependent on the continued funding and success ofour research and development programs with our existing collaborators. Ourcollaborations with Schering-Plough ceased in April 2007.  We will continue to be entitled to paymentsresulting from the successful achievement by Schering-Plough, if any, ofpreclinical and clinical milestones as well as royalty payments from sales, ifany, of products resulting from compounds already delivered by us and acceptedby Schering-Plough under the collaborations.

The increase inour expected future losses from our proprietary programs may be partiallyoffset by revenue associated with our alliance with Cephalon that we enteredinto in June 2006, our partnering with Wyeth on our JAK3 kinase inhibitorprogram in December 2006 and our new agreement with Organon in February 2007.

Our adoption ofSFAS 123R, which was effective January 1, 2006, increased our compensationcosts and will continue to have a significant impact on our results ofoperations.  Changes in the fair value ofthe warrants we issued in October 2006 are reported in the statements ofoperations as income or expense. As such, changes to the market price of ourcommon stock or to the assumptions used in calculating the fair value of thewarrants may cause significant increases or decreases to our results ofoperations. However, neither the impact of share-based compensation costs, northe impact of changes in the fair value of the warrant liability will have animpact on our cash flows.

There is no assurance that we will ever achieve profitable operations, orthat profitable operations, if achieved, could be sustained on a continuingbasis.

**Critical AccountingPolicies and Estimates**

The preparation of ourfinancial statements and disclosures involve the use of judgments andestimates.  We believe the followingcritical accounting policies which we follow involve significant judgments anduse estimates.

*Revenue Recognition*

Contract revenue isgenerally recognized either (i) on a proportional performance basis, forcontracts specifying payment for services over a given period, or (ii) asservices are performed under the agreement for contracts specifying payment ona full-time employee basis.

Revenue earned related toup-front product and technology license fees is recognized in accordance withStaff Accounting Bulletin 104 issued by the SEC and EITF Issue 00-21, “RevenueArrangements with Multiple Deliverables” issued by the FASB. Accordingly,amounts received under multiple-element arrangements requiring ongoing servicesor performance by us are recognized over the period of such services orperformance.

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Revenue from milestonesis recognized when earned, as evidenced by written acknowledgement from thecollaborator, provided that (i) the milestone event is substantive, itsachievability was not reasonably assured at the inception of the agreement, andwe have no further performance obligations relating to that event, and(ii)  collectibility is reasonably assured.  If these criteria are not met, the milestonepayment is recognized over the remaining period of our performance obligationsunder the arrangement.  Royalties are recognizedas earned in accordance with the terms of various research and collaborationagreements.

*Share-basedCompensation*

Effective January 1,2006, we adopted the fair value recognition provisions of SFAS 123R, using themodified-prospective transition method. This statement is a revision to SFAS123, supersedes Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” (APB 25) and amends SFAS No. 95, “Statementof Cash Flows.”  Under this transitionmethod, compensation cost recognized includes compensation costs for allshare-based payments granted prior to, but not yet vested as of December 31,2005 based on the grant date fair value estimated in accordance with theoriginal provisions of SFAS 123, and compensation cost for all share-basedpayments granted subsequent to December 31, 2005 based on the grant date fairvalue estimated in accordance with provisions of SFAS 123R.

Under SFAS 123R, we usethe Black-Scholes option pricing model to estimate the fair value of theshare-based awards as of the grant date. The Black-Scholes model, by itsdesign, is highly complex and dependent upon key data inputs estimated bymanagement. The primary data inputs with the greatest degree of judgment arethe estimated lives of the share-based awards and the estimated volatility ofour stock price. The Black-Scholes model is sensitive to changes in these twodata inputs. Beginning in fiscal year 2006, we calculated the estimated life ofstock options granted using a “simplified” method, which is based on theaverage of the vesting term and the actual term of the option, as a result ofguidance from the SEC as contained in Staff Accounting Bulletin No. 107permitting the initial use of this method through 2007. Typically, expectedstock price volatility is based on the daily historical trading data from anappropriate point in time through the last day of the applicable period.Because our historical trading data only dates back to May 3, 2004, the date ofour spin-off from Accelrys, we have determined expected volatility for fiscalyear 2006 using an analysis of the stock price volatility of companiescomparable to ours in our industry.

*WarrantLiability*

We follow EITF00-19 in accounting for our warrants, which provides guidance fordistinguishing between permanent equity, temporary equity and assets andliabilities. Under EITF 00-19, to qualify as permanent equity, an equityderivative, including warrants, must permit us to settle in unregisteredshares. Under securities law, if the warrants were issued in connection with apublic offering and have a cash settlement feature at the holder’s option, theCompany does not have the ability to settle in unregistered shares. Therefore,the warrants cannot be classified as permanent equity and are insteadclassified as a liability. The approximately 1,450,000 warrants that we issuedas part of our equity financing in October 2006 meet this criteria, and theirfair value has been recorded as a liability in the accompanying balancesheets.  Other warrants we had previouslyissued qualify as permanent equity and do not require remeasurement.

We record ourwarrant liabilities at fair value using a Black-Scholes option-pricing modeland remeasure at each reporting date until the warrants are exercised or haveexpired. Changes in the fair value of the warrants are reported in thestatements of operations as income or expense. The fair value of the warrantscould be subject to significant fluctuation based on changes in our stockprice, expected volatility, expected life, the risk-free interest rate anddividend yield. The market price for our common stock has been and may continueto be volatile. Consequently, future fluctuations in the price of our commonstock may cause significant increases or decreases in the fair value of thewarrants issued in October 2006.

*Long-Lived Assets*

We review long-livedassets, including leasehold improvements, property and equipment, and acquiredtechnology rights, for impairment whenever events or changes in businesscircumstances indicate that the carrying amount of the assets may not be fullyrecoverable.  This requires us toestimate future cash flows related to these assets.  Actual results could differ from theseestimates, which may affect the carrying amount of assets and the actualamortization expense.  As ofMarch 31, 2007, we had long-lived assets with a net book value of $11.2million.

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*Accounting for Uncertain Tax Positions*

In June 2006, the FASBissued Interpretation No. 48, “Accounting for Uncertainty in Tax Positions – anInterpretation of FASB Statement No. 109” (FIN 48).  FIN 48 appliesto all open tax positions accounted for in accordance with SFAS No. 109, “Accountingfor Income Taxes” and is intended to result in increased relevance andcomparability in financial reporting of income taxes and to provide moreinformation about the uncertainty in income tax assets and liabilities. TheCompany adopted FIN 48, effective January 1, 2007, and has concluded that theCompany has no significant open tax positions as of March 31, 2007, and thus,such adoption had no impact on its income tax assets and liabilities.

**NewAccounting Pronouncements**

*Fair Value Measurements*

In September 2006, theFASB issued SFAS No. 157, “Fair Value Measurements,” (SFAS 157). SFAS 157establishes a framework for measuring fair value in accordance with generallyaccepted accounting principles and expands disclosures about fair valuemeasurements. SFAS 157 is effective for fiscal years beginning after November15, 2007, and interim periods within those fiscal years. We are currentlyevaluating the impact of SFAS No. 157 on our financial position and results ofoperations.

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

Our international salesgenerally are denominated in United States Dollars, and are, therefore, notexposed to changes in foreign currency exchange rates.

We do not use derivativefinancial instruments for trading or speculative purposes. However, weregularly invest excess cash in overnight repurchase agreements that aresubject to changes in short-term interest rates. We believe that the marketrisk arising from holding these financial instruments is minimal.

Our exposure to marketrisks associated with changes in interest rates relates primarily to theincrease or decrease in the amount of interest income earned on our investmentportfolio since we have minimal debt. We ensure the safety and preservation ofinvested funds by limiting default risks, market risk and reinvestment risk. Wemitigate default risk by investing in investment grade securities. Ahypothetical 100 basis point adverse move in interest rates along the entireinterest rate yield curve would not have materially affected the fair value ofour interest sensitive financial instruments as of March 31, 2007.

**Item4. Controls and Procedures**

For the threemonths ended March31, 2007, our management carried out an evaluation, under thesupervision and with the participation of our President and Chief ExecutiveOfficer and our Executive Vice President, Chief Financial Officer and Treasurer(our principal financial officer and chief accounting officer), of theeffectiveness of our disclosure controls and procedures pursuant toRules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, or theExchange Act, as of the end of the period covered by this report. Based uponthis evaluation, our President and Chief Executive Officer and our ExecutiveVice President, Chief Financial Officer and Treasurer concluded that as of March 31, 2007, ourdisclosure controls and procedures were effective to ensure that theinformation required to be disclosed by us in reports filed under the ExchangeAct was recorded, processed, summarized and reported within the time periodsspecified in the rules and forms of the SEC. Our management, including ourPresident and Chief Executive Officer and our Executive Vice President, ChiefFinancial Officer and Treasurer, does not expect that our disclosure controlsor our internal controls will prevent all errors and all fraud. A controlsystem, no matter how well designed and operated, cannot provide assurance thatthe objectives of the control system are met, and no evaluation of controls canprovide absolute assurance that all control issues and instances of fraud, ifany, within a company have been detected.

Additionally, ourPresident and Chief Executive Officer and our Executive Vice President, ChiefFinancial Officer and Treasurer determined that there were no changes in ourinternal control over financial reporting during the three month period ended March 31, 2007, thathave materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

**PART II. OTHER INFORMATION**

**Item 1.****     ****Legal Proceedings**

We are not currently aparty to any legal proceedings the negative outcome of which would have amaterial adverse effect on our business, financial condition or results ofoperations.

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**Item 1A.****   RiskFactors**

Our performance andfinancial results are subject to risks and uncertainties, including, but notlimited to, the specific risks disclosed in Item 1A. Risk Factors in our AnnualReport on Form 10-K for the year ended December 31, 2006. Except as notedbelow, there have been no material changes to the risk factors disclosed in theForm 10-K.

**RISKSRELATED TO OUR BUSINESS AND INDUSTRY**

***If we consume cash more quickly than expected, and if we areunable to raise additional capital, we may be forced to curtail operations.***

As of March 31,2007, we had cash, cash equivalents and marketable securities aggregating $59.7million. Additionally, we received approximately $37.1 million on May 7, 2007,representing the net proceeds from the sale of approximately 8.1 million sharesof our common stock in our May 2007 public underwritten offering. Also as ofMarch 31, 2007, we had deferred revenue and other liabilities of approximately$37.7 million relating to research and development activities that are to beprovided by us subsequent to March 31, 2007. We anticipate that our capitalresources on hand following the consummation of our May 2007 publicunderwritten offering will be adequate to fund our operations at their currentlevels at least through December 31, 2008. However, changes may occur that would cause us to consume availablecapital resources before that time. Examples of relevant potential changes thatcould impact our capital resources include:

·                  the costsassociated with our drug research and development activities, including thecosts associated with our Phase 1 and Phase 2 clinical developmentprograms for our product candidate PS433540 and additional costs we may incurif our development programs are delayed or are more expensive to implement thanwe currently anticipate;

·                  changes inexisting collaborative relationships, including the funding we receive inconnection with those relationships;

·                  the progress ofour milestone and royalty producing activities;

·                  acquisitions ofother businesses or technologies;

·                  the purchase ofadditional capital equipment;

·                  cash refunds wemay be required to make to GSK if, prior to March 24, 2011, we exercise ourdiscretionary termination right under the GSK Agreement;

·                  cash payments wemay be required to make to BMS if we fail to deliver certain compound librariesunder the BMS Agreement;

·                  cash payments wemay be required to make to Organon relating to a termination fee if, prior toAugust 2010, we exercise our discretionary termination right under the OrganonAgreement;

·                  penalties we maybe required to pay certain institutional investors that participated in theprivate placement transaction we closed in August 2005 if we fail to complywith certain covenants and obligations related to that transaction;

·                  competingtechnological and market developments; and

·                  the cost offiling, prosecuting, defending and enforcing patent claims and otherintellectual property rights, and the outcome of related litigation.

In May 2007, weraised capital through a public underwritten offering of common stock. Ourissuance of approximately 8.1 million shares of common stock in connection withthis financing resulted in significant dilution in the percentage ownership ofour stockholders that owned stock prior to the financing. It is likely that wewill raise capital in the future. The capital could be raised through public orprivate financings involving debt or common stock or other classes of ourequity. Further issuances of equity securities will further dilute ourstockholders’ percentage ownership.  Asof May 7, 2007, there were approximately 4,084,000 stock options outstandinggranted under our various equity compensation plans, and approximately 1,626,000warrants outstanding, which includes approximately 176,000 warrants issued inconnection with the GSK Agreement and approximately 1,450,000 warrants issuedin connection with our October 2006 financing transaction. These equityinstruments represent approximately 19% of our shares 

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outstanding at May 7,2007. The significant dilution represented by our outstanding warrants andequity compensation awards may make it more difficult for us to raiseadditional capital. Additional capital may not be available on favorable terms,or at all. If adequate funds are not available, we may be required to curtailoperations significantly or to obtain funds by entering into arrangements withcollaborative partners or others that may require us to relinquish rights tocertain of our technologies, products or potential markets that we would nototherwise relinquish.

***Because PS433540is in Phase 1 clinical development, there is a high risk that furtherdevelopment and testing will demonstrate that the product candidate is notsuitable for commercialization. In addition, because we exclusively licensedPS433540 from BMS, any dispute with BMS may adversely affect our ability todevelop and commercialize PS433540.***

We have no products thathave received regulatory approval for commercial sale. PS433540 is in Phase 1clinical development, and we face the substantial risks of failure inherent indeveloping drugs based on new technologies.

PS433540 must satisfyrigorous standards of safety and efficacy before the FDA and foreign regulatoryauthorities will approve it for commercial use. We will need to conductsignificant additional clinical trials to demonstrate the safety and efficacyof PS433540 to the satisfaction of the FDA and foreign regulatory authoritiesto obtain product approval.

Clinical development is along, expensive and uncertain process. It may take us many years to completeclinical trials, and failure can occur at any stage of trials. Success inpreclinical testing and early clinical trials does not ensure that laterclinical trials will be successful. We may suffer significant setbacks inadvanced clinical trials, even after promising results in earlier trials. Wemay not be able to enroll a sufficient number of patients to complete ourclinical trials in a timely manner. Based on results at any stage ofpreclinical testing or clinical trials, we may decide to discontinuedevelopment of PS433540.

We do not know whetherany future clinical trials of PS433540 will demonstrate sufficient safety andsufficient efficacy necessary to obtain the requisite regulatory approvals orwill result in marketable products. Our failure to adequately demonstrate thesafety and efficacy of PS433540 under development will prevent receipt of FDAand foreign regulatory approvals and, ultimately, their commercialization.

If there is any disputebetween us and BMS regarding our rights under the BMS Agreement, our ability todevelop and commercialize PS433540 may be adversely affected. Any loss of ourrights from BMS could delay or completely terminate our product developmentefforts for PS433540 and other compounds licensed from BMS.

***Our development of***PS433540 may be adverselyimpacted if our clinical trials show certain adverse effects reported by othercompanies in connection with clinical trials of their endothelin receptorantagonist (ERA) productcandidates.

Abnormal liver function test (LFT)results, which are indicative of potential liver toxicity, have been reportedby other companies as complications in their clinical trials of ERA productcandidates. Approval of PS433540 may be delayed or ultimately blocked bysuch concerns. If the results of any of our PS433540 clinicaltrials indicate abnormal LFTs, we may not receive regulatory approval to marketthe product candidate and our product candidate, if approved for marketing, maynot be able to compete with other products. There can be no assurance that thelack of LFT abnormalities seen with respect to PS433540 prior tonow will be confirmed by subsequent clinical trial results.

As developed by othercompanies, ERAsand angiotensin receptor blockers (ARBs) have also demonstrated teratogenicityin animals.  If approved for marketing, we assume that PS433450will be subject to a black box warning regarding teratogenicity and therefore may not beable to compete with other products that do not have a similar warning.

Prior clinical trials byother companies have also indicated that ERAs as a class of drugs may causeperipheral edema (fluid retention) in some patients. Consequently, PS433540 maynot be successfully developed as a treatment for heart failure or for use inpatients at risk for heart failure and may therefore have a more limited marketpotential than antihypertensives that are approved for the treatment of heartfailure.

***We had net losses in recent years and our futureprofitability is uncertain.***

During the threemonths ended March 31, 2007, we had a net loss of approximately $10.0million.  The net loss was primarily due to costs incurred in our internalproduct development efforts, including the costs of developing our DARA programand the research and development of our other product candidates.

We expect to incur losses in future periods and these losses are expectedto increase as compared to prior periods as a result of the increased level ofinvestment we plan to make in our internal proprietary programs in the future.

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Our adoption ofSFAS 123R, which was effective January 1, 2006, increased our compensationcosts and will continue to have a significant impact on our results ofoperations. In addition, under EITF 00-19, the accounting treatment of thewarrants that we issued in our October 2006 equity financing may have asignificant impact on our results of operations, depending on the volatility ofthe market price of our common stock and the assumptions used in calculatingthe fair value of the warrants.

On a quarterlybasis, our future operating results are likely to be highly volatile dependingupon our receipt of milestone payments from our collaborators. We may not receivemilestone payments on a regular basis or at all. Our ability to achieveprofitability, if ever, will be significantly impacted by the level ofinvestment we plan to make in our internal proprietary programs in the future,as well as the results of those programs.

Continuing net losses maylimit our ability to fund our operations and we may not generate income fromoperations in the future.

**Item 2.****     ****Unregistered Sales of EquitySecurities and Use of Proceeds**

**None.**

**Item 3.**      **Defaults upon Senior Securities**

None.

**Item 4.****     ****Submission of Matters to aVote of Security Holders.**

None.

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

On May 10, 2007,the Company entered into a severance agreement with Maria L. Webb, Ph.D., theCompany’s Vice President, Preclinical, Biological and PharmacologicalServices.  In the event Dr. Webb’s employment with the Company isterminated without “cause” or Dr. Webb terminates her employment for “goodreason”, then Dr. Webb is entitled, in addition to all accrued, unpaid basesalary and benefits, to (1) a lump sum payment of six (6) months’ basesalary, (2) within 30 days after the termination date, a pro rataportion of her target incentive bonus for the calendar year in which thetermination occurred, based on the number of full months employed during theyear, (3) continuation of group medical coverage until the earlier of six(6) months following the termination date or until Dr. Webb has obtainedcomparable medical coverage, and (4) exercise all vested options or otherincentive securities pursuant to the terms of the option agreements under whichgranted.  Dr. Webb must execute a release to receive payments and otherbenefits under the severance agreement.  During her employment and for aone year period after termination, Dr. Webb may not compete with the Company,solicit or divert any business or any customer from the Company, cause anyperson to not do business with the Company or solicit for employment a currentemployee or consultant of the Company.  In the event of termination due todisability, Dr. Webb will receive only those benefits provided under theCompany’s Long Term Disability Plan and her stock options will be treated underthe Disability section of the applicable plans under which they weregranted.

If Dr. Webb’semployment with the Company is terminated by the Company without “cause” or byDr. Webb for “good reason” at any time during the period commencingtwo (2) months before and ending twelve (12) months after a change incontrol, then she will receive (1) all unpaid compensation and benefitsaccrued up to the termination date, (2) a lump sum payment ofnine (9) months’ base salary in effect on termination date, (3) alump sum payment of seventy-five percent (75%) of her target incentive bonus,(4) group medical continuation coverage until the earlier of nine (9)months after her termination date or the date Dr. Webb obtains comparablemedical coverage, and (5) all unvested stock options or any other unvestedincentive securities will vest immediately and must be exercised by the earlierof one year following the termination date or the expiration of the optionterm.

Dr. Webb hasserved as our Vice President, Preclinical Research, Biological andPharmacological Sciences since May 2005. She was Vice President, Drug Discovery Research from April 2002 toMay 2005.  She served as VicePresident, Biology of the Pharmacopeia Drug Discovery division of our formerparent Accelrys from October 2000 to April 2002 and as ExecutiveDirector, Biology, from November 1999 to October 2000, Senior Director,Biology, from January 1999 to November 1999 and Director, Biologyfrom September 1996 to January 1999.

