PHARMACOPEIA INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2002
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Commission file number 0-27118

PHARMACOPEIA, INC.
(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		33-0557266 (I.R.S. Employer Identification No.)
CN 5350, Princeton, New Jersey (Address of principal executive offices)		08543-5350 (Zip code)
(609) 452-3600 (Registrant's telephone number, including area code)
Not Applicable (Former name, former address and former fiscal year, if changed since last report)

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

Class

Common Stock, $.0001 par value

Outstanding at October 24, 2002

23,491,558

PHARMACOPEIA, INC.

Form 10-Q

Table of Contents

Item		Page
PART I. FINANCIAL INFORMATION
Item 1.	Consolidated Unaudited Financial Statements:
	Balance Sheets—September 30, 2002 and December 31, 2001	3
	Statements of Operations—Three and Nine months ended September 30, 2002 and 2001	4
	Statements of Cash Flows—Nine months ended September 30,2002 and 2001	5
	Notes to Consolidated Unaudited Financial Statements	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	15
Item 4.	Controls and Procedures	15
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	16
Item 2.	Changes in Securities and Use of Proceeds	16
Item 3.	Defaults upon Senior Securities	16
Item 4.	Submission of Matters to a Vote of Security Holders	16
Item 5.	Other Information	16
Item 6.	Exhