**UNITED STATES SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**Form 10-K**

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| x          | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                                                                                                                                |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | **For the  fiscal year ended December 31, 2005**                                                                                                                                                                                                               |
| **or**     |
| o          | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                                                                                                                            |
| ** ** | ** ** | **For the  transition period from                      to                    ** |

 

**Commissionfile number 000-27765**

**Symyx Technologies, Inc.**

*(Exact name of registrant asspecified in its charter)*

| **Delaware**                                                       |   | **77-0397908**                                               |
|--------------------------------------------------------------------|--------|--------------------------------------------------------------|
| *(State  or other jurisdiction of  incorporation or organization)* |   | *(IRS  Employer  Identification Number)*                     |
| **3100 Central Expressway  Santa Clara, California 95051**         |   | **(408) 764-2000**                                           |
| *(Address of principal executive  offices including zip code)*     |   | *(Registrant’s telephone number,  including area code)* |

 

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

**None**

**Securities registeredpursuant to Section 12(g) of the Act:**

**CommonStock, $0.001 Par Value**

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

Indicate by check markwhether the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.  o Yes  x No

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.  x Yes  o No

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part IIIof this Form 10-K or any amendment to this Form 10-K.  x

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definitions of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one).

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

 

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

The approximate aggregatemarket value of the registrant’s common stock held by non-affiliates as of June 30,2005 (the last business day of the registrant’s most recently completed secondfiscal quarter) was $877,740,000, based on the closing price for the commonstock on the Nasdaq National Market on such date. As of February 28, 2006,33,299,889 shares of Common Stock were outstanding.

**DOCUMENTS INCORPORATED BYREFERENCE**

Certainsections of the Proxy Statement to be filed in connection with the 2006 AnnualMeeting of Stockholders are incorporated by reference into Part III ofthis Annual Report on Form 10-K where indicated.

 

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**TABLE OF CONTENTS**

| ITEM       | ** **                                                                                                               | ** ** | ** ** | ** ** | **P****age** |
|------------|--------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|--------------|
|       | **Part I**                                                                                                          |       |       |
| 1.         | Business                                                                                                                 |       | 1          |       |
| 1A.        | Risk Factors                                                                                                             |       | 14         |       |
| 1B.        | Unresolved Staff Comments                                                                                                |       | 26         |       |
| 2.         | Properties                                                                                                               |       | 26         |       |
| 3.         | Legal Proceedings                                                                                                        |       | 26         |       |
| 4.         | Submission of Matters to a  Vote of Security Holders                                                                     |       | 26         |       |
| ** ** | **Part II**                                                                                                         |       |       |       |
| 5.         | Market for Registrant’s  Common Equity, Related Stockholder Matters and Issuer Purchases of  Equity Securities |       | 27         |       |
| 6.         | Selected Financial Data                                                                                                  |       | 29         |       |
| 7.         | Management’s Discussion and  Analysis of Financial Condition and Results of Operation                               |       | 30         |       |
| 7A.        | Quantitative and Qualitative  Disclosures About Market Risk                                                              |       | 49         |       |
| 8.         | Financial Statements and  Supplementary Data                                                                             |       | 50         |       |
| 9.         | Changes in and Disagreements  With Accountants on Accounting and Financial Disclosure                                    |       | 89         |       |
| 9A.        | Controls and Procedures                                                                                                  |       | 89         |       |
| 9B.        | Other Information                                                                                                        |       | 91         |       |
| ** ** | **Part III**                                                                                                        |       |       |       |
| 10.        | Directors and Executive  Officers of the Registrant                                                                      |       | 92         |       |
| 11.        | Executive Compensation                                                                                                   |       | 92         |       |
| 12.        | Security Ownership of  Certain Beneficial Owners and Management and Related Stockholder Matters                          |       | 92         |       |
| 13.        | Certain Relationships and  Related Transactions                                                                          |       | 92         |       |
| 14.        | Principal Accounting Fees  and Services                                                                                  |       | 92         |       |
| ** ** | **Part IV**                                                                                                         |       |       |       |
| 15.        | Exhibits and Financial  Statement Schedules                                                                              |       | 93         |       |
| Signatures |                                                                                                                     | 96         |       |

 

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**PART I**

**Item 1.**                        *Business*

*This discussion andother parts of this Annual Report on Form 10-K (“Report”), includingthe “Management’s Discussion and Analysis of Financial Condition and Results ofOperation,” contain forward-looking statements that involve risks anduncertainties, within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. These statements typically may be identified by the use offorward-looking words or phrases such as “may,” “will,” “believe,” “expect,” “plan,”“intend,” “goal,” “anticipate,” “should,” “planned,” “estimated,” “potential,”and “continue,” or the negative thereof or other comparable terminologyregarding beliefs, plans, expectations or intentions regarding the future. Thecautionary statements made in this Annual Report on Form 10-K shouldbe read as being applicable to all related forward-looking statements wheneverthey appear in this Annual Report on Form 10-K.*

*Forward-looking statements include, without limitation,statements regarding: our belief that we can help transform the chemical,energy, pharmaceutical, electronics, consumer goods, and automotive companiesby discovering break-through new materials faster and more cost effectively thanby using traditional methods; our ability to help transform how our customersperform research, by providing Symyx Tools, Symyx Software, and patentedmethods that they can apply to increase their research productivity; our beliefthat we will have a growing portfolio of intellectual property and that thisportfolio will create future source of revenue for us; our belief that we will continueto expand our capabilities through the development of new instruments andsoftware and enhanced versions of existing systems; our commitment to retainingour position as a leading company that develops and supplies high-throughputtechnologies; our intent to continue to enter into new collaborativearrangements; our expectations that new collaborations will come from existingpartners extending programs and undertaking new research initiatives as well asfrom new partners; our belief that we have created a growing pipeline ofmaterials that have emerged from our discovery platform; our expectation toreceive royalties from the sale of sensors, or that we could become a supplierof sensor modules; our belief that our proprietary database will emerge as apowerful tool in accelerating materials discovery by enabling our scientists tobenefit from the cumulative effect of our research; our belief that service isan important component of the value we offer our customers; our belief that oursupply arrangements are adequate and that there are no material constraints onthe sources and availability of materials; our belief that our success dependsupon our proprietary technology; that we will realize a revenue backlog in thefiscal year 2006 and beyond; our intent to augment the already committedrevenue base with new and extended collaborations, new tools sales, and newintellectual property and software licenses; our belief that our future successdepends in part upon our continued ability to hire and retain qualifiedpersonnel; our belief that we are in substantial compliance with environmentallaws and regulations; our expectations that ExxonMobil, Dow, and a select listof other companies will in aggregate continue to account for a substantialportion of our revenue for the foreseeable future and the loss of one or moreof these customers or collaborative partners would harm our business andoperating results; our belief that our success is partially dependent on ourability to successfully integrate the software acquired in connection with theacquisitions of IntelliChem, Inc. and Synthematix, Inc. with existingsoftware and each other; our belief that we may engage in additionalacquisitions and will expand our business focus in order to exploit technologyor market opportunities; our expectation that our quarterly results ofoperations will fluctuate; our belief that our collaborative agreements arestructured in a manner to enable us to minimize conflicts with ourcollaborators; our intention to continue to expand our international presencein order to increase our export sales; our expectation that the ultimate costto resolve our legal proceedings, claims and litigation arising in the ordinarycourse of business will not have a material adverse effect on our consolidatedfinancial position, results of operations, or cash flows; our belief that weare well positioned to capitalize on our investment in the technology,instrumentation and informatics necessary to pursue high-throughput discovery ofmaterials; our expectation that we will continue to generate revenue from theEuropean market through Symyx Tools sales, research collaboration service,license of our software, and license of our sensor technologies and intellectualproperty; our expectation that a significant portion of our total revenue willcontinue to be generated from a few*

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*key customers; our belief that our expanding customerbase will contribute to our expected growth of Symyx Tools revenue; our expectationthat our software revenue will continue to grow as we recognize revenue underthe ExxonMobil and Dow agreements; our anticipation that our customers willcommercialize an additional four materials during 2006 and that these materialswill contribute to our growth in Materials and Intellectual Property Licensingrevenue in the future; our expectation that the cost of products sold as apercentage of product sales will fluctuate from period to period; ouranticipation of an effective income tax rate close to our statutory rate of40.75% in 2006; our anticipation that our headcount will continue to increaseto meet the mix and level staffing required by the ExxonMobil and Dow alliancesand by the expansion of our business; our expectation to receive over $200million in revenue from ExxonMobil and over $120 million in revenue from Dowduring the five-year term of each of the alliances; our belief that revenuefrom our strategic alliances will greatly contribute to our expected growth inResearch Collaborations revenue in 2006 through 2009; our belief that expandingour customer base will contribute to our expected growth of Symyx Toolsrevenue; our belief that the demonstrated acceptance of our high-throughputexperimentation technology by our customers will lead to the expected growth inour license fee revenue in future years; our expectation to continue to devotesubstantial resources to research and development; our expectation thatresearch and development expenses will continue to increase; our expectationthat our sales, general and administrative expenses will increase; ouranticipation that our interest income in 2006 will be greater than 2005 due tothe impact of recent interest rate increases and our positive cash flows fromoperating and financing activities will continue to increase our averageinvestment balance; the expectation that the adoption of 123(R) willresult in additional expenses of between $7 million to $8 million, net of tax,or approximately $0.20 diluted loss per share, in 2006 and will reduce netoperating cash flows and increase net financing cash flows in periods afteradoption; our anticipation that the adoption of certain accounting standardswill not have a material impact on our consolidated financial statements; ourexpectation that we will continue to generate positive cash flow from ouroperating activities in the near future; our expectation to continue to makesignificant investments in the purchase of property and equipment to supportour expanding operations; our expectation to satisfy the obligations of ourprincipal and other commitments; our belief that our current cash,available-for-sale securities balances and the cash flows generated byoperations will be sufficient to satisfy our anticipated cash needs; our beliefthat we are not currently a party to any material pending legal proceedings andthat we may become subject to legal proceedings, claims and litigation arisingin the ordinary course of business; our belief that our insurance protection isreasonable in view of the nature and scope of our operations; our expectationto retain future earnings, if any, to support the development of our businessand that we do not anticipate that we will pay any cash dividends in theforeseeable future; our expectation for the annual amortization expense oftotal intangible assets to be approximately $4,116,000 in 2006, $3,469,000 in2007, $3,460,000 in 2008, $2,217,000 in 2009, $795,000 in 2010 and $390,000thereafter. The Private Securities Litigation Reform Act of 1995 provides a “safeharbor” for such forward-looking statement. In order to comply with the termsof the safe harbor, we note that a variety of factors could cause actualresults and experience to differ materially from the anticipated results orother expectations expressed in such forward-looking statements. Among thefactors that could cause actual results to differ materially are the factorsdetailed under the heading “Risk Factors.”*Such factors include but are not limited tothe following: the market may not accept our products and services; wemay lose one or more of our major customers or partners; we have concentratedreliance on certain major collaborators to successfully commercialize products;we depend on a limited number of suppliers and our manufacture of products maybe delayed if shipments from these suppliers are interrupted; the pace,quality or number of our discoveries of new materials may be inadequate; ourinability to compete with the greater financial, marketing, technical andcustomer service capabilities of our competitors; uncertainties as to patent protection and litigation; our futuregrowth strategy, including impact of acquisitions, mergers or other changes inbusiness strategy, could result in large one-time charges or disrupt our businessif integration or execution of such strategies is unsuccessful; lack ofinvestment income to support expanding operations; a limited customer base; assumptionsunderlying our critical accounting policies and system of internal ordisclosure controls may be incorrect, and there can be no assurance that suchsystems will succeed in achieving their goals of preventing misstatements,errors or fraud; general economic conditions in the United States and in majorEuropean and Asian markets; exposure to risks associated with export sales andoperations; future competition from new market entrants; exposure toclaims 

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*outside our insurance coverage; miscalculations in theassessment of our amortization calculations;*and natural disasters, power failures andother disasters. Given these uncertainties, readers are cautioned not to placeundue reliance on the forward-looking statements. All forward-lookingstatements and risk factors included in this document are made as of the filingdate hereof, based on information available to Symyx as of the filing datehereof, and Symyx assumes no obligation to update any forward-looking statementor risk factor. You should also consult the risk factors listed from time totime in the Company’s Reports on Form 10-Q and other SEC filings.

**General**

Symyx Technologies, Inc. (the “Company” or “Symyx”)is dedicated to helping customers maximize the effectiveness and success oftheir research and development programs. We develop and applyhigh-throughput research technologies and research software for customers inthe chemical, energy, pharmaceutical, electronics and other industries. Weperform research for customers using proprietary technologies to discover newand innovative materials, sell automated high-throughput instrumentation,license software for use in customers’ own laboratories, and license discoveredmaterials, sensors and intellectual property.

Symyx® wasincorporated in California on September 20, 1994 and completed areincorporation in the state of Delaware in February 1999. Symyx’sheadquarters and mailing address is 3100 Central Expressway, Santa Clara,California, 95051, and the telephone number at that location is (408) 764-2000.Our SEC filings are available free of charge through our website atwww.symyx.com. Our Common Stock trades on the Nasdaq National Market under thesymbol “SMMX.”

We help customersachieve high levels of research productivity by developing and applyinginnovative high-throughput research technologies and research software. We helpcustomers compete on a global basis by addressing their needs for:

·       Researchacceleration,

·       Innovation,

·       Controlof and visibility into research information, and

·       Costcompetitiveness.

We have a substantial intellectual property portfoliocovering our methodologies, discoveries, instruments and software, with 290issued patents and 380 patent applications filed worldwide.

Our diversifiedbusiness model provides complementary ways for us to work with our customersand to further our innovation and growth. We perform research for ourcustomers, sell high-throughput automated instruments called Symyx Tools,license Symyx Software, and license our discovered materials, sensors, and someof our intellectual property:

·       Wetypically perform research for customers on a collaborative basis in exclusivefields for which we receive research funding and royalties or other paymentsfrom the commercialization of materials we discover. In these collaborationsand in our internal research efforts, we seek to discover a broad range ofmaterials, including catalysts for the manufacturing of chemicals and plastics,polymers for a range of industrial applications, phosphors and other electronicmaterials.

·       SymyxTools focuses on providing automated instruments to accelerate experimentation,lower cost per experiment and improve results. For our pharmaceuticalcustomers, we sell Symyx Tools for use in pharmaceutical pre-clinical testing,including pre-formulations, liquid formulations, polymorph screening andprocess chemistry. For our chemical and energy customers, we sell Symyx Toolsfor use in catalyst and materials discovery, optimization, and formulation.

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·       SymyxSoftware captures and integrates research knowledge across globalorganizations, increasing research productivity and enabling better, fasterdecision-making through more efficient, enterprise-wide access to information.Symyx Software integrates the full spectrum of research processes, for bothhigh-throughput and conventional one-at-a-time experimentation. With customizedfront-end interfaces and a common storage system, our software enablesscientists to design experiments, automate their execution, capture, analyzeand present the results of the experiments, and store the data for futuremining, all on a single, integrated platform. Our electronic lab notebook (“ELN”)software applications facilitate data mining, experiment planning, datacollection and reporting. Our scientific software supports the entireexperimental process and offers integrated data management to enableenterprise-wide access to research information.

·       We license the materials wediscover for others to commercialize, in return for royalties or license fees.Some of these materials are discovered under our collaborations programs andsome through internal research efforts. We also license some of ourintellectual property, including sensors and methodology patents, in return forroyalties or license fees.

**Customers**

We have a track record of building enduringrelationships with customers in the chemical, energy, pharmaceutical,electronics and other industries, including several major universities. Ourcustomers apply our various offerings in flexible ways to meet their needs. Wehave long-term relationships with certain customers where we are committed toresearch collaboration projects and/or programs to transform a company’sresearch and development organization by applying a cross-section of ourofferings. We are able to narrowly define the fields in which we are performingresearch for our customers and give our customers research exclusivity incertain fields of interest. We work closely with customers to pair their domainexpertise with our advanced research technologies to yield significant globalcompetitive advantage for our customers.

Additionally, we work with customers in alliances,where our customers work with us across all of our business offerings under asubstantial, multi-year commitment. To date, we have such alliances in placewith the Exxon Mobil Corporation (“ExxonMobil”) and The Dow Chemical Company (“Dow”).Under the ExxonMobil alliance effective April 1, 2003, we are contractedto provide research services, develop and sell Symyx Tools systems, and licenseour software and intellectual property. The ExxonMobil alliance provides uswith an expected five-year revenue stream of over $200 million (of which $100.8million has been recognized as revenue through December 31, 2005) fromcurrently planned alliance activities, purchases of Symyx Tools systems, andlicensing fees and advance royalties. In addition, we are also entitled toreceive royalties from the commercialization of materials, processes, andproducts based on discoveries made in the fields covered by the agreement.Under the Dow alliance effective January 1, 2005, we are contracted toperform research in a number of exclusive areas, develop and provide our SymyxTools, and license our Symyx Software as well as certain intellectual property.Dow is obligated to make payments to us over the five-year term ofapproximately $120 million (of which $25.6 million has been recognized asrevenue through December 31, 2005). In addition, we are entitled toreceive royalties on commercialized discoveries resulting from thecollaborative research.

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Forthe fiscal years ended December 31, 2005, 2004, and 2003, the followingcustomers contributed more than 10% of our total revenue (in thousands):

| ** **                | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------|------------|---------------------------------------------|------------|
| ** **                | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| ExxonMobil                |       | $                                           | 42,254     |   | $ | 45,016 |   | $ | 21,945 |   |
| Merck                     |       | 1,535                                       |       | 3,553 |   | 8,410 |   |
| The Dow Chemical  Company |       | 26,765                                      |       | 4,420 |   | 4,350 |   |
| Undisclosed  Partner      |       | 146                                         |       | 2,427 |   | 6,657 |   |
| Total                     |       | $                                           | 70,700     |   | $ | 55,416 |   | $ | 41,362 |   |

 

For the fiscal years endedDecember 31, 2005, 2004, and 2003, approximately 17%, 22%, and 16%,respectively, of our total revenue was generated from sales to customerslocated in foreign countries.

**Industry Background**

Materials and their diverse properties contribute invital ways to many of the products in every day use. Examples include thecatalysts used in the manufacture of major chemicals, pharmaceuticals, plasticsand rubbers, the plastics in many of our household and office goods, andluminescent materials in lighting and computer and television screens.

Traditional materials discovery relies on an expensiveand time-consuming process of trial and error: making one material; testing it;then making a different material; testing it and so on. Traditional discoverymethods are not fast enough to keep pace with today’s growth expectations andthe trend to shorter product life cycles.

By applying miniaturization,parallelization, and automation to the discovery of high-value materials, webelieve that we can help transform chemical, energy, pharmaceutical,electronics, consumer goods, and automotive companies by discoveringbreak-through new materials faster and more cost-effectively than is possibleusing traditional methods. We can also help transform how our customers performresearch, by providing Symyx Tools, Symyx Software, patented methods, SymyxSensors and other innovations that they can apply to increase the researcheffectiveness and success of our customers’ research and development programs.

**Symyx Solution**

Our technologies include the rapid creation of largedirected libraries of materials that are then synthesized and tested using ourfully integrated high-throughput primary and secondary screens. During primaryscreening, unconventional methods are used to carry out experiments in largephase space — chemicals, temperatures, pressures, etc. — so that researcherscan identify the smaller areas to focus on. During secondary screening, moreexperiments are carried out to make a more detailed evaluation of the focusedareas. In conventional terms, creating and testing a single material isconsidered one experiment. Using our miniaturized, automated technology toexecute hundreds to thousands of experiments at a time, our scientists candramatically increase the probability of success and reduce the time and costsper experiment to discover new materials. For example, using traditional trial anderror methods, a team consisting of a chemist plus a technician could perform500 to 1,000 experiments per year. In our labs, that same team could perform upto 50,000 experiments per year. As a result, our scientists would generatesignificantly more data, increase the possibility of successful discoverieswithin that timeframe, and reduce the associated costs per experimentdramatically.

To achieve these efficiencies, we require extensivecapabilities in materials synthesis, screening, and data analysis. A particularchallenge is the ability to screen materials for a wide range of properties.For example, to discover a new catalyst, we need to screen how well it performsa specific chemical reaction, 

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and to discover a newpolymer, we need to screen for physical and mechanical properties such asmolecular weight and toughness.

As the pioneer inhigh-throughput materials science, we found no existing technology capable ofmeeting our synthesis, screening, and data analysis requirements. To addressthis challenge, we assembled a multi-disciplined team of people with expertisein the fields of inorganic, physical, polymer, and organic chemistries,physics, engineering, and software programming. This team has successfullydesigned, built, and validated a powerful array of highly specializedproprietary instruments and software. Our scientists can synthesize a widerange of materials and screen for properties including catalytic, chemical,physical, mechanical, electronic, and optical properties. In addition, we continueto expand our capabilities through the development of new instruments andsoftware and enhanced versions of existing systems.

**Symyx Offerings**

We are committed toretaining our position as a leading company that develops and supplieshigh-throughput technologies for the discovery of new materials withcommercially valuable properties. We have created several complementaryofferings in support of that objective, including Symyx ResearchCollaborations, Symyx Tools, Symyx Software, Symyx Sensors, and Materials andIntellectual Property (“Materials and IP”) Licensing.

***Symyx ResearchCollaborations***

The Symyx Research Collaborations program contributesgreatly toward the development of our intellectual property, including patentscovering methodology, composition of matter, instrumentation, and software. Inour Research Collaborations, we perform research for customers typically inexclusive fields, for which we receive research funding and rights todownstream royalties or other payments on materials we may discover.

We provide the platform technologies and effort, andour partners acquire rights to develop and commercialize resulting materialswithin their defined field of license. Typically, we enter into collaborativearrangements to discover materials that require considerable investment inproduct development and manufacturing, as well as extensive marketing efforts.Our collaborative partners have already developed the infrastructure to supportthese requirements, and may therefore be in a strong position to commercializeour discoveries.

Much of our collaborative research is focused on thechemicals industry, where we apply proprietary high-throughput technologiesaimed at making break-through discoveries leading to improved commercialprocesses and materials. Our technology innovations can help chemical companiesaddress the rising costs and manufacturing challenges presented by low-costcompeting producers overseas. We are working with leading companies to discovercatalysts for the manufacture of polyolefins and a variety of other commoditychemicals. The range of new technologies developed in these researchcollaborations — including instruments, software, methods, and materials  — results in a growing portfolio ofintellectual property that creates future source of revenue for Symyx.

We receive funding from our collaborative partnerstypically through quarterly research payments. These payments are made over theterm of the research contract, which is generally one to five years. If a newmaterial is discovered and commercialized, we typically receive rights toroyalties or other payments.

Under the typical collaborative arrangement, we own orcontrol all inventions pertaining to high-throughput methodology conceived andreduced to practice in connection with activities under the agreements and allknow-how and intellectual property rights related thereto. Our collaborativepartners typically receive exclusive rights in the defined field of theircollaborative agreement. The agreements are typically cancelable only in theevent of breach by either party or for other defined, limited reasons.

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We donot track fully burdened research and development costs or capital expendituresby project. However, based on hours spent on each project, we estimate the researchand development efforts undertaken for various projects were as follows:

| ** **                                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Projects funded  by collaboration partners |       |     | 73         | %        |       |     | 79         | % |   |   | 68 | % |   |
| Internally funded  research                |       |     | 5          | %        |       |     | 10         | % |   |   | 15 | % |   |
| Internal software  development             |       |     | 21         | %        |       |     | 5          | % |   |   | 7 | % |   |
| Internal tools  development                |       |     | 1          | %        |       |     | 6          | % |   |   | 10 | % |   |
| Total                                      |       |     | 100        | %        |       |     | 100        | % |   |   | 100 | % |   |

 

Due to the nature of our research and our dependenceon our collaborative partners to commercialize the results of the research, wecannot predict with any certainty whether any particular collaboration orresearch effort will ultimately result in a commercial product and thereforewhether we will achieve future milestones or royalty payments under our variouscollaborations.

In order to expand ourtechnologies and grow our product pipeline, we intend to continue to enter intonew collaborative arrangements. As a result of these new arrangements, and theconclusion of existing collaborations, our portfolio of collaborations willchange over time. We expect that new collaborations will come from existingpartners extending current programs and undertaking new research initiatives aswell as from new partners.

***Symyx Tools***

Through Symyx Tools, we leverage the power of ourinventions by selling automated instruments to pharmaceutical companies tospeed and improve preclinical testing of drug candidates, and to chemical andenergy companies for catalyst and other research. Symyx Tools may includehigh-throughput reactors, screening systems, robots and analytical equipment,all integrated with Symyx Software which facilitates the process of designing,executing, and evaluating chemical and material research and development.

Companies that purchase Symyx Tools from us are ableto implement high-throughput technologies at a great time and cost savingscompared to taking a license to operate from us and then developing andbuilding a system internally. These complete Symyx Tools systems, aimed ataccelerating research as well as product optimization and process development, enablescientists to increase their research effectiveness up to 100-fold.

We primarily sell Symyx Tools systems topharmaceutical and chemical companies. Pharmaceutical companies use ourinstrumentation to automate and improve pre-clinical research, including drugpolymorph, solubility studies and process optimization. The systems we sell topharmaceutical companies include pre-formulation workflows, solubilityworkflows, high pressure, or HiP, reactors, and Parallel Pressure Reactors, orPPR®.Chemical companies use our Symyx Tools systems to automate and integrate theirmaterial discovery and research and development processes. The systems we sellto chemical companies include our PPR system, fixed bed reactors, andhigh-temperature rapid GPC system, as well as a variety of systems designed totest polymer physical properties.

We offer our customers theflexibility of purchasing either complete systems or individualized systemcomponents. This approach allows customers to build full high-throughputexperimentation capability gradually with the assurance that they will be ableto integrate the systems and data management of different research processes atany time.

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***Symyx Software***

We license our Symyx Software to enhance experimentdesign, laboratory automation, data capture, data analysis and visualization,and data communication in high-throughput and traditional researchenvironments. Symyx Software facilitates the process of designing, executing,and evaluating chemical and material research and development. Symyx Softwareconsists of several related software applications, each focused on users andspecific to the actual day-to-day tasks of laboratory research.

In November 2004, we acquired IntelliChem, Inc.(“IntelliChem”) and in April 2005 we acquired Synthematix, Inc. (“Synthematix”).These two software acquisitions allowed us to further expand the offerings ofour software to include electronic lab notebook (“ELN”) software applicationssuch as data mining, experiment planning, data collection and reporting. SymyxSoftware now enables global access to research information.

Key aspects of oursoftware include the following:

·       Electronic laboratorynotebook software that provides uniform IP protection and project datamanagement across the enterprise, along with tailored user interfaces offeringimmediate direct benefit to scientists in medicinal chemistry as well aspharmaceutical and chemical development

·       Experimentaldesign and broad data capture capability applicable to conventional andautomated research

·       Flexible,vendor-independent laboratory automation for automated research

·       Enterprise-widereal time data warehousing, querying and reporting to support effective andtimely decision-making

Customers of our softwareinclude chemical, energy, and pharmaceutical customers, as well as otherindustrial customers seeking to improve and integrate their research datamanagement. Chemical, energy and other industrial companies may use oursoftware broadly across their research groups. Pharmaceutical and biotechnologycompanies may use Symyx Software to support their pre-clinical researchactivities as well as some pharmaceutical discovery research and chemicalsresearch.

***Symyx Sensors***

We have developed asolid-state mechanical resonator (“sensor”) technology for use in our own labsto test polymer viscosity, density, and other properties. We have determinedthat these sensors have many potential applications outside of the lab, and webegan an active program to license these sensors to industrial companies. One identifiedapplication of our sensor technology is for real-time, in-situ monitoring ofthe condition of motor oil in vehicles. Lubrication management assures bettervehicle performance, as oil condition can vary greatly based on environmentalconditions. We have developed relationships to introduce Symyx sensortechnology into both the passenger and commercial vehicle markets.Additionally, our sensors and technologies are also licensed and in developmentat other companies, including both an oil exploration company and for use inmonitoring polyethylene reactors. We expect to receive royalties from the saleof these sensors, or, in some cases, we could ultimately become a supplier ofthe sensor modules themselves.

***Materials and IPLicensing***

*Discovered Materials*

We discover and patent a range of materials in ourResearch Collaborations and internal research programs. These discoveredmaterials provide the foundation for our potential future royalties.

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Our portfolio ofdiscovered materials provides us with an array of licensing opportunities, andoffers a significant path to commercialization of new materials. Ourdiscoveries demonstrate the ability of our high-throughput researchtechnologies to address a range of materials for use in a variety of chemical andother industrial applications. As a result, we have created a growing pipelineof materials that have emerged from our discovery platform. At the time of thisfiling, our discoveries include 3 commercialized materials, 14 developmentcandidates and 10 emerging development candidates.

*Patents*

Launched in mid-2002, our patent licensingprogram leverages our established capabilities in the field of high-throughputmaterials discovery, including our broad-based research capabilities, validatedinstruments and software, and extensive know-how. Created to give companiesselective access to our broad methodology patents, this program offers aconstructive way to uphold the value of our intellectual property portfoliowhile expanding the ways in which we can work with potential customers.

We developed our patentlicensing program to accommodate companies that want to implementhigh-throughput materials research on a smaller scale — generally increasingtheir research productivity by approximately 10-fold. Because our patentlicenses typically are for a limited number of experiments or for a limitednumber of scientists’ use, this licensing approach complements our otherbusiness offerings by targeting research programs that are generally too smallto warrant investment in Symyx Research Collaborations or Symyx Tools. In thismanner, companies can benefit from our inventions by licensing our patents andpatent applications for a fee.

**Technology**

Our scientists begin thediscovery process by working with our collaborative partners or our ownbusiness development staff to define a research objective in terms of thespecific properties a new material should have to meet the needs of a givenapplication. We then apply the components of our combinatorialprocess — synthesis, screening and software — to seek to discovermaterials that match these criteria.

***Synthesis***

The materials research process begins with chemists’theories about what elements from the periodic table of elements might becombined to create new materials with desired properties. However, whilechemists working in traditional labs have to choose the few experiments theywill perform on a given day, our chemists have the ability to perform hundredsor thousands of experiments during the same time frame. Our chemists aretherefore able to pursue their theories both broadly, across a wide range ofelements, and comprehensively, quickly creating materials with the samecomponents, in different ratios.

A Symyx chemist initiates the synthesis process byusing our Symyx Software Library Studio® software application, a computer softwarepackage created by our programmers to design the group, or “library,” ofmaterials to be synthesized. These instructions, or “recipes,” are then relayedto synthesis instruments automated with our Symyx Software Impressionist® or Epoch® applications, eachbeing computer software packages that direct automated equipment functions.These instruments create the library on a single substrate such as a three-inchdiameter silicon wafer or a 96-well plate. The quantity of each compoundsynthesized is very small, generally ranging from micrograms to hundreds ofmilligrams. This contrasts dramatically with traditional synthesis, where gramsto kilogram quantities of a material are usually necessary. Librariessynthesized on silicon wafers may range from a few hundred different candidatematerials to several thousand, depending on the type of material and the typeof analysis to be done.

Each material synthesizedrepresents a unique experiment and potential discovery. The desired end resultof these experiments is defined at the outset of the experiment as a targetmaterial having specific performance properties. Our scientists, in conjunctionwith our collaborative partners, or independently 

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for our proprietarydiscovery programs, set the specific performance properties and define thedesired performance attributes of the target material for a given applicationor applications. Generally, these criteria are well beyond the performanceattributes of currently used materials.

***Screening***

Once created, the library of materials is analyzed fordesired properties. As with synthesis, our technical staff has designed andbuilt a broad array of instruments and software to evaluate differentproperties under a wide variety of process conditions. These properties includecatalytic, physical, mechanical, thermal, chemical, electronic, and opticalproperties. In general, a Symyx chemist can design, synthesize, and screen alibrary in a single day.

To reach the point ofcommercialization, a candidate material must progress through an increasinglystringent set of requirements, progressing from a hit to a lead to adevelopment candidate. First, we screen materials to identify those materialsthat have a limited set of properties defined for the target discovery, called “hits.”Hits are subjected to additional testing and optimization, to find a largernumber of desired properties. Hits may also identify areas that merit furtherexploration, and new libraries are created using this information. Candidatematerials that continue to meet or exceed the defined criteria are thenclassified as “leads.” Leads are then transferred to a partner or processedinternally for additional testing and scale up. Leads are tested on a largerscale, as bulk samples of, e.g. 1 to 100 grams, to confirm that the materialsstill perform at this “bench scale” level. Once a lead has passed this benchscale testing by either a collaborative partner or us, it may become adevelopment candidate. Finally, if all is successful, the decision may be madeto commercialize the material. Once a material has been identified as adevelopment candidate, the time to the first sale or commercial usage may be asshort as one to two years. For industrial catalysts to produce high volumecommodity chemicals, on the other hand, it may require five to seven or moreyears to reach the market because of the extensive process development,customer evaluation, and capital investment involved.

***Software***

A critical factor in ourdiscovery process is the ability to retain and access the huge amounts of datagenerated by our synthesis and screening activities. Given the broad acceptanceof high-throughput combinatorial discovery in pharmaceuticals, a number ofsoftware applications exist to support organic chemistry. However, thosesoftware applications were not sufficient to address the storage and retrievalneeds of our diverse array of inorganic, organometallic, and polymerchemistries. To that end, we have devoted considerable resources to build aproprietary database capable of addressing these needs. Our chemists can querythis database to identify materials screened in the past that possess theproperty or properties specified. We believe that this database will emerge asa powerful tool in accelerating materials discovery by enabling our scientiststo benefit from the cumulative effect of all of our research.

**Sales and Sales Support**

Our sales organization is comprised of approximately20 professionals in the United States, Europe, and Japan. We have dedicatedsales organizations targeting the chemicals/energy industries and thepharmaceutical/biotechnology industries.

We believe that service isan important component of the value we offer our customers. While salesrepresentatives have direct responsibility for account relationships, our salessupport group works closely with our customers to maximize the value of ouroffering. Our sales organization includes field application scientists whoparticipate in the pre-sales effort to the customers’ R&D managers, ITpersonnel, and product managers to gather a better understanding of customers’needs. Our sales organization also includes field service engineers dedicatedto post-sales support, who train users at our facilities in 

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Californiaand at customer sites, install instruments and software for customers, andprovide any customization requested by the customer.

**Assembly**

**We assemble and ship our SymyxTools systems at our facilities in California. As we assemble our systems, we generallymanufacture only critical components ourselves, usually components that containproprietary technology. When outside manufacturing is more efficient, wecontract with others for certain components. We use a wide range of suppliers.We believe our supply arrangements to be adequate and that there are nomaterial constraints on the sources and availability of materials. From time totime we rely on a single supplier for all of our requirements of a particularcomponent.**

**IntellectualProperty and Other Proprietary Rights**

Our success dependsupon our proprietary technology. The risks associated with patents andintellectual property are more fully discussed in the “Risk Factors” sectioncontained in Item 1A of this Annual Report on Form 10-K. There are fivegeneral areas that may be patented using our high-throughput approach:

·       librarysynthesis methods;

·       thelibraries themselves;

·       screeningor characterization methods;

·       equipmentand software; and

·       newmaterials and their uses.

During 2005, we wereissued 51 patents worldwide. Our patent portfolio as of year end 2005 consistedof 286 issued patents, including 242 United States patents, 18 Europeanpatents, and 26 patents in other countries, and approximately 380 patentapplications pending worldwide. These patents and applications covercomposition of matter, instruments, and methodology, and include issued patentswith broad claims in high-throughput combinatorial methodologies. We co-ownwith Lawrence Berkeley National Laboratory, on behalf of The Regents of theUniversity of California, 9 of the issued United States patents and 7 of theissued patents in other countries. We have an exclusive license to thesepatents and patent applications from Lawrence Berkeley National Laboratory,which was agreed to upon our formation. In addition to patents, we rely oncopyright, trademark and trade secret rights, confidentiality procedures, andlicensing arrangements to establish and protect our proprietary rights.

**Markets**

Symyx provides chemical,energy, pharmaceutical development, electronics, consumer goods, and automotivecustomers with materials and chemical solutions to increase their research anddevelopment effectiveness by achieving better results with shorter timelinesand lower costs. We realize value through collaborative research, the sale ofSymyx Tools, and the license of intellectual property, software, sensors, andmaterials. Our market opportunities fall into two primary areas: our customers’research and development expenditures and the market for sales of materials.

***Research andDevelopment (“R&D”) Expenditures Market***

Our customers in thevarious industries we serve have an aggregate R&D expenditure in excess of$10 billion annually and need to achieve an increased return on their R&Dinvestments. These investments include personnel costs in basic research anddiscovery, purchases of instruments, workflows and tools, and deployment ofsupporting informatics and software environments.

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***Materials Markets***

The materials we discovercover a broad range of applications, including catalysts for the manufacture ofplastics and commodity chemicals, polymers for industrial, consumer goods andlife science applications, and diverse electronic materials. Each of thesematerials typically may generate annual worldwide sales for our customers inthe range of $100 million to $500 million.

**Competition**

Among our high-throughput research technologyofferings, our competition consists chiefly of in-house efforts of certainchemical companies with internal high-throughput materials discovery programs.In addition, two European based companies, Avantium Technologies and HTE, mayalso use high-throughput approaches to materials discovery.

Furthermore, certain instrument manufacturers,including Chemspeed, Zinsser, and others, offer instruments that may competewith our Symyx Tools business area. Because high-throughput materialsexperimentation is an emerging field, competition for Symyx ResearchCollaborations and Symyx Tools could increase. In addition, other companies maybe addressing the same materials targets as we do and would representcompetition for our discovered materials.

We compete in thepharmaceutical research software market with companies like CambridgeSoftCorporation, and in more limited areas, with Mettler-Toledo International Inc.,and Waters Corporation.

**Backlog of Committed Revenue**

As of December 31,2005, our customers have contractually committed approximately $100 million ofour 2006 revenue for the purchase of Symyx Tools, licenses to Symyx Software,Symyx Sensors and intellectual property, and funding for research anddevelopment under collaborative agreements in 2006. We also have an additional$146 million in revenue backlog expected to be realized in fiscal 2007 andbeyond. As of December 31, 2004, our total backlog of committed revenue was$309 million. The decrease in backlog from 2004 to 2005 was primarily due tothe delivery of services and tools under our alliances with ExxonMobil and Dowduring 2005.

**Employees**

Currently we have a totalof approximately 350 employees, including over 250 scientific and technicalemployees and approximately 100 people in business development, legal, sales,and general and administrative services. Our headcount increased significantlyduring 2005 because of the expansion of our software group, the acquisition ofSynthematix in April 2005, and hiring of scientific and technicalemployees to fulfill the needs under our ExxonMobil and Dow alliances. None ofour employees is represented by a labor union, and we consider our employeerelations to be good. We believe that our future success depends in part uponour continued ability to hire and retain qualified personnel.

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**ExecutiveOfficers of the Registrant**

Setforth below is information regarding our executive officers as of February 28,2006:

| **Name of Executive Officer** | ** ** | ** ** | ** ** | **Age**                                               | ** ** | ** ** | **Position with the Company** | ** ** |
|-------------------------------|------------|------------|------------|-------------------------------------------------------|------------|------------|-------------------------------|------------|
| Steven D. Goldby(1)           |       | 65         |       | Chairman of the Board  and Chief Executive Officer    |
| Isy Goldwasser(2)             |       | 36         |       | President                                             |
| Jeryl L. Hilleman(3)          |       | 48         |       | Executive Vice President  and Chief Financial Officer |
| Paul J. Nowak(4)              |       | 51         |       | Executive Vice President  and Chief Operating Officer |
| W. Henry Weinberg(5)          |       | 61         |       | Executive Vice President  and Chief Technical Officer |

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(1)          Before joining Symyx in1998, Mr. Goldby served as Chief Executive Officer for more than ten yearsat MDL Information Systems, Inc., the enterprise software company thatpioneered scientific information management. Earlier, Mr. Goldby heldvarious management positions at ALZA Corporation, including President of AlzaPharmaceuticals. Mr. Goldby received a B.S. degree in chemistry from theUniversity of North Carolina and a law degree from Georgetown University LawCenter.

(2)          Mr. Goldwasser hasbeen with Symyx since its founding and was appointed President and ChiefOperating Officer in 1998. He is responsible for Symyx’s business developmentefforts. Mr. Goldwasser received a B.S. degree in chemical engineeringfrom the Massachusetts Institute of Technology and an M.S. degree in chemicalengineering from Stanford University.

(3)          Prior to joining Symyxin 1997, Ms. Hilleman served as Vice President Finance and Chief FinancialOfficer with two public biotechnology companies, Geron Corporation and CytelCorporation. Ms. Hilleman received her A.B. degree from Brown Universityand an M.B.A. from the Wharton Graduate School of Business. She was selected asa 1999 Crown Fellow by the Aspen Institute.

(4)          Mr. Nowak joinedSymyx in June 2004. Prior to Symyx, Mr. Nowak held a variety ofpositions with VWR International, including President and Chief OperatingOfficer of VWR International since January 2001. Mr. Nowak received aB.S. degree in biology from the State University of New York.

(5)          Dr. Weinberg joinedSymyx in 1996, and also remains an Adjunct Professor at the University ofCalifornia, Santa Barbara. Dr. Weinberg is a member of the NationalAcademy of Engineering and is widely known for his work on aspects of surfacechemistry and physics, heterogeneous catalysis, and combinatorial materialsscience. Dr. Weinberg obtained a B.S. degree in chemical engineering fromthe University of South Carolina, and a Ph.D. in chemical engineering from theUniversity of California, Berkeley.

There is no familyrelationship between any of the foregoing executive officers or between any ofsuch executive officers and any of the members of our Board of Directors. Ourexecutive officers serve at the discretion of the Board.

**Environmental Matters**

Our U.S. operations aresubject to federal, state, and local environmental laws and regulations. Wehave a number of proactive programs underway to minimize our impact on theenvironment, and we believe that we are in substantial compliance withenvironmental laws and regulations.

**CompanyWebsite and Available Information**

Our website can be found at www.symyx.com. The websitecontains information about Symyx and our operations. Copies of each of ourfilings with the SEC on Form 10-K, Form 10-Q, and Form 8-Kand all amendments to those reports can be viewed and downloaded free of chargeat our website when they are 

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filed with the SEC.Furthermore, any materials we file with the SEC may be read at the SEC’s PublicReference Room at 100 F Street, NE, Washington, DC 20549. Anyone may obtaininformation on the operation of the Public Reference Room by calling the SEC at1-800-SEC-0330.

Our website also containsour Corporate Governance Guidelines, charter and membership of the Board’sAudit, Compensation and Nominating and Governance Committees, as well as a Codeof Conduct and Ethics.

**Item 1A.**                *Risk Factors*

Set forth below andelsewhere in this Annual Report on Form 10 K and in other documents we filewith the SEC are risks and uncertainties that could cause actual results todiffer materially from the results contemplated by the forward-lookingstatements contained in this Annual Report on Form 10 K. These are not the onlyrisks and uncertainties facing us. Additional risks and uncertainties notpresently known to us or that we currently deem immaterial also may impair ourbusiness operations.

***Most of our revenue is generatedfrom a small number of key customers and the loss of a key customer couldsubstantially reduce our revenues and be perceived as a loss of momentum in ourbusiness***

Over time we have expandedour base of customers and collaborative partners, however, substantial portionsof our revenues are generated from a small number of companies. In particular,ExxonMobil and The Dow Chemical Company accounted for 39% and 25%,respectively, of our total revenue in 2005. We expect that ExxonMobil, The DowChemical Company, and a select list of other companies will in the aggregatecontinue to account for a substantial portion of our revenues for theforeseeable future and the loss of one or more of these customers orcollaborative partners would harm our business and operating results. Thecancellation of the ExxonMobil or The Dow Chemical Company strategic allianceor loss of another significant customer or collaborative partner could also beperceived as a loss of momentum in our business and have an adverse impact onour financial results, which may cause the market price of our common stock tofall.

***Failureto integrate our various software products and achieve customer acceptance ofthe electronic laboratory notebook technology would harm our revenue andoperating results***

We recently acquiredIntelliChem, Inc. and Synthematix, Inc., providers of electronic labnotebook software. Our success is partially dependent on our ability tosuccessfully integrate the software we acquired in these acquisitions with ourexisting software and with each other. If this integration is not successful orif the integrated software products do not achieve substantial market acceptanceamong new and existing customers, due to factors such as technologicalproblems, competition, pricing, sales execution or market shifts, it will havea material adverse effect on our revenues and operating results.

***Businessactivities such as the development of a new line of business or the acquisitionof a company or technology could disrupt our business, affect our operatingresults and distract our management team***

We have recently completedtwo acquisitions, and in the future, we may engage in additional acquisitionsand expand our business focus in order to exploit technology or marketopportunities. In the event of any future acquisitions, we may issue stock thatwould dilute our current stockholders’ percentage ownership, pay cash, incurdebts, or assume liabilities. We may not be able to successfully integrate ourrecently acquired business, IntelliChem, Inc. and Synthematix, Inc.,or any future acquired business, into our existing business in a timely andnon-disruptive manner or at all. In addition, acquisitions may adversely affectour operating results and could result in, among other things, large one-timecharges associated with acquired in-process research and development, futurewrite-offs of goodwill that is deemed to be impaired, restructuring chargesrelated to consolidation of operations, charges associated with 

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unknownor unforeseen liabilities of acquired businesses, increased general andadministrative expenses, and the loss of key employees. In the event that wedevelop a new line of business, our management’s attention may be diverted fromnormal daily operations of the business. Furthermore, an acquisition orbusiness expansion may not produce the revenues, earnings or business synergiesthat we anticipate. The time, capital management and other resources spent onan acquisition or business expansion that fails to meet our expectations couldcause our business and financial condition to be materially and adverselyaffected.

***We maynot be able to maintain and grow a profitable business***

Our ability tomaintain or increase our rate of profitability and grow our business isdependent on our ability to:

·       makediscoveries that our customers choose to commercialize that generate asubstantial stream of royalties and other revenue;

·       extendcurrent collaboration research and development arrangements and add new ones;

·       securenew Symyx Tools customers; and

·       addadditional licensees of both our software and intellectual property.

Our ability to achieve ourobjectives and maintain or increase the profitability of our business willdepend in large part on acceptance by potential customers of ourhigh-throughput screening technology and methodology as an effective tool inthe discovery of new materials. Historically, pharmaceutical and chemical companieshave conducted materials research and discovery activities internally usingtraditional manual discovery methods. In order for us to achieve our businessobjectives, we must convince these companies that our technology andcapabilities justify outsourcing part of their basic research and discoveryprograms. We cannot assure you that we will achieve the levels of customeracceptance that will be necessary for us to maintain and grow a profitablebusiness. A failure to achieve the necessary customer acceptance and extendcurrent collaborations and add new ones, secure new Symyx Tools customers, andadd additional licensees of our software and intellectual property wouldadversely affect our revenue and profitability and may cause our stock price todecrease.

***Failureto successfully commercialize our discoveries would reduce our revenues andprofitability and harm our business***

For us to achieve and sustain a significant level ofprofitability, we must continuously make discoveries with significant commercialpotential.

If we license our discovered materials, sensortechnologies, or methodologies to other companies, we typically do not receiveroyalties on sales of products by our partners until they have commencedcommercial sales of products containing our materials or produced using ourmethods. The commercialization of discovered materials can be a long andexpensive process and we cannot control our partners’ activities in thisregard. The failure of our partners to commercialize development candidatesresulting from our research efforts would reduce our future revenue and wouldharm our business and operating results. In addition, our partners may delay orcancel commercialization of development candidates which may harm our businessand operating results.

In order for us tocommercialize development candidates ourselves, we would need to develop, orobtain through outsourcing arrangements, the capability to manufacture, market,and sell products. We do not have this capability, and we may not be able todevelop or otherwise obtain the requisite manufacturing, marketing, and salescapabilities. If we are unable to successfully commercialize products resultingfrom our proprietary research efforts, our revenues and operating results woulddecline.

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***We are dependenton the research and development activities of companies in the chemical,energy, pharmaceutical, electronics, consumer goods, and automotive industries,and declines or reductions in research and development activities in theseindustries could harm our business***

The market for our discovery services,instrumentation, and software within the chemical, energy, pharmaceutical,electronics, consumer goods, and automotive industries depends on our customers’ability and willingness to invest in research and development. A majority ofour revenues are attributable to our collaborative arrangements with chemical,pharmaceutical, electronics, consumer goods, and automotive companies. Thesecontracts generally expire after a fixed period of time. If we cannot renewexisting contracts or enter into new collaborative arrangements, our businessand operating results may be harmed.

In particular, manycompanies in the chemical and pharmaceutical industries have, in the pastseveral years, experienced declining profitability or even losses. As a result,some chemical and pharmaceutical companies have reduced their research anddevelopment activities. In addition, many chemical products have becomecommodity products that compete primarily on the basis of price. Ifcommoditization of chemical products and other pressures affecting theindustry, including governmental regulations and governmental spending,continue in the future, more companies could adopt strategies that involvesignificant reductions in their research and development programs. Although webelieve that our approach can help chemical, energy, pharmaceutical,electronics, consumer goods, and automotive companies increase the efficiencyof their research and development activities, our efforts to convince them ofthis value may be unsuccessful. To the extent that these companies reduce theirresearch and development activities, they would be less likely to do businesswith us. As a result of current negative economic conditions, a number of thesecompanies have recently both reduced the size of their research and developmentbudgets as well as the size of their workforces. Decisions by these companiesto reduce their research and development activities could result in fewer orsmaller scale collaborations with us, fewer or smaller scale intellectualproperty and software licenses, fewer sales of our Symyx Tools systems andrelated licenses and products, or choosing not to work with Symyx, any of whichcould reduce our revenues and harm ourbusiness and operating results.

***We cannotpredict the pace, quality or number of discoveries we may generate, and anyinability of ours to generate a significant number of discoveries would reduceour revenues and harm our business***

Our future revenues andprofitability are dependent upon our ability to achieve discoveries, whetherthrough collaborations with customers or through our own proprietary research,which our partners or we choose to commercialize. Because of the inherentlyuncertain nature of research activities, we cannot predict with a high level ofprecision the pace with which we may generate discoveries or the quality of anydiscoveries that we may generate. Due to the uncertain nature of materialsdiscovery, in which several hundred thousand compounds must often be screenedto identify a single development candidate, we may not generate the number ofdiscoveries that we would expect to generate from a given number ofexperiments, or any discoveries at all. In addition, our development candidatesmay not result in products having the commercial potential our collaborators orwe anticipate. If this happens, our existing and potential new customers maynot renew or enter into new agreements with us. Consequently, our futurerevenues from our research collaborations and from commercialization of ourdiscovered materials would likely decline and harm our business and operatingresults.

***Difficultieswe may encounter managing our growth may divert resources and limit our abilityto successfully expand our operations***

We have experienced aperiod of rapid and substantial growth that has placed, and our anticipatedgrowth in the future will continue to place, a strain on our research,administrative, and operational infrastructure. As our operations expanddomestically and internationally, we will need to continue to manage multiplelocations and additional relationships with various collaborative partners,suppliers, and 

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otherthird parties. Our ability to manage our operations and growth effectivelyrequires us to continue to improve our reporting systems and procedures as wellas our operational, financial and management controls. In addition, recent SEC rules andregulations have increased the internal control and regulatory requirementsunder which we operate. We may not be able to successfully improve ourmanagement information and control systems to a level necessary to manage ourgrowth and we may discover deficiencies in existing systems and controls thatwe may not be able to remediate in an efficient or timely manner.

***Weconduct research programs for our own account and for a number of collaborativepartners, and any conflicts between these programs would harm our business***

Our strategy includesconducting research programs for our own account as well as for collaborativepartners. We believe that our collaborative agreements are structured in amanner to enable us to minimize conflicts with our collaborators relating torights to potentially overlapping leads developed through programs for our ownaccount and through programs funded by a collaborator, or through programsfunded by different collaborators. However, conflicts between a collaboratorand us, or between collaborators, could potentially arise. In this event, wemay become involved in a dispute with our collaborators regarding the material.Disputes of this nature could harm the relationship between us and ourcollaborators, and concerns regarding our proprietary research programs couldalso affect our ability to enter into new collaborative relationships and causeour revenues and operating results to decline.

***We have alimited number of contracts for the sale of Symyx Tools systems and for thelicensing of intellectual property, software, technologies, and materials todate, and we cannot assure you that we will be able to build a sustainablebusiness related to either the sale of additional systems or the licensing ofintellectual property, software, technologies, and materials***

To date, we have entered a growing but still limitednumber of contracts for our Symyx Tools systems. Because of the high cost andcomplexity of these systems, the sales cycle for them has been and is likely tocontinue to be long. Sales of these systems will require us to educate ourpotential customers about the full benefits of these systems, which may requiresignificant time.

Sales of SymyxTools systems and licensing of intellectual property, software, technologies,and materials will be subject to a number of significant risks over which wehave little or no control, including:

·       customers’budgetary constraints and internal acceptance review procedures;

·       customers’willingness to acknowledge the validity of our patent portfolio and their needto obtain a license to our intellectual property in order to undertake researchusing high-throughput combinatorial chemistry methods;

·       complexityof our systems and difficulties we may encounter in meeting individual customerspecifications and commitments on a timely basis;

·       ourability to build new systems and design software and workflows to meet thedemands of our customers;

·       customers’willingness to renew annual right to use software licenses;

·       thefact that there may be only a limited number of customers that are willing topurchase our larger systems or enter into licensing agreements with us;

·       along sales cycle that involves substantial human and capital resources; and

·       potentialdownturns in general or in industry specific economic conditions.

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If we are unable tocontinue to build the infrastructure to support Symyx Tools and intellectualproperty and software licensing, or if the sales or build cycles for SymyxTools systems lengthen unexpectedly, our revenues may decline or not grow asanticipated and our results from operations may be harmed.

***The lossof key personnel or the inability to attract and retain additional personnelcould have a material adverse effect on our results of operations***

We believe our futuresuccess will depend upon our ability to attract and retain highly skilledpersonnel, including key scientific and managerial personnel. As we seek toexpand our operations, the hiring of qualified scientific and technicalpersonnel will be difficult, as the number of people with experience inhigh-throughput materials science is limited and we may face competition forqualified professionals, especially in the San Francisco Bay Area, where we areheadquartered. Further, as we form new alliances with other collaborationpartners, we may need personnel with specific skill sets that may be difficultto locate or attract. Failure to attract and retain personnel, particularlyscientific and technical personnel, would impair our ability to grow ourbusiness and pursue new discovery initiatives and collaborative arrangements.

***Competitioncould increase, and competitive developments could render our technologiesobsolete or noncompetitive, which would reduce our revenues and harm ourbusiness***

The field ofhigh-throughput materials science is increasingly competitive. We are aware ofcompanies that may apply their expertise in high-throughput chemistry to theirinternal materials research and development programs. In addition, there arecompanies focusing on aspects of high-throughput chemistry for the discovery ofmaterials. In addition, academic and research institutions may seek to developtechnologies that would be competitive with our technologies for materialsdiscovery. Because high-throughput materials science is an emerging field,competition from additional entrants may increase. Our Symyx Tools and SymyxSoftware business groups are facing increasing competition from a number ofinstrument manufacturing and software companies. To the extent these companiesdevelop competing technologies, our own technologies, methodologies, systemsand workflows, and software could be rendered obsolete or noncompetitive. Wewould then experience a decline in our revenues and operating results.

***Ourinability to adequately protect our proprietary technologies could harm ourcompetitive position and have a material adverse effect on our business***

The success of our business depends, in part, on ourability to obtain patents and maintain adequate protection of our intellectualproperty for our technologies and products in the U.S. and other countries. Thelaws of some foreign countries do not protect proprietary rights to the sameextent as the laws of the U.S., and many companies have encountered significantproblems in protecting their proprietary rights in these foreign countries.These problems can be caused by, for example, a lack of rules andprocesses allowing for meaningfully defending intellectual property rights. Ifwe do not adequately protect our intellectual property, competitors may be ableto practice our technologies and erode our competitive advantage, and ourbusiness and operating results could be harmed.

The patent positions of technology companies,including our patent positions, are often uncertain and involve complex legaland factual questions. We will be able to protect our proprietary rights fromunauthorized use by third parties only to the extent that our proprietarytechnologies are covered by valid and enforceable patents or are effectivelymaintained as trade secrets. We apply for patents covering our technologies andproducts as we deem appropriate. However, we may not obtain patents on allinventions for which we seek patents, and any patents we obtain may bechallenged and may be narrowed in scope or extinguished as a result of suchchallenges. Our existing patents and any future patents we obtain may not 

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be sufficiently broad toprevent others from practicing our technologies or from developing competingproducts. Others may independently develop similar or alternative technologiesor design around our patented technologies or products. These companies wouldthen be able to offer research services and develop, manufacture and sellproducts that compete directly with our research services and products. In thatcase, our revenues and operating results would decline.

We rely upon trade secretprotection for certain of our confidential information. We have taken measuresto protect our confidential information. These measures may not provideadequate protection for our trade secrets or other confidential information. Weseek to protect our confidential information by entering into confidentialityagreements with employees, collaborators, and consultants. Nevertheless,employees, collaborators or consultants may still disclose or misuse ourconfidential information, and we may not be able to meaningfully protect ourtrade secrets. In addition, others may independently develop substantiallyequivalent information or techniques or otherwise gain access to our tradesecrets. Disclosure or misuse of our confidential information would harm ourcompetitive position and could cause our revenues and operating results todecline.

***Failureto adequately enforce our intellectual property rights could harm ourcompetitive position and have a material adverse effect on our business***

Our success depends on our ability to enforce ourintellectual property rights through either litigation or licensing. To besuccessful in enforcing our intellectual property through litigation orlicensing there are several aspects to consider, including maintaining thevalidity of our intellectual property, proving that others are infringing andobtaining a commercially significant outcome as a result of such infringement.Intellectual property litigation can be successful if our intellectual propertywithstands close scrutiny. If it does not withstand this scrutiny, we can losepart or all of our intellectual property position. In addition, we are involvedin several administrative proceedings, such as opposition proceedings in theEuropean Patent Office, that challenge the validity of the patents we have obtainedthere. If we lose part or all of our intellectual property position, whetherthrough litigation or opposition proceedings, our business and operatingresults may be harmed.

With regard to proving infringement of ourintellectual property, our success depends in part on obtaining useableknowledge of what technologies others are practicing. If others do not publishor disclose the technologies that they are using, our ability to discoverinfringing uses and enforce our intellectual property rights will diminish. Ifwe are unable to enforce our intellectual property rights or if the ability toenforce such rights diminishes, our revenues from intellectual propertylicensing and our operating results may decline.

Our intellectual propertymust protect our overall business structure by allowing us to obtaincommercially significant results from litigation, including compensation and/orrelevant injunctions, without resulting in undue cost and expense. Enforcementof our intellectual property through litigation can result in significantexpenses, distractions and risks that might cause us to lose focus or mayotherwise harm our profitability and weaken our intellectual property position.Enforcement proceedings can adversely affect our intellectual property whilecausing us to spend resources on the enforcement proceedings. As our licensingactivities have matured, we have become involved in arbitration and litigationto assert and defend our intellectual property. These matters may becomematerial and more such matters may arise. Successful conclusion of thesematters will assist our business, while unsuccessful conclusion of thesematters will cost us time and money and possibly loss of rights. Our ability tomanage the costs of these proceedings to obtain a successful result cannot bepredicted.

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***Ourbusiness may be harmed if we are found to infringe proprietary rights of others***

Our commercial successalso depends in part on ensuring we do not infringe patents or otherproprietary rights of third parties. Others have filed, and in the future arelikely to file, patent applications covering technologies that we may wish toutilize with our proprietary technologies, or products that are similar toproducts developed with the use of our technologies. If these patentapplications result in issued patents and we wish to use the claimedtechnology, we would need to obtain a license from the third party and thiswould increase our costs of operations and harm our operating results.

Third parties may assertthat we are employing their proprietary technology without authorization. Inaddition, third parties may obtain patents in the future and claim that use ofour technologies infringes these patents. We could incur substantial costs anddiversion of the time and attention of management and technical personnel indefending ourselves against any such claims. Furthermore, parties making claimsagainst us may be able to obtain injunctive or other equitable relief thatcould effectively block our ability to further develop, commercialize, and sellproducts, and such claims could result in the award of substantial damagesagainst us. In the event of a successful claim of infringement against us, wemay be required to pay damages and obtain one or more licenses from thirdparties. We may not be able to obtain these licenses at a reasonable cost, ifat all. In that event, we could encounter delays in product introductions whilewe attempt to develop alternative methods or products, or be required to ceasecommercializing affected products, which would harm our operating results.

***We expect that ourquarterly results of operations will fluctuate, and this fluctuation couldcause our stock price to decline, causing investor losses***

Our quarterlyoperating results have fluctuated in the past and are likely to do so in the future.These fluctuations could cause our stock price to fluctuate significantly ordecline. Revenues in future fiscal periods may be greater or less than revenuesin the immediately preceding period or in the comparable period of the prioryear. Some of the factors that could cause our operating results to fluctuateinclude:

·       expirationof research contracts with major collaborative partners, which may not berenewed or replaced with contracts with other companies;

·       thesuccess rate of our discovery efforts associated with milestones and royalties;

·       thetiming and willingness of partners to commercialize our discoveries that wouldresult in royalties;

·       developmentsor disputes concerning patent or other proprietary rights;

·       specialcharges related to acquisitions;

·       thesize and timing of customer orders for shipments of, and payments related to,Symyx Tools instrumentation;

·       thesize and timing of royalties we receive from third parties, including those wholicense our laboratory instruments and software for resale;

·       thesize and timing of internal research and development programs we undertake onan un-funded basis;

·       thesize and timing of both software and intellectual property licensing agreementswe may enter into;

·       changesin estimates and underlying assumptions related to our warranty expenseaccrual, inventory valuation reserve, and income tax valuation allowance;

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·       inaccurateassessment of demand for our products and services, including our software;

·       fluctuationsin the market values of our cash equivalents and short and long-terminvestments and in interest rates, including any gains or losses arising on thesale of these investments;

·       changesin accounting rules and regulations, including those related to revenuerecognition and accounting for stock options granted to employees; and

·       generaland industry specific economic conditions, which may affect our customers’capital investment levels and research and development investment decisions.

A large portion of our expenses, including expensesfor facilities, equipment, and personnel, are relatively fixed in nature.Accordingly, in the event revenues decline or do not grow as anticipated due toexpiration of research contracts, failure to obtain new contracts or otherfactors, we may not be able to correspondingly reduce our operating expenses.Failure to achieve anticipated levels of revenues could therefore significantlyharm our operating results.

Due to the possibility offluctuations in our revenues and expenses, we believe that quarter-to-quartercomparisons of our operating results are not a good indication of our futureperformance. As a result of these possible fluctuations, it is difficultfor our management to predict or estimate our quarterly or annualoperating results and to give accurate guidance. Our operating results in somequarters may not meet the expectations of stock market analysts and investors.In that case, our stock price would probably decline, and investors wouldexperience a decline in the value of their investment.

***Our stock price has been and may continue to bevolatile***

The market price ofour common stock since our initial public offering has been highly volatile.Volatility in the market price for our common stock will be affected by anumber of factors, including the following:

·       decisionsby significant stockholders to acquire or divest their stock holdings, giventhe relatively low average daily trading volumes we have historicallyexperienced;

·       theannouncement of new products or services by us or our competitors;

·       quarterlyvariations in our or our competitors’ results of operations;

·       failureto achieve operating results projected by securities analysts;

·       failureto achieve operating results within guidance provided by our senior management;

·       changesin earnings estimates or recommendations by securities analysts;

·       changesin management;

·       changesin investors’ beliefs as to the appropriate valuation ratios for us and ourcompetitors;

·       investors’perception that we have not validated parts of our business model;

·       changesin investors’ levels of risk aversion;

·       speculationin the press or analyst community;

·       developmentsin our industry;

·       changesin our growth rates; and

·       generalmarket conditions, political influences and other factors, including factorsunrelated to our operating performance or the operating performance of ourcompetitors.

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These factors andfluctuations, as well as general economic, political, and market conditions,may materially adversely affect the market price of our common stock. Securitiesclass action litigation is often brought against a company following periods ofvolatility in the market price of its securities. We may in the future be thetarget of similar litigation. Securities litigation, whether with or withoutmerit, could result in substantial costs and divert management’s attention andresources, which could harm our business and financial condition, as well asthe market price of our common stock. Additionally, volatility or a lack ofpositive performance in our stock price may adversely affect our ability toretain key employees, most of whom have been granted stock options.

***We depend on alimited number of suppliers and will be delayed in our manufacture or unable tomanufacture our Symyx Tools if shipments from these suppliers are delayed orinterrupted***

Key parts of our Symyx Tools systems are currentlyavailable only from a single source or a limited number of sources. Inaddition, components of our capital equipment are available from one or only afew suppliers. In the event that supplies from these vendors are delayed orinterrupted for any reason, we may not be able to get equipment or componentsfor Symyx Tools systems or our own research efforts in a timely fashion or insufficient quantities or under acceptable terms.

Even if alternativesources of supply are available, it could be time-consuming and expensive forus to qualify new vendors and integrate their components into our Symyx Toolssystems. In addition, we are dependent on our vendors to provide components ofappropriate quality and reliability. Consequently, in the event that suppliesfrom these vendors were delayed or interrupted for any reason, we could bedelayed in our ability to develop and deliver products.

***Our investments could lose market value andconsequently harm our ability to fund continuing operations***

The primary objective of our investment activities isto preserve principal while at the same time maximizing yields withoutsignificantly increasing risk. To achieve this objective, we maintain ourportfolio of cash equivalents, short-term and long-term investments in avariety of securities, including government and corporate obligations and moneymarket funds. These securities are generally classified as available-for-saleand consequently are recorded on the balance sheet at fair value withunrealized gains or losses reported as a separate component of accumulatedother comprehensive income (loss), net of estimated tax. The market values ofthese investments may fluctuate due to market conditions and other conditionsover which we have no control. Fluctuations in the market price and valuationsof these securities may require us to record losses due to impairment in thevalue of the securities underlying our investment. This could result in futurecharges on our earnings. All securities are held in U.S. currency.

Investments in both fixedrate and floating rate interest earning instruments carry varying degrees ofinterest rate risk. Fixed rate securities may have their fair market value adverselyimpacted due to a rise in interest rates. In general, securities with longermaturities are subject to greater interest rate risk than those with shortermaturities. Although floating rate securities generally are subject to lessinterest rate risk than fixed rate securities, floating rate securities mayproduce less income than expected if interest rates decrease. Due in part tothese factors, our investment income may fall short of expectations or we maysuffer losses in principal if securities are sold that have declined in marketvalue due to changes in interest rates.

***Changes inaccounting standards regarding stock option plans have limited the desirabilityof granting stock options, which may harm our ability to attract and retainemployees, reduce our profitability and may affect our stock price***

We are required to adopt SFASNo. 123(R), *Share-Based Payment,*on January 1,2006. This statement requires us to treat the value of stock options granted toemployees as an expense. The adoption of this 

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statementwill reduce the attractiveness of granting stock options because the additionalexpense associated with these grants will reduce our profitability. However,stock-based compensation is an important employee recruitment and retentiontool, and we may not be able to attract and retain key personnel if we reducethe scope of our employee stock programs. We may need to limit the use ofstock-based compensation and continue to explore other compensation plans toassist in employee recruitment and retention. We cannot determine how investorswill view the change in accounting treatment of stock-based compensation andthe change in our practices and how these changes may impact our stock priceand perception of the value of our company.

***Failure to maintaineffective internal controls in accordance with Section 404 of theSarbanes-Oxley Act could have a material adverse effect on our business andstock price***

Each year we are requiredto document and test our internal control procedures in order to satisfy therequirements of Section 404 of the Sarbanes-Oxley Act, which requiresannual management assessments of the effectiveness of our internal controlsover financial reporting and a report by our Independent Registered PublicAccounting Firm addressing these assessments and the effectiveness of internalcontrol over financial reporting. During the course of our testing we mayidentify deficiencies that we are required to remediate in order to comply withthe requirements of Section 404. In addition, if we fail to maintain theadequacy of our internal controls, as such standards are modified, supplementedor amended from time to time, we may not be able to ensure that we can concludeon an ongoing basis that we have effective internal controls over financialreporting in accordance with Section 404 of the Sarbanes-Oxley Act.Furthermore, there are certain areas of accounting such as income tax thatinvolve extremely complex rules that vary by country, where an innocenterror, not misconduct, could be deemed to be a significant deficiency or amaterial weakness in our internal controls. Failure to maintain an effectiveinternal control environment could have a material adverse effect on our stockprice.

***If our products contain defects, it could harm our revenuesand expose us to litigation***

The products we offer are internally complex and,despite extensive testing and quality control, may contain errors or defects,especially when we first introduce them. We may need to issue correctivereleases of our software products to fix any defects or errors. Any defects orerrors could also cause injury to personnel and/or damage to our reputation andresult in increased costs, loss of revenues, product returns or ordercancellations, or lack of market acceptance of our products. Accordingly, anydefects or errors could have a material and adverse effect on our business,results of operations and financial condition.

Our license agreementswith our customers typically contain provisions designed to limit our exposure topotential product liability claims. It is possible, however, that thelimitation of liability provisions contained in our license agreements may notbe effective as a result of existing or future federal, state or local laws orordinances or unfavorable judicial decisions. Although we have not experiencedany product liability claims to date, sale and support of our products entailsthe risk of such claims, which could be substantial in light of our customers’use of such products in mission-critical applications. If a claimant brings aproduct liability claim against us, it could have a material adverse effect onour business, results of operations and financial condition. Our productsinteroperate with many parts of complicated computer systems, such asmainframes, servers, personal computers, application software, databases,operating systems and data transformation software. Failure of any one of theseparts could cause all or large parts of computer systems to fail. In suchcircumstances, it may be difficult to determine which part failed, and it islikely that customers will bring a lawsuit against several suppliers. Even ifour software is not at fault, we could suffer material expense and materialdiversion of management time in defending any such lawsuits.

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***We are exposed to general global economic and marketconditions***

Our business is subject tothe effects of general economic conditions in the United States, Europe, Asia,and globally, and, in particular, market conditions in the pharmaceutical andchemical industries. In recent quarters, our ability to conclude Symyx Toolssale agreements and research and development collaborative arrangements havebeen adversely affected as a result of unfavorable economic conditions andreduced capital spending in the United States, Europe, and Asia. If theeconomic conditions in the United States and globally do not improve, or if weexperience a worsening in the global economic slowdown, we may experiencematerial adverse impacts on our business, operating results, and financialcondition.

***We are exposed torisks associated with export sales and operations that may limit our ability togenerate revenue from our products and intellectual property***

We have recentlyestablished operations in certain parts of Europe and Asia. We intend tocontinue to expand our international presence in order to increase our exportsales. Export sales to international customers and operating in foreigncountries entail a number of risks, including:

·       obtainingand enforcing intellectual property rights under a variety of foreign laws;

·       unexpectedchanges in, or impositions of, legislative or regulatory requirements;

·       delaysresulting from difficulty in obtaining export licenses for certain technology,and tariffs, quotas, and other trade barriers and restrictions;

·       longerpayment cycles and greater difficulty in accounts receivable collection;

·       potentiallyadverse taxes;

·       currencyexchange fluctuations;

·       greaterdifficulties in maintaining and enforcing U.S. accounting and public reportingstandards;

·       greaterdifficulties in staffing and managing foreign operations;

·       theburdens of complying with a variety of foreign laws; and

·       otherfactors beyond our control.

We are also subject togeneral geopolitical risks in connection with international operations, such aspolitical, social and economic instability, terrorism, potential hostilities,changes in diplomatic and trade relationships, and disease outbreaks. Althoughto date we have not experienced any material adverse effect on our operationsas a result of such regulatory, geopolitical and other factors, we cannotassure investors that such factors will not have a material adverse effect onour business, financial condition and operating results or require us to modifyour current business practices.

***Any inability ofours to keep pace with technological advances and evolving industry standardswould harm our business***

The market for ourproducts is characterized by continuing technological development, evolvingindustry standards and changing customer requirements. Due to increasingcompetition in our field, it is likely that the pace of innovation andtechnological change will increase. Our success depends upon our ability toenhance existing products and services and to respond to changing customerrequirements. Failure to develop and introduce new products and services, orenhancements to existing products, in a timely manner in response to changingmarket conditions, industry standards or other customer requirements would harmour future revenues and our business and operating results.

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***We use hazardousmaterials in our business, and any claims relating to improper handling,storage or disposal of these materials could subject us to significantliabilities***

Our business involves the useof a broad range of hazardous chemicals and materials. Environmental lawsimpose stringent civil and criminal penalties for improper handling, disposaland storage of these materials. In addition, in the event of an improper orunauthorized release of, or exposure of individuals to, hazardous materials, wecould be subject to civil damages due to personal injury or property damagecaused by the release or exposure. A failure to comply with environmental lawscould result in fines and the revocation of environmental permits, which couldprevent us from conducting our business. Accordingly, any violation ofenvironmental laws or failure to properly handle, store or dispose of hazardousmaterials could result in restrictions on our ability to operate our businessand could require us to incur potentially significant costs for personalinjuries, property damage and environmental cleanup and remediation.

***Our facilities arelocated near known earthquake fault zones, and the occurrence of an earthquakeor other disaster could cause damage to our facilities and equipment and harmour business***

Our facilities are locatedin the Silicon Valley near known earthquake fault zones and are vulnerable todamage from earthquakes. In October 1989, a major earthquake that causedsignificant property damage and a number of fatalities struck this area. We arealso vulnerable to damage from other types of disasters, including fire,floods, power outages or losses, communications failures and similar events. Ifany disaster were to occur, our ability to operate our business at ourfacilities would be seriously, or potentially completely, impaired. Inaddition, the unique nature of our research activities and of much of ourequipment could make it difficult for us to recover from a disaster. We do notcarry earthquake insurance on the property that we own and the insurance we domaintain may not be adequate to cover our losses resulting from disasters orother business interruptions. Accordingly, an earthquake or other disaster couldharm our business and operating results.

***Some of ourexisting stockholders can exert control over us, and may not make decisionsthat are in the best interests of all stockholders***

Our officers, directorsand principal stockholders (greater than 5% stockholders) together controlapproximately 37% of our outstanding common stock. As a result, thesestockholders, if they act together, will be able to exert a significant degreeof influence over our management and affairs and over matters requiringstockholder approval, including the election of directors and approval ofsignificant corporate transactions. This concentration of ownership may havethe effect of delaying or preventing a change in control of Symyx and mightaffect the market price of our common stock, even when such a change may be inthe best interests of all stockholders.

***Provisions of ourcharter documents may have anti-takeover effects that could prevent a change inour control, even if this would be beneficial to stockholders***

Provisions of ouramended and restated certificate of incorporation, bylaws and Delaware lawcould make it more difficult for a third party to acquire us, even if doing sowould be beneficial to our stockholders. These provisions include:

·       aclassified Board of Directors, in which our board is divided into three classeswith three-year terms with only one class elected at each annual meeting ofstockholders, which means that a holder of a majority of our common stock willneed two annual meetings of stockholders to gain control of the Board;

·       aprovision which prohibits our stockholders from acting by written consentwithout a meeting;

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·       aprovision which permits only the Board of Directors, the President or theChairman to call special meetings of stockholders; and

·       aprovision which requires advance notice of items of business to be broughtbefore stockholders meetings.

These provisions can beamended only with the vote of the holders of 66 2/3% of our outstanding capitalstock.

**Item 1B.**               *Unresolved Staff Comments*

None.

**Item 2.**                        *Properties*

Our facilities currentlyconsist of an aggregate of 147,000 square feet of office, research, andlaboratory space in several locations in California, New Jersey, NorthCarolina, Oregon, and other states and countries. We own the 39,000 square-footbuilding at 3100 Central Expressway, Santa Clara, California and lease theremaining office spaces under lease agreements that expire from April 2006to November 2015.

**Item 3.**                        *Legal Proceedings*

We are currently not a party to any legal proceedingsthat we believe to be material.

We may become subject tolegal proceedings, claims, and litigation arising in the ordinary course ofbusiness. Although the outcome of these matters is currently not determinable,management does not expect that the ultimate costs to resolve these matterswill have a material adverse effect on our consolidated financial position,results of operations, or cash flows.

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

None.

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**PART II**

**Item 5.**                        *Market for Registrant’s Common Equity, Related Stockholder Matters andIssuer Purchases of Equity Securities*

Ourcommon stock is traded on the Nasdaq National Market System under the symbol of“SMMX.” The following table sets forth, for the period indicated, the low andhigh bid prices per share for our common stock as reported by the NasdaqNational Market.

| ** **     | ** ** | **High**   | ** ** | **Low**    | ** ** |
|----------------|------------|------------|------------|------------|------------|
| **2004**       | ** ** | ** ** | ** ** | ** ** | ** ** |
| First Quarter  |       | $          | 29.95      |       | $          | 20.61 |   |
| Second Quarter |       | $          | 30.22      |       | $          | 22.40 |   |
| Third Quarter  |       | $          | 24.26      |       | $          | 16.51 |   |
| Fourth Quarter |       | $          | 32.20      |       | $          | 22.05 |   |
| **2005**       | ** ** | ** ** | ** ** | ** ** | ** ** |
| First Quarter  |       | $          | 30.61      |       | $          | 21.61 |   |
| Second Quarter |       | $          | 28.49      |       | $          | 21.47 |   |
| Third Quarter  |       | $          | 31.09      |       | $          | 24.01 |   |
| Fourth Quarter |       | $          | 28.77      |       | $          | 22.84 |   |

 

As of February 28, 2006, there were approximately136 holders of record of our common stock.

No dividends have been paid on our common stock sinceour inception and we currently intend to retain all future earnings, if any,for use in our business and do not anticipate paying any cash dividends in theforeseeable future.

We have not repurchasedany of our common stock during the year ended December 31, 2005.

**EquityCompensation Plan Information**

Thefollowing table provides information as of December 31, 2005 with respectto our shares of common stock that may be issued under our existing equitycompensation plans.

| **Plan Category**                                          | ** ** | ** ** | ** ** | **A  Number of Securities to  Be Issued Upon  Exercise of Outstanding  Options** | ** ** | **B  Weighted Average  Exercise Price of  Outstanding  Options** | ** ** | **C  Number of Securities  Remaining Available for  Future Issuance Under  Equity Compensation Plans  (Excluding Securities  Reflected in Column A)** | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  Compensation Plans Approved by Stockholders(1)     |       |       | 7,692,025  | (3)                                                                                                                 |       |                                                                            | $          | 25.93                                                                                                                                                                                                             |       |   |   | 2,019,118 | (4) |   |
| Equity  Compensation Plans Not Approved by Stockholders(2) |       |       | 401,787    |                                                                                                                |       |                                                                            | $          | 25.57                                                                                                                                                                                                             |       |   |   | 655,999 |   |   |
| **Total**                                                       |       |       | 8,093,812  |                                                                                                                |       |                                                                            | $          | 25.91                                                                                                                                                                                                             |       |   |   | 2,675,117 |   |   |

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(1)          Consists of the 1996Stock Option Plan, 1997 Stock Option Plan and the 1999 Employee Stock PurchasePlan.

(2)          Consists ofIntelliChem, Inc. 2003 Stock Option Plan assumed in connection with theacquisition of IntelliChem on November 30, 2004, theSynthematix, Inc. 2000 Equity Compensation Plan, as amended, assumed inconnection with the acquisition of Synthematix on April 1, 2005, and the2001 Non-statutory Stock Option Plan. A description of these plans is availablein Note 4 of the Notes to Consolidated Financial Statements.

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(3)          Excludes purchase rightsaccruing under our 1999 Employee Stock Purchase Plan which has a stockholderapproved reserve of 1,547,295 shares as of December 31, 2005. Under the1999 Employee Stock Purchase Plan, each eligible employee may purchase up to amaximum of 10,000 shares per annum of common stock at semi-annual intervals onthe last U.S. business day of April and October each year at apurchase price per share equal to 85% of the lower of (i) the closingselling price per share of common stock on the employee’s entry date into thetwo-year offering period in which that semi-annual purchase date occurs or(ii) the closing selling price per share on the semi-annual purchase date.Eligible employees may defer up to 10% of their salary, but not to exceed$25,000, in any calendar year, to purchase shares under this Plan. 

(4)          Consists of sharesavailable for future issuance under our 1996 Stock Option Plan, 1997 Stock OptionPlan and the 1999 Employee Stock Purchase Plan. As of December 31, 2005,an aggregate of 1,547,295 shares of common stock were available for issuanceunder the 1999 Employee Stock Purchase Plan and 471,823 shares of common stockwere available for issuance under the 1996 Stock Option Plan and 1997 StockOption Plan. The 1999 Employee Stock Purchase Plan provides for annualincreases in the number of shares available for issuance under the Plan on thefirst day of each fiscal year, equal to the lesser of 1% of the outstandingshares of common stock on the first day of the fiscal year, 350,000 shares, ora lesser amount as determined by our Board of Directors. The 1997 Stock OptionPlan provides for an annual increase in the number of shares of common stockreserved for issuance equal to the lesser of 1,500,000 shares, 4% of theoutstanding shares on the date of the annual increase, or a lesser amount asdetermined by our Board of Directors.

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**Item 6.**                        *Selected Financial Data*

Thefollowing selected historical information has been derived from our auditedfinancial statements. The financial information as of December 31, 2005and 2004 and for each of the three years in the period ended December 31,2005 are derived from audited financial statements included elsewhere in thisAnnual Report on Form 10-K. The table should be read in conjunctionwith Item 7, “Management’s Discussion and Analysis of Financial Condition andResults of Operation,” and Item 8, “Financial Statements and SupplementaryData.”

| ** **                                                            | ** ** | **For the Years Ended December 31,**      | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                            | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                            | ** ** | **(In thousands, except per share data)** | ** ** |
| **Consolidated Statements of Operations Data:**                       | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue:                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| Service revenue                                                       |       | $                                                                  | 56,980     |   | $ | 42,251 |   | $ | 38,689 |   | $ | 35,397 |   | $ | 42,629 |   |
| Product sales                                                         |       | 26,663                                                             |       | 27,060 |   | 14,458 |   | 25,877 |   | 14,216 |   |
| License fees and  royalties                                           |       | 24,494                                                             |       | 13,874 |   | 9,816 |   | 3,547 |   | 3,175 |   |
| Total revenue                                                         |       | 108,137                                                            |       | 83,185 |   | 62,963 |   | 64,821 |   | 60,020 |   |
| Operating expenses:                                                   |       |                                                               |       |   |   |   |   |   |   |   |   |
| Cost of products sold                                                 |       | 11,090                                                             |       | 7,857 |   | 2,937 |   | 6,239 |   | 6,591 |   |
| Research and development                                              |       | 50,660                                                             |       | 41,142 |   | 40,058 |   | 39,307 |   | 38,718 |   |
| Sales, general and  administrative                                    |       | 25,566                                                             |       | 18,007 |   | 14,933 |   | 14,592 |   | 12,524 |   |
| Acquired in-process  research and  development                        |       | 1,590                                                              |       | 2,260 |   | — |   | — |   | — |   |
| Amortization of  intangible assets arising from business combinations |       | 3,515                                                              |       | 231 |   | — |   | — |   | — |   |
| Total operating expenses                                              |       | 92,421                                                             |       | 69,497 |   | 57,928 |   | 60,138 |   | 57,833 |   |
| Income from operations                                                |       | 15,716                                                             |       | 13,688 |   | 5,035 |   | 4,683 |   | 2,187 |   |
| Interest and other  income                                            |       | 4,427                                                              |       | 2,521 |   | 1,996 |   | 3,269 |   | 6,117 |   |
| Interest and other  expense                                           |       | —                                                             |       | — |   | — |   | (9 | ) | (660 | ) |
| Income before income tax  expense                                     |       | 20,143                                                             |       | 16,209 |   | 7,031 |   | 7,943 |   | 7,644 |   |
| Income tax expense                                                    |       | 8,141                                                              |       | 3,327 |   | 1,290 |   | 2,657 |   | 1,306 |   |
| Net income                                                            |       | $                                                                  | 12,002     |   | $ | 12,882 |   | $ | 5,741 |   | $ | 5,286 |   | $ | 6,338 |   |
| Basic net income per  share                                           |       | $                                                                  | 0.37       |   | $ | 0.40 |   | $ | 0.18 |   | $ | 0.17 |   | $ | 0.21 |   |
| Shares used in computing  basic net income per share             |       | 32,819                                                             |       | 32,067 |   | 31,199 |   | 30,647 |   | 29,904 |   |
| Diluted net income per  share                                         |       | $                                                                  | 0.35       |   | $ | 0.38 |   | $ | 0.18 |   | $ | 0.17 |   | $ | 0.20 |   |
| Shares used in computing diluted net income per share            |       | 34,564                                                             |       | 33,872 |   | 32,470 |   | 31,638 |   | 31,196 |   |

 

| ** **                                                    | ** ** | **December 31,**   | ** ** |
|---------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                    | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                    | ** ** | **(In thousands)** | ** ** |
| **Consolidated  Balance Sheet Data:**                         | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash, cash equivalents and available-for-sale securities |       | $                       | 168,625    |   | $ | 136,541 |   | $ | 138,698 |   | $ | 118,020 |   | $ | 113,326 |   |
| Working capital                                               |       | 162,237                 |       | 142,361 |   | 131,154 |   | 118,363 |   | 101,925 |   |
| Goodwill and intangible assets                                |       | 32,065                  |       | 24,397 |   | 856 |   | 910 |   | 1,335 |   |
| Total assets                                                  |       | 241,412                 |       | 207,002 |   | 177,536 |   | 157,368 |   | 151,070 |   |
| Total stockholders’ equity                               |       | 218,529                 |       | 191,009 |   | 159,438 |   | 145,483 |   | 134,497 |   |
|                                                               |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**Item 7.**                        *Management’s Discussion and Analysis of Financial Condition and Resultsof Operation*

*All percentage amounts and ratios were calculatedusing the underlying data in thousands. Operating results for the year ended December 31,2005, are not necessarily indicative of the results that may be expected forfuture fiscal years. The following discussion and analysis should be read inconjunction with our historical financial statements and the notes to thosefinancial statements that are included in Item 8 of Part II of this AnnualReport on Form 10-K.*

**Overview**

We have been a public company for six years, and havebuilt upon our broad technology platform to establish ourselves as a profitablecompany with several complementary operating business areas. Since our initialpublic offering in 1999, our revenue has increased at a compounded averageannual rate of 23%, and we have been profitable since the first quarter of2001.

Since our inception, wehave invested heavily in establishing the technology, instrumentation, andsoftware necessary to transform traditional research and development and pursuehigh-throughput discovery of materials. Through our Research Collaborations andour own internal research, we continue to develop high-throughput technologiesfor discovery of new materials. We apply our expertise in high-throughputresearch technologies to offer an expanding line of Symyx Tools. Symyx Softwarecontinues to expand, offering our customers integrated data managementcapabilities and enterprise-wide access to research information. Our list ofdiscovered materials continues to advance, including catalysts to manufacturecommodity chemicals and polyolefins, polymers and phosphors for life scienceand industrial applications, and specialized materials for electronicsapplications. We believe we are now well positioned to capitalize on theseinvestments.

**Recent Developments**

Our major recentdevelopments and their impact on our business are highlighted below:

·       NewSymyx Tools — During 2005, we enabled further modularization of our Symyx Toolssystems with the introduction of our Extended Core Module (XCM), an update toour CORE*(x)* module that we offered in 2004.Our XCM provides the base building block for Symyx Tools systems. It can beconfigured and expanded to fit customers’ requirements and can be modified assystem requirements change by removing one module and inserting another. Builtupon our new XCM, during the year, we also introduced the Forced Degradation (“FD”)system to the pharmaceutical industry, for testing pharmaceutical ingredientsin a variety of extreme chemical and environmental conditions. Our new FDsystem offers significant improvement in throughput compared to current, manualpractices.

·       Integrationof Symyx Software offering — In November 2004, we acquired IntelliChem, Inc.and in April 2005, we completed the acquisition of Synthematix, Inc.During 2005, we completed the integration of our Symyx Software operations,incorporating product features of lab automation, electronic lab notebook anddata mining software applications. We realigned our sales force, which doubledto approximately 20, as a result of acquisitions. Our sales force is noworganized by industry focus, and we added offices in New Jersey, Switzerlandand Japan.

·       Co-investingto develop new applications for our high-throughput technologies — We areco-investing in research programs with smaller companies, often venture-backed,to pursue opportunities in new fields. These research and developmentpartnerships combine our partner’s domain knowledge and relationships with ourexpertise in high-throughput research technologies. We are working withIntermolecular, Inc. in the field of integrated circuits, with anundisclosed 

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company in photovoltaics,and with Stargate Mobile to introduce oil condition sensors in the field ofcommercial vehicles.

In the year ended December 31, 2005, we generatedtotal revenue of $108.1 million, with operating income of $15.7 million, netincome of $12.0 million and diluted earnings per share of $0.35. Included inthe 2005 operating income and net income were purchase accounting adjustmentsand other special charges arising from the acquisitions of IntelliChem andSynthematix, including approximately $1.6 million of an in-process research anddevelopment charge, $3.5 million of amortization of intangible assets, andother merger related expenses.

During 2005, we generated positive cash flow fromoperations and ended the year with $168.6 million in cash, cash equivalents andavailable-for-sale securities after paying a net $12.8 million to acquireSynthematix.

Our total headcountincreased from 235 employees at the end of 2003 to 275 employees at the end of2004 and to 347 employees at the end of 2005 primarily as the result ofIntelliChem and Synthematix acquisitions, the expansion of our software groupand additional research personnel to meet our contractual obligation under ouralliance agreements with ExxonMobil and Dow. We anticipate that our headcountwill continue to increase to meet the mix and level of staffing required by ourcollaborative, tools and software agreements.

**Critical Accounting Policies**

Our financial statementsand accompanying notes are prepared in accordance with accounting principlesgenerally accepted in the United States of America (“GAAP”). Note 1 to theConsolidated Financial Statements included under Item 8 in this Annual Reporton Form 10-K, describes the significant accounting policies andmethods used in the preparation of the Consolidated Financial Statements.Preparing financial statements and related disclosures requires management toexercise judgment in making estimates and assumptions that affect the reportedamounts of assets, liabilities, revenue, and expenses. These estimates andassumptions are affected by management’s application of accounting policies.Estimates are used for, but not limited to, revenue recognition, establishingthe warranty expense accrual, establishing slow-moving, obsolete and excessinventory reserves, determining when technical feasibility for our softwareproducts has been achieved, and determining the useful life of intangibleassets. The following critical accounting policies, among others, are impactedsignificantly by judgments, estimates and assumptions used in the preparationof the Consolidated Financial Statements.

***Source of Revenueand Revenue Recognition Policy***

We recognize revenue in accordance with the Securitiesand Exchange Commission’s Staff Accounting Bulletin No. 104 (“SAB 104”), *Revenue Recognition*, the American Institute of CertifiedPublic Accountants Statement of Position (“SOP”) 97-2, *Software Revenue Recognition*, as amended by SOP 98-9,*Modification of SOP 97-2, SoftwareRevenue Recognition*, Financial Accounting Standards Board TechnicalBulletin 90-1, *Accounting for SeparatelyPriced Extended Warranty and Product Maintenance Contracts*, the Emerging Issues Task Force consensus onIssue 00-21 or EITF 00-21, *Multiple-DeliverableRevenue Arrangements*, and other authoritative accountingliterature. We generate revenue fromservices provided under research collaborations, the sale of products, licenseof software, provision of support and maintenance services, and the license ofintellectual property. It is possible for our customers to work with us inmultiple areas of our business and contracts may include multiple elements ofservice revenue, product revenue, and license and royalty revenue. Indetermining the basis for revenue recognition, we first determine the fairvalue of any extended warranty services and defer this revenue to be recognizedover the service period. For those contracts that involve multiple elementdeliverables, we identify all deliverables and allocate revenue between theunits of accounting in accordance with EITF 00-21. In an 

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arrangement that includessoftware that is more than incidental to the products or services as a whole,we recognize revenue from the software and software-related elements, as wellas any non-software deliverable(s) for which a software deliverable isessential to its functionality, in accordance with SOP 97-2.

Service revenue consistsof research and development funding received from collaborative partners aswell as support and maintenance or extended warranty agreements. Productrevenue consists of payments from customers for Symyx Tools systems, comprisinghardware, associated software and intellectual property licenses andconsumables. Royalties and license fees include fees for licensing of oursoftware, intellectual property, proprietary materials and technology license paymentsand royalties on laboratory instruments and software sold under license bythird parties.

*Service Revenue*

We recognize revenue from research collaborationagreements, software consulting, and support and maintenance agreements asearned upon performance of the services specified in the agreements. Paymentsreceived that are related to future performance are deferred and recognized asrevenue as the performance requirements are fulfilled.

Non-refundable up-front payments received inconnection with research and development collaboration agreements, includingtechnology access fees, are deferred and recognized on a straight-line basisover the relevant periods specified in the agreement, generally the researchterm. Revenue from milestone payments, which are substantially at risk untilthe milestones are completed, is recognized upon completion of these milestoneevents. Milestone payments to date have been immaterial.

Revenue allocable tosupport and maintenance is recognized on a straight-line basis over the periodthe support and maintenance is provided. Our product-related software licensesmay provide for technical support, bug fixes and rights to unspecified upgradeson a when-and-if-available basis for periods defined within the contract.Revenue related to this post-contract customer support is deferred andrecognized over the term of the contracted support.

*Product Sales*

We recognize revenue fromthe sale of Symyx Tools hardware and the license of associated software, andall related costs of products sold are expensed, once delivery has occurred andcustomer acceptance has been achieved. A warranty expense accrual isestablished at the time of customer acceptance. A determination is made foreach system delivered as to whether software is incidental to the system as awhole. If software is not incidental to the Symyx Tools system as a whole,revenue from these arrangements is recognized in accordance with SOP 97-2,as amended. If software is incidental to the Symyx Tools system, revenue fromthe sale of the Symyx Tools system is earned and recognized when persuasiveevidence of an arrangement exists, delivery of the product has occurred, nosignificant obligations with regard to implementation remain, the fee is fixedor determinable, and collectibility is reasonably assured. If there areextended payment terms, we recognize product revenue as these payments becomedue. We consider all arrangements with payment terms extending beyond 12 monthsnot to be fixed or determinable. If the fee is not fixed or determinable,revenue is recognized as payments become due from the customer. In multipleelement arrangements, we use the residual method to allocate revenue todelivered elements once it has established fair value for all undeliveredelements. Payments received in advance under these arrangements are recorded asdeferred revenue until earned.

*Software License Fees*

Forsoftware licensed on an annual right to use basis, revenue is recognizedstraight line over the term of the license. For revenue allocable to thesoftware portion of a multiple element arrangement or licensed on a perpetualbasis, we recognize revenueupon delivery of the software product to the end-user and 

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commencement of the license, unless we have ongoingobligations for which fair value cannot be established or the fee is not fixedor determinable or collectibility is not reasonably assured, in which case werecognize revenue only when each of these criteria have been met. By wayof example, for the ELN software products that we acquired from IntelliChem, Inc.and Synthematix, Inc, we have not yet established the fair value of all theongoing obligations and accordingly, any perpetual license fees are recognizedratably over the period of the ongoing obligations (typically a bundled supportand maintenance commitment of one year). Weconsider all arrangements with payment terms longer than 12 months not tobe fixed or determinable. If the fee is not fixed or determinable, revenue isrecognized as payments become due from the customer. If evidence of the fairvalue of one or more undelivered elements does not exist, the total revenue isdeferred and recognized when delivery of those elements occurs or when fairvalue can be established.

*Intellectual Property License Fees and Royalties*

We recognize license fee revenue for licenses to ourintellectual property when earned under the terms of the agreements. Generally,revenue is recognized upon transfer of the license unless we have continuingobligations for which fair value cannot be established, in which case therevenue is recognized over the period of the obligation. If there are extendedpayment terms, we recognize license fee revenue as these payments become due.We consider all arrangements with payment terms extending beyond 12 monthsnot to be fixed or determinable. In certain licensing arrangements there isprovision for a variable fee as well as a non-refundable minimum amount. Insuch arrangements, the amount of the non-refundable minimum guarantee isrecognized upon transfer of the license unless we have continuing obligationsfor which fair value cannot be established and the amount of the variable feein excess of the guaranteed minimum is recognized as revenue when it is fixedand determinable.

We recognize royalty revenue based on reported salesby third party licensees of products containing our materials and intellectualproperty. If there are extended payment terms, royalty revenue is recognized asthese payments become due. Non-refundable royalties, for which there are no furtherperformance obligations, are recognized when due under the terms of theagreements.

See Note 1 of the Notes toConsolidated Financial Statements for a further discussion of our revenuerecognition policies.

***Warranty ExpenseAccrual***

A warranty expense accrualis established at the time of customer acceptance of a Symyx Tool system and isincluded as a cost of product sold. Management is required to exercise judgmentin establishing the appropriate level of warranty expense accrual for eachSymyx Tool system delivered and establishes the accrual based, in part, onreference to actual warranty costs incurred on similar systems. The actualresults with regard to warranty expenditures could have a material impact onour financial statements. When actual warranty costs are anticipated to behigher than our original estimates, an additional expense is charged to cost ofproducts sold in the period in which such a determination is made. When actualwarranty costs are lower than our original estimates, the difference will havea favorable impact to cost of products sold at the time the warranty expiresfor the systems. In years 2005, 2004 and 2003, we have recorded favorableadjustments of approximately $416,000, $966,000 and $300,000, respectively.

***Research and DevelopmentCosts***

We account for researchand development costs in accordance with several accounting pronouncements,including SFAS 2, *Accounting for Research and DevelopmentCosts*, and SFAS 86, *Accounting for the Costsof Computer Software to be Sold, Leased, or Otherwise Marketed*. SFAS86 specifies that costs incurred internally in creating a computer softwareproduct should be charged to expense when 

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incurredas research and development until technological feasibility has beenestablished for the product. Once technological feasibility is established, allsoftware costs should be capitalized until the product is available for generalrelease to customers. Judgment is required in determining when thetechnological feasibility of a product is established. We have determined thattechnological feasibility for our software products is reached shortly beforethe products are released to manufacturing. Costs incurred after technologicalfeasibility is established are not material, and accordingly, we expense oursoftware development costs when incurred.

***Inventories***

We carry our inventoriesat the lower of cost or market, cost being determined on a specificidentification basis. We apply judgment in determining the provisions forslow-moving, excess and obsolete inventories based on historical experience andanticipated product demand.

***Intangible Assets***

We amortize intangibleassets over their estimated economic lives. Determining the estimated economiclife of intangible assets requires judgment on the part of management. Forexample, if we determined that the estimated economic lives of these assetswere one year less than those reported in Note 10 of the Notes to ConsolidatedFinancial Statements, the 2005 amortization expense of intangibles would havebeen increased by $1.0 million. We conduct impairment reviews of intangibleassets annually or when circumstances indicate the potential impairment ofintangible assets. We also review the amortization periods for intangibleassets when circumstances indicate there may be a change in economic lives ofintangible assets.

***Employee StockOptions***

We generally grant stockoptions to our employees for a fixed number of shares with an exercise priceequal to the fair value of the shares on the date of grant. As allowed underthe Statement of Financial Accounting Standards No. 123, *Accounting for Stock-Based Compensation*, (“SFAS 123”), wehave elected to follow Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees (“APB 25”), and related interpretationsin accounting for stock awards to employees. Accordingly, no compensationexpense is recognized in our financial statements prior to January 1, 2006in connection with stock options granted to employees with exercise prices notless than fair value. Deferred compensation for options assumed in connectionwith business combinations is determined as the difference between the exerciseprice and the fair market value of our common stock on the date options wereassumed. Deferred compensation is being amortized on a graded vesting method.Had we elected to expense stock options based on their fair value in accordancewith SFAS 123, we would have reported a net loss of approximately $8.3 million,$135,000 and $9.4 million for 2005, 2004 and 2003, respectively.

**Business Acquisitions**

*Acquisition ofIntelliChem, Inc.*

On November 30, 2004, we acquired 100% of theoutstanding capital stock of IntelliChem, a provider of intelligent electroniclab notebooks for customers in the pharmaceutical, biotechnology, and chemicalindustries. The results of IntelliChem’s operations have been included in theconsolidated financial statements since that date.

The total purchase price for this acquisition was$30.6 million, consisting of approximately $29.3 million in cash, $1.0 millionin fair value of assumed stock options to purchase 44,126 shares of our commonstock, and $0.3 million in transaction costs, consisting of legal and otherprofessional service fees. 

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The intrinsic value ofthese options, totaling approximately $0.7 million, has been recorded asdeferred stock compensation.

Inaccordance with Statement of Financial Accounting Standards No. 141, *Business Combinations*, we allocated the purchase price tothe tangible assets, deferred compensation, liabilities, and intangible assetsacquired, as well as in-process research and development, based on theirestimated fair values. The excess purchase price over the fair values wasrecorded as goodwill. The fair value assigned to intangible assets acquired wasbased on estimates and assumptions determined by management. The acquiredgoodwill was assigned entirely to our software segment. Purchased intangibleswith finite lives are amortized on a straight-line basis over their respectiveuseful lives. The purchase price allocation was as follows (in thousands):

| ** **                                                                                                                                                                                                                        | ** ** | **Amount** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| Fair value of net  assets purchased                                                                                                                                                                                               |       | $          | 4,476      |   |
| Deferred tax  assets                                                                                                                                                                                                              |       | 145        |       |
| In-process  research and development                                                                                                                                                                                              |       | 2,260      |       |
| Trade name                                                                                                                                                                                                                        |       | 860        |       |
| Developed  technology                                                                                                                                                                                                             |       | 8,370      |       |
| Customer  relationships                                                                                                                                                                                                           |       | 4,700      |       |
| Unearned stock  compensation                                                                                                                                                                                                      |       | 651        |       |
| Deferred tax  liabilities                                                                                                                                                                                                         |       | (4,151     | )          |
| Release of  valuation allowance against acquirer’s deferred income tax assets upon  recognition of deferred income tax liabilities on acquired identifiable  intangible assets in connection with acquisition of IntelliChem |       | 4,151      |       |
| Goodwill                                                                                                                                                                                                                          |       | 9,138      |       |
| Total                                                                                                                                                                                                                             |       | $          | 30,600     |   |

 

The allocation of the consideration for theacquisition of IntelliChem to its individual assets and liabilities was basedon management’s analysis and estimates of the fair values of the acquiredassets and liabilities. In addition to the value assigned to in-processresearch and development (“IPR&D”) projects, and IntelliChem’s tangibleassets, specific intangible assets were identified and valued. The identifiableintangible assets included customer relationships, a trade name, and developedtechnology.

The IPR&D project that IntelliChem has beenworking on was the development of next generation of IntelliChem software. Thatsoftware had not yet been proven to be technologically feasible but had beendeveloped to a point where it had value associated with potential futurerevenue. Because technological feasibility was not yet proven and noalternative future uses were believed to exist for the in-process technologies,the assigned value was expensed immediately upon the closing date of theacquisition, in accordance with FASB Interpretation No. 4, *Applicability of FASB Statement No. 2 to Business CombinationsAccounted for by the Purchase Method*.

The value of IPR&D was determined by estimatingthe expected cash flows from the projects once commercially viable, discountingthe net cash flows back to their present value and then applying a percentageof completion to the calculated value as defined below. A discount rate of 28%was used which is higher than IntelliChem’s computed weighted average cost ofcapital of 20% due to inherent risk surrounding the successful development ofthe IPR&D and the increase in projected financial results compared withhistorical results. This project has been completed in 2005 and costsassociated with this project were not material and were included in theresearch and development expenses.

Inperforming this purchase price allocation, we considered, among other factors,our intention for future use of the acquired assets, analyses of historicalfinancial performance and estimates of future performance of IntelliChem’sproducts. The fair value of intangible assets was primarily based on the 

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income approach. The relief from royalty approach wasalso utilized when appropriate. The rates utilized to discount the net cashflows to their present values ranged from 24% to 28%. These discount rates weredetermined after consideration of our rate of return and the weighted averagereturn on assets. Risks we identified and considered in this analysis includedachieving anticipated levels of market acceptance and penetration, successfulcompletion of development efforts, market growth rates, and risks related tothe impact of potential changes in future target markets. At December 31,2005, identifiable intangible assets purchased in the IntelliChem acquisitionconsisted of the following (in thousands, except for useful life) with aweighted average useful life of 5.0 years. No significant residual value was estimatedfor these assets.

| ** **                                  | ** ** | **Amount** | ** ** | **Useful Life** | ** ** |
|---------------------------------------------|------------|------------|------------|----------------------|------------|
| Trade name                                  |       | $          | 860        |                 |       | 1 year |   |   |
| Developed  technology                       |       | 8,370      |       |                 | 4.5 years  |   |   |
| Customer  relationships                     |       | 4,700      |       |                 | 6.5 years  |   |   |
| Balance at  December 31, 2005, at cost |       | $          | 13,930     |                 |       |   |   |   |

 

*Acquisition ofSynthematix, Inc.*

On April 1, 2005, we completed the acquisition of100% of the outstanding shares of privately-held Synthematix, Inc., basedin Durham, North Carolina. Synthematix was a provider of organic synthesisreaction planning software systems for scientific knowledge management inchemistry research, with customers primarily in the pharmaceutical,biotechnology, and fine chemical industries. The results of Synthematix’soperations have been included in our consolidated financial statements sincethat date. On August 1, 2005, Synthematix was merged into one of oursubsidiaries, Symyx IntelliChem, Inc., whose name was subsequently changedto Symyx Renaissance Software, Inc.

The preliminary purchase price for this acquisitionwas $14,015,000, consisting of approximately $13,079,000 in cash, $571,000 infair value of assumed stock options to purchase 23,876 shares of Symyx commonstock, and $365,000 in transaction costs, consisting of legal and otherprofessional service fees.

According to the merger agreement, additional purchaseconsideration of up to $4,000,000 would be payable upon the achievement ofcertain 2005 revenue targets for products developed by the former Synthematix.Based on the actual revenue generated by Synthematix in 2005, we did not recordany additional purchase consideration as of December 31, 2005.

In accordance with Statement of Financial AccountingStandards No. 141, *Business Combinations*,the Company allocated the preliminary purchase price to the tangible assets,deferred compensation, liabilities, and intangible assets acquired, as well asin-process research and development (“IPR&D”), based on their estimatedfair values. The excess purchase price over the fair values was recorded asgoodwill. The fair value assigned to intangible assets acquired was based onestimates and assumptions determined by management. The acquired goodwill wasassigned entirely to the Company’s software segment. Purchased intangibles withfinite lives are amortized on a straight-line basis over their respective usefullives. See Note 7 of Notes to Consolidated Financial Statements for informationregarding the purchase price allocation.

Inperforming this purchase price allocation, the Company considered, among otherfactors, its intention for future use of the acquired assets, analyses ofhistorical financial performance and estimates of future performance ofSynthematix’s products. The fair value of intangible assets was primarily basedon the income approach. The relief from royalty approach was also utilized whenappropriate. The rates utilized to discount the net cash flows to their presentvalues ranged from 15% to 17.5%. These discount rates were determined afterconsideration of the Company’s rate of return and the weighted average returnon assets. Risks the Company identified and considered in this analysisincluded achieving anticipated levels of market acceptance and penetration,successful completion of development efforts, 

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market growth rates, and risks related to the impactof potential changes in future target markets. At December 31, 2005,identifiable intangible assets purchased in the Synthematix acquisitionconsisted of the following (in thousands, except for useful life) with aweighted average useful life of 4.6 years. No significant residual value isestimated for these assets.

| ** **                                 | ** ** | **Amount** | ** ** | **Useful Life** | ** ** |
|--------------------------------------------|------------|------------|------------|----------------------|------------|
| Trade name                                 |       |       | $          | 280                  |       |   |   | 1 year |   |   |
| Developed technology                       |       |       | 2,350      |                 |       |   | 4.5 years |   |   |
| Customer relationships                     |       |       | 500        |                 |       |   | 7.0 years |   |   |
| Balance at December 31, 2005, at cost |       |       | $          | 3,130                |       |   |   | 4.6 years |   |   |

 

The IPR&D project that Synthematix was working onwas the development of next generation of Synthematix software. At the date ofacquisition, that software had not yet been proven to be technologicallyfeasible but had been developed to a point where it had value associated withpotential future revenue. Because technological feasibility was not proven andno alternative future uses were believed to exist for the in-processtechnologies, the assigned value was expensed immediately upon the closing ofthe acquisition, in accordance with FASB Interpretation No. 4, *Applicability of FASB Statement No. 2 to Business CombinationsAccounted for by the Purchase Method*.

The value of IPR&D wasdetermined by estimating the expected cash flows from the projects oncecommercially viable, discounting the net cash flows back to their present valueand then applying a percentage of completion to the calculated value as definedbelow. A discount rate of 20% was used for IPR&D which is higher than thediscount rate used to value other Synthematix assets due to inherent risksurrounding the successful development of the IPR&D and the increase inprojected financial results compared with historical results.

**Results of Operations**

*Revenue*

| ** **                  | ** ** | **2005**                 | ** ** | **2004**                         | ** ** | **2003**                 | ** ** |
|-----------------------------|------------|--------------------------|------------|----------------------------------|------------|--------------------------|------------|
| ** **                  | ** ** | **Amount**               | ** ** | **Change  over  Previous  Year** | ** ** | **Amount**               | ** ** | **Change  over  Previous  Year** | ** ** | **Amount** | ** ** |
| ** **                  | ** ** | **(in 000’s)** | ** ** | ** **                       | ** ** | **(in 000’s)** | ** ** | ** ** | ** ** | **(in 000’s)** | ** ** |
| Service revenue             |       | $                        | 56,980     |                             |       | 35                       | %          |   | $ | 42,251 |   |   | 9 | % |   | $ | 38,689 |   |
| Product sales               |       | 26,663                   |       |                             | (1         | )%                       |       | 27,060 |   |   | 87 | % |   | 14,458 |   |
| License fees and  royalties |       | 24,494                   |       |                             | 77         | %                        |       | 13,874 |   |   | 41 | % |   | 9,816 |   |
| Total revenue               |       | $                        | 108,137    |                             |       | 30                       | %          |   | 83,185 |   |   | 32 | % |   | 62,963 |   |
|                             |            |                          |            |                                  |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |

 

Our total revenue increased32% from 2003 to 2004 and 30% from 2004 to 2005. This increase wasprimarily due to the expansion of revenue under our alliance with The DowChemical Company, as well as an increase in software license fees androyalties.

In 2005, we commenced bifurcating Symyx Tools salestransactions into product sales revenue (reported under the Symyx Toolssegment) and software license fees revenue (the majority of which was reportedunder the Symyx Software segment). Prior to 2005, Symyx Tools salestransactions were reported solely in the product sales revenue line in theConsolidated Income Statements. The impact to our 2005 Consolidated IncomeStatement, if we reported our 2005 revenue from Symyx Tools sales transactionsin the same way as we reported in periods prior to 2005, would be an additional$1.4 million of revenue reported in the product sales revenue line rather thanin the license fees and royalties line. With respect to segment reporting, wewould have reported an additional $1.3 million of revenue under the Symyx Toolssegment rather than the Symyx Software segment.

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Revenueis attributed to the following geographic locations based on the physicallocation of Symyx’s customers (as a percentage of total revenue in therespective periods):

| ** **                  | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|----------|------------|
| North America               |       |     | 83         | %        |       |     | 80         | % |   |   | 86 | % |   |
| Japan                       |       |     | 2          | %        |       |     | 7          | % |   |   | 11 | % |   |
| Belgium                     |       |     | 2          | %        |       |     | 10         | % |   |   | * |   |   |
| Europe (excluding  Belgium) |       |     | 13         | %        |       |     | 3          | % |   |   | 3 | % |   |
| Total                       |       |     | 100        | %        |       |     | 100        | % |   |   | 100 | % |   |

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*                    Less than 1%

In the last two years, we increased our market sharein the European market primarily by selling our Symyx Tools to Europeancustomers. We have also experienced an increase in our service revenue from theexpansion of our research collaboration with an energy customer in Europe. Weexpect that we will continue to generate revenue from the European marketthrough Symyx Tools sales, research collaboration service, license of oursoftware, as well as license of our sensor technologies and intellectualproperty.

Thefollowing table lists our major customers for the years ended December 31,2005, 2004 and 2003 and revenue generated from these customers as a percentageof our total revenue in the respective periods. We expect that a significantportion of our total revenue will continue to be generated from a few keycustomers*.*

| ** **                | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|
| ExxonMobil                |       |     | 39         | %        |       |     | 54         | % |   |   | 35 | % |   |
| Merck                     |       |     | 1          | %        |       |     | 4          | % |   |   | 13 | % |   |
| The Dow Chemical  Company |       |     | 25         | %        |       |     | 5          | % |   |   | 7 | % |   |
| Undisclosed  Partner      |       |     | *          |     |       |     | 3          | % |   |   | 11 | % |   |
| Total                     |       |     | 65         | %        |       |     | 66         | % |   |   | 66 | % |   |

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*                    Less than 1%

Wesegregate revenue by the following segments:

| ** **                  | ** ** | **2005**                 | ** ** | **2004**                         | ** ** | **2003**                 | ** ** |
|-----------------------------|------------|--------------------------|------------|----------------------------------|------------|--------------------------|------------|
| ** **                  | ** ** | **Amount**               | ** ** | **Change  over  Previous  Year** | ** ** | **Amount**               | ** ** | **Change  over  Previous  Year** | ** ** | **Amount** | ** ** |
| ** **                  | ** ** | **(in 000’s)** | ** ** | ** **                       | ** ** | **(in 000’s)** | ** ** | ** ** | ** ** | **(in 000’s)** | ** ** |
| Research  Collaborations    |       | $                        | 53,818     |                             |       | 28                       | %          |   | $ | 42,131 |   |   | 11 | % |   | $ | 37,796 |   |
| Symyx Tools                 |       | 30,829                   |       |                             | 8          | %                        |       | 28,576 |   |   | 52 | % |   | 18,861 |   |
| Symyx Software              |       | 15,315                   |       |                             | 125        | %                        |       | 6,815 |   |   | 455 | % |   | 1,228 |   |
| Materials and IP  Licensing |       | 5,268                    |       |                             | 26         | %                        |       | 4,191 |   |   | 8 | % |   | 3,887 |   |
| Symyx Sensors               |       | 2,907                    |       |                             | 97         | %                        |       | 1,472 |   |   | 24 | % |   | 1,191 |   |
| Total                       |       | $                        | 108,137    |                             |       | 30                       | %          |   | $ | 83,185 |   |   | 32 | % |   | $ | 62,963 |   |

 

The reconciliation ofsegment revenue above to the revenue disclosed in the Consolidated IncomeStatements is provided in Note 6 “Segment Disclosure” of Notes to theConsolidated Financial Statements.

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***ResearchCollaborations Revenue***

The Research Collaborations group generates revenueprimarily from the research services it provides to our collaboration partners.

The increase in Research Collaborations revenue from2003 to 2004 was primarily attributable to the funding received under thealliance agreement we entered into with ExxonMobil effective April 2003partially offset by a decrease in the level of funding received from anundisclosed partner. In 2005 the Dow alliance further accelerated the growth inResearch Collaborations revenue.

We expect to receive over$200 million in revenue from ExxonMobil and over $120 million in revenue fromDow during the five-year term of each of the alliances, through our researchcollaborations, product sales, and license of software and intellectualproperty. Through December 31, 2005, we had recognized $100.8 million and$25.6 million from ExxonMobil and Dow alliances, respectively, including totalof approximately $75.8 million in Research Collaborations revenue from thesetwo alliances. We believe these two alliances will continue to be the majorcontributors to our Research Collaborations revenue in 2006 through 2009.

***Symyx Tools Revenue***

The Symyx Tools group generates revenue primarily fromthe sale of Tools and associated software and intellectual property.

Symyx Tools revenue increased from $18.9 million in2003 to $28.6 million in 2004 and $30.8 million in 2005. For the year ended December 31,2005, Symyx Tools Revenue included $26.7 million product sales, $4.1 million ofservice revenue, and $70,000 of license revenue. For the year ended December 31,2004, Symyx Tools revenue included $25.7 million of product sales, $2.8 millionof service revenue, and $31,000 of license revenue. For the year ended December 31,2003, Symyx Tools revenue included $14.5 million of product sales and $4.4million of service revenue. The increase in Symyx Tools revenue in 2005 and2004 was primarily due to increased shipments of Symyx Tools systems. Duringyears 2005 and 2004, we shipped 20 and 13 Tools systems,respectively, including our CORE(x) modules and extended core modules, tochemical, pharmaceutical, academic institutions, and several other customers.We adopted our modular strategy in 2004 to facilitate timely customer purchasesbecause purchase decisions on a complete Symyx Tools system may take a longtime. This modular approach allows our customers to build up full combinatorialhigh-throughput experimentation capability over time by acquiring stand-aloneportions of a Symyx Tools system that integrate together to make an entireworkflow.

Under the ExxonMobil andDow alliances, we are contracted to deliver multiple Symyx Tools systems in thenext few years. We also negotiate with other chemical and pharmaceuticalcompanies for the sale of Symyx Tools systems. We believe our expanding customer base will contribute to ourexpected growth of Symyx Tools revenue.

***Symyx SoftwareRevenue***

The Symyx Software groupgenerates revenue primarily from the licensing of software, includingautomation and data mining applications and ELN software, and provision ofassociated support, maintenance and consulting services.

Symyx Software revenueincreased from $1.2 million in 2003 to $6.8 million in 2004 and to $15.3million in 2005. The increase in Symyx Software revenue in 2004 was primarilydue to the increased revenue from ExxonMobil and Pfizer for software licenses,and associated maintenance and support. The increase in Symyx Software revenuein 2005 was due to increased revenue from software licenses and servicesprovided to ExxonMobil and Dow as well as increased ELN software licenses. Inthe last quarter of 2005, we entered into several license agreements with majorpharmaceutical companies. We expect 

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SymyxSoftware revenue will continue to grow as we recognize the revenue for licensesand services under these agreements.

***Materials Licensingand IP Revenue***

The Materials and IP Licensing group generates revenueprimarily from the licensing fees received from licensing our intellectualproperty and from royalties paid by third party licensees for sale of productscontaining our materials and intellectual property.

Materials and IP Licensing revenue increased from $3.9million in 2003 to $4.2 million in 2004 and to $5.3 million in 2005. Theincrease in licensing revenue in 2004 over 2003 was primarily due to paymentsreceived from ExxonMobil and UOP. The increase in licensing revenue in 2005over 2004 was primarily due to payments received from Dow. We believe that thedemonstrated acceptance of our high-throughput experimentation technology byour customers will lead to the expected growth in our license fee revenue infuture years.

We currently have threematerials commercialized by Dow, JSR Corporation and Agfa-Gevaert N.V. Weanticipate that our customers may commercialize an additional four materialsduring 2006. We believe that these commercialized materials will contribute toour growth in Intellectual Property and Materials Licensing revenue in thefuture.

***Symyx SensorsRevenue***

The Symyx Sensors groupoffers development services and licenses for specific applications to oursensor technology. Symyx Sensors revenue in both 2004 and 2003 consistedprimarily of payments received from Hella KG. Symyx Sensors revenue increasedsignificantly in 2005 over 2004 due primarily to payments received fromUnivation for the sensor development, partially offset by the decrease inpayments received from Hella KG.

*Cost of Products Sold*

Cost of products sold was $11.1 million, or 42% ofproduct sales revenue in 2005, compared to $7.9 million, or 29% of productsales revenue in 2004 and $2.9 million, or 20% of product sales revenue for theyear ended December 31, 2003. The increase in the total cost of productssold in 2005 and 2004 was primarily due to the increase of products sold, alongwith changes in product mix. The increase in cost of products sold as apercentage of product sales revenue in 2005 over 2004 was due to the change inthe product mix shipped in the respective years, the bifurcation of Symyx Toolssales transactions into product sales revenue and software license fees revenuediscussed under “*Revenue*” above, as well as anunfavorable inventory obsolescence charge of approximately $725,000 in 2005.The increase in cost of products sold as a percentage of product sales revenuein 2004 over 2003 was due to a change in the product mix shipped in therespective years, the development costs related to prototypes delivered beingexpensed as discussed below, partially offset by a favorable adjustment ofaccrued warranty expense of approximately $1.0 million.

The cost of products sold may be driven by thevariability of product mix and sales volume in each period. The cost ofproducts sold as a percentage of product sales is expected to fluctuate fromperiod to period because the majority of Symyx Tools systems are built to orderor to particular specifications. For systems that include a significantdevelopment component prior to their commercial build, or systems delivered tocustomers as a prototype, the development costs incurred prior to thecommercial build are expensed as development costs, which results in a lowercost of products sold and higher margin in the quarter in which such a systemis delivered to the customer.

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The cost of products soldmay also be affected by adjustments to the warranty expense accrual forpre-existing sales. When actual warranty costs are lower than our estimates,the difference will have a favorable impact to cost of products sold at thetime the warranty expires for the systems. When actual warranty costs areanticipated to be higher than our original estimates, an additional expense ischarged to cost of products sold in the period in which such a determination ismade.

*OtherOperating Expenses*

| ** **                                                            | ** ** | **2005**                 | ** ** | **2004**                                          | ** ** | **2003**                         | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------|------------|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                            | ** ** | **Amount**               | ** ** | **As a  Percentage of  Total  Revenue** | ** ** | **Change  over  Previous  Year** | ** ** | **Amount** | ** ** | **As a  Percentage  of Total  Revenue** | ** ** | **Change  over  Previous  Year** | ** ** | **Amount** | ** ** | **As a  Percentage  of Total  Revenue** | ** ** |
| ** **                                                            | ** ** | **(in 000’s)** | ** ** | ** **                                        | ** ** | ** **                       | ** ** | **(in 000’s)** | ** ** | ** ** | ** ** | ** ** | ** ** | **(in 000’s)** | ** ** | ** ** | ** ** |
| Research and development                                              |       |                     | $          | 50,660                                            |       |                             |       | 47 | % |   |   | 23 | % |   |   | $ | 41,142 |   |   |   | 49 | % |   |   | 3 | % |   |   | $ | 40,058 |   |   |   | 63 | % |   |
| Sales, general and administrative                                |       |                     | 25,566     |                                              |       |                             | 24         | % |   |   | 42 | % |   |   | 18,007 |   |   |   | 22 | % |   |   | 21 | % |   |   | 14,933 |   |   |   | 24 | % |   |
| Acquired in-process research and development                          |       |                     | 1,590      |                                              |       |                             | 1          | % |   |   | (30 | )% |   |   | 2,260 |   |   |   | 3 | % |   |   | n/a |   |   |   | — |   |   |   | — | % |   |
| Amortization of intangible assets arising from  business combinations |       |                     | 3,515      |                                              |       |                             | 3          | % |   |   | 1,422 | % |   |   | 231 |   |   |   | * |   |   |   | n/a |   |   |   | — |   |   |   | — | % |   |
| Total operating  expenses                                             |       |                     | $          | 81,331                                            |       |                             |       | 75 | % |   |   | 32 | % |   |   | $ | 61,640 |   |   |   | 74 | % |   |   | 12 | % |   |   | $ | 54,991 |   |   |   | 87 | % |   |

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*       Less than 1%

*Research andDevelopment Expenses*

Our research anddevelopment expenses consist primarily of salaries and other personnel-relatedexpenses, facility costs, supplies, and depreciation of facilities andlaboratory equipment.

Thetable below indicates the major collaborative partners, defined as thosecontributing greater than 10% of collaborative research revenue in 2005, forwhom we conducted research and development, together with the date upon whichthe current contract ends and the primary focus of the collaborations.Contracts may only be extended by mutual agreement between us and thecollaborative partner.
| Partner                                                                                       | ** ** | ** ** | ** ** | **Current  Research  Contract Ends** | ** **                                                   | **Primary focus of current collaborative  efforts** |
|-----------------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------------|--------------------------------------------------------------|-----------------------------------------------------|
| BP (including both BP  and Innovene. Innovene was spun off from BP at the end of   2005) |       | 3/31/2006  |       |                                 | Catalysts for certain  commodity chemicals                   |
| ExxonMobil                                                                                    |       | 5/31/2008  |       |                                 | Catalysts for certain  commodity chemicals including olefins |
| The Dow Chemical Company                                                                      |       | 12/31/2009 |       |                                 | Polyolefin catalysts for certain commodity chemicals         |

 

We donot track fully burdened research and development costs or capital expendituresby project. However, based on hours spent on each project, we estimate theresearch and development efforts undertaken for various projects were asfollows:

| ** **                                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Projects funded by  collaboration partners |       |     | 73         | %        |       |     | 79         | % |   |   | 68 | % |   |
| Internally funded  research                |       |     | 5          | %        |       |     | 10         | % |   |   | 15 | % |   |
| Internal software  development             |       |     | 21         | %        |       |     | 5          | % |   |   | 7 | % |   |
| Internal tools  development                |       |     | 1          | %        |       |     | 6          | % |   |   | 10 | % |   |
| Total                                      |       |     | 100        | %        |       |     | 100        | % |   |   | 100 | % |   |

 

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Due to the nature of our research and our dependenceon our collaborative partners to commercialize the results of the research, wecannot predict with any certainty whether any particular collaboration orresearch effort will ultimately result in a commercial product and thereforewhether we will achieve future milestones or royalty payments under our variouscollaborations.

Research and development expenses in 2004 and 2003included $1.2 million and $1.7 million, respectively, of direct costs ofresearch services provided to Ilypsa, a related party. The increase of researchand development expenses in 2005 and 2004 was due primarily to increases insalary related expenses due to the hiring of additional scientific andtechnical staff to work on research and development projects for ExxonMobil andDow and increased headcount to develop our software platform.

Research and developmentexpenses as a percentage of total revenue decreased sequentially in 2005 and2004 because the increase in research and development expenses lagged thesignificant increase in total revenue. Our core business areas are research todiscover new materials, the sale of instruments and licensing of relatedsoftware and licensing of intellectual property and materials discovered in ourcollaborative and internal research programs. Accordingly, we expect tocontinue to devote substantial resources to research and development, and weexpect that research and development expenses will continue to increase inabsolute dollars.

*Sales, General and Administrative Expenses*

Our sales, general and administrative expenses consistprimarily of personnel costs for business development, legal, generalmanagement, finance, and human resources, as well as payments of commissions toour sales agents and professional expenses, such as legal and accounting. Theincrease of sales, general and administrative expenses in 2005 and 2004 wasprimarily due to an increase of personnel costs, mainly as a result of adding anumber of business development and sales staff to manage and support ourgrowth, and an increase in auditing and tax related service fees, largely as aresult of the requirements of the Sarbanes-Oxley Act, offset partially by thedecrease in legal fees for intellectual property litigation.

Although our sales,general and administrative expenses as a percentage of total revenue in 2005,2004 and 2003 did not vary significantly, we expect that our sales, general andadministrative expenses will continue to increase in absolute dollar amounts aswe:

·       have expanded our business development and sales staff with the acquisitionsof IntelliChem and Synthematix and may continue to expand our personnel as aresult of future acquisitions;

·       continueto add to and improve our existing laboratory and engineering facilities;

·       incurescalating costs related to being a public company, such as increasingprofessional fees; and

·       are required to recognizestock-based compensation expenses under SFAS 123(R) starting January 1,2006.

*Acquired In-Process Research and Development*

In April 2005, we acquired Synthematix in atransaction accounted for as a purchase. The purchase price was allocated tothe assets acquired, including intangible assets, based on their estimated fairvalues. The intangible assets include approximately $1.6 million for acquiredin-process technology for projects that did not have future alternative uses.The value of the purchased in-process technology was determined using theincome approach. At the date of the Synthematix acquisition, the development ofthese projects had not yet reached technological feasibility, and thetechnology in process had no alternative future uses. Accordingly, these costswere expensed in the second quarter of 2005. Additional discussion on acquiredin-process research and development can be found under “Business Combination.”

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In November 2004, weacquired IntelliChem in a transaction accounted for as a purchase. The purchaseprice was allocated to the assets acquired, including intangible assets, basedon their estimated fair values. The intangible assets include approximately$2.3 million for acquired in-process technology for projects that did not havefuture alternative uses. The value of the purchased in-process technology wasdetermined using the income approach. At the date of the IntelliChemacquisition, the development of these projects had not yet reachedtechnological feasibility, and the technology in process had no alternativefuture uses. Accordingly, these costs were expensed in 2004.

*Amortization of Intangible Assets Arising fromBusiness Combinations*

In connection with theacquisitions of IntelliChem in November 2004 and Synthematix in April 2005,we recorded $17.1 million of intangible assets (See Notes 7 and 10 of the Notesto Condensed Consolidated Financial Statements). These intangible assets arebeing amortized on a straight-line basis over the estimated useful lives of theassets. During the three months ended September 30, 2005, we advanced ourbranding strategy for our software offerings and accordingly the remaininguseful life of the trade names acquired in the IntelliChem and Synthematixacquisitions was reassessed to be 12 months starting from September 1,2005. For the years ended December 31, 2005 and 2004, we recorded $3.5million and $231,000, respectively, of amortization of intangible assetsexpense related to these acquisitions. In 2003 there was no amortization ofintangible assets arising from business combinations.

***Interest and Other Income***

Interest and other incomefor the years ended December 31, 2005, 2004 and 2003 consisted primarilyof interest income of approximately $4.3 million, $2.4 million and $2.0million, respectively. Interest income represents interest income earned on ourcash, cash equivalents and available-for-sale securities. Interest incomeincreased in 2005 and 2004 due to the impact of rising average interest ratesand average investment balance in the past two years. We anticipate that ourinterest income in 2006 will be greater than in 2005 in anticipation that thecurrently higher interest rates will sustain and that our positive cash flowsfrom operating and financing activities continue to increase our averageinvestment balance.

***Provision for Income Taxes***

We recorded an income tax expense of $8.1 million in2005, $3.3 million in 2004 and $1.3 million in 2003. Our effective income taxrate was 40.4% for 2005, 20.5% for 2004 and 18.3% for 2003. The effectiveincome tax rate was significantly lower than our statutory rate in both 2004and 2003 due to the recognition of approximately $4.3 million and $1.3 million,respectively, of income tax benefits from certain of our deferred tax assets in2004 and 2003, which had previously been offset by a valuation allowance. Weexpect our 2006 effective income tax rate will be close to our statutory rateof 40.75%, including state income taxes.

As of December 31, 2005, we had net deferred taxassets of approximately $4.8 million. Our net deferred tax assets primarilyrelate to federal and state research and development credits and the temporarydifference between book and tax depreciation expenses, partially offset bydeferred tax liabilities recognized for intangible assets in the IntelliChemand Synthematix acquisitions. As of December 31, 2005, we had federal netoperating loss carryforwards of approximately $2.0 million. The net operating lossesfrom the acquisitions of Synthematix may be subject to an annual limitation dueto the ownership change limitations provided by the Internal Revenue Code of1986, as amended, and similar state provisions. The annual limitation mayresult in the expiration of net operating losses and credits beforeutilization. The net operating loss carryforwards will start to expire in 2010,if not utilized.

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As of December 31, 2004,we had federal and California research and development tax credits ofapproximately $293,000 and $2.3 million, respectively. The federal research anddevelopment tax credits will begin to expire in 2021, while the state researchand development credits have no expiration date. The federal research anddevelopment tax credits arose from the acquisitions of IntelliChem andSynthematix and may be subject to an annual limitation due to the ownershipchange limitations provided by the Internal Revenue Code of 1986, as amended,and similar state provisions.

**Recent Accounting Pronouncements**

*Share-Based Payment*

On December 16, 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS 123 (revised 2004), *Share-BasedPayment*, (“SFAS 123(R)”), which is a revision of SFAS 123. SFAS 123(R)supersedes APB 25 and amends SFAS 95, *Statement of Cash Flows*.Generally, the approach in SFAS 123(R) is similar to the approachdescribed in SFAS 123. However, SFAS 123(R) requires all share-based paymentsto employees, including grants of employee stock options, to be recognized inthe income statement based on their fair values. Pro forma disclosure is nolonger an alternative.

We are required to adopt SFAS 123(R) effective January1, 2006.

SFAS 123(R) permits public companies to adopt itsrequirements using either the “modified-prospective” method or the “modifiedretrospective” method. We expect to adopt SFAS 123(R) using themodified-prospective method.

In August 2005, the FASB issued FASB Staff PositionFAS 123(R)-1, *Classification andMeasurement of Freestanding Financial Instruments Originally Issued in Exchangefor Employee Services under FASB Statement No. 123(R)* (“FSP FAS123(R)-1”). FSP FAS 123(R)-1 defers indefinitely the requirement ofSFAS 123 that a share-based payment to an employee subject to SFAS 123(R) becomessubject to the recognition and measurement requirements of other applicableGAAP when the rights conveyed by the instrument are no longer dependent on theholder being an employee. The guidance in FSP FAS 123(R)-1 will beapplied upon initial adoption of SFAS 123(R).

In October 2005, the FASB issued FASB Staff PositionFAS 123(R)-2, *Practical Accommodation tothe Application of Grant Date as Defined in FASB Statement No. 123(R)*(“FSPFAS 123(R)-2”). FSP FAS 123(R)-2 provides an exception tothe application of the concept of “mutual understanding” in the determinationof whether a grant date (and, for an equity award, a measurement date) hasoccurred. The exception permits companies to measure compensation cost forequity awards to employees on the Board approval date if certain conditions aremet, provided that the communication to the employees occurs within arelatively short period of time from the approval date. The guidance in FSP FAS123(R)-2 will be applied upon initial adoption of SFAS 123(R).

In November 2005, the FASB issued FASB Staff PositionFAS 123R-3, *Transition Election Related to Accountingfor the Income Tax Effects of Share-Based Payment awards*(“FSP FAS123(R)-3”)*.* FSP FSP FAS 123(R)-3allows an elective short-cut approach to simplify the calculation of excess taxbenefits available to absorb tax deficiency (“APIC pool”) and provides guidancefor the presentation of excess tax benefits in the statement of cash flows forcompanies that elect to adopt the simplified alternative method of calculatingthe APIC pool. The guidance in FSP FSP FAS 123(R)-3 is effective on November10, 2005. We do not expect to adopt this elective alternative method incalculating the APIC pool.

As permitted by SFAS 123,through December 31, 2005, we have accounted for share-based payments toemployees using APB 25’s intrinsic value method and, as such, have recognizedno compensation cost for employee stock options. Accordingly, the adoption ofSFAS 123(R)’s fair value method will have a material impact on our results ofoperations, although it will have no direct impact on our overall financialposition. The impact of adopting SFAS 123(R) is expected to be additionalexpenses of between $7 million 

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to $8million, net of tax, or approximately $0.20 diluted loss per share, in 2006.Had we adopted SFAS 123(R) in prior periods, the impact of that standardwould have approximated the impact of SFAS 123 as described in the disclosureof pro forma net income (loss) and earnings per share in Note 1 of the Notes toConsolidated Financial Statements (“Stock Based Compensation”). SFAS 123(R) alsorequires the benefits of tax deductions in excess of recognized compensationcost to be reported as a financing cash flow, rather than as an operating cashflow as required under current literature. This requirement will reduce netoperating cash flows and increase net financing cash flows in periods afteradoption.

*TheMeaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments*

In November 2005, the FASBissued FSP Nos. FAS 115-1 and FAS 124-1, *The Meaningof Other-Than-Temporary Impairment and Its Application to Certain Investments*(“FSPFAS 115-1 and FAS 124-1”). FSP FAS 115-1 and FAS 124-1addresses the determination as to when an investment is considered impaired,whether that impairment is other than temporary, and the measurement of animpairment loss. This FSP also includes accounting considerations subsequent tothe recognition of an other-than-temporary impairment and requires certaindisclosures about unrealized losses that have not been recognized asother-than-temporary impairments. The guidance in this FSP amends FASBStatements No. 115, *Accounting for CertainInvestments in Debt and Equity Securities*, and No. 124,*Accounting for Certain Investments Held by Not-for-ProfitOrganizations*, and APB Opinion No. 18, *The EquityMethod of Accounting for Investments in Common Stock*. The guidancein FSP FAS 115-1 and FAS 124-1 shall be applied to reportingperiods beginning after December 15, 2005. We do not anticipate that theadoption of this standard will have a material impact on our consolidatedfinancial statements.

*Accounting for Rental Costs Incurred during aConstruction Period*

In October 2005, FASBissued FASB Staff Position FAS 13-1, *Accounting for RentalCosts Incurred during a Construction Period.*(“FSP FAS 13-1”).FSP FAS 13-1 concludes that rental costs incurred during and after aconstruction period are for the right to control the use of a leased assetduring and after construction of a lessee asset and that there is nodistinction between the right to use a leased asset during the constructionperiod and the right to use that asset after the construction period. Therefore,rental costs associated with ground or building operating leases that areincurred during a construction period should be recognized as rental expense.The guidance in FSP FAS 13-1 is to be applied to the first reportingperiod beginning after December 15, 2005. This is consistent with how we havehistorically accounted for rental costs during a construction period andtherefore we do not anticipate that the adoption of this standard will have amaterial impact on our consolidated financial statements.

*Inventory Costs*

In November 2004, the FASBissued SFAS No. 151, *Inventory Costs — anamendment of ARB No. 43, Chapter 4* (“SFAS 151”). SFAS 151 amends ARB43, Chapter 4 to clarify that “abnormal” amount of idle facility expense,freight, handling costs and spoilage should be recognized as current periodcharges. SFAS 151 is effective for inventory costs incurred during fiscalyears beginning after June 15, 2005. We do not anticipate that the adoption ofthis standard will have a material impact on our consolidated financialstatements.

*DeterminingWhether to Aggregate Operating Segments That Do Not Meet the QuantitativeThresholds*

In October 2004, the FASBratified Emerging Issues Task Force consensus on Issue No. 04-10, *Determining Whether to Aggregate Operating Segments That Do Not Meetthe Quantitative Thresholds*(“EITF Issue No. 04-10”),which provides guidance regarding how an enterprise should evaluate theaggregation criteria in paragraph 17 of FASB Statement 131 when determiningwhether operating segments that do not meet the quantitative thresholds may beaggregated in accordance with paragraph 19 

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of FASBStatement 131. The effective date of EITF Issue No. 04-10 has not beendetermined, but early application is permitted. The adoption of EITF Issue No. 04-10is not expected to have a material impact on our consolidated financialstatements.

*Accounting Changes and Error Corrections*

In May 2005, the FASBissued SFAS No. 154, *Accounting Changes andError Corrections, a replacement of APB Opinion No. 20 and Statement No. 3 (“SFAS154”).*SFAS 154 changes the requirements for the accounting andreporting of a change in accounting principle. It applies to all voluntarychanges in accounting principle, as well as to changes required by anaccounting pronouncement that does not include specific transition provisions.SFAS 154 is effective for accounting changes and corrections of errors made infiscal years beginning after December 15, 2005. We do not anticipate that theadoption of this standard will have a material impact on our consolidatedfinancial statements.

***Liquidityand Capital Resources***

This section discusses theeffects of the changes in our balance sheets, cash flows, and commitments onour liquidity and capital resources.

*Balance Sheet and Cash Flows*

We had positive cash flow from operating activitiesfor the year ended December 31, 2005 and finished the year with cash, cashequivalents and available-for-sale securities of approximately $168.6 million,after paying a net $12.8 million in the acquisition of Synthematix. Thiscompared to cash, cash equivalents and available-for-sale securities ofapproximately $136.5 million at December 31, 2004.

As of December 31, 2005, we had no long-termliabilities.

Our operating activities provided $42.6 million, $22.9million and $27.2 million of cash in 2005, 2004, and 2003, respectively. Thesources of cash for the three years were primarily the receipt of research anddevelopment funding from collaborative partners and revenue from product salesand licensing, partially offset by operating expenses. We expect that we willcontinue to generate positive cash flow from our operating activities in thenear future.

Net cash used in investing activities was $2.7million, $32.7 million and $43.1 million, respectively, in 2005, 2004, and2003. Included in the 2005 cash used in investing activities was the $12.8million net cash paid associated with the acquisition of Synthematix. Includedin the 2004 cash used in investing activities was the $26.9 million net cashpaid associated with the acquisition of IntelliChem. The other fluctuationsfrom period to period were due primarily to the timing of purchases, sales, andmaturity of our available-for-sale securities. Cash used in purchases ofproperty, plant and equipment was $6.5 million, $4.5 million and $9.7 million,respectively, in 2005, 2004, and 2003. Included in the 2003 cash used inpurchases of property, plant and equipment was $3.9 million paid for a buildingwhich houses a number of our laboratories as well as some office space. Weexpect to continue to make significant investments in the purchases of propertyand equipment to support our expanding operations, including investing in theleasehold improvement of a newly leased facility in Sunnyvale, California.

Financing activities provided cash of $11.3 million,$12.1 million and $7.4 million in 2005, 2004, and 2003, respectively. Theseamounts are primarily the proceeds from the exercise of stock options and saleof stock under the Employee Share Purchase Plan in each of the three years.

Current liabilitiesincreased by approximately $6.9 million at December 31, 2005 as compared to December31, 2004. All current liabilities, with the exception of the warranty expenseaccrual, have increased in 2005 due to the expansion of our operations in 2005.Warranty expense accrual has decreased 

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as anumber of our customers are now purchasing extended warranty programs which areincluded in deferred revenue rather than in warranty expense accrual.

*Backlog*

As of December 31, 2005,our customers have contractually committed to funding of approximately $100million and $146 million, respectively, for year 2006 and beyond, for thepurchase of Symyx Tools systems, licenses to our intellectual property andsoftware, royalty for the sale of products containing Symyx-discoveredmaterials and research work to be undertaken.

*Principal Commitments*

Our principal commitments consisted of our obligationsunder operating leases, our commitments to purchase inventory and fixed assets,and our commitments made for leasehold improvements. As of December 31, 2005and 2004, our principal commitments were $17.7 million and $11.3 million,respectively. Our principal commitments increased significantly due primarilyto the lease of additional facilities to accommodate the expansion of ourbusiness. We expect to satisfy these obligations as they become due over thenext ten years.

Futureprincipal commitments as of December 31, 2005 were as follows (in thousands):

| ** **            | ** ** | **Total** | ** ** | **Less than  1 Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More Than  5 Years** | ** ** |
|-----------------------|------------|-----------|------------|---------------------------------|------------|--------------------|------------|--------------------|------------|----------------------------------|------------|
| Facility  Commitments |       | $         | 14,906     |                            |       | $                  | 2,539      |               |       |                             | $          | 5,217 |   |   |   | $ | 4,019 |   |   |   | $ | 3,131 |   |   |
| Purchase  Commitments |       | 2,797     |       |                            | 2,797      |               |       |               | —     |                             |       |   | — |   |   |   | — |   |   |
| Total                 |       | $         | 17,703     |                            |       | $                  | 5,336      |               |       |                             | $          | 5,217 |   |   |   | $ | 4,019 |   |   |   | $ | 3,131 |   |   |

 

We believe that our current cash, available-for-salesecurities balances and the cash flows generated by operations will besufficient to satisfy our anticipated cash needs for working capital, capitalexpenditures, investment requirements, stock repurchases, and other liquidityrequirements associated with our existing operations for at least the comingyear. Nonetheless, we may raise additional funds through public or privatefinancing, collaborative relationships or other arrangements. We cannot assureyou that additional funding, if sought, will be available on terms favorable tous. Further, any additional equity financing may be dilutive to stockholders,and debt financing, if available, may involve restrictive covenants.Collaborative arrangements may require us to relinquish our rights to some ofour technologies or products. Our failure to raise capital when needed may harmour business and operating results.

A portion of our cash maybe used to acquire or invest in complementary businesses or products or toobtain the right to use complementary technologies. From time to time, in theordinary course of business, we may evaluate potential acquisitions of suchbusinesses, products or technologies.

*Other Commitments*

As discussed in the “*Off Balance Sheet Financing and Related PartyTransactions”*below*,*our committed investments related to theCollaborative Development and License Agreement with Intermolecular, Inc.as of December 31, 2005 were $964,000. We expect to meet this commitment in thenext two years.

*Customer Indemnification*

From time to time, weagree to indemnify our customers against certain third party liabilities,including liability if our products infringe a third party’s intellectualproperty rights. Such indemnification provisions are accounted for inaccordance with FASB Interpretation No. 45, *Guarantor’s Accounting and*

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*DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers.* The indemnification is typically limited to no morethan the amount paid by the customer. As of December 31, 2005, we were notsubject to any pending intellectual property-related litigation.

*Contingencies*

We do not believe that we are currently a party to anymaterial pending legal proceedings. We may become subject to legal proceedings,claims, and litigation arising in the ordinary course of business. Although theoutcome of these matters is currently not determinable, we do not currentlyexpect that the ultimate costs to resolve these matters will have a materialadverse effect on our consolidated financial position, results of operations,or cash flows.

We carry insurance withcoverage and coverage limits that we believe to be adequate. Although there canbe no assurance that such insurance is sufficient to protect us against allcontingencies, our management believes that our insurance protection isreasonable in view of the nature and scope of our operations.

*Off Balance Sheet Financing and Related PartyTransactions*

We have not enteredinto any off-balance sheet financing arrangements and have not established anyspecial purpose entities as of December 31, 2005. We have not guaranteed anydebt or commitments of other entities or entered into any options onnon-financial assets. The only transactions between us and related partiesduring 2005 were:

·       Revenuereceived for software maintenance and support from Ilypsa, Inc. of which we ownapproximately 18% of outstanding common stock, totaled $179,000;

·       MarioM. Rosati, one of our directors, is also a member of Wilson Sonsini Goodrich &Rosati, Professional Corporation, which has provided legal services withrespect to real estate issues, for which it has received compensation at normalcommercial rates totaling $108,000 in 2005.

·       On March 17, 2005, we entered into a CollaborativeDevelopment and License Agreement and on December 19, 2005, we entered into anAlliance Agreement, with Intermolecular, Inc. Under the agreements, the twocompanies will work together to conduct research and development andother activities with respect to materials and high-throughput technology foruse in semiconductor applications. Each party is bearing its own expenses. Thomas Baruch, one of our board members, is adirector of Intermolecular, Inc. and CMEA Ventures, of which Mr. Baruch is ageneral partner, holds a 17.5% interest in Intermolecular, Inc. W. HenryWeinberg, one of our executive officers, is a scientific advisory board memberof Intermolecular, Inc. and a holder of options to purchase 115,000 shares ofcommon stock of Intermolecular, Inc. In 2005 we recognized $88,000 in revenueassociated with the sale of a CORE(x) module to Intermolecular and a gain of$20,000 from the sale of a fixed asset with $130,000 net book value toIntermolecular, Inc. for its original cost of $150,000.

***Dividend Policy***

We have never declared orpaid any dividends on our capital stock. We currently expect to retain futureearnings, if any, to support the development of our business and do notanticipate paying any cash dividends in the foreseeable future.

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**Item 7A.**                QuantitativeAnd Qualitative Disclosures About Market Risk

Our exposure tomarket risk is principally confined to our cash, cash equivalents andinvestments which have maturities of less than two years. We maintain anon-trading investment portfolio of investment grade, liquid debt securities thatlimit the amount of credit exposure to any one issue, issuer or type ofinstrument. At December 31, 2005 our investment portfolio was comprised ofapproximately $70.6 million in money market funds and $98.0 million in U.S.corporate debt. The securities in our investment portfolio are not leveraged,are classified as available-for-sale and are therefore subject to interest raterisk. We currently do not hedge interest rate exposure. If market interestrates were to increase by 100 basis points, or 1%, from December 31, 2005levels, the fair value of our portfolio would decline by approximately$415,000. The modeling technique used measures the change in fair valuesarising from an immediate hypothetical shift in market interest rates andassumes ending fair values include principal plus accrued interest.

**Interest Rate Sensitivity:Principal Amount by Expected Maturity (in thousands)Average Interest Rate**

| ** **                     | ** ** | **Mature in  2006** | ** ** | **Fair Value  As of December 31,  2005** | ** ** |
|--------------------------------|------------|--------------------------|------------|--------------------------------------------------------------|------------|
| Available-for-sale  securities |       |                     | $          | 98,292                                                       |       |   |   | $ | 98,018 |   |   |
| Average interest rate          |       |                     | 3.79       | %                                                            |       |   |   |   |   |

 

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**Item8.**                        *Financial Statements and Supplementary Data*

| Index to  Consolidated Financial Statements                                                                          | ** ** | **Page** |
|----------------------------------------------------------------------------------------------------------------------|------------|----------|
| Report  of Independent Registered Public Accounting Firm on Consolidated Financial  Statements                       |       | 51       |   |
| Consolidated  Balance Sheets at December 31, 2005 and 2004                                                      |       | 52       |   |
| Consolidated  Income Statements for the Years Ended December 31, 2005, 2004 and 2003                            |       | 53       |   |
| Consolidated Statements of Stockholders’ Equity for  the Years Ended December 31, 2005, 2004 and 2003 |       | 54       |   |
| Consolidated  Statements of Cash Flows for the Years Ended December 31, 2005, 2004 and  2003                    |       | 56       |   |
| Notes to Consolidated Financial Statements                                                                           |       | 57       |   |

 

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM ONCONSOLIDATED FINANCIAL STATEMENTS**

**TheBoard of Directors and Stockholders of Symyx Technologies, Inc.**

We have audited the accompanying consolidated balancesheets of Symyx Technologies, Inc. as of December 31, 2005 and 2004,and the related consolidated income statements, consolidated statements ofstockholders’ equity and consolidated statements of cash flows for each of thethree years in the period ended December 31, 2005. These financial statementsare the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of Symyx Technologies, Inc. at December 31, 2005 and 2004,and the consolidated results of its operations and its cash flows for each ofthe three years in the period ended December 31, 2005, in conformity withU.S. generally accepted accounting principles.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of SymyxTechnologies, Inc.’s internal control over financial reporting as of December 31,2005, based on criteria established in Internal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commissionand our report dated March 3, 2006 expressed an unqualified opinionthereon.
| /s/ ERNST &  YOUNG LLP |   |
|---------------------------------|--------|
| Palo Alto, California           |   |
| March 3, 2006              |   |

 

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**SYMYX TECHNOLOGIES, INC.**

**CONSOLIDATED BALANCE SHEETS(In thousands, except share and per share information)**

| ** **                                                                                                                                                                  | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                  | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                                                                                  |       |                  |       |   |   |
| Current assets:                                                                                                                                                             |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                                   |       | $                     | 70,607     |   | $ | 19,459 |   |
| Available-for-sale securities                                                                                                                                               |       | 98,018                |       | 117,082 |   |
| Accounts receivable                                                                                                                                                         |       | 9,852                 |       | 10,954 |   |
| Inventories                                                                                                                                                                 |       | 841                   |       | 2,579 |   |
| Deferred tax assets, current                                                                                                                                                |       | 2,739                 |       | 3,885 |   |
| Interest receivable and other current assets                                                                                                                                |       | 3,063                 |       | 4,395 |   |
| Total current assets                                                                                                                                                        |       | 185,120               |       | 158,354 |   |
| Property, plant  and equipment, net                                                                                                                                         |       | 21,756                |       | 22,679 |   |
| Goodwill                                                                                                                                                                    |       | 17,618                |       | 9,283 |   |
| Intangible  assets, net                                                                                                                                                     |       | 14,447                |       | 15,114 |   |
| Deferred tax and  other assets                                                                                                                                              |       | 2,471                 |       | 1,572 |   |
| Total assets                                                                                                                                                                |       | $                     | 241,412    |   | $ | 207,002 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                               |       |                  |       |   |   |
| Current liabilities:                                                                                                                                                        |       |                  |       |   |   |
| Accounts payable                                                                                                                                                            |       | $                     | 2,273      |   | $ | 1,399 |   |
| Other accrued liabilities                                                                                                                                                   |       | 5,081                 |       | 3,908 |   |
| Accrued compensation and employee benefits                                                                                                                                  |       | 6,144                 |       | 3,929 |   |
| Income taxes payable                                                                                                                                                        |       | 3,737                 |       | 1,927 |   |
| Deferred rent                                                                                                                                                               |       | 759                   |       | 747 |   |
| Deferred revenue                                                                                                                                                            |       | 4,244                 |       | 3,430 |   |
| Warranty expense accrual                                                                                                                                                    |       | 645                   |       | 653 |   |
| Total current liabilities                                                                                                                                                   |       | 22,883                |       | 15,993 |   |
| Commitments and  contingencies (Note 3)                                                                                                                                     |       |                  |       |   |   |
| Stockholders’  equity:                                                                                                                                                 |       |                  |       |   |   |
| Preferred stock, $0.001 par value, 10,000,000 shares  authorized, issuable in series; no shares issued and outstanding                                                      |       | —                |       | — |   |
| Common stock, $0.001 par value, 60,000,000 shares  authorized and 33,194,140 and 32,484,589 shares issued and outstanding at  December 31, 2005 and 2004, respectively |       | 33                    |       | 32 |   |
| Additional paid-in capital                                                                                                                                                  |       | 196,815               |       | 181,846 |   |
| Deferred stock compensation                                                                                                                                                 |       | (261                  | )          | (618 | ) |
| Accumulated other comprehensive loss                                                                                                                                        |       | (298                  | )          | (489 | ) |
| Retained earnings                                                                                                                                                           |       | 22,240                |       | 10,238 |   |
| Total stockholders’ equity                                                                                                                                             |       | 218,529               |       | 191,009 |   |
| Total liabilities  and stockholders’ equity                                                                                                                            |       | $                     | 241,412    |   | $ | 207,002 |   |

 

See accompanying notes.

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**SYMYX TECHNOLOGIES,INC.**

**CONSOLIDATEDINCOME STATEMENTS(In thousands, except per share amounts)**

| ** **                                                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Revenue:                                                              |       |     |       |     |       |     |       |
| Service revenue                                                       |       | $        | 56,980     |     | $          | 42,251   |       | $ | 38,689 |   |
| Product sales                                                         |       | 26,663   |       | 27,060   |       | 14,458   |       |
| License fees and royalties                                            |       | 24,494   |       | 13,874   |       | 9,816    |       |
| Total revenue                                                         |       | 108,137  |       | 83,185   |       | 62,963   |       |
| Operating  expenses:                                                  |       |     |       |     |       |     |       |
| Cost of products sold                                                 |       | 11,090   |       | 7,857    |       | 2,937    |       |
| Research and development                                              |       | 50,660   |       | 41,142   |       | 40,058   |       |
| Sales, general and administrative                                     |       | 25,566   |       | 18,007   |       | 14,933   |       |
| Acquired in-process research and development                          |       | 1,590    |       | 2,260    |       | —   |       |
| Amortization of intangible assets arising from  business combinations |       | 3,515    |       | 231      |       | —   |       |
| Total operating expenses                                              |       | 92,421   |       | 69,497   |       | 57,928   |       |
| Income from operations                                                |       | 15,716   |       | 13,688   |       | 5,035    |       |
| Interest and  other income                                            |       | 4,427    |       | 2,521    |       | 1,996    |       |
| Income before  income tax expense                                     |       | 20,143   |       | 16,209   |       | 7,031    |       |
| Income tax  expense                                                   |       | 8,141    |       | 3,327    |       | 1,290    |       |
| Net income                                                            |       | $        | 12,002     |     | $          | 12,882   |       | $ | 5,741 |   |
| Basic net income per share                                            |       | $        | 0.37       |     | $          | 0.40     |       | $ | 0.18 |   |
| Diluted net income per share                                          |       | $        | 0.35       |     | $          | 0.38     |       | $ | 0.18 |   |
| Shares used in computing basic net income per share                   |       | 32,819   |       | 32,067   |       | 31,199   |       |
| Shares used in  computing diluted net income per share                |       | 34,564   |       | 33,872   |       | 32,470   |       |

 

See accompanying notes.

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**SYMYX TECHNOLOGIES,INC.**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(In thousands)**

| ** ** | ** ** | ** **               | ** ** | ** **            | ** ** | ** **  | ** ** | ** ** | ** ** | ** **     | ** ** | ** **        | ** ** | ** **       | ** ** | **Accumulated**        | ** ** | **Retained** | ** ** | ** ** | ** ** |
|------------|------------|--------------------------|------------|-----------------------|------------|-------------|------------|------------|------------|----------------|------------|-------------------|------------|------------------|------------|------------------------|------------|--------------|------------|------------|------------|
| ** ** | ** ** | ** **               | ** ** | ** **            | ** ** | ** **  | ** ** | ** ** | ** ** | **Additional** | ** ** | **Stockholder**   | ** ** | **Deferred**     | ** ** | **Other**              | ** ** | **Earnings** | ** ** | **Total**  | ** ** |
| ** ** | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Notes**  | ** ** | **Stock**      | ** ** | **Comprehensive** | ** ** | **(Accumulated** | ** ** | **Stockholders’** | ** ** |
| ** ** | ** ** | **Shares**               | ** ** | **Amount**            | ** ** | **Shares**  | ** ** | **Amount** | ** ** | **Capital**    | ** ** | **Receivable**    | ** ** | **Compensation** | ** ** | **Income (Loss)** | ** ** | **Deficit)** | ** ** | **Equity** | ** ** |

| Balance at January 1, 2003                                                            |   |   | — |   |   |   | $      | — |   |   |   | 30,920 |   |   |   | $      | 31     |   |    |   | $      | 154,213 |   |   |   | $      | (404   | )      |   |   | $      | (92    | )      |   |   | $      | 120    |   |    |   | $      | (8,385 | ) |   |   | $ | 145,483 |   |   |
|--------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|---------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|--------|---|--------|--------|---|---------|--------|--------|
| Repurchase of  common stock                                                           |   |   | — |   |   |   | — |   |   |   | (2     | )      |   |   | — |   |   |   | (2      | )      |   |    | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (2      | )      |   |
| Issuance of common  stock on exercise of options                                           |   |   | — |   |   |   | — |   |   |   | 579    |   |   |   | 1      |   |   |   | 6,006   |   |   |    | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 6,007   |   |   |
| Issuance of common  stock under employee share purchase plan                               |   |   | — |   |   |   | — |   |   |   | 113    |   |   |   | — |   |   |   | 1,115   |   |   |    | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 1,115   |   |   |
| Repayment of notes    receivable                                                           |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |    | 270    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 270     |   |   |
| Issuance of  options to consultants for services received                                  |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 94      |   |   |    | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 94      |   |   |
| Amortization of  deferred stock compensation                                          |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |    | — |   |   |   | 43     |   |   |   | — |   |   |   | — |   |   |   | 43      |   |   |
| Deferred stock  compensation related to terminated employees                               |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (42     | )      |   |    | — |   |   |   | 42     |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |
| Tax benefit from  employee stock option plans                                              |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 776     |   |   |    | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 776     |   |   |
| Comprehensive income:                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |
| Net income                                                                                 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |    | — |   |   |   | — |   |   |   | — |   |   |   | 5,741  |   |   |   | 5,741   |   |   |
| Unrealized gain  (loss) on foreign currency   translation                                  |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |    | — |   |   |   | — |   |   |   | 2      |   |   |   | — |   |   |   | 2       |   |   |
| Unrealized gain  (loss) on available-for-sale securities, net of income taxes of $61  |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |    | — |   |   |   | — |   |   |   | (91    | )      |   |   | — |   |   |   | (91     | )      |   |
| Comprehensive  income                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 5,652   |   |   |
| Balance at December 31,  2003                                                         |   |   | — |   |   |   | — |   |   |   | 31,610 |   |   |   | 32     |   |   |   | 162,160 |   |   |    | (134   | )      |   |   | (7     | )      |   |   | 31     |   |   |   | (2,644 | )      |   |   | 159,438 |   |   |
| Issuance of common  stock on exercise of options                                           |   |   | — |   |   |   | — |   |   |   | 742    |   |   |   | — |   |   |   | 10,574  |   |   |    | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 10,574  |   |   |
| Issuance of common  stock under employee share purchase plan                               |   |   | — |   |   |   | — |   |   |   | 133    |   |   |   | — |   |   |   | 1,433   |   |   |    | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 1,433   |   |   |
| Repayment of notes    receivable                                                           |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |    | 134    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 134     |   |   |
| Issuance of  options in connection with acquisition                                   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 1,041   |   |   |    | — |   |   |   | (651   | )      |   |   | — |   |   |   | — |   |   |   | 390     |   |   |
| Amortization of  deferred stock compensation                                          |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |    | — |   |   |   | 40     |   |   |   | — |   |   |   | — |   |   |   | 40      |   |   |
| Issuance of  options to consultants for services received                                  |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 500     |   |   |    | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 500     |   |   |
| Tax benefit from  employee stock option plans                                              |   |   |   |   |   |   |   |   |   |   | — |   |   |   | — |   |   |   | 6,138   |   |   |    | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 6,138   |   |   |
| Comprehensive income:                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |
| Net income                                                                                 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |    | — |   |   |   | — |   |   |   | — |   |   |   | 12,882 |   |   |   | 12,882  |   |   |
| Unrealized gain  (loss) on foreign currency   translation                                  |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |    | — |   |   |   | — |   |   |   | (1     | )      |   |   | — |   |   |   | (1      | )      |   |
| Unrealized gain  (loss) on available-for-sale securities, net of income taxes of $28  |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |    | — |   |   |   | — |   |   |   | (519   | )      |   |   | — |   |   |   | (519    | )      |   |
| Comprehensive  income                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 12,362  |   |   |
| Balance at  December 31,  2004                                                        |   |   | — |   |   |   | — |   |   |   | 32,485 |   |   |   | 32     |   |   |   | 181,846 |   |   |    | — |   |   |   | (618   | )      |   |   | (489   | )      |   |   | 10,238 |   |   |   | 191,009 |   |   |
| Issuance of common  stock on exercise of options                                      |   |   | — |   |   |   | — |   |   |   | 632    |   |   |   | 1      |   |   |   | 9,728   |   |   |    | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 9,729   |   |   |
| Issuance of common  stock under employee share purchase plan                               |   |   | — |   |   |   | — |   |   |   | 77     |   |   |   | — |   |   |   | 1,566   |   |   |    | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 1,566   |   |   |
| Issuance of options in  connection with acquisition                                   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 571     |   |   |    | — |   |   |   | (216   | )      |   |   | — |   |   |   | — |   |   |   | 355     |   |   |
| Amortization of  deferred stock compensation, net of reversals                        |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |    | — |   |   |   | 343    |   |   |   | — |   |   |   | — |   |   |   | 343     |   |   |

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**SYMYX TECHNOLOGIES, INC.**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY — (Continued) (In thousands)**

 

| Reversal of  deferred stock compensation related to terminated employees |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (230   | )      |   |   | — |   |   |   | 230    |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|--------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Tax benefit from employee  stock option plans                            |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 3,334  |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 3,334  |   |   |
| Comprehensive income:                                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                               |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 12,002 |   |   |   | 12,002 |   |   |
| Unrealized gain  (loss) on foreign currency translation                  |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (29    | )      |   |   | — |   |   |   | (29    | )      |   |
| Unrealized gain  (loss) on available-for-sale   securities               |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 220    |   |   |   | — |   |   |   | 220    |   |   |
| Comprehensive  income                                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 12,193 |   |   |

| Balance at  December 31,  2005 |   |   | — |   |   |   | $ | — |   |   |   | 33,194 |   |   |   | $ | 33 |   |   |   | $ | 196,815 |   |   |   | $ | — |   |   |   | $ | (261 | ) |   |   | $ | (298 | ) |   |   | $ | 22,240 |   |   |   | $ | 218,529 |   |   |
|-------------------------------------|--------|--------|--------|--------|--------|--------|---|--------|--------|--------|--------|--------|--------|--------|--------|---|----|--------|--------|--------|---|---------|--------|--------|--------|---|--------|--------|--------|--------|---|------|---|--------|--------|---|------|---|--------|--------|---|--------|--------|--------|--------|---|---------|--------|--------|

 

See accompanying notes.

55

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**SYMYX TECHNOLOGIES,INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)**

| ** **                                                                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| OPERATING ACTIVITIES                                                                          |       |     |       |     |       |     |       |
| Net income                                                                                    |       | $        | 12,002     |     | $          | 12,882   |       | $ | 5,741 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities:            |       |     |       |     |       |     |       |
| Depreciation and amortization                                                                 |       | 10,508   |       | 12,723   |       | 11,925   |       |
| Amortization of intangible assets arising from  business combinations                    |       | 3,515    |       | 231      |       | —   |       |
| Acquired in-process research and development                                                  |       | 1,590    |       | 2,260    |       | —   |       |
| Stock-based compensation, net of reversals                                                    |       | 343      |       | 540      |       | 137      |       |
| Gain on sale of property, plant and equipment                                                 |       | (11      | )          | (155     | )          | —   |       |
| Deferred income taxes                                                                         |       | 55       |       | (3,469   | )          | 103      |       |
| Tax benefit from employee stock transactions                                                  |       | 3,334    |       | 6,138    |       | 776      |       |
| Changes in  operating assets and liabilities, excluding effects of business acquisition: |       |     |       |     |       |     |       |
| Accounts receivable                                                                           |       | 1,645    |       | (7,012   | )          | 4,080    |       |
| Inventories                                                                                   |       | 1,738    |       | 1,164    |       | (1,503   | )          |
| Interest receivable and other current assets                                                  |       | 1,390    |       | 364      |       | (881     | )          |
| Other long-term assets                                                                        |       | 257      |       | 257      |       | 142      |       |
| Accounts payable                                                                              |       | 874      |       | 679      |       | (286     | )          |
| Other accrued liabilities                                                                     |       | 866      |       | (526     | )          | 555      |       |
| Accrued compensation and employee benefits                                                    |       | 2,031    |       | 1,528    |       | 937      |       |
| Income taxes payable                                                                          |       | 1,810    |       | 900      |       | 863      |       |
| Deferred rent                                                                                 |       | 12       |       | 66       |       | 119      |       |
| Deferred revenue                                                                              |       | 618      |       | (4,498   | )          | 4,626    |       |
| Warranty expense accrual                                                                      |       | (8       | )          | (1,147   | )          | (99      | )          |
| Net cash provided by operating activities                                                     |       | 42,569   |       | 22,925   |       | 27,235   |       |
| INVESTING ACTIVITIES                                                                          |       |     |       |     |       |     |       |
| Purchase of property, plant and equipment, net                                                |       | (6,527   | )          | (4,470   | )          | (9,723   | )          |
| Purchase of available-for-sale securities                                                     |       | (119,840 | )          | (113,936 | )          | (145,198 | )          |
| Proceeds from maturities of available-for-sale  securities                                    |       | 136,440  |       | 101,326  |       | 112,090  |       |
| Proceeds from sales of available-for-sale securities                                          |       | —   |       | 11,987   |       | —   |       |
| Acquisition of a business, net of cash acquired                                               |       | (12,760  | )          | (26,873  | )          | —   |       |
| Acquisition of technology                                                                     |       | —   |       | (750     | )          | (315     | )          |
| Net cash used in investing activities                                                         |       | (2,687   | )          | (32,716  | )          | (43,146  | )          |
| FINANCING ACTIVITIES                                                                          |       |     |       |     |       |     |       |
| Proceeds from issuance of common stock                                                        |       | 11,295   |       | 12,141   |       | 7,390    |       |
| Effect of foreign exchange rate changes on cash and  cash equivalents                         |       | (29      | )          | (1       | )          | 2        |       |
| Net increase (decrease) in cash and cash equivalents                                          |       | 51,148   |       | 2,349    |       | (8,519   | )          |
| Cash and cash equivalents at beginning of period                                              |       | 19,459   |       | 17,110   |       | 25,629   |       |
| Cash and cash equivalents at end of period                                                    |       | $        | 70,607     |     | $          | 19,459   |       | $ | 17,110 |   |
| SUPPLEMENTAL DISCLOSURE  OF CASH FLOW   INFORMATION                                           |       |     |       |     |       |     |       |
| Income taxes paid (refunded), net                                                             |       | $        | 2,087      |     | $          | (243     | )          | (474 | ) |
| SUPPLEMENTAL DISCLOSURE  OF NON-CASH INVESTING AND FINANCING ACTIVITIES                  |       |     |       |     |       |     |       |
| Employee stock options assumed in connection with  acquisitions                               |       | $        | 571        |     | $          | 1,041    |       | $ | — |   |

 

See accompanying notes.

56

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**SYMYX TECHNOLOGIES,INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1. Summaryof Significant Accounting Policies**

***Business and Basis of Presentation***

Symyx Technologies, Inc.(the “Company” or “Symyx”) develops and applies high-throughput researchtechnologies and research software for customers in the pharmaceutical,chemical, energy, electronics and other industries. Symyx performsresearch for customers using proprietary technologies to discover new andinnovative materials, sells automated high-throughput instrumentation, licensessoftware for use in customers’ own laboratories, and licenses discoveredmaterials, sensors and intellectual property.

***Principles of consolidation***

These consolidatedfinancial statements include the accounts of the Company and its wholly-ownedsubsidiaries, Symyx Discovery Tools, Inc., incorporated in California,Symyx Technologies International, Inc., incorporated in Delaware, SymyxRenaissance Software, Inc. (formerly Symyx IntelliChem, Inc.),incorporated in Oregon, and Symyx Technologies AG, incorporated in Switzerland.Synthematix, Inc. was acquired on April 1 and was merged into SymyxRenaissance Software, Inc. effective August 1, 2005. All significantintercompany balances and transactions have been eliminated on consolidation.

***Use of Estimates***

Preparing financialstatements requires management to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenue, and expenses. Estimatesinclude future warranty expenditures and product life cycles, and assumptionssuch as the elements comprising a software arrangement, including thedistinction between upgrades/enhancements and new products; when technologicalfeasibility is achieved for the Company’s products; the potential outcome offuture tax consequences of events that have been recognized in the Company’sfinancial statements or tax returns; and determining when investmentimpairments are other-than-temporary. Actual results and outcomes may differfrom management’s estimates and assumptions. For example, the actual resultswith regard to warranty expenditures could have a material unfavorable impacton the Company if system failures or the cost to repair a system is greaterthan what the Company has used in estimating the warranty expense accrual.

***Cash and Cash Equivalents***

The Company considers allhighly liquid investments, with maturities of three months or less on the dateof purchase, to be cash equivalents. Cash equivalents are carried at fairvalue.

***Available-For-Sale Investments***

Management determines theappropriate classification of debt securities at the time of purchase andreevaluates such determination as of each balance sheet date. The Company hasclassified its entire investment portfolio as available-for-sale.Available-for-sale securities are stated at fair value, with the unrealizedgains and losses, net of tax, reported in other comprehensive income. Realizedgains and losses and declines in value judged to be other-than-temporary onavailable-for-sale securities are included in interest income. The estimatedfair value amounts have been determined by the Company using available marketinformation.

57

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

The amortized cost of debtsecurities is adjusted for amortization of premiums and accretion of discountsto maturity. Such amortization is included in interest income. The cost ofsecurities sold is based on the specific identification method. Interest anddividends are included in interest income.

The Company invests itsexcess cash primarily in deposits with banks and short-term and medium-termmarketable securities. These investments primarily include corporate notes,money market funds, and U.S. treasury notes. By policy, the Company restrictsits investments to long-term bank obligations rated “A” or higher andshort-term obligations rated “P1” or higher by Moody’s or “A1” or higher byStandard & Poor’s (“S&P”), and corporate obligations, includingintermediate term notes rated “A” or higher, and commercial paper rated “P1” orhigher by Moody’s, or “A1” or higher by S&P. By policy, the Companyrestricts its investments to instruments with maturities of less thantwenty-four months.

Thefollowing is a summary of the fair value of cash, cash equivalents andavailable-for-sale securities (in thousands):

| ** **                      | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Cash and cash  equivalents      |       | $                     | 70,607     |   | $ | 19,459 |   |
| U.S. corporate  debt securities |       | 98,018                |       | 117,082 |   |
| Total                           |       | $                     | 168,625    |   | $ | 136,541 |   |

 

Aboveamounts are included in the following line items on the Consolidated BalanceSheets (in thousands):

| ** **                     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Cash and cash  equivalents     |       | $                     | 70,607     |   | $ | 19,459 |   |
| Available-for-sale  securities |       | 98,018                |       | 117,082 |   |
| Total                          |       | $                     | 168,625    |   | $ | 136,541 |   |

 

The Company had norealized gains or losses for the years ended December 31, 2005 and 2003.Realized losses on the sale of available-for-sale securities for the year endedDecember 31, 2004 were minimal. Unrealized gains and losses for the yearsended December 31, 2005, 2004 and 2003 are included in Note 1 “ComprehensiveIncome.”

Thefair value of the Company’s investment in debt securities, by contractualmaturity, is as follows (in thousands):

| ** **               | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Due in less than  1 year |       | $                     | 96,016     |   | $ | 104,764 |   |
| Due in 1 to 2  years     |       | 2,002                 |       | 12,318 |   |
| Total                    |       | $                     | 98,018     |   | $ | 117,082 |   |

 

58

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

Unrealizedlosses on available-for-sale securities by duration and fair value ofinvestments are as follows (in thousands):

| ** **            | ** ** | **December 31,**  | ** ** |
|-----------------------|------------|------------------------|------------|
| ** **            | ** ** | **2005**               | ** ** | **2004** | ** ** |
| ** **            | ** ** | **Unrealized  Losses** | ** ** | **Related Fair   Value of  Investments** | ** ** | **Unrealized  Losses** | ** ** | **Related Fair  Value of  Investments** | ** ** |
| Less than 12  months  |       |                   | $          | (261 | ) |   |   | $ | 85,446 |   |   |   | $ | (442 | ) |   |   | $ | 87,607 |   |   |
| 12 months or  greater |       |                   | (27        | ) |   |   | 12,059 |   |   |   | (69 | ) |   |   | 21,437 |   |   |
| Total                 |       |                   | $          | (288 | ) |   |   | $ | 97,505 |   |   |   | $ | (511 | ) |   |   | $ | 109,044 |   |   |

 

At December 31,2005 unrealized losses of $288,000 were all related to 56 investments in U.S.corporate debt securities. Unrealized losses are primarily attributable tochanges in interest rates. Of the unrealized losses of $288,000 at December 31,2005, $27,000 exceeded twelve months. The Company does not believe anyunrealized losses represent an other-than-temporary impairment as of December 31,2005.

***Restricted Cash***

In connection with a leasetransaction acquired as part of the business combination with IntelliChem (SeeNote 7 “Business Combinations.”), the Company had restricted cash at December 31,2004 of approximately $104,000 representing a security deposit required by thelease agreement for its Bend, Oregon facility. The requirement of retaining therestricted cash expired on March 31, 2005. There was no restricted cash atDecember 31, 2005. The balance of restricted cash as of December 31,2004 was consolidated with other current assets on the Consolidated BalanceSheets.

***Property, Plant and Equipment***

Property, plant andequipment are stated at cost. Depreciation of equipment is computed on thestraight-line method using a life of three to five years for financialreporting purposes and by accelerated methods for income tax purposes.Depreciation of buildings is computed on the straight-line method using a lifeof thirty years for financial reporting purposes. Leasehold improvements areamortized over the shorter of the lease term or the estimated useful life ofthe assets for financial reporting purposes.

Property,plant and equipment consist of the following (in thousands):

| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Machinery and  equipment                        |       | $                     | 24,349     |   | $ | 21,216 |   |
| Computers and  software                         |       | 4,410                 |       | 3,236 |   |
| Land and building                               |       | 3,551                 |       | 3,551 |   |
| Leasehold  improvements                         |       | 25,186                |       | 25,033 |   |
| Construction in  progress                       |       | 2,279                 |       | 987 |   |
| Furniture and  fixtures                         |       | 1,146                 |       | 1,032 |   |
| Property, plant and equipment, gross            |       | 60,921                |       | 55,055 |   |
| Less accumulated  depreciation and amortization |       | (39,165               | )          | (32,376 | ) |
| Property, plant  and equipment, net             |       | $                     | 21,756     |   | $ | 22,679 |   |

 

59

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

At December 31, 2005,no property, plant and equipment were pledged as collateral against borrowings.Amortization of leasehold improvements is included in depreciation expense.Depreciation expense was $7,532,000, $7,951,000, and $7,797,000 in 2005, 2004,and 2003, respectively.

***Long-Lived Assets***

The Company routinelyevaluates the carrying value of its long-lived assets. The Company recordsimpairment losses on long-lived assets used in operations when events andcircumstances indicate that assets may be impaired, the undiscounted cash flowsestimated to be generated by the assets are less than the carrying amount ofthose assets, and the fair values of those assets are less than theirrespective carrying amounts. To date, no impairment charges have beenrecognized.

***Revenue Recognition***

The Company recognizesrevenue in accordance with the Securities and Exchange Commission’s StaffAccounting Bulletin No. 104 (“SAB 104”), *RevenueRecognition*, the American Institute of Certified Public AccountantsStatement of Position (“SOP”) 97-2, *Software RevenueRecognition*, as amended by SOP 98-9, *Modificationof SOP 97-2, Software Revenue Recognition*, FinancialAccounting Standards Board Technical Bulletin 90-1, *Accountingfor Separately Priced Extended Warranty and Product Maintenance Contracts*,the Emerging Issues Task Forceconsensus on Issue 00-21, *Multiple-DeliverableRevenue Arrangements* (“EITF 00-21”), and otherauthoritative accounting literature. The Company generates revenue fromservices provided under research collaborations, the sale of products, thelicense of software, the provision of support and maintenance services, and thelicense of intellectual property. It is possible for the Company’s customers towork with it in multiple areas of its business and contracts may includemultiple elements of service revenue, product revenue, and license and royaltyrevenue. In determining the basis for revenue recognition, the Company firstdetermines the fair value of any extended warranty services and defers thisrevenue to be recognized over the service period. For those contracts thatinvolve multiple element deliverables, the Company identifies all deliverables,determines the units of accounting and allocates revenue between the units ofaccounting in accordance with EITF 00-21. In an arrangement that includes software that is more thanincidental to the products or services as a whole, the Company recognizesrevenue from the software and software-related elements, as well as anynon-software deliverable(s) for which a software deliverable is essentialto its functionality, in accordance with SOP 97-2.

*Service Revenue*

The Company recognizesservice revenue from research collaboration agreements, software consulting,and support and maintenance agreements as earned based upon the performancerequirements of the agreements. Payments received prior to performance aredeferred and recognized as revenue when earned over future performance periods.Collaboration agreements specify minimum levels of research effort required tobe performed by the Company. Payments received under research collaborationagreements are not refundable if the research effort is not successful. Directcosts associated with research collaborations are included in research anddevelopment expense. Software consulting agreements specify the number of daysof consulting services to be provided by the Company. Support and maintenanceagreements specify the term of the product maintenance and the nature of theservices to be provided by the Company during the term. Direct costs associatedwith software consulting and support and maintenance were immaterial to dateand therefore were also included in research and development expense.

60

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

Non-refundable up-frontpayments received in connection with research and development collaborationagreements, including technology access fees, are deferred and recognized on astraight-line basis over the relevant periods specified in the agreement,generally the research term. Revenue from milestone payments, which aresubstantially at risk until the milestones are completed, is recognized uponcompletion of these milestone events. Milestone payments to date have beenimmaterial.

Extended productmaintenance contracts, which typically provide both extended warranty coverageand product maintenance services, are separately priced from the product, andare recognized as revenue on a straight-line basis over the term of thecoverage. The Company’s product-related software licenses may provide fortechnical support, bug fixes and rights to unspecified upgrades on awhen-and-if-available basis for periods defined within the contract. Revenuerelated to this post-contract customer support is deferred and recognized overthe term of the contracted support.

*Product Sales*

Product sales revenueincludes sales of Symyx Tools hardware and the license of associated software.The Company’s Symyx Tools systems are typically delivered undermultiple-element arrangements, which include hardware, software andintellectual property licenses, and maintenance. A determination is made foreach system delivered as to whether software is incidental to the system as awhole. If software is not incidental to the Symyx Tools system as a whole,revenue from these arrangements is recognized in accordance with SOP 97-2,as amended. If software is incidental to the Symyx Tools system, revenue fromthe sale of the Symyx Tools system is earned and recognized when persuasiveevidence of an arrangement exists, delivery of the product has occurred, no significantobligations with regard to implementation remain, the fee is fixed ordeterminable, and collectibility is reasonably assured. This is generally uponshipment, transfer of title to and acceptance by the customer of the hardwareand associated licenses to software and intellectual property, unless there areextended payment terms. The Company considers all arrangements with paymentterms extending beyond twelve months not to be fixed or determinable. If thefee is not fixed or determinable, revenue is recognized as payments become duefrom the customer. In multiple element arrangements, the Company uses theresidual method to allocate revenue to delivered elements once it hasestablished fair value for all undelivered elements. Payments received in advanceunder these arrangements are recorded as deferred revenue until earned.

An accrual is establishedfor warranty expenses at the time the associated revenue is recognized.Shipping and insurance costs associated with the sale of discovery tools systemsare not material and are included in sales, general and administrativeexpenses.

*Software LicenseFees*

Revenue is recognized whenpersuasive evidence of an arrangement exists, delivery has occurred, the fee isfixed or determinable, and collectibility is reasonably assured. The Companyenters into certain arrangements where it is obligated to deliver multipleproducts and/or services (multiple elements). In these transactions, theCompany allocates the total revenue among the elements based on the sales priceof each element when sold separately (vendor-specific objective evidence) whenall such information is available.

If the fair value of allelements has not been determined, the amount of revenue allocated toundelivered elements is based on the vendor-specific objective evidence of fairvalue for those elements using the residual method. Under the residual method,the total fair value of the undelivered elements, as indicated byvendor-specific objective evidence, is recorded as unearned, and the differencebetween the total arrangement fee and the amount for the undelivered elementsis recognized as revenue related to 

61

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

deliveredelements. If evidence of the fair value of one or more undelivered elementsdoes not exist, the total revenue is deferred and recognized when delivery ofthose elements occurs or when fair value can be established.

Forsoftware licensed on an annual right to use basis, revenue is recognizedstraight line over the term of the license. Revenue from multi-yearlicensing arrangements are accounted for as subscriptions, with billingsrecorded as unearned revenue and recognized as revenue ratably over the billingcoverage period. Certain multi-year licensing arrangements include rights toreceive future versions of software products on a when-and-if-available basis.For software licensed on a perpetual basis, where the Company has notestablished vendor specific objective evidence of the fair value of thesoftware licenses and maintenance and support (primarily the ELN software productsthat we acquired from IntelliChem, Inc. and Synthematix, Inc.), theperpetual license fee is recognized ratably over the period of the bundledsupport and maintenance commitment.

The Company considers allarrangements with payment terms longer than 12 months not to be fixed ordeterminable. If the fee is not fixed or determinable, revenue is recognized aspayments become due from the customer, provided all the other revenuerecognition criteria have been met.

*IntellectualProperty License Fees and Royalties*

Amounts received fromthird parties for licenses to the Company’s intellectual property arerecognized when earned under the terms of the agreements. Revenue is recognizedupon transfer of the license unless the Company has continuing obligations forwhich fair value cannot be established, in which case the revenue is recognizedover the period of the obligation. If there are extended payment terms, licensefee revenue is recognized as these payments become due. The Company considersall arrangements with payment terms extending beyond 12 months not to be fixedor determinable. If there is a provision in the licensing agreement for avariable fee in addition to a non-refundable minimum amount, the amount of thenon-refundable minimum guarantee is recognized upon transfer of the licenseunless the Company has continuing obligations for which fair value cannot beestablished and the amount of the variable fee in excess of the guaranteedminimum is recognized as revenue when it is fixed and determinable.

Royalty revenue isrecorded based on reported sales by third party licensees of productscontaining the Company’s software and intellectual property. If there areextended payment terms, royalty revenues are recognized as these paymentsbecome due. Non-refundable royalties, for which there are no furtherperformance obligations, are recognized when due under the terms of theagreements.

Amounts received fromthird parties for options to license certain technology or enter collaborativearrangements upon specified terms are deferred until either the option isexercised or expires.

***Concentration of Revenue***

Duringthe years ended December 31, 2005, 2004, and 2003, the following customerscontributed more than 10% of the Company’s total revenue for the year (in thousands):

| ** **                | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------|------------|---------------------------------------------|------------|
| ** **                | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| ExxonMobil                |       | $                                           | 42,254     |   | $ | 45,016 |   | $ | 21,945 |   |
| Merck                     |       | 1,535                                       |       | 3,553 |   | 8,410 |   |
| The Dow Chemical  Company |       | 26,765                                      |       | 4,420 |   | 4,350 |   |
| Undisclosed  Partner      |       | 146                                         |       | 2,427 |   | 6,657 |   |
| Total                     |       | $                                           | 70,700     |   | $ | 55,416 |   | $ | 41,362 |   |

 

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

Therevenue from the above customers has been included in the following reportablesegments for the years ended December 31, 2005, 2004, and 2003 (inthousands):

| ** **                  | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------|------------|---------------------------------------------|------------|
| ** **                  | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Research  Collaborations    |       | $                                           | 38,742     |   | $ | 30,970 |   | $ | 26,731 |   |
| Symyx Tools                 |       | 18,321                                      |       | 16,668 |   | 10,838 |   |
| Symyx Software              |       | 9,447                                       |       | 4,678 |   | 943 |   |
| Materials and IP  Licensing |       | 4,190                                       |       | 3,100 |   | 2,850 |   |
| Total                       |       | $                                           | 70,700     |   | $ | 55,416 |   | $ | 41,362 |   |

 

Therevenue from the above customers has been included in the Consolidated IncomeStatements as follows (in thousands):

| ** **                  | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------|------------|---------------------------------------------|------------|
| ** **                  | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Service revenue             |       | $                                           | 34,539     |   | $ | 28,325 |   | $ | 25,097 |   |
| Product sales               |       | 16,938                                      |       | 15,648 |   | 8,275 |   |
| License fees and  royalties |       | 19,223                                      |       | 11,443 |   | 7,990 |   |
| Total                       |       | $                                           | 70,700     |   | $ | 55,416 |   | $ | 41,362 |   |

 

***Inventory***

Work in process inventoryconsists of customized Symyx Tools systems in the process of being built.Finished goods inventory consists of customized Symyx Tools systems that havebeen finished but are pending shipment to customers. Inventories are carried atthe lower of cost or market, with cost determined on a specific identificationbasis. The Company’s inventory balances at December 31, 2005 and 2004 wereall work in process inventory.

***Accounts Receivable and Allowance for DoubtfulAccounts***

Trade accounts receivableare recorded at the invoiced amount and do not bear interest. Substantially allreceivables were trade receivables at December 31, 2005 and 2004. TheCompany determined that no allowance for doubtful accounts was required at December 31,2005 and 2004 based on historical customer review.

***Warranty ExpenseAccrual***

The Company offers a warranty on each Symyx ToolSystem shipped. The specific terms and conditions of these warranties varydepending upon the product sold and country in which the Company does business.However, they typically include coverage for parts and labor and software bugfixes, for a specified period (typically one year). The Company estimates thecosts that may be incurred under its basic limited warranty and records aliability in the amount of such costs at the time product revenue isrecognized. Factors that affect the Company’s warranty liability include thenumber of installed units, historical and anticipated rates of warranty claims,and cost per claim. The Company periodically assesses the adequacy of itsrecorded warranty liabilities and adjusts the amounts as necessary.

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

Changesin the Company’s warranty expense accrual during the years ended December 31,2005 and 2004 are as follows (in thousands):

| ** **                                                                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Balance as of  January 1                                                               |       | $        | 653        |     | $          | 1,800 |   |
| New warranties  issued during the period                                                    |       | 679      |       | 421      |       |
| Costs incurred  during the period on specific systems                                       |       | (271     | )          | (602     | )          |
| Changes in  liability for pre-existing warranties during the period, including  expirations |       | (416     | )          | (966     | )          |
| Balance as of  December 31                                                             |       | $        | 645        |     | $          | 653 |   |

 

***Goodwill***

The Company’s goodwill wasreported under the Symyx Software business segment. Goodwill increased in 2005due to the acquisition of Synthematix as discussed in Note 7 of the Notes toConsolidated Financial Statements. Goodwill is tested using a fair-value-basedapproach for impairment on at least an annual basis or more frequently ifindicators of potential impairment exist. No impairment of goodwill has been identifiedduring any of the periods presented.

***Intangible Assets***

Intangible assets areamortized using the straight-line method over their estimated period ofbenefit, ranging from one to seven years. The Company evaluates therecoverability of intangible assets periodically and takes into account eventsor circumstances that warrant revised estimates of useful lives or thatindicate that impairment exists. All of the Company’s intangible assets aresubject to amortization. No impairments of intangible assets have beenidentified during any of the periods presented.

***Research andDevelopment***

Symyx’s policy is toexpense as incurred all costs of research and development, including direct andallocated expenses, related both to costs incurred on its own behalf and onbehalf of its customers. The types of costs classified as research anddevelopment expense include salaries of technical staff, consultant costs,chemical and scientific supplies costs, facilities rental, and utilities costsrelated to laboratories and offices occupied by technical staff, depreciationon equipment and facilities used by technical staff and outside services, suchas machining and third-party research and development costs.

***Income Taxes***

Income taxes have beenprovided using the liability method. Deferred tax assets and liabilities aredetermined based on the difference between the financial statement and taxbases of assets and liabilities as measured by the enacted tax rates which willbe in effect when these differences reverse. The Company provides a valuationallowance against net deferred tax assets if, based upon the availableevidence, it is not more likely than not that the deferred tax assets will berealized.

***SoftwareDevelopment Costs***

Statement of FinancialAccounting Standards No. 86, *Accounting for the Costsof Computer Software to be Sold, Leased or Otherwise Marketed*,requires the capitalization of certain software development costs subsequent tothe establishment of technological feasibility. As the Company’s business modelhas evolved, 

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

it hascommenced bundling with the Symyx Tools it sells licenses to software that wasoriginally developed for internal research and development purposes. Due to theunique nature of the Symyx Tool systems, and the required product development process,technological feasibility is established only upon the completion of a workingmodel. Costs incurred by the Company between the completion of the workingmodel and the point at which the product is ready for general release have beeninsignificant. Accordingly, the Company has charged all such costs to researchand development expense in the period incurred.

***Stock-BasedCompensation***

The Company has generally granted stock options to itsemployees for a fixed number of shares with an exercise price equal to the fairvalue of the shares on the date of grant. As allowed under the Statement ofFinancial Accounting Standards No. 123, *Accountingfor Stock-Based Compensation* (“SFAS 123”), the Company has electedto follow Accounting Principles Board Opinion No. 25, *Accountingfor Stock Issued to Employees* (“APB 25”) and related interpretationsin accounting for stock awards to employees. Accordingly, no compensationexpense has been recognized in the Company’s financial statements prior to January 1,2006 in connection with stock options granted to employees with exercise pricesnot less than fair value. Deferred compensation for options granted toemployees has been determined as the difference between the deemed fair marketvalue of the Company’s common stock on the date options were granted and theexercise price. For purposes of this pro-forma disclosure, the estimated fairvalue of the options has been assumed to be amortized to expense over theoptions’ vesting periods.

Stock compensation expense for options granted tonon-employees has been determined in accordance with SFAS 123 and EITF 96-18,*Accounting for Equity Instruments That Are Issuedto Other Than Employees for Acquiring, or in Conjunction with Selling, Goods orServices,* usingthe Black-Scholes option pricing model. Stock compensation expense for optionsgranted to non-employees is periodically re-measured as the underlyingoptions vest.

Proforma net loss information is required by SFAS 123, computed as if the Companyhad accounted for its employee stock options granted under the fair valuemethod of that Statement. The fair value for options granted prior to theCompany’s initial public offering in November 1999 was estimated at thedate of grant using the minimum value method. Options granted following theCompany’s November 1999 initial public offering have been valued using theBlack-Scholes method with valuation assumptions as follows:

| ** **                       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected dividend  yield         |       | 0        | %          | 0        | %          | 0        | %          |
| Expected stock  price volatility |       | 0.52     |       | 0.53     |       | 0.67     |       |
| Risk-free  interest rate         |       | 3.8      | %          | 3.0      | %          | 2.2      | %          |
| Expected life (years)            |       | 3.5      |       | 3.5      |       | 3.5      |       |

 

Thefair value of issuances under the Employee Stock Purchase Plan is estimated onthe issuance date using the Black-Scholes model assuming no expected dividends andthe following weighted average assumptions for issuance made in 2005, 2004, and2003.

| ** **                       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected stock  price volatility |       | 0.52     |       | 0.51     |       | 0.48     |       |
| Risk-free  interest rate         |       | 2.6      | %          | 1.7      | %          | 1.5      | %          |
| Expected life (years)            |       | 0.67     |       | 1.62     |       | 0.75     |       |

 

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

Hadthe Company valued its stock options and stock purchase rights according to thefair value provisions of SFAS 123, pro forma net loss and pro forma net lossper share would have been as follows (in thousands, except per share data):

| ** **                                                                                                                                   | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income  (loss):                                                                                                                          | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| As reported                                                                                                                                  |       | $                                           | 12,002     |   | $ | 12,882 |   | $ | 5,741 |   |
| Add: Stock-based employee compensation expense  included in reported net income, net of related tax effects                                  |       | 243                                         |       | 40 |   | 43 |   |
| Deduct: Total stock-based employee compensation  expense determined under fair value method for all awards, net of related tax  effects |       | (20,541                                     | )          | (13,057 | ) | (15,171 | ) |
| Pro forma                                                                                                                                    |       | $                                           | (8,296     | ) | $ | (135 | ) | $ | (9,387 | ) |
| Basic net income  (loss) per share:                                                                                                          |       |                                        |       |   |   |   |   |
| As reported                                                                                                                                  |       | $                                           | 0.37       |   | $ | 0.40 |   | $ | 0.18 |   |
| Pro forma                                                                                                                                    |       | $                                           | (0.25      | ) | $ | * |   | $ | (0.30 | ) |
| Diluted net  income (loss) per share:                                                                                                        |       |                                        |       |   |   |   |   |
| As reported                                                                                                                                  |       | $                                           | 0.35       |   | $ | 0.38 |   | $ | 0.18 |   |
| Pro forma                                                                                                                                    |       | $                                           | (0.25      | ) | $ | * |   | $ | (0.30 | ) |

----

*                    Less than$0.01 per share

On two separate occasionsduring the three month period ended September 30, 2005, the CompensationCommittee of the Company’s Board of Directors approved amendments to the termsof outstanding options to purchase shares of the Company’s common stock. Oneach occasion, the terms of options with exercise prices above a designatedthreshold were amended to become fully-vested and exercisable on December 30,2005, provided that the holder of such option remains an employee or consultantof the Company on such date. The first occasion was on September 13, 2005,when the Company amended the terms of outstanding options to purchaseapproximately 251,000 shares of the Company’s common stock with exercise pricesabove $30 per share. The second occasion was on September 22, 2005, whenthe Company amended the terms of outstanding options to purchase approximately159,000 shares of the Company’s common stock with exercise prices equal orgreater than $24.67 per share. All such options were issued pursuant to theterms of the Company’s 1997 Stock Plan, the Company’s 2001 Nonstatutory StockOption Plan or Symyx IntelliChem’s 2003 Stock Option Plan. No options held byexecutive officers or directors of the Company were accelerated pursuant tothis authorization. The Company accelerated the vesting schedule for the aboveoptions to avoid future compensation expenses to be recorded in accordance withSFAS 123(R). No compensation expense was recorded in connection with theacceleration of the vesting schedule of the above options because the fairmarket value of the common stock was less than the exercise price of theaccelerated options on each of the respective measurement dates. The impact onpro forma loss from these accelerations has been included in the above table.

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

***Net Income PerShare***

Basic net income per share has been computed using theweighted-average number of shares of common stock outstanding during theperiod, less shares subject to repurchase. Diluted net income per share hasbeen calculated based on the shares used in the calculation of basic net incomeper share plus the dilutive effect of stock options and shares subject torepurchase by the Company.

Thefollowing table presents the calculation of basic and diluted net income pershare (in thousands, except per share data):

| ** **                                                                    | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                    | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income                                                                    |       | $                                           | 12,002     |   | $ | 12,882 |   | $ | 5,741 |   |
| Weighted-average  shares of common stock outstanding                          |       | 32,819                                      |       | 32,067 |   | 31,213 |   |
| Less:  weighted-average shares subject to repurchase                          |       | —                                      |       | — |   | (14 | ) |
| Weighted-average  shares used in computing basic net income per share         |       | 32,819                                      |       | 32,067 |   | 31,199 |   |
| Dilutive effect  of employee stock options, using the treasury stock   method |       | 1,745                                       |       | 1,805 |   | 1,257 |   |
| Weighted-average  shares subject to repurchase                                |       | —                                      |       | — |   | 14 |   |
| Weighted-average  shares used in computing diluted net income per   share     |       | 34,564                                      |       | 33,872 |   | 32,470 |   |
| Basic net income  per share                                                   |       | $                                           | 0.37       |   | $ | 0.40 |   | $ | 0.18 |   |
| Diluted net income per  share                                                 |       | $                                           | 0.35       |   | $ | 0.38 |   | $ | 0.18 |   |

 

The Company has excludedoptions for the purchase of 3,375,000, 3,160,000 and 2,768,000 shares of commonstock from the calculation of diluted net income per share in 2005, 2004, and2003, respectively, because all such securities are anti-dilutive for therespective periods.

***Employee SavingsPlan***

The Company has a savingsplan in the United States that qualifies under Section 401(k) of theInternal Revenue Code. Participating U.S. employees may contribute up to 60% oftheir pretax salary, but not more than statutory limits. The Company started tomake employer contribution to the plan in 2004. In 2005 the Company increasedthe employer contributions from 25 cents in 2004 to 50 cents in 2005 for eachdollar a participant contributes under this plan, with a maximum matchingcontribution of 2% of a participant’s earnings (increased from 1% of aparticipant’s earnings in 2004). Matching contributions for the plan were$504,000 and $250,000 in 2005 and 2004, respectively. Matching contributionsare invested proportionate to each participant’s voluntary contributions in theinvestment options provided under the plan. Investment options in the plan donot include Symyx common stock.

***Foreign CurrencyTranslation***

The financial statementsof the Company’s wholly owned subsidiaries, Symyx Technologies AG, SymyxTechnologies (France) SARL, Symyx Technologies (Germany) GmbH, and SymyxTechnologies (UK) Ltd., are measured using the local currency as the functionalcurrency. Assets and liabilities of the subsidiaries are translated at therates of exchange at the balance sheet date. The resultant translationadjustments are recorded as a separate component of stockholders’ equity asaccumulated other 

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

comprehensiveincome (loss) and have not been significant to date. Income and expense itemsare translated at average monthly rates of exchange.

***Impairment ofLong-Lived Assets***

The Company accounts forthe impairment and disposal of long-lived assets utilizing Statement ofFinancial Accounting Standards No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets* (“SFAS 144”).SFAS 144 requires that long-lived assets, such as property, plant andequipment, and purchased intangible assets subject to amortization, be reviewedfor impairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. The recoverability of anasset is measured by a comparison of the carrying amount of an asset to itsestimated undiscounted future cash flows expected to be generated. If thecarrying amount of an asset exceeds its estimated future cash flows, animpairment charge is recognized for the amount by which the carrying amount ofthe asset exceeds the fair value of the asset. Assets to be disposed of wouldbe separately presented in the balance sheet and reported at the lower of thecarrying amount or fair value less costs to sell, and would no longer bedepreciated. The assets and liabilities of a disposed group classified as heldfor sale would be presented separately in the appropriate asset and liabilitysections of the balance sheet.

***ComprehensiveIncome (loss)***

The components of other comprehensive income (loss)consist of unrealized gains and losses on available-for-sale securities and aforeign currency translation adjustment, both net of tax. Comprehensive incomehas been disclosed in the statement of stockholders’ equity for all periods presented.

Thecomponents of accumulated other comprehensive income (loss) at December 31,2005, 2004, and 2003 are as follows (in thousands):

| ** **                                                          | ** ** | **Foreign  Currency  Translation  Adjustments** | ** ** | **Unrealized  Gain (Loss) On  Available-For-  Sale Securities** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------------|------------|-------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|-----------|------------|
| Balance at  January 1, 2003                                    |       |                                            | $          | (13                                                                            | )          |      |       | $ | 133 |   |   | $ | 120 |   |
| Foreign currency  translation adjustment                            |       |                                            | 2          |                                                                           |       |      | —     |   |   | 2 |   |
| Unrealized loss  on available-for-sale securities, net of $61 taxes |       |                                            | —     |                                                                           |       |      | (91        | ) |   | (91 | ) |
| Balance at  December 31, 2003                                  |       |                                            | (11        | )                                                                              |       |      | 42         |   |   | 31 |   |
| Foreign currency  translation adjustment                            |       |                                            | (1         | )                                                                              |       |      | —     |   |   | (1 | ) |
| Unrealized loss  on available-for-sale securities, net of $28 taxes |       |                                            | —     |                                                                           |       |      | (519       | ) |   | (519 | ) |
| Balance at  December 31, 2004                                  |       |                                            | (12        | )                                                                              |       |      | (477       | ) |   | (489 | ) |
| Foreign currency  translation adjustment                            |       |                                            | (29        | )                                                                              |       |      | —     |   |   | (29 | ) |
| Unrealized gain  on available-for-sale securities                   |       |                                            | —     |                                                                           |       |      | 220        |   |   | 220 |   |
| Balance at  December 31, 2005                                  |       |                                            | $          | (41                                                                            | )          |      |       | $ | (257 | ) |   | $ | (298 | ) |

 

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

***Effect of NewAccounting Pronouncements***

***Share-Based Payment***

On December 16, 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS 123 (revised 2004), *Share-BasedPayment*, (“SFAS 123(R)”), which is a revision of SFAS 123. SFAS 123(R) supersedesAPB 25 and amends SFAS 95, *Statement of Cash Flows*.Generally, the approach in SFAS 123(R) is similar to the approachdescribed in SFAS 123. However, SFAS 123(R) requires all share-basedpayments to employees, including grants of employee stock options, to berecognized in the income statement based on their fair values. Pro formadisclosure is no longer an alternative.

The Company is required to adopt SFAS123(R) effective January 1, 2006.

SFAS 123(R) permits public companies to adopt itsrequirements using either the “modified-prospective” method or the “modifiedretrospective” method. The Company expects to adopt SFAS 123(R) usingthe modified-prospective method.

In August 2005, the FASB issued FASB StaffPosition FAS 123(R)-1, *Classification and Measurementof Freestanding Financial Instruments Originally Issued in Exchange forEmployee Services under FASB Statement No. 123(R)* (“FSPFAS 123(R)-1”). FSP FAS 123(R)-1 defers indefinitely therequirement of SFAS 123 that a share-based payment to an employee subject toSFAS 123(R) becomes subject to the recognition and measurementrequirements of other applicable GAAP when the rights conveyed by theinstrument are no longer dependent on the holder being an employee. Theguidance in FSP FAS 123(R)-1 is expected to be applied upon initialadoption of SFAS 123(R).

In October 2005, the FASB issued FASB StaffPosition FAS 123(R)-2, *Practical Accommodation tothe Application of Grant Date as Defined in FASB Statement No. 123(R) *(“FSPFAS 123(R)-2”). FSP FAS 123(R)-2 provides an exception to theapplication of the concept of “mutual understanding” in the determination ofwhether a grant date (and, for an equity award, a measurement date) hasoccurred. The exception permits companies to measure compensation cost for equityawards to employees on the Board approval date if certain conditions are met,provided that the communication to the employees occurs within a relativelyshort period of time” from the approval date. The guidance in FSP FAS 123(R)-2is expected to be applied upon initial adoption of SFAS 123(R).

In November 2005, the FASB issued FASB StaffPosition FAS 123(R)-3, *Transition ElectionRelated to Accounting for the Income Tax Effects of Share-Based Payment awards*(“FSPFAS 123(R)-3”)*.* FSP FAS 123(R)-3allows an elective short-cut approach to simplify the calculation of excess taxbenefits available to absorb tax deficiency (“APIC pool”) and provides guidancefor the presentation of excess tax benefits in the statement of cash flows forcompanies that elect to adopt the simplified alternative method of calculatingthe APIC pool. The guidance in FSP FAS 123(R)-3 is effective on November 10,2005. The Company does not expect to adopt this elective alternative method incalculating the APIC pool.

As permitted by SFAS 123,through December 31, 2005, the Company has accounted for share-basedpayments to employees using APB 25’s intrinsic value method and, as such, hasrecognized no compensation cost for employee stock options. Accordingly, theadoption of SFAS 123(R)’s fair value method will have a material impact on theCompany’s results of operations, although it will have no direct impact on theCompany’s overall financial position. The Company expects to issue restrictedstock units rather than stock options to its employees in 2006. The impact ofadopting of SFAS 123(R) in 2006 is expected to be between $7 million and$8 million additional compensation expense, net of tax, or approximately $0.20diluted loss per share. Had the Company adopted SFAS 123(R) in priorperiods, the impact of that standard would have approximated the impact of SFAS123 as described in the disclosure of 

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

proforma net loss and pro forma loss per share in Note 1 of the Notes toConsolidated Financial Statements (“Stock Based Compensation”). SFAS 123(R) alsorequires the benefits of tax deductions in excess of recognized compensationcost to be reported as a financing cash flow, rather than as an operating cashflow as required under current literature. This requirement will reduce netoperating cash flows and increase net financing cash flows in periods afteradoption.

*The Meaning of Other-Than-Temporary Impairment and ItsApplication to Certain Investments*

In November 2005, theFASB issued FSP Nos. FAS 115-1 and FAS 124-1, *The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments*(“FSP FAS 115-1 and FAS 124-1”). FSP FAS 115-1and FAS 124-1 addresses the determination as to when an investment isconsidered impaired, whether that impairment is other than temporary, and themeasurement of an impairment loss. This FSP also includes accountingconsiderations subsequent to the recognition of an other-than-temporaryimpairment and requires certain disclosures about unrealized losses that havenot been recognized as other-than-temporary impairments. The guidance in thisFSP amends FASB Statements No. 115, *Accountingfor Certain Investments in Debt and Equity Securities*, and No. 124,*Accounting for Certain Investments Held byNot-for-Profit Organizations*, and APB Opinion No. 18, *The Equity Method of Accounting for Investments inCommon Stock*. The guidance in FSP FAS 115-1 and FAS 124-1shall be applied to reporting periods beginning after December 15, 2005.It is not expected that the adoption of this standard will have a materialimpact on the Company’s consolidated financial statements.

*Accounting for Rental Costs Incurred during aConstruction Period*

In October 2005, theFASB issued FASB Staff Position FAS 13-1, *Accountingfor Rental Costs Incurred during a Construction Period*(“FSP FAS 13-1”).FSP FAS 13-1 concludes that rental costs incurred during and after aconstruction period are for the right to control the use of a leased assetduring and after construction of a leased asset and that there is no distinctionbetween the right to use a leased asset during the construction period and theright to use that asset after the construction period. Therefore, rental costsassociated with ground or building operating leases that are incurred during aconstruction period should be recognized as rental expense. The guidance in FSPFAS 13-1 is to be applied to the first reporting period beginning after December 15,2005. This is consistent with how the Company has historically accounted forrental costs during a construction period and therefore the adoption of thisstandard is not expected to have a material impact on the Company’sconsolidated financial statements.

*Inventory Costs*

In November 2004, theFASB issued SFAS No. 151, *Inventory Costs — anamendment of ARB No. 43, Chapter 4* (“SFAS 151”). SFAS 151amends ARB 43, Chapter 4 to clarify that “abnormal” amount of idle facilityexpense, freight, handling costs and spoilage should be recognized as currentperiod charges. SFAS 151 is effective for inventory costs incurred duringfiscal years beginning after June 15, 2005. It is not expected that theadoption of this standard will have a material impact on the Company’sconsolidated financial statements.

*Determining Whether to Aggregate Operating SegmentsThat Do Not Meet the Quantitative Thresholds*

In October 2004, theFASB ratified Emerging Issues Task Force consensus on Issue No. 04-10,*Determining Whether to Aggregate Operating SegmentsThat Do Not Meet the Quantitative Thresholds*(“EITF Issue No. 04-10”),which provides guidance regarding how an enterprise should evaluate theaggregation criteria in paragraph 17 of FASB Statement 131 when determiningwhether operating segments that do not 

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

meet thequantitative thresholds may be aggregated in accordance with paragraph 19 ofFASB Statement 131. The effective date of EITF Issue No. 04-10has not been determined, but early application is permitted. It is not expectedthat the adoption of this standard will have a material impact on the Company’sconsolidated financial statements.

*Accounting Changes and Error Corrections*

In May 2005, the FASBissued SFAS No. 154, *Accounting Changes andError Corrections, a replacement of APB Opinion No. 20 and Statement No. 3(“SFAS 154”).*SFAS 154 changes the requirements for the accountingand reporting of a change in accounting principle. It applies to all voluntarychanges in accounting principle, as well as to changes required by anaccounting pronouncement that does not include specific transition provisions.SFAS 154 is effective for accounting changes and corrections of errors made infiscal years beginning after December 15, 2005. It is not expected thatthe adoption of this standard will have a material impact on the Company’sconsolidated financial statements.

**2.   Researchand Development Arrangements**

The Company has entered into a number of multi-yearresearch and development collaborations to perform research for partners inexclusive fields over multiple years. The major collaborative arrangements havesimilar contractual terms and are non-cancelable other than for material breachor certain other conditions. Under the collaborative arrangements, the Companyis responsible for performing research at levels defined in the agreements,including synthesis, screening, and informatics. The partner, in turn, isentitled to develop and commercialize materials discovered in or undercollaboration within the defined field. The Company typically receives researchand development funding at specified amounts per full time equivalent employee workingon the project and is entitled to receive royalties on the sale of any productscommercialized under the agreement or payments on the achievement of specifiedresearch milestones. The agreements also contain procedures by which theCompany and the partner will determine royalty rates for the sale or license ofproducts under the agreements.

Thetable below indicates some of the significant collaborative partners for whomthe Company conducted research and development in 2005, together with theprimary focus of the collaborations. In addition to these partners the Companyhas a number of other undisclosed partners, none of which individuallyconstituted more than 5% of total revenue in 2005:
| Partner                                                                                      | ** ** | ** ** | ** ** | **Current Research  Contract Ends**                             | ** ** | **Primary focus of current collaborative  efforts** |
|----------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------------------------------------------|------------|-----------------------------------------------------|
| BP (including both BP  and  Innovene. Innovene was spun off from BP at the end of 2005) |       | 3/31/2006  |       | Catalysts for certain  commodity chemicals                      |
| Dow                                                                                          |       | 12/31/2009 |       | Catalysts for  polyolefins and other chemicals and formulations |
| ExxonMobil                                                                                   |       | 5/31/2008  |       | Catalysts for certain commodity chemicals including  olefins    |

 

The Company’s collaborative agreements may provide fora variety of structures with respect to ownership of inventions conceived andreduced to practice in connection with activities under the agreements, butunder a typical collaborative arrangement, the Company owns all inventionsconceived and reduced to practice solely by the Company and all know-how andintellectual property rights related 

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

thereto; and the Companyand the collaborative partner jointly own all inventions made, conceived,reduced to practice, or otherwise developed jointly by employees or consultantsof the Company and those of the collaborative partner in connection withactivities under the agreement and all know-how and intellectual propertyrights related thereto. The Company’s collaborative partner typically receivesexclusive rights in the defined field of the collaborative agreement.

The agreements are typically cancelable only in theevent of breach by either party or certain other conditions. As of December 31,2005, the Company had committed funding from existing collaborative partners,excluding milestone payments that are contingent upon the success of theresearch, of approximately $115 million. Revenue from collaborative partnerswho individually comprised more than 10% of revenue is included within Note 1 “Concentrationof Revenue.”

In 2003, Symyx entered into an Alliance, TechnologyTransfer and License Agreement effective April 1, 2003 with ExxonMobilResearch and Engineering Company under which the Company is contracted toprovide research services, develop and sell Symyx Tools Systems, and licenseits software and intellectual property. The ExxonMobil alliance provides Symyxwith an expected five-year revenue stream of over $200 million from currentlyplanned alliance activities, purchases of Symyx Tools systems, and licensingfees. In addition, Symyx is entitled to receive royalties from thecommercialization of materials, processes, and products based on discoveriesmade in the fields of agreement.

In December 2004, Symyx entered into an Alliance,Technology Transfer, Research and License Agreement effective January 1,2005 with The Dow Chemical Company under which the Company is contracted toperform research in a number of exclusive areas, develop and provide SymyxTools, and license Symyx Software as well as certain intellectual property. Dowwill make payments to Symyx over the five-year term of approximately $120 million.In addition, Symyx is entitled to receive royalties on commercializeddiscoveries resulting from the collaborative research.

TheCompany does not track or allocate actual costs by collaboration or project, asthe requirement from its collaborative partners is to staff the variousprojects on a full-time-equivalent (“FTE”) employee basis. Accordingly, theCompany tracks the hours incurred by assigned research scientists and engineersto each project. Based on hours spent on each project, the Company estimatesthe research and development efforts undertaken for various projects were asfollows:

| ** **                                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Projects funded  by collaboration partners |       |     | 73         | %        |       |     | 79         | % |   |   | 68 | % |   |
| Internally funded  research                |       |     | 5          | %        |       |     | 10         | % |   |   | 15 | % |   |
| Internal software  development             |       |     | 21         | %        |       |     | 5          | % |   |   | 7 | % |   |
| Internal tools  development                |       |     | 1          | %        |       |     | 6          | % |   |   | 10 | % |   |
| Total                                      |       |     | 100        | %        |       |     | 100        | % |   |   | 100 | % |   |

 

Due to the nature of theCompany’s research and dependence on its collaborative partners tocommercialize the results of the research, the Company cannot predict with anycertainty whether any particular collaboration or research effort willultimately result in a commercial product and therefore whether the Companywill achieve future milestones or royalty payments under its various collaborations.

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**3.   Commitments and Contingencies**

***Leases***

TheCompany entered into various operating lease agreements for facilities in fivestates and two foreign countries with lease terms ranging from one to tenyears. Rent expense, which is being recognized on a straight-line basis overthe lease terms, was approximately $2,317,000, $1,955,000 and $1,996,000 forthe years ended December 31, 2005, 2004, and 2003, respectively. Futurecommitments and obligations under the operating leases for the Company’sfacilities, to be satisfied as they become due over the next ten years, are asfollows as of December 31, 2005 (in thousands):

| **Years ending December 31,** | ** ** | ** ** | ** ** | **Amount** | ** ** |
|----------------------------------------------|------------|------------|------------|------------|------------|
| 2006                                         |       | $          | 2,539      |       |
| 2007                                         |       | 2,753      |       |
| 2008                                         |       | 2,464      |       |
| 2009                                         |       | 2,198      |       |
| 2010                                         |       | 1,821      |       |
| Thereafter                                   |       | 3,131      |       |
| Total                                        |       | $          | 14,906     |       |

 

***Other Commitments***

As of December 31, 2005, the Company had purchasecommitments for inventory, fixed assets and services of approximately$2,797,000.

As discussed in “*OffBalance Sheet Financing and Related Party Transactions”*below*,*theCompany’s committed investments related to the Collaborative Developmentand License Agreement with Intermolecular, Inc. as of December 31,2005 were $964,000. The Company expects to meet this commitment in the next twoyears.

As of December 31,2005, the Company had no amounts due under loan agreements and had no lines ofcredit or other finance facilities in place.

***CustomerIndemnification***

From time to time, theCompany agrees to indemnify its customers against certain third partyliability, including liability if the Company’s products infringe a third party’sintellectual property rights. Such indemnification provisions are accounted forin accordance with FASB Interpretation No. 45, *Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others.* The indemnification istypically limited to no more than the amount paid by the customer. As of December 31,2005, the Company was not subject to any pending intellectual property-relatedlitigation.

**4.   Stockholders’ Equity**

***Preferred Stock***

In September 1999,the Board of Directors approved an amendment to the Company’s certificate ofincorporation to authorize 10,000,000 shares of undesignated preferred stock,for which the Board of Directors is authorized to fix the designation, powers,preferences, and rights.

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

***Common Stock***

At the Company’s annualmeeting in May 2003, the stockholders approved an amendment to the Company’sCertificate of Incorporation to reduce the number of authorized shares ofcommon stock from 100,000,000 to 60,000,000 shares.

***Stock Purchase Plan***

In October 1999, theCompany’s stockholders approved the adoption of the 1999 Employee StockPurchase Plan (the “Purchase Plan”). A total of 300,000 shares of the Company’scommon stock were initially reserved for issuance under the Purchase Plan. ThePurchase Plan permits eligible employees to purchase common stock at adiscount, but only through payroll deductions, during concurrent 24-monthoffering periods. Each offering period will be divided into four consecutivesix-month purchase periods. The price at which stock is purchased under thePurchase Plan is equal to 85% of the fair market value of the common stock onthe first or last day of the offering period, whichever is lower. In addition,the Purchase Plan provides for annual increases in the number of sharesavailable for issuance under the Purchase Plan on the first day of each fiscalyear, equal to the lesser of 1% of the outstanding shares of common stock onthe first day of the fiscal year, 350,000 shares, or a lesser amount asdetermined by the Board of Directors. At December 31, 2005, shares ofcommon stock available for future issue under the Purchase Plan were 1,547,295.

***Stock Option Plans***

The Company’s 1996 Stock Option Plan was adopted in March 1996and provided for the issuance of options for up to 1,153,444 shares of commonstock to employees, directors, and consultants.

During 1997, the Company’s Board of Directors approvedthe adoption of the 1997 Stock Option Plan with terms and conditions the sameas those of the 1996 Stock Option Plan (collectively, the “Qualified Plans”).The 1997 Stock Option Plan provides for the issuance of options for up to12,762,807 shares of common stock to employee and consultants. The QualifiedPlans provide for an annual increase in the number of shares of common stockreserved for issuance equal to the lesser of 1,500,000 shares, 4% of theoutstanding shares on the date of the annual increase, or a lesser amount asdetermined by the Board of Directors. As of December 31, 2005, options topurchase 471,823 shares of common stock were available for future grant underthe Qualified Plans.

In October 2001, the Company’s Board of Directorsapproved the adoption of the 2001 Nonstatutory Stock Option Plan (the “NSO Plan”).The NSO Plan provides for the issuance of options for up to 1,000,000 shares ofcommon stock to non-executive employees and consultants. As of December 31,2005, options to purchase 649,600 shares of common stock were available forfuture grant under the NSO Plan.

In connection with the acquisition of IntelliChem (SeeNote 7), the Company assumed all the unvested outstanding stock options issuedpursuant to IntelliChem’s 2003 Stock Option Plan (“IntelliChem Plan”) topurchase 44,126 shares of Symyx’s common stock. In connection with theacquisition of Synthematix (See Note 7), the Company assumed all the unvestedoutstanding stock options issued pursuant to Synthematix’s 2000 EquityCompensation Plan (“Synthematix Plan”), as amended, to purchase 23,876 sharesof Symyx’s common stock. These options generally retained all of the rights,terms, and conditions of the plan under which they were originally granted. Asof December 31, 2005, options to purchase 5,920 and 479 shares of commonstock were available for future grant under the IntelliChem Plan andSynthematix Plan, respectively.

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

Stock options granted under the Qualified Plans may beeither incentive stock options or nonstatutory stock options, whereas stockoptions granted under the NSO Plan are nonstatutory stock options. Options aregenerally granted with exercise prices equal to the fair value of the commonstock on the grant date, as determined by the Board of Directors. The optionsexpire no more than 10 years after the date of grant or earlier if employmentor relationship as a director or consultant is terminated. The Board ofDirectors shall determine the times during the term when the options may beexercised and the number of shares for which an option may be granted. Optionsmay be granted with different vesting terms from time to time but will providefor annual vesting of at least 20% of the total number of shares subject to theoption.

Asummary of activity under the 1996 and 1997 Stock Option Plans, the NSO Plan,the IntelliChem Plan and the Synthematix Plan, is as follows:

| ** **                         | ** ** | **Outstanding Stock Options** | ** ** |
|------------------------------------|------------|-----------------------------------------|------------|
| ** **                         | ** ** | **Number of  Shares**              | ** ** | **Exercise  Price** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| Balance at  January 1, 2003   |       | 5,376,981                               |       | $ | 0.19 — $58.25 |   |   | $ | 25.21 |   |   |
| Options granted                    |       | 1,983,750                               |       | $ | 11.97 — $30.00 |   |   | $ | 14.47 |   |   |
| Options exercised                  |       | (578,572                                | )          | $ | 0.19 — $22.68 |   |   | $ | 10.38 |   |   |
| Options cancelled                  |       | (255,159                                | )          | $ | 0.96 — $57.00 |   |   | $ | 23.35 |   |   |
| Balance at  December 31, 2003 |       | 6,527,000                               |       | $ | 0.19 — $58.25 |   |   | $ | 23.33 |   |   |
| Options granted  and assumed       |       | 1,950,851                               |       | $ | 2.63 — $32.00 |   |   | $ | 26.11 |   |   |
| Options exercised                  |       | (741,302                                | )          | $ | 0.39 — $30.25 |   |   | $ | 14.26 |   |   |
| Options cancelled                  |       | (302,064                                | )          | $ | 3.86 — $57.00 |   |   | $ | 32.19 |   |   |
| Balance at  December 31, 2004 |       | 7,434,485                               |       | $ | 0.19 — $58.25 |   |   | $ | 24.98 |   |   |
| Options granted  and assumed       |       | 1,599,226                               |       | $ | 0.51 — $31.00 |   |   | $ | 26.68 |   |   |
| Options exercised                  |       | (632,058                                | )          | $ | 0.39 — $30.25 |   |   | $ | 15.39 |   |   |
| Options cancelled                  |       | (307,841                                | )          | $ | 0.51 — $57.00 |   |   | $ | 28.90 |   |   |
| Balance at  December 31, 2005 |       | 8,093,812                               |       | $ | 0.19 — $58.25 |   |   | $ | 25.91 |   |   |

 

At December 31, 2005, 2004, and 2003, vested andoutstanding options for the purchase of 7,313,292, 5,125,025, and 4,287,355shares of common stock were exercisable at weighted-average exercise prices of$26.75, $26.51 and $25.75, respectively. The weighted-average grant date fairvalue of options granted during the years ended December 31, 2005, 2004,and 2003 was $12.20, $12.12, and $7.44, respectively.

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

Ananalysis of options outstanding at December 31, 2005 is as follows:

| ** **              | ** ** | ** ** | ** ** | **Weighted-**                                                 | ** ** | ** **                                            | ** ** | ** **                                  | ** ** | ** **                                  | ** ** |
|-------------------------|------------|------------|------------|---------------------------------------------------------------|------------|-------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **              | ** ** | ** ** | ** ** | **Average**                                                   | ** ** | **Options**                                           | ** ** | **Options Vested**                     | ** ** |
| **Exercise Price** | ** ** | ** ** | ** ** | **Options  Outstanding at  December 31, 2005** | ** ** | **Remaining  Contractual Life  (in years)** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Vested at  December 31,  2005** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
| $0.19 — $0.39      |       |       | 55,611     |                                                          |       |                                                  | 1.9        |                                        |       |                                        | $          | 0.38 |   |   |   | 55,611 |   |   |   | $ | 0.38 |   |   |
| $0.51 — $0.96      |       |       | 165,625    |                                                          |       |                                                  | 3.2        |                                        |       |                                        | $          | 0.93 |   |   |   | 157,237 |   |   |   | $ | 0.96 |   |   |
| $1.93 — $3.86      |       |       | 65,529     |                                                          |       |                                                  | 5.6        |                                        |       |                                        | $          | 2.70 |   |   |   | 48,885 |   |   |   | $ | 2.73 |   |   |
| $6.43 — $8.63      |       |       | 93,693     |                                                          |       |                                                  | 5.1        |                                        |       |                                        | $          | 7.17 |   |   |   | 81,581 |   |   |   | $ | 6.97 |   |   |
| $10.39 — $14.75    |       |       | 1,616,731  |                                                          |       |                                                  | 6.4        |                                        |       |                                        | $          | 12.95 |   |   |   | 1,350,899 |   |   |   | $ | 12.91 |   |   |
| $15.22 — $23.22    |       |       | 1,144,170  |                                                          |       |                                                  | 7.4        |                                        |       |                                        | $          | 18.23 |   |   |   | 869,490 |   |   |   | $ | 17.56 |   |   |
| $23.58 — $25.83    |       |       | 1,545,090  |                                                          |       |                                                  | 6.7        |                                        |       |                                        | $          | 24.93 |   |   |   | 1,342,226 |   |   |   | $ | 25.04 |   |   |
| $26.01 — $34.65    |       |       | 2,281,658  |                                                          |       |                                                  | 8.5        |                                        |       |                                        | $          | 29.00 |   |   |   | 2,281,658 |   |   |   | $ | 29.00 |   |   |
| $36.50 — $51.50    |       |       | 113,444    |                                                          |       |                                                  | 4.5        |                                        |       |                                        | $          | 39.99 |   |   |   | 113,444 |   |   |   | $ | 39.99 |   |   |
| $55.38 — $58.25    |       |       | 1,012,261  |                                                          |       |                                                  | 4.2        |                                        |       |                                        | $          | 57.01 |   |   |   | 1,012,261 |   |   |   | $ | 57.01 |   |   |
|                    |       |       | 8,093,812  |                                                          |       |                                                  | 6.8        |                                        |       |                                        | $          | 25.91 |   |   |   | 7,313,292 |   |   |   | $ | 26.75 |   |   |
|                         |            |            |            |                                                               |            |                                                       |            |                                             |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As of December 31, 2005, the Company has reserved9,221,634 shares of common stock for future issuance in relation to the Company’sstock option plans.

Prior to 2000, in connection with the grant of certainshare options to employees, the Company recorded deferred stock compensation of$4,070,000 and $605,000, respectively, representing the difference between theexercise price and the deemed fair value of the Company’s common stock on thedate such stock options were granted. Deferred stock compensation is includedas a reduction of stockholders’ equity and is being amortized to expense on agraded vesting method. During the years ended December 31, 2005, 2004, and2003, the Company recorded amortization of deferred stock compensation expenseof approximately $0, $7,000 and $43,000, respectively. At December 31,2005, the Company had fully amortized the deferred stock compensation discussedabove.

During the years ended December 31, 2005 and2004, in connection with the acquisitions of Synthematix and IntelliChem, theCompany recorded deferred stock compensation amounting to $216,000 and$651,000, respectively, for the unvested stock options assumed with an exerciseprice below the fair market value. Deferred stock compensation is included as areduction of stockholders’ equity and is being amortized to expense on a gradedvesting method. During the years ended December 31, 2005 and 2004, theCompany recorded amortization of deferred stock compensation expense associatedwith these options of approximately $343,000 and $33,000, respectively. TheCompany also reduced the unamortized balance by $230,000 in 2005 due to thetermination of certain employees to whom these options were granted. Theremaining balance of deferred stock compensation in the amount of $261,000 willbe amortized through March 2009.

In prior years, the Company also issued stock optionsto an outside consultant, for which the Company recorded approximately $500,000and $94,000 of stock-based compensation during the years ended December 31,2004 and 2003, respectively. The Company did not issue any stock options tooutside consultants in 2005.

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

Theamortization of deferred stock compensation, combined with the expenseassociated with stock options granted to non-employees, has been included inthe following items in the accompanying Consolidated Income Statements (inthousands):

| ** **                         | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|
| ** **                         | ** ** | **  2005  **            | ** ** | **  2004  ** | ** ** | **  2003  ** | ** ** |
| Research and  development          |       |                                        | $          | 221 |   |   |   | $ | 22 |   |   |   | $ | 51 |   |   |
| Sales, general  and administrative |       |                                        | 122        |   |   |   | 518 |   |   |   | 86 |   |   |
| Total                              |       |                                        | $          | 343 |   |   |   | $ | 540 |   |   |   | $ | 137 |   |   |

 

**5.   IncomeTaxes**

Theprovision for income taxes consisted of the following (in thousands):

| ** **                  | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------|------------|---------------------------------------------|------------|
| ** **                  | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Current:                    | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal                     |       | $                                           | 6,856      |   | $ | 5,520 |   | $ | 1,255 |   |
| State                       |       | 553                                         |       | 745 |   | (78 | ) |
| Foreign                     |       | 25                                          |       | 18 |   | 10 |   |
| Total                       |       | 7,434                                       |       | 6,283 |   | 1,187 |   |
| Deferred:                   |       |                                        |       |   |   |   |   |
| Federal                     |       | 366                                         |       | (760 | ) | 235 |   |
| State                       |       | 341                                         |       | (2,196 | ) | (132 | ) |
| Total                       |       | 707                                         |       | (2,956 | ) | 103 |   |
| Provision for income  taxes |       | $                                           | 8,141      |   | $ | 3,327 |   | $ | 1,290 |   |

 

Tax benefits resulting from the exercise ofnonqualified stock options and the disqualifying dispositions of shares issuedunder the Company’s stock-based compensation plans were approximately $3,334,000in 2005, $6,138,000 in 2004 and $776,000 in 2003. Such benefits were creditedto additional paid-in capital.

Thereconciliation of federal statutory income tax to the Company’s provision forincome taxes is as follows (in thousands):

| ** **                                    | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Expected  provision at federal statutory rate |       | $                                           | 7,050      |   | $ | 5,671 |   | $ | 2,461 |   |
| State taxes, net  of federal impact           |       | 894                                         |       | (1,451 | ) | (210 | ) |
| Research and  development credits             |       | (351                                        | )          | (1,780 | ) | (125 | ) |
| Valuation  allowance utilized                 |       | —                                      |       | — |   | (798 | ) |
| Permanent  difference related to acquisitions |       | 557                                         |       | 791 |   | — |   |
| Other  individually immaterial items          |       | (9                                          | )          | 96 |   | (38 | ) |
| Provision for  income taxes                   |       | $                                           | 8,141      |   | $ | 3,327 |   | $ | 1,290 |   |

 

Deferredincome taxes reflect the net tax effects of temporary differences between thecarrying amounts of assets and liabilities for financial reporting purposes andthe amounts used for income tax 

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

purposes. Significant components of the Company’sdeferred tax assets and liabilities are as follows (in thousands):

| ** **                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Deferred tax assets:                                 | ** ** | ** **            | ** ** | ** ** | ** ** |
| Net operating loss carry-forwards                    |       | $                     | 693        |   | $ | 806 |   |
| Deferred revenue                                     |       | 30                    |       | 30 |   |
| Capitalized research and development                 |       | 348                   |       | 472 |   |
| Depreciation                                         |       | 4,934                 |       | 3,935 |   |
| Warranty expense accrual                             |       | 263                   |       | 266 |   |
| Research and development and other credits           |       | 1,850                 |       | 2,442 |   |
| Other accruals and reserves                          |       | 1,838                 |       | 2,304 |   |
| Total deferred tax assets before valuation allowance |       | 9,956                 |       | 10,255 |   |
| Valuation allowance for deferred tax assets          |       | —                |       | (95 | ) |
| Total deferred tax assets                            |       | 9,956                 |       | 10,160 |   |
| Deferred tax  liabilities:                           |       |                  |       |   |   |
| Prepaid insurance and property tax                   |       | (445                  | )          | (486 | ) |
| Intangible assets                                    |       | (4,687                | )          | (4,820 | ) |
| Total deferred tax liabilities                       |       | (5,132                | )          | (5,306 | ) |
| Net deferred tax  assets                             |       | $                     | 4,824      |   | $ | 4,854 |   |

 

Deferred tax assets are recognized if realization ofsuch assets is more likely than not. Based upon the weight of availableevidence, which includes the Company’s historical operating performance, theCompany did not provide a valuation allowance against deferred tax assets as ofDecember 31, 2005 because it determined all its deferred tax assets aremore likely than not to be realizable. The net valuation allowance decreased byapproximately $95,000, $6,427,000 and $19,000 during the years ended December 31,2005, 2004, and 2003, respectively.

The reduction of valuation allowance in 2004 consistedof three major components: (1) $4,151,000 was used to reduce goodwill whena deferred tax liability was recorded on the acquisition of IntelliChem, duringwhich $1,667,000 of tax benefits related to the exercise of stock options wereabsorbed; (2) $1,162,000 was related to the exercise of stock optionswhich is not reflected as an expense for financial reporting purposes(accordingly, this amount had been credited directly to stockholders’ equityand not reflected as an income tax benefit in the consolidated incomestatement); and (3) the remaining $1,114,000 was recognized as a statedeferred tax benefit in the consolidated income statement.

As of December 31, 2005, the Company had federalnet operating loss carryforwards of approximately $2,045,000. The net operatinglosses from the acquisition of Synthematix may be subject to an annuallimitation due to the ownership change limitations provided by the InternalRevenue Code of 1986, as amended, and similar state provisions. The annuallimitation may result in the expiration of net operating losses and creditsbefore utilization. The net operating loss carryforwards will start to expirein 2010, if not utilized.

As of December 31,2005, the Company had federal and California research and development taxcredit carryforwards of approximately $293,000 and $2,340,000, respectively.The federal research and development tax credits will begin to expire in 2021.The state research and development credits have no expiration date. Theresearch and development tax credits arose from the acquisitions of Intellichemand 

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

Synthematixmay be subject to an annual limitation of Section 383 due to ownershipchange limitations provided by the Internal Revenue Code of 1986, as amended,and similar state provisions.

**6.   Segment Disclosure**

Statement of Financial Accounting Standards No. 131,*Disclosures about Segments of an Enterprise andRelated Information* (“SFAS 131”), requires disclosures of certaininformation regarding operating segments, products and services, geographicareas of operation and major customers. The method for determining whatinformation to report under SFAS 131 is based upon the “management approach,”or the way that management organizes the operating segments within a company,for which separate financial information is available that is evaluatedregularly by the Chief Operating Decision Maker (“CODM”) in deciding how toallocate resources and in assessing performance. Symyx’s CODM is the ChiefExecutive Officer. The CODM evaluates the performance of the Company based onconsolidated profit or loss from operations before income taxes. For thepurpose of making operating decisions, the CODM primarily considers financialinformation presented on a consolidated basis accompanied by disaggregated informationabout revenue. Revenue is defined as revenue from external customers.

Symyx allocates research personnel time to eachcollaboration arrangement on a full-time-equivalent basis but does not allocateactual research and development expenses to each collaboration or businesssegment. The Company does not assess segment performance below the revenuelevel or allocate sales, general and administrative expenses or assets to theindividual segments and, therefore, financial performance including depreciationand amortization and capital expenditures is not reported on a segment basis.

Revenue isdisaggregated into:

·       ResearchCollaborations — research services on behalf of collaborative partners

·       SymyxTools — sale of select proprietary instruments and associated software andintellectual property

·       SymyxSoftware — license of automation and data mining applications as well asELN software and provision of associated support, maintenance, andconsulting services

·       Materialsand IP Licensing — license of discovered materials and methodology patents, androyalties due to the Company upon successful commercialization of productsincorporating materials discovered in the Company’s industry collaborations

·       SymyxSensors — development services and licenses for specific applications tointellectual property associated with the Company’s sensor technology

In 2005, the Company commenced bifurcating Symyx Toolssales transactions into product sales revenue (reported under the Symyx Toolssegment) and software license fees revenue (the majority of which was reportedunder the Symyx Software segment). Prior to 2005, Symyx Tools salestransactions were reported solely in the product sales revenue line in theConsolidated Income Statements. The impact to the 2005 Consolidated IncomeStatement, if the Company reported its 2005 revenue from Symyx Tools salestransactions in the same way as it reported in periods prior to 2005, would bean additional $1,379,000 of revenue reported in the product sales revenue linerather than in the license fees and royalties line. With respect to segmentreporting, the Company would have reported an additional $1,309,000 of revenueunder the Symyx Tools segment rather than the Symyx Software segment.

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

Thedisaggregated financial information reviewed by the CODM is as follows (inthousands):

| ** **                  | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------|------------|---------------------------------------------|------------|
| ** **                  | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Research  Collaborations    |       | $                                           | 53,818     |   | $ | 42,131 |   | $ | 37,796 |   |
| Symyx Tools                 |       | 30,829                                      |       | 28,576 |   | 18,861 |   |
| Symyx Software              |       | 15,315                                      |       | 6,815 |   | 1,228 |   |
| Materials and IP  Licensing |       | 5,268                                       |       | 4,191 |   | 3,887 |   |
| Symyx Sensors               |       | 2,907                                       |       | 1,472 |   | 1,191 |   |
| Total                       |       | 108,137                                     |       | $ | 83,185 |   | $ | 62,963 |   |
|                             |            |                                             |            |  |  |  |  |  |  |  |

 

Thedisaggregated financial information reviewed by the CODM can be reconciled tothe revenue disclosed in the Consolidated Income Statements as follows (inthousands):

|                             | ** ** | **Year Ended December 31, 2005** | ** ** |
|-----------------------------|------------|------------------------------------------------------|------------|
| ** **                  | ** ** | **Service  Revenue**                                 | ** ** | **Product  Sales** | ** ** | **License  Fees and  Royalties** | ** ** | **Total  Revenue** | ** ** |
| Research  Collaborations    |       | $                                                    | 43,818     |   | $ | — |   | $ | 10,000 |   | $ | 53,818 |   |
| Symyx Tools                 |       | 4,096                                                |       | 26,663 |   | 70 |   | 30,829 |   |
| Symyx Software              |       | 7,134                                                |       | — |   | 8,181 |   | 15,315 |   |
| Materials and IP  Licensing |       | —                                               |       | — |   | 5,268 |   | 5,268 |   |
| Symyx Sensors               |       | 1,932                                                |       | — |   | 975 |   | 2,907 |   |
| Total                       |       | $                                                    | 56,980     |   | $ | 26,663 |   | $ | 24,494 |   | $ | 108,137 |   |

 

| ** **                  | ** ** | **Year Ended December 31, 2004** | ** ** |
|-----------------------------|------------|------------------------------------------------------|------------|
| ** **                  | ** ** | **Service  Revenue**                                 | ** ** | **Product  Sales** | ** ** | **License  Fees and  Royalties** | ** ** | **Total  Revenue** | ** ** |
| Research  Collaborations    |       | $                                                    | 36,131     |   | $ | — |   | $ | 6,000 |   | $ | 42,131 |   |
| Symyx Tools                 |       | 2,831                                                |       | 25,714 |   | 31 |   | 28,576 |   |
| Symyx Software              |       | 2,599                                                |       | 1,329 |   | 2,887 |   | 6,815 |   |
| Materials and IP  Licensing |       | —                                               |       | — |   | 4,191 |   | 4,191 |   |
| Symyx Sensors               |       | 690                                                  |       | 17 |   | 765 |   | 1,472 |   |
| Total                       |       | $                                                    | 42,251     |   | $ | 27,060 |   | $ | 13,874 |   | $ | 83,185 |   |

 

| ** **                  | ** ** | **Year Ended December 31, 2003** | ** ** |
|-----------------------------|------------|------------------------------------------------------|------------|
| ** **                  | ** ** | **Service  Revenue**                                 | ** ** | **Product  Sales** | ** ** | **License  Fees and  Royalties** | ** ** | **Total  Revenue** | ** ** |
| Research  Collaborations    |       | $                                                    | 33,296     |   | $ | — |   |   | $ | 4,500 |   |   | $ | 37,796 |   |
| Symyx Tools                 |       | 4,403                                                |       | 14,458 |   |   | — |   |   | 18,861 |   |
| Symyx Software              |       | 373                                                  |       | — |   |   | 855 |   |   | 1,228 |   |
| Materials and IP  Licensing |       | —                                               |       | — |   |   | 3,887 |   |   | 3,887 |   |
| Symyx Sensors               |       | 617                                                  |       | — |   |   | 574 |   |   | 1,191 |   |
| Total                       |       | $                                                    | 38,689     |   | $ | 14,458 |   |   | $ | 9,816 |   |   | $ | 62,963 |   |

 

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

*Geographic Area Data*

Allsignificant long-lived assets were geographically located in the United Statesfor all periods presented. All revenue is generated in the United States forall periods presented, but is presented in the table below based on thephysical location of Symyx’s customers (in thousands).

| ** **                  | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------|------------|---------------------------------------------|------------|
| ** **                  | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| North America               |       | $                                           | 89,828     |   | $ | 66,607 |   | $ | 53,803 |   |
| Japan                       |       | 1,841                                       |       | 5,432 |   | 7,174 |   |
| Belgium                     |       | 2,261                                       |       | 8,334 |   | 50 |   |
| Europe (excluding  Belgium) |       | 14,207                                      |       | 2,812 |   | 1,936 |   |
| Total                       |       | $                                           | 108,137    |   | $ | 83,185 |   | $ | 62,963 |   |

 

**7.   BusinessCombination**

*Acquisition of IntelliChem, Inc.*

On November 30, 2004, Symyx acquired 100% ofoutstanding common and preferred shares of IntelliChem, Inc. (“IntelliChem”),a provider of intelligent electronic lab notebooks for customers in thepharmaceutical, biotechnology, and chemical industries. The results ofIntelliChem’s operations have been included in the consolidated financialstatements since that date.

In accordance with Statement of Financial AccountingStandards No. 141, *Business Combinations*,the Company allocated the purchase price to the tangible assets, deferredcompensation, liabilities, and intangible assets acquired, as well asin-process research and development, based on their estimated fair values. Theexcess purchase price over the fair values was recorded as goodwill. The fairvalue assigned to intangible assets acquired was based on estimates andassumptions determined by management. The acquired goodwill was assignedentirely to the Company’s software segment. Purchased intangibles with finitelives are amortized on a straight-line basis over their respective usefullives.

Thetotal purchase price for this acquisition was $30,600,000, consisting ofapproximately $29,259,000 in cash, $1,041,000 in fair value of assumed stockoptions to purchase 44,126 shares of Symyx common stock, and $300,000 intransaction costs, consisting of legal and other professional service fees. Stockoptions were valued using the Black-Scholes option pricing model. Theassumptions used in calculating fair value were as follows:

| ** **               | ** ** | **Group A  Options** | ** ** | **Group B  Options** | ** ** |
|--------------------------|------------|---------------------------|------------|---------------------------|------------|
| Expected life  (years)   |       |                      | 3          |                      |       |   | 4 |   |   |
| Risk-free rate           |       |                      | 3.23       | %                         |       |   | 3.44 | % |   |
| Expected dividend  yield |       |                      | 0          | %                         |       |   | 0 | % |   |
| Volatility               |       |                      | 55.7       | %                         |       |   | 55.7 | % |   |
| Fair value per share     |       |                      | $          | 26.05                     |       |   |   | $ | 13.37 |   |   |
|                          |            |                           |            |                           |            |  |  |  |  |  |  |

 

The intrinsic value of these options, totalingapproximately $651,000, has been recorded as deferred stock compensation.

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

Thepurchase price allocation was as follows (in thousands):

| ** **                                                                                                                                                                                                                        | ** ** | **Amount** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| Fair value of net  assets purchased                                                                                                                                                                                               |       | $          | 4,476      |   |
| Deferred tax  assets                                                                                                                                                                                                              |       | 145        |       |
| In-process  research and development                                                                                                                                                                                              |       | 2,260      |       |
| Trade name                                                                                                                                                                                                                        |       | 860        |       |
| Developed  technology                                                                                                                                                                                                             |       | 8,370      |       |
| Customer relationships                                                                                                                                                                                                            |       | 4,700      |       |
| Unearned stock  compensation                                                                                                                                                                                                      |       | 651        |       |
| Deferred tax  liabilities                                                                                                                                                                                                         |       | (4,151     | )          |
| Release of  valuation allowance against acquirer’s deferred income tax assets upon  recognition of deferred income tax liabilities on acquired identifiable  intangible assets in connection with acquisition of IntelliChem |       | 4,151      |       |
| Goodwill                                                                                                                                                                                                                          |       | 9,138      |       |
| Total                                                                                                                                                                                                                             |       | $          | 30,600     |   |

 

Thefair values of IntelliChem’s net assets as of the acquisition date were (inthousands):

| ** **                                      | ** ** | **Amount** | ** ** |
|-------------------------------------------------|------------|------------|------------|
| Cash                                            |       |       | $          | 2,492 |   |   |
| Restricted cash                                 |       |       | 104        |   |   |
| Accounts receivable, net                        |       |       | 1,325      |   |   |
| Income tax receivable                           |       |       | 855        |   |   |
| Prepaids and other  assets                      |       |       | 298        |   |   |
| Plant, property and  equipment                  |       |       | 323        |   |   |
| Accounts payable and  other accrued liabilities |       |       | (374       | ) |   |
| Accrued compensation                            |       |       | (259       | ) |   |
| Deferred revenue                                |       |       | (288       | ) |   |
| Fair value of IntelliChem’s net assets     |       |       | $          | 4,476 |   |   |

 

The allocation of theconsideration for the acquisition of IntelliChem to its individual assets andliabilities was based on management’s analysis and estimates of the fair valuesof the acquired assets and liabilities. In addition to the value assigned toin-process research and development (“IPR&D”) projects, and IntelliChem’stangible assets, specific intangible assets were identified and valued. Theidentifiable intangible assets included customer relationships, a trade name,and developed technology.

The IPR&D project thatIntelliChem had been working on was the development of next generation ofIntelliChem software. That software had not yet been proven to betechnologically feasible, but had been developed to a point where it had valueassociated with potential future revenue at the time of acquisition. Becausetechnological feasibility was not yet proven and no alternative future useswere believed to exist for the in-process technologies, the assigned value wasexpensed immediately upon the closing date of the acquisition, in accordancewith FASB Interpretation No. 4, *Applicability of FASBStatement No. 2 to Business Combinations Accounted for by the PurchaseMethod*.

The value of IPR&D wasdetermined by estimating the expected cash flows from the projects oncecommercially viable, discounting the net cash flows back to their present valueand then applying a percentage of completion to the calculated value as definedbelow. A discount rate of 28% was used which is higher than IntelliChem’scomputed weighted average cost of capital of 20% due to inherent risk 

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

surroundingthe successful development of the IPR&D and the increase in projectedfinancial results compared with historical results. This project has beencompleted in 2005 and costs associated with this project were not material andwere included in the research and development expenses.

Inperforming this purchase price allocation, the Company considered, among otherfactors, its intention for future use of the acquired assets, analyses ofhistorical financial performance and estimates of future performance ofIntelliChem’s products. The fair value of intangible assets was primarily basedon the income approach. The relief from royalty approach was also utilized whenappropriate. The rates utilized to discount the net cash flows to their presentvalues ranged from 24% to 28%. These discount rates were determined afterconsideration of the Company’s rate of return and the weighted average returnon assets. Risks the Company identified and considered in this analysisincluded achieving anticipated levels of market acceptance and penetration,successful completion of development efforts, market growth rates, and risksrelated to the impact of potential changes in future target markets. At December 31,2005, identifiable intangible assets purchased in the IntelliChem acquisitionconsisted of the following (in thousands, except for useful life) with aweighted average useful life of 5.0 years. No significant residual value wasestimated for these assets.

| ** **                                  | ** ** | **Amount** | ** ** | **Useful Life** | ** ** |
|---------------------------------------------|------------|------------|------------|----------------------|------------|
| Trade name                                  |       | $          | 860        |                 |       | 1 year |   |   |
| Developed technology                        |       | 8,370      |       |                 | 4.5 years  |   |   |
| Customer relationships                      |       | 4,700      |       |                 | 6.5 years  |   |   |
| Balance at  December 31, 2005, at cost |       | $          | 13,930     |                 |       |   |   |   |

 

***Pro FormaFinancial Information (unaudited)***

Theunaudited financial information in the table below summarized the combinedresults of operations of Symyx and IntelliChem, on a pro forma basis, as thoughthe companies had been combined as of the beginning of each period presented.The impact of the IPR&D charge associated with the acquisition had beenexcluded. This pro forma financial information was presented for informationalpurposes only and was not necessarily indicative of the results of operationsthat would have been achieved had the acquisition taken place at the beginningof each period presented. The unaudited pro forma combined income statementdata for the year ended December 31, 2004 combined the historical resultsfor Symyx for the year ended December 31, 2004 and the historical resultsfor IntelliChem for the period of January 1, 2004 through November 30,2004. The unaudited pro forma combined income statement data for the year endedDecember 31, 2003 combined the historical results for Symyx for the yearended December 31, 2003 and the historical results for IntelliChem for theyear ended December 31, 2003. The following amounts were in thousands,except per share amounts.

| ** **               | ** ** | **Years Ended December 31,**                          | ** ** |
|--------------------------|------------|----------------------------------------------------------------------|------------|
| ** **               | ** ** | **     2004     ** | ** ** | **     2003     ** | ** ** |
| Revenue                  |       |                                                                 | $          | 84,909 |   |   |   | $ | 66,586 |   |   |
| Net income               |       |                                                                 | $          | 10,971 |   |   |   | $ | 4,382 |   |   |
| Basic income per share   |       |                                                                 | $          | 0.34 |   |   |   | $ | 0.14 |   |   |
| Diluted income per share |       |                                                                 | $          | 0.32 |   |   |   | $ | 0.13 |   |   |

 

***Acquisitionof Synthematix, Inc.***

On April 1, 2005, Symyx completed the acquisitionof 100% of the outstanding shares of privately-held Synthematix, Inc. (“Synthematix”),based in Durham, North Carolina. Synthematix is a provider of organic synthesisreaction planning software systems for scientific knowledge management inchemistry research, 

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

with customers primarilyin the pharmaceutical, biotechnology, and fine chemical industries. Theacquisition was accounted for using the purchase method. The results ofSynthematix’s operations have been included in the Company’s consolidatedfinancial statements since that date.

The preliminary purchase price for this acquisitionwas $14,015,000, consisting of approximately $13,079,000 in cash, $571,000 infair value of assumed stock options to purchase 23,876 shares of Symyx commonstock, and $365,000 in transaction costs, consisting of legal and otherprofessional service fees.

Additional purchase price consideration of up to$4,000,000 was to be payable upon the achievement of certain 2005 revenuetargets for products developed by Synthematix. Based on the actual results, theCompany determined that the 2005 revenue targets were not achieved bySynthematix. Therefore, no additional consideration was recorded.

Stockoptions were valued using the Black-Scholes option pricing model. Theassumptions used in calculating fair value were as follows:

| ** **               | ** ** | **Group A  Options** | ** ** | **Group B  Options** | ** ** | **Group C  Options** | ** ** |
|--------------------------|------------|---------------------------|------------|---------------------------|------------|---------------------------|------------|
| Expected life  (years)   |       |                      | 2          |                      |       |                      | 0.5        |   |   |   | 2 |   |   |
| Risk-free rate           |       |                      | 2.0        | %                         |       |                      | 1.7        | % |   |   | 2.0 | % |   |
| Expected dividend  yield |       |                      | 0          | %                         |       |                      | 0          | % |   |   | 0 | % |   |
| Volatility               |       |                      | 51.0       | %                         |       |                      | 51.0       | % |   |   | 51.0 | % |   |
| Fair value per share     |       |                      | $          | 26.42                     |       |                      |       | $ | 24.77 |   |   |   | $ | 18.79 |   |   |
|                          |            |                           |            |                           |            |                           |            |  |  |  |  |  |  |  |  |  |

 

The intrinsic value of these options, totalingapproximately $216,000, has been recorded as deferred stock compensation.

Inaccordance with Statement of Financial Accounting Standards No. 141, *Business Combinations*, the Company allocated the purchaseprice to the tangible assets, deferred compensation, liabilities, andintangible assets acquired, as well as in-process research and development (“IPR&D”),based on their estimated fair values. The excess purchase price over the fairvalues was recorded as goodwill. The purchase price was allocated as follows(in thousands):

| ** **                                   | ** ** | **Amount** | ** ** |
|----------------------------------------------|------------|------------|------------|
| Fair value of net  tangible assets purchased |       | $          | 708        |   |
| Current deferred tax  assets                 |       | 143        |       |
| In-process research and  development         |       | 1,590      |       |
| Bargain lease  arrangement                   |       | 10         |       |
| Trade name                                   |       | 280        |       |
| Developed technology                         |       | 2,350      |       |
| Customer relationships                       |       | 500        |       |
| Unearned stock  compensation                 |       | 216        |       |
| Deferred tax liabilities                     |       | (188       | )          |
| Goodwill                                     |       | 8,406      |       |
| Total                                        |       | $          | 14,015     |   |

 

Pro forma financial information is not providedbecause the acquisition was not material to the Company’s Consolidated IncomeStatements.

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

Goodwill and intangibleassets arising from both the IntelliChem acquisition and Synthematixacquisition were recorded in the Company’s Symyx Software segment only. None ofthe goodwill will be deductible for tax purposes.

**8.   Related Party Transactions**

In June 2005, after Ilypsa, Inc. completedthe first part of its Series B Financing, the Company’s ownership ofIlypsa’s shares outstanding fell from approximately 37% to approximately 18%.As a result, the Company changed the way it accounts for its ownership interestin Ilypsa from the equity method to the cost method as the Company does nothave the ability to exert significant influence on the strategic, operating,investing and financing activities of Ilypsa. While using the equity method,the Company had not recorded any proportionate share of Ilypsa’s operatinglosses in its financial statements as the Company’s investment in Ilypsa had nocost basis for accounting purposes under U.S. generally accepted accountingprinciples.

On May 6, 2003, the Company entered into an 18-monthCollaborative Research and License Agreement with Ilypsa. Under the terms ofthat Agreement, Ilypsa paid research funding to the Company in considerationfor direct costs incurred by the Company specifically attributable to, orspecifically used in furtherance of, the research program. Research fundingpayments were due to the Company at the start of each month, with an adjustmentat the end of each month for the difference between forecast and actual costsincurred. Revenue resulting from work performed under that Agreement during theyears ended December 31, 2004 and 2003 amounted to $1,173,000 and $1,671,000,respectively. This revenue has beenclassified as service revenue in the Consolidated Income Statements. TheAgreement expired in 2004.