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**Item 6.****     ****Exhibits**
| Exhibits. | ** ** | ** **                                                                                                                                                                                                                                                                    |
|-----------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|      |       |                                                                                                                                                                                                                                                                          |
| 3.1       |       | Amended and Restated Certificate of Incorporation of  the Company. (1)                                                                                                                                                                                                        |
|      |       |                                                                                                                                                                                                                                                                          |
| 10.1      |       | Collaboration and License Agreement, amended and  restated effective as of February 8, 2007, between the Company and N.V.  Organon.(1)(2)                                                                                                                                     |
|      |       |                                                                                                                                                                                                                                                                          |
| 10.2      |       | Severance Agreement, dated May 10, 2007, between the  Company and Maria L. Webb, Ph.D. (1)(3)                                                                                                                                                                                 |
|      |       |                                                                                                                                                                                                                                                                          |
| 31.1      |       | Certification of the Principal Executive Officer of  Pharmacopeia, Inc. pursuant to Rule 13a-l4(a) of the Securities  Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.(1)                              |
|      |       |                                                                                                                                                                                                                                                                          |
| 31.2      |       | Certification of the Principal Financial Officer and  Chief Accounting Officer of Pharmacopeia, Inc. pursuant to  Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(1) |
|      |       |                                                                                                                                                                                                                                                                          |
| 32.1      |       | Certification of the Principal Executive Officer of  Pharmacopeia, Inc. pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(1)                                                                          |
|      |       |                                                                                                                                                                                                                                                                          |
| 32.2      |       | Certification of the Principal Financial Officer and  Chief Accounting Officer of Pharmacopeia, Inc. pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.(1)                                            |

 

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(1)             Filed herewith.

(2)             Confidentialtreatment of certain provisions of this exhibit has been requested.

(3)    Compensation plan or arrangement inwhich directors and executive officers are eligible to participate.

24

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.
|                                | PHARMACOPEIA, INC. |
|--------------------------------|--------------------|
|                           |               |   |
| Date:  May  10, 2007 | By:                | /s/ Leslie J. Browne, Ph.D. |
|                           |               | Leslie J. Browne, Ph.D. |
|                           |               | President, Chief Executive Officer  and Director |
|                           |               | (Principal Executive Officer) |
|                           |               |   |
|                           | By:                | /s/ Brian M. Posner |
|                           |               | Brian M. Posner |
|                           |               | Executive Vice President, |
|                           |               | Chief Financial Officer and Treasurer |
|                           |               | (Principal Financial Officer and Chief  Accounting Officer) |

 

25

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**PHARMACOPEIA, INC.**

**INDEX TOEXHIBITS**
| Exhibits. | ** ** | ** **                                                                                                                                                                                                                                                                     |
|-----------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|      |       |                                                                                                                                                                                                                                                                           |
| 3.1       |       | Amended and  Restated Certificate of Incorporation of the Company.(1)                                                                                                                                                                                                          |
|      |       |                                                                                                                                                                                                                                                                           |
| 10.1      |       | Collaboration  and License Agreement, amended and restated effective as of February 8, 2007,  between the Company and N.V. Organon. (1)(2)                                                                                                                                     |
|      |       |                                                                                                                                                                                                                                                                           |
| 10.2      |       | Severance  Agreement, dated May 10, 2007, between the Company and Maria L. Webb, Ph.D.  (1)(3)                                                                                                                                                                                 |
|      |       |                                                                                                                                                                                                                                                                           |
| 31.1      |       | Certification of  the Principal Executive Officer of Pharmacopeia, Inc. pursuant to  Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(1)                               |
|      |       |                                                                                                                                                                                                                                                                           |
| 31.2      |       | Certification of  the Principal Financial Officer and Chief Accounting Officer of Pharmacopeia, Inc.  pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as  amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.(1) |
|      |       |                                                                                                                                                                                                                                                                           |
| 32.1      |       | Certification of  the Principal Executive Officer of Pharmacopeia, Inc. pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.(1)                                                                          |
|      |       |                                                                                                                                                                                                                                                                           |
| 32.2      |       | Certification of  the Principal Financial Officer and Chief Accounting Officer of  Pharmacopeia, Inc. pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(1)                                             |

 

----

(1)             Filed herewith.

(2)             Confidentialtreatment of certain provisions of this exhibit has been requested.

(3)    Compensation plan or arrangement inwhich directors and executive officers are eligible to participate.

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