Ilypsa also licensed software from the Company. Thesoftware support revenue reported by the Company in 2005 amounted to $179,000.This revenue has been classified as service revenue in the Consolidated IncomeStatements. The amount receivable from Ilypsa was approximately $5,000 and$7,000 as of December 31, 2005 and 2004, respectively.

InMarch 2005, the Company entered into a Collaborative Developmentand License Agreement and on December 19, 2005, the Company entered intoan Alliance Agreement, with Intermolecular, Inc. Under the agreements, thetwo companies will work together to conduct research and development and otheractivities with respect to materials and high-throughput technology for use insemiconductor applications. Each party is bearing its own expenses. ThomasBaruch, one of the Company’s board members, is a director of Intermolecular, Inc.and CMEA Ventures, of which Mr. Baruch is a general partner, holds a 17.5%interest in Intermolecular, Inc. Dr. W. Henry Weinberg, one of Symyx’sexecutive officers, is a scientific advisory board member of Intermolecular, Inc.and a holder of options to purchase 115,000 shares of common stock ofIntermolecular, Inc. In 2005 the Company recognized $88,000 revenueassociated with a CORE(x) core module sold to Intermolecular, Inc.and $20,000 gain from the sale of a fixed asset with $130,000 net book value,which was sold to Intermolecular, Inc. for its original cost of $150,000.

**9.   Financial Instruments**

The Company has notentered into any derivative contracts at December 31, 2005. The followingis a summary of the Company’s risk management strategies and the effect ofthese strategies on the Company’s consolidated financial statements.

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

***Concentrations of credit risk***

Financial instruments thatpotentially subject the Company to significant concentrations of credit riskconsist principally of cash and investments. The Company does not carry asignificant trade accounts receivable balance from a specific customer. TheCompany maintains cash and cash equivalents and available-for-sale investmentsin various corporate debt securities and money market mutual funds. The Company’spolicy is designed to limit exposure to any one institution or company. Therelative credit standing of the security issuers is monitored to ensurecompliance with the Company’s investment strategy. The Company does not requirecollateral on these financial instruments.

***Financial Instruments***

The following methods and assumptions were used by theCompany in estimating its fair value disclosures for financial instruments:

*Cashand cash equivalents:*   The carrying amountsreported in the balance sheets for cash and cash equivalents are their fairvalues.

*Accountsreceivable and accounts payable:*   The carryingamounts reported in the balance sheets for accounts receivable and accountspayable approximate their fair values.

*Available-for-salesecurities:*   The fair values foravailable-for-sale equity securities are based on quoted market prices. Thefair values for available-for-sale securities together with information inrelation to their maturity dates are included in Note 1 to these financialstatements.

**10.   IntangibleAssets**

TheCompany acquired certain patent rights and know-how from third parties. It alsoobtained certain intangible assets in the acquisitions of IntelliChem andSynthematix in November 2004 and April 2005, respectively. Theseintangible assets are being amortized on a straight-line basis over theestimated useful lives of the assets. The useful lives of trade names acquiredin the IntelliChem and Synthematix acquisitions were estimated to be 4.5 yearsat the time of the acquisitions. During the three months ended September 30,2005, the remaining useful lives of these trade names were reassessed as oneyear commencing from September 1, 2005 due to the advancement of theCompany’s branding strategy for its software offerings. The current usefullives and carrying amounts of these intangible assets are as follows (inthousands, except for useful lives):

| ** **              | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|-------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **Useful  Lives  (Years)**      | ** ** | **Gross  Carrying  Amount**     | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** |
| Acquired  technology    |       | 5.0                             |       | $                               | 3,130      |   |   | $ | (2,007 | ) |   | $ | 1,123 |   | $ | 3,130 |   |   | $ | (1,715 | ) |   | $ | 1,415 |   |
| Bargain lease           |       | < 1                          |       | 10                              |       |   | (10 | ) |   | — |   | — |   |   | — |   |   | — |   |
| Trade name              |       | 1                               |       | 1,140                           |       |   | (493 | ) |   | 647 |   | 860 |   |   | (16 | ) |   | 844 |   |
| Developed  technology   |       | 4.5                             |       | 10,720                          |       |   | (2,406 | ) |   | 8,314 |   | 8,370 |   |   | (155 | ) |   | 8,215 |   |
| Customer  relationships |       | 6.5 — 7                    |       | 5,200                           |       |   | (837 | ) |   | 4,363 |   | 4,700 |   |   | (60 | ) |   | 4,640 |   |
| Total intangibles       |       |                            |       | $                               | 20,200     |   |   | $ | (5,753 | ) |   | $ | 14,447 |   | $ | 17,060 |   |   | $ | (1,946 | ) |   | $ | 15,114 |   |

 

In the years ended December 31,2005, 2004 and 2003, the Company recorded amortization expenses of intangibleassets of $3,807,000, $422,000, and $369,000, respectively. Assuming nosubsequent impairment of the underlying assets, the annual amortization expenseof total intangible assets is expected 

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

to beapproximately $4,116,000 in 2006, $3,469,000 in 2007, $3,460,000 in 2008,$2,217,000 in 2009, $795,000 in 2010 and $390,000 thereafter.

**11.   QuarterlyResults of Operations (Unaudited)**

Thefollowing is a summary of the quarterly results of operations for the yearsended December 31, 2005 and 2004 (in thousands, except per share amounts).

| ** **                                                            | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                            | ** ** | **March 31,**               | ** ** | **June 30,** | ** ** | **September 30(b),** | ** ** | **December 31(b),** | ** ** |
| **2005**                                                              | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total revenue                                                         |       |                             | $          | 21,508 |   |   | $ | 24,052 |   |   | $ | 31,715 |   |   |   | $ | 30,862 |   |   |
| Operating expenses:                                                   |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of products sold                                                 |       |                             | 1,368      |   |   | 1,962 |   |   | 3,533 |   |   |   | 4,227 |   |   |
| Research and development                                              |       |                             | 11,440     |   |   | 12,542 |   |   | 12,934 |   |   |   | 13,744 |   |   |
| Sales, general and  administrative                                    |       |                             | 5,935      |   |   | 6,660 |   |   | 6,619 |   |   |   | 6,351 |   |   |
| Acquired in-process  research and development                         |       |                             | —     |   |   | 1,590 |   |   | — |   |   |   | — |   |   |
| Amortization of  intangible assets arising from business combinations |       |                             | 694        |   |   | 859 |   |   | 919 |   |   |   | 1,044 |   |   |
| Total operating expenses                                              |       |                             | 19,437     |   |   | 23,613 |   |   | 24,005 |   |   |   | 25,366 |   |   |
| Income from operations                                                |       |                             | 2,071      |   |   | 439 |   |   | 7,710 |   |   |   | 5,496 |   |   |
| Interest and other  income                                            |       |                             | 802        |   |   | 873 |   |   | 1,172 |   |   |   | 1,580 |   |   |
| Income before income tax  expense                                     |       |                             | 2,873      |   |   | 1,312 |   |   | 8,882 |   |   |   | 7,076 |   |   |
| Income tax expense                                                    |       |                             | 1,171      |   |   | 926 |   |   | 2,964 |   |   |   | 3,080 |   |   |
| Net income                                                            |       |                             | $          | 1,702 |   |   | $ | 386 |   |   | $ | 5,918 |   |   |   | $ | 3,996 |   |   |
| Basic net income per  share(a)                                        |       |                             | $          | 0.05 |   |   | $ | 0.01 |   |   | $ | 0.18 |   |   |   | $ | 0.12 |   |   |
| Diluted net income per share(a)                                       |       |                             | $          | 0.05 |   |   | $ | 0.01 |   |   | $ | 0.17 |   |   |   | $ | 0.11 |   |   |

 

| ** **                                                            | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                            | ** ** | **March 31,**               | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31(c),** | ** ** |
| **2004**                                                              | ** ** |                             | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Total revenue                                                         |       |                             | $          | 19,479 | ** ** |   | $ | 18,916 |   |   | $ | 19,558 | ** ** |   |   | $ | 25,232 |   |   |
| Operating expenses:                                                   |       |                             |       | ** ** |   |   |   |   |   | ** ** |   |   |   |   |   |
| Cost of products sold                                                 |       |                             | 1,678      | ** ** |   | 1,940 |   |   | 1,437 | ** ** |   |   | 2,802 |   |   |
| Research and development                                              |       |                             | 10,842     | ** ** |   | 10,422 |   |   | 9,864 | ** ** |   |   | 10,014 |   |   |
| Sales, general and  administrative                                    |       |                             | 4,111      | ** ** |   | 4,311 |   |   | 4,375 | ** ** |   |   | 5,210 |   |   |
| Acquired in-process  research and development                         |       |                             | —     | ** ** |   | — |   |   | — | ** ** |   |   | 2,260 |   |   |
| Amortization of  intangible assets arising from business combinations |       |                             | —     | ** ** |   | — |   |   | — | ** ** |   |   | 231 |   |   |
| Total operating expenses                                              |       |                             | 16,631     | ** ** |   | 16,673 |   |   | 15,676 | ** ** |   |   | 20,517 |   |   |
| Income from operations                                                |       |                             | 2,848      | ** ** |   | 2,243 |   |   | 3,882 | ** ** |   |   | 4,715 |   |   |
| Interest and other  income                                            |       |                             | 519        | ** ** |   | 716 |   |   | 610 | ** ** |   |   | 676 |   |   |
| Income before income tax  expense (benefit)                           |       |                             | 3,367      | ** ** |   | 2,959 |   |   | 4,492 | ** ** |   |   | 5,391 |   |   |
| Income tax expense  (benefit)                                         |       |                             | 1,360      | ** ** |   | 1,247 |   |   | 1,720 | ** ** |   |   | (1,000 | ) |   |
| Net income                                                            |       |                             | $          | 2,007 | ** ** |   | $ | 1,712 |   |   | $ | 2,772 | ** ** |   |   | $ | 6,391 |   |   |
| Basic net income per  share(a)                                        |       |                             | $          | 0.06 | ** ** |   | $ | 0.05 |   |   | $ | 0.09 | ** ** |   |   | $ | 0.20 |   |   |
| Diluted net income per share(a)                                       |       |                             | $          | 0.06 | ** ** |   | $ | 0.05 |   |   | $ | 0.08 | ** ** |   |   | $ | 0.19 |   |   |

----

(a)           Earning per share, orEPS, for each quarter is computed using the weighted-average number of sharesoutstanding during that quarter, while EPS for the fiscal year is computedusing the weighted-average 

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**SYMYX TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

number of shares outstandingduring the year. Thus, the sum of the EPS for each of the four quarters may notequal the EPS for the fiscal year.

(b)          In the second half of2005, delivery of multiple Symyx Tools systems to the Company’s customersresulted in significantly higher product sales revenue that contributed to thehigher earnings per share in the third and fourth quarters when compared withthe other quarters in 2005.

(c)           In the last quarter of2004, delivery of high dollar value Symyx Tools systems to the Company’s customersresulted in significantly higher product sales revenue, which, combined withincome tax benefits recognized upon the release of valuation allowances,contributed to the higher earnings per share in that quarter when compared withthe other quarters in 2004.

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**Item 9.**                        *Changes in and Disagreements with Accountants on Accounting and FinancialDisclosure*

Not applicable.

**Item 9A.**   *Controls and Procedures*

*Evaluation ofdisclosure controls and procedures*

Based on an evaluation ofour disclosure controls and procedures as of the end of the period covered bythis Annual Report on Form 10-K, our Chief Executive Officer andChief Financial Officer have concluded that our disclosure controls andprocedures (as defined in Rules 13a-14(c) and 15d-14(c) underthe Securities Exchange Act of 1934 (the “Exchange Act”)) are effective in timelyalerting them to material information required to be disclosed by us in thisAnnual Report on Form 10-K. There have been no changes in ourinternal controls or in other factors that could significantly affect internalcontrols during our most recent fiscal quarter that have materially affected orare reasonably likely to materially affect our internal controls over financialreporting.

*Changes in internalcontrols*

*Therehave been no changes in our internal controls or in other factors that couldsignificantly affect internal controls during our most recent fiscal quarterthat has materially affected or is reasonably likely to materially affect ourinternal control over financial reporting.*

*Management reporton internal control over financial reporting*

Management of the Company is responsible forestablishing and maintaining adequate internal control over financialreporting. Internal control over financial reporting is defined in Rules 13a-15(f) and15d-15(f) promulgated under the Securities Exchange Act of 1934, asamended, as a process designed by, or under the supervision of, the Company’sprincipal executive and principal financial officers and effected by theCompany’s Board, management, and other personnel to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles and includes those policies and procedures that:(i) pertain to the maintenance of records that, in reasonable detail,accurately and fairly reflect the transactions and dispositions of the assetsof the Company; (ii) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the Company are being made only in accordance withauthorizations of management and Directors of the Company; and (iii) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of the Company’s assets that could have amaterial effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Projectionsof any evaluation of effectiveness to future periods are subject to the risksthat controls may become inadequate because of changes in conditions or thatthe degree of compliance with the policies or procedures may deteriorate.

The Company’s management assessed the effectiveness ofthe Company’s internal control over financial reporting as of December 31,2005. In making this assessment, the Company’s management used criteria setforth by the Committee of Sponsoring Organizations of the Treadway Commission(COSO) in Internal Control-Integrated Framework. Based on its assessment, theCompany’s management believes that, as of December 31, 2005, the Company’sinternal control over financial reporting was effective based on the criteriaset forth by COSO.

89

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TheCompany’s independent registered public accounting firm, Ernst & YoungLLP, has issued an attestation report on management’s assessment of the Company’sinternal control over financial reporting. This report is included in Item 9A.
| /s/ STEVEN  D. GOLDBY                |   | /s/ JERYL L. HILLEMAN                                |
|--------------------------------------|--------|------------------------------------------------------|
| Steven D. Goldby                     |   | Jeryl L. Hilleman                                    |
| Chairman and Chief Executive Officer |   | Executive Vice President and Chief Financial Officer |

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRMON INTERNAL CONTROL OVER FINANCIAL REPORTING**

The Board of Directors and Stockholders ofSymyx Technologies, Inc.

We have audited management’s assessment, included inthe accompanying Management Report on Internal Control Over FinancialReporting, that Symyx Technologies, Inc. maintained effective internalcontrol over financial reporting as of December 31, 2005, based on criteria established in Internal Control —Integrated Framework issued by the Committee of Sponsoring Organizations of theTreadway Commission (the COSO criteria). Symyx Technologies, Inc.’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of the company’sinternal control over financial reporting based on our audit.

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

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

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

In our opinion, management’s assessment that SymyxTechnologies, Inc. maintained effective internal control over financialreporting as of December 31, 2005, is fairly stated, in all materialrespects, based on 

90

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the COSO criteria. Also,in our opinion, Symyx Technologies, Inc. maintained, in all materialrespects, effective internal control over financial reporting as of December 31,2005, based on the COSO criteria.

We also have audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theconsolidated balance sheets of Symyx Technologies, Inc. as of December 31,2005 and 2004, and the related consolidated income statements, consolidatedstatements of stockholders’ equity and consolidated statements of cash flowsfor each of the three years in the period ended December 31, 2005 of SymyxTechnologies, Inc. and our report dated March 3, 2006 expressed anunqualified opinion thereon.
|                        | /s/ ERNST & YOUNG LLP |
|------------------------|--------------------------------|
| Palo Alto,  California |                           |
| March 3,  2006    |                           |

 

**Item 9B.     *Other Information***

On March 1, 2006, the Compensation Committee ofthe Company’s Board of Directors approved a Cash Bonus Plan for executiveofficers for 2006. A summary of the Plan is attached as exhibit 10.8 to thisAnnual Report on Form 10-K and is incorporated herein by reference.

On March 1, 2006, the Compensation Committee ofthe Company’s Board of Directors approved grants of restricted stock units tothe Company’s executive officers. The Chief Executive Officer, Chief TechnicalOfficer and President each received 33,000 restricted stock units and the ChiefFinancial Officer and Chief Operating Officer each received 27,000 restrictedstock units. Each restricted stock unit represents a right to receive one shareof the Company’s common stock. These restricted stock units vest on March 1,2007.

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**PART III**

**Item 10.**                 *Directors and Executive Officers of the Registrant*

The information required by this item is herebyincorporated by reference from the information under the captions “Election ofDirectors” and “Executive Officers” contained in the Company’s definitive ProxyStatement, to be filed with the Securities and Exchange Commission no laterthan 120 days from the end of the Company’s last fiscal year in connection withthe solicitation of proxies for its 2006 Annual Meeting of Stockholders (the “ProxyStatement”). The information required by Section 16(a) isincorporated by reference from the information under the caption “Compliancewith Section 16(a) of the Securities Exchange Act of 1934” in theProxy Statement.

The Company has adopted aCode of Conduct and Ethics that applies to its employees, including principalexecutive officer, principal financial officer and controller, within themeaning of Section 404 of the Sarbanes-Oxley Act of 2002 and the rules promulgatedthereunder. A copy of the Code of Conduct and Ethics is available at theCompany’s website: www.symyx.com and without charge upon written request to:Corporate Secretary, 3100 Central Expressway, Santa Clara, CA 95051. To theextent required by the law, amendments to, and waivers from, any provision ofthe Company’s Code of Conduct and Ethics will promptly be disclosed to thepublic. To the extent permitted by such legal requirements, the Company intendsto make such public disclosure by posting such information on the Company’swebsite in accordance with SEC rules.

**Item 11.**                 *Executive Compensation*

The information requiredby this item is incorporated by reference from the information under thecaption “Executive Officer Compensation” in the Proxy Statement.

**Item 12.**                 *Security Ownership of Certain Beneficial Owners and Management andRelated Stockholder Matters*

The information appearing in our 2006 Proxy Statementunder the heading “Security Ownership of Certain Beneficial Owners andManagement” is incorporated by reference. 

In order to diversify their investment portfolios, ourfive executive officers, Steven D. Goldby, Isy Goldwasser, Jeryl L.Hilleman, Dr. W. Henry Weinberg, and Paul Nowak, and two of our boarddirectors, Dr. Peter Schultz and Martin Gerstel, have adopted stocktrading plans to facilitate the sale of shares of our common stock pursuant to Rule 10b5-1of the Securities Exchange Act of 1934, as amended.

See “Equity CompensationPlans” in Part II, Item 5 of this Annual Report on Form 10-Kregarding shares authorized for issuance under equity compensation plansapproved by stockholders and not approved by stockholders. For descriptions ofour equity compensation plans, see Note 4 “Stockholders’ Equity” of Notes tothe Consolidated Financial Statements in Part II, Item 8 of this AnnualReport on Form 10-K. 

**Item 13.**                 *Certain Relationships and Related Transactions*

The information requiredby this item is incorporated by reference to the information under the caption “CertainRelationships and Related Transactions” in the Proxy Statement.

**Item 14.**                 *Principal Accounting Fees and Services*

The information requiredby this item is incorporated by reference to the information under the caption “PrincipalAuditor Fees and Services” in the Proxy Statement.

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**PART IV**

**Item 15.**                 *Exhibits and Financial Statement Schedules*

(a) 1.                        *Financial Statements*

The following Financial Statements of SymyxTechnologies, Inc. and the Report of Ernst & Young LLP,Independent Registered Public Accounting Firm, have been filed as part of thisAnnual Report on Form 10-K. See index to Consolidated Financial Statementsunder Item 8 above:

Report of Independent Registered Public AccountingFirm on Consolidated Financial Statements

Consolidated Balance Sheets at December 31, 2005and 2004

Consolidated Income Statements for the Years Ended December 31,2005, 2004 and 2003

Consolidated Statements of Stockholders’ Equity forthe Years Ended December 31, 2005, 2004 and 2003

Consolidated Statements of Cash Flows for the YearsEnded December 31, 2005, 2004 and 2003

Notes to ConsolidatedFinancial Statements

(a) 2.                        *Financial Statement Schedules*

All schedules areomitted because they are not applicable or the required information is shown inthe Financial Statements or the notes thereto.

(a) 3.                        *Exhibits*

Refer to (b) below.

(b) Exhibits
| Exhibit   Number | ** ** | **Description of Document**                                                                                                                                                                                                                                                   |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1*(8)          |       | Agreement and Plan of  Merger, dated as of November 12, 2004, by and among Symyx  Technologies, Inc., and IntelliChem, Inc.                                                                                                                                    |
| 3.1(1)           |       | Amended and Restated Certificate of Incorporation                                                                                                                                                                                                                             |
| 3.2(7)           |       | Amended and Restated Bylaws of Symyx  Technologies, Inc.                                                                                                                                                                                                                 |
| 3.3(9)           |       | Certificate of Amendment to the Amended and Restated  Bylaws of Symyx Technologies, Inc.                                                                                                                                                                                 |
| 4.1(2)           |       | Specimen Common Stock Certificate                                                                                                                                                                                                                                             |
| 10.1**(10)       |       | Synthematix, Inc. Amended and Restated 2000  Equity Compensation Plan and forms of agreements thereunder                                                                                                                                                                 |
| 10.2**(2)        |       | 1996 Stock Plan and forms of agreements thereunder                                                                                                                                                                                                                            |
| 10.3**(12)       |       | Amended and Restated 1997 Stock Plan and forms of  agreements thereunder                                                                                                                                                                                                      |
| 10.4**(2)        |       | 1999 Employee Stock Purchase Plan                                                                                                                                                                                                                                             |
| 10.5(2)          |       | Form of Director and Executive Officer  Indemnification Agreement                                                                                                                                                                                                        |
| 10.6**(2)        |       | Form of Change of Control Agreement between  Symyx and the following individuals: Steven D. Goldby, Isy Goldwasser, Jeryl  L. Hilleman, and W. Henry Weinberg                                                                                                            |
| 10.7(2)          |       | Standard Industrial/Commercial Single-Tenant Lease  dated November 15, 1996 between Symyx and Patrick and Bette Ng,  Co-Trustees for The Ng Living Trust, for office space located at 3100 Central  Expressway, Santa Clara, California, and addenda and inserts thereto |
| 10.7(a)(2)       |       | First Amendment to Lease between Symyx and Patrick  and Bette Ng, Co-Trustees for The Ng Living Trust                                                                                                                                                                    |

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| 10.8**(12) |   | 2006 Cash Bonus Plan for  Executive Officers                                                                                                                                                                                                               |
|------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.9(2)    |   | Celanese-Symyx Collaboration Agreement dated  August 1, 1998 between Symyx and Celanese Ltd.                                                                                                                                                          |
| 10.10(2)   |   | Collaborative Research and License Agreement dated  January 1, 1999 between Symyx and The Dow Chemical Company                                                                                                                                        |
| 10.11(2)   |   | License Agreement dated June 22, 1995 between  Symyx and Lawrence Berkeley Laboratory, on behalf of The Regents of the  University of California                                                                                                      |
| 10.12(2)   |   | License and Supply Agreement effective  August 6, 1999 between Symyx and Argonaut Technologies, Inc.                                                                                                                                             |
| 10.13(3)   |   | Lease by and between East Arques Sunnyvale, LLC and  Symyx Technologies, Inc. for the premises at 1263 E. Arques, Sunnyvale,  California, and addenda and inserts thereto                                                                             |
| 10.14(4)   |   | 2001 Nonstatutory Stock Option Plan                                                                                                                                                                                                                        |
| 10.15*(5)  |   | License Agreement dated February 21, 2003  between Symyx Technologies, Inc. and Symyx Therapeutics, Inc.                                                                                                                                    |
| 10.16*(6)  |   | Alliance, Technology Transfer, and License Agreement  effective April 1, 2003 between Symyx Technologies, Inc., Symyx  Discovery Tools, Inc. and ExxonMobil Research and Engineering Company                                                |
| 10.17*(9)  |   | Alliance Agreement dated December 16, 2004  between Symyx Technologies, Inc., Symyx Discovery Tools, Inc. and  The Dow Chemical Company                                                                                                     |
| 10.18**(9) |   | 2003 IntelliChem, Inc. Stock Option Plan and  forms of agreements thereunder                                                                                                                                                                          |
| 10.19(11)  |   | Lease by and between Oakmead Ventures LLC and Symyx  Technologies, Inc. for the premises at 415 Oakmead Parkway, Sunnyvale,  California, and addenda and inserts thereto                                                                              |
| 14(7)      |   | Symyx Technologies, Inc. Code of Conduct and  Ethics                                                                                                                                                                                                  |
| 21(12)     |   | List of Subsidiaries                                                                                                                                                                                                                                       |
| 23.1(12)   |   | Consent of Independent Registered Public Accounting  Firm                                                                                                                                                                                                  |
| 31.1(12)   |   | Certification of Chief Executive Officer pursuant to  Rules 13a-14(a) and 15d-14(a) promulgated under the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302(a) of the Sarbanes-Oxley Act of 2002. |
| 31.2(12)   |   | Certification of Chief Financial Officer pursuant to  Rules 13a-14(a) and 15d-14(a) promulgated under the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302(a) of the Sarbanes-Oxley Act of 2002. |
| 32.1(12)   |   | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                             |
| 32.2(12)   |   | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                             |

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*                    Confidentialtreatment has been requested for portions of these exhibits.

**             Management controlsor compensatory plans or arrangements.

(1)          Incorporated byreference to the same number exhibit filed with Registrant’s Quarterly Reporton Form 10-Q for the period ended June 30, 2003.

(2)          Incorporated byreference to the same number exhibit filed with Registrant’s RegistrationStatement on Form S-1 (File No. 333-87453), as amended.

(3)          Incorporated byreference to the same number exhibit filed with Registrant’s Annual Report on Form 10-Kfor the year ended December 31, 2000.

(4)          Incorporated byreference to exhibit 4.1 filed with Registrant’s Registration Statement on Form S-8(File No. 333-82166).

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(5)          Incorporated by referenceto the same number exhibit filed with Registrant’s Quarterly Report on Form 10-Qfor the period ended June 30, 2003.

(6)          Incorporated byreference to the same number exhibit filed with Registrant’s Quarterly Reporton Form 10-Q for the period ended September 30, 2003.

(7)          Incorporated byreference to the same number exhibit filed with Registrant’s Annual Report on Form 10-Kfor the year ended December 31, 2003.

(8)          Incorporated byreference to the same number exhibit filed with Registrant’s Current Report on Form 8-Kon December 2, 2004.

(9)          Incorporated byreference to the same number exhibit filed with Registrant’s Annual Report on Form 10-Kfor the year ended December 31, 2004.

(10)   Incorporated by reference tothe same number exhibit filed with Registrant’s Quarterly Report on Form 10-Qfor the period ended March 31, 2005.

(11)   Incorporated by reference tothe same number exhibit filed with Registrant’s Current Report on Form 8-Kon November 15, 2005.

(12)   Filed here within.

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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.
|                          | SYMYX  TECHNOLOGIES, INC.                                                                           |   |
|--------------------------|-----------------------------------------------------------------------------------------------------|--------|
|                     | (Registrant)                                                                                        |   |
| Date: March 6, 2006 |                                                                                                |
|                     | /s/  STEVEN D. GOLDBY                                                                               |
|                     | Steven D. Goldby                                                                                    |
|                     | *Chairman  of the Board,  Chief Executive Officer  (Principal Executive Officer)*                   |
| Date: March 6, 2006 |                                                                                                |
|                     | /s/  JERYL L. HILLEMAN                                                                              |
|                     | Jeryl L. Hilleman                                                                                   |
|                     | *Executive  Vice President,  Chief Financial Officer  (Principal Financial and Accounting Officer)* |

 

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**POWER OF ATTORNEY**

KNOW ALL PERSONS BY THESE PRESENTS, that each personwhose signature appears below constitutes and appoints Steven D. Goldby andJeryl L. Hilleman, or either of them, each with the power of substitution, hisattorney-in-fact, to sign any amendments to this Annual Report on Form 10-K(including post-effective amendments), and to file the same, with exhibitsthereto and other documents in connection therewith, with the Securities andExchange Commission, hereby ratifying and confirming all that each of saidattorneys-in-fact, or his substitute or substitutes, may do or cause to be doneby virtue hereof.

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.
|        | ** **                 | **Signature** | ** **                                                     | ** ** | ** **         | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|--------|----------------------------|---------------|----------------------------------------------------------------|------------|--------------------|-----------|------------|------------|------------|----------|------------|
| By     | /s/ STEVEN D. GOLDBY       |          | Chief Executive Officer and                                    |       | March 6, 2006 |
|   | Steven D. Goldby           |          | Chairman of the Board  (Principal Executive Officer)           |       |               |
| By     | /s/ JERYL L. HILLEMAN      |          | Executive Vice President and Chief                             |       | March 6, 2006 |
|   | Jeryl L. Hilleman          |          | Financial Officer(Principal Financial  and Accounting Officer) |       |               |
| By     | /s/ THOMAS R.  BARUCH      |          | Director                                                       |       | March 6, 2006 |
|   | Thomas  R. Baruch          |          |                                                           |       |               |
| By     | /s/ SAMUEL D.  COLELLA     |          | Director                                                       |       | March 6, 2006 |
|   | Samuel D. Colella          |          |                                                           |       |               |
| By     | /s/ EDWIN F.  GAMBRELL     |          | Director                                                       |       | March 6, 2006 |
|   | Edwin  F. Gambrell         |          |                                                           |       |               |
| By     | /s/ MARTIN S. GERSTEL      |          | Director                                                       |       | March 6, 2006 |
|   | Martin  S. Gerstel         |          |                                                           |       |               |
| By     | /s/ KENNETH J.  NUSSBACHER |          | Director                                                       |       | March 6, 2006 |
|   | Kenneth  J. Nussbacher     |          |                                                           |       |               |
| By     | /s/ MARIO M.  ROSATI       |          | Director                                                       |       | March 6, 2006 |
|   | Mario  M. Rosati           |          |                                                           |       |               |
| By     | /s/ PETER G.  SCHULTZ      |          | Director                                                       |       | March 6, 2006 |
|   | Peter G. Schultz           |          |                                                           |       |               |

 

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**EXHIBIT INDEX**
| Exhibit   Number | ** ** | **Description of Document**                                                                                                                                                                                                                                                    |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1*(8)          |       | Agreement and Plan of  Merger, dated as of November 12, 2004, by and among Symyx Technologies, Inc.,  and IntelliChem, Inc.                                                                                                                                |
| 3.1(1)           |       | Amended and Restated  Certificate of Incorporation                                                                                                                                                                                                                             |
| 3.2(7)           |       | Amended and Restated  Bylaws of Symyx Technologies, Inc.                                                                                                                                                                                                                  |
| 3.3(9)           |       | Certificate of Amendment  to the Amended and Restated Bylaws of Symyx Technologies, Inc.                                                                                                                                                                                  |
| 4.1(2)           |       | Specimen Common Stock  Certificate                                                                                                                                                                                                                                             |
| 10.1**(10)       |       | Synthematix, Inc.  Amended and Restated 2000 Equity Compensation Plan and forms of agreements  thereunder                                                                                                                                                                 |
| 10.2**(2)        |       | 1996 Stock Plan and  forms of agreements thereunder                                                                                                                                                                                                                            |
| 10.3**(12)       |       | Amended and Restated  1997 Stock Plan and forms of agreements thereunder                                                                                                                                                                                                       |
| 10.4**(2)        |       | 1999 Employee Stock  Purchase Plan                                                                                                                                                                                                                                             |
| 10.5(2)          |       | Form of Director  and Executive Officer Indemnification Agreement                                                                                                                                                                                                         |
| 10.6**(2)        |       | Form of Change of  Control Agreement between Symyx and the following individuals: Steven D.  Goldby, Isy Goldwasser, Jeryl L. Hilleman, and W. Henry Weinberg                                                                                                             |
| 10.7(2)          |       | Standard  Industrial/Commercial Single-Tenant Lease dated November 15, 1996  between Symyx and Patrick and Bette Ng, Co-Trustees for The Ng Living Trust,  for office space located at 3100 Central Expressway, Santa Clara, California,  and addenda and inserts thereto |
| 10.7(a)(2)       |       | First Amendment to Lease  between Symyx and Patrick and Bette Ng, Co-Trustees for The Ng Living Trust                                                                                                                                                                          |
| 10.8**(12)       |       | 2006 Cash Bonus Plan for  Executive Officers                                                                                                                                                                                                                                   |
| 10.9(2)          |       | Celanese-Symyx  Collaboration Agreement dated August 1, 1998 between Symyx and Celanese  Ltd.                                                                                                                                                                             |
| 10.10(2)         |       | Collaborative Research  and License Agreement dated January 1, 1999 between Symyx and The Dow  Chemical Company                                                                                                                                                           |
| 10.11(2)         |       | License Agreement dated  June 22, 1995 between Symyx and Lawrence Berkeley Laboratory, on behalf  of The Regents of the University of California                                                                                                                          |
| 10.12(2)         |       | License and Supply  Agreement effective August 6, 1999 between Symyx and Argonaut  Technologies, Inc.                                                                                                                                                                |
| 10.13(3)         |       | Lease by and between  East Arques Sunnyvale, LLC and Symyx Technologies, Inc. for the premises  at 1263 E. Arques, Sunnyvale, California, and addenda and inserts thereto                                                                                                 |
| 10.14(4)         |       | 2001 Nonstatutory Stock  Option Plan                                                                                                                                                                                                                                           |
| 10.15*(5)        |       | License Agreement dated  February 21, 2003 between Symyx Technologies, Inc. and Symyx  Therapeutics, Inc.                                                                                                                                                       |
| 10.16*(6)        |       | Alliance, Technology  Transfer, and License Agreement effective April 1, 2003 between Symyx  Technologies, Inc., Symyx Discovery Tools, Inc. and ExxonMobil  Research and Engineering Company                                                                   |

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| 10.17*(9)  |   | Alliance Agreement dated  December 16, 2004 between Symyx Technologies, Inc., Symyx Discovery  Tools, Inc. and The Dow Chemical Company                                                                                                     |
|------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.18**(9) |   | 2003  IntelliChem, Inc. Stock Option Plan and forms of agreements thereunder                                                                                                                                                                          |
| 10.19(11)  |   | Lease by and between  Oakmead Ventures LLC and Symyx Technologies, Inc. for the premises at  415 Oakmead Parkway, Sunnyvale, California, and addenda and inserts thereto                                                                              |
| 14(7)      |   | Symyx  Technologies, Inc. Code of Conduct and Ethics                                                                                                                                                                                                  |
| 21(12)     |   | List of Subsidiaries                                                                                                                                                                                                                                       |
| 23.1(12)   |   | Consent of Independent  Registered Public Accounting Firm                                                                                                                                                                                                  |
| 31.1(12)   |   | Certification of Chief  Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated  under the Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302(a) of the Sarbanes-Oxley Act of 2002. |
| 31.2(12)   |   | Certification of Chief  Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated  under the Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302(a) of the Sarbanes-Oxley Act of 2002. |
| 32.1(12)   |   | Certification of Chief  Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                             |
| 32.2(12)   |   | Certification of Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                             |

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*                    Confidentialtreatment has been requested for portions of these exhibits.

**             Management controlsor compensatory plans or arrangements.

(1)          Incorporated byreference to the same number exhibit filed with Registrant’s Quarterly Reporton Form 10-Q for the period ended June 30, 2003.

(2)          Incorporated byreference to the same number exhibit filed with Registrant’s RegistrationStatement on Form S-1 (File No. 333-87453), as amended.

(3)          Incorporated byreference to the same number exhibit filed with Registrant’s Annual Report on Form 10-Kfor the year ended December 31, 2000.

(4)          Incorporated byreference to exhibit 4.1 filed with Registrant’s Registration Statement on Form S-8(File No. 333-82166).

(5)          Incorporated byreference to the same number exhibit filed with Registrant’s Quarterly Reporton Form 10-Q for the period ended June 30, 2003.

(6)          Incorporated byreference to the same number exhibit filed with Registrant’s Quarterly Reporton Form 10-Q for the period ended September 30, 2003.

(7)          Incorporated byreference to the same number exhibit filed with Registrant’s Annual Report on Form 10-Kfor the year ended December 31, 2003.

(8)          Incorporated byreference to the same number exhibit filed with Registrant’s Current Report on Form 8-Kon December 2, 2004.

(9)          Incorporated byreference to the same number exhibit filed with Registrant’s Annual Report on Form 10-Kfor the year ended December 31, 2004.

99

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(10)   Incorporated by reference tothe same number exhibit filed with Registrant’s Quarterly Report on Form 10-Qfor the period ended March 31, 2005.

(11)   Incorporated by reference tothe same number exhibit filed with Registrant’s Current Report on Form 8-Kon November 15, 2005.

(12)   Filed here within.

100

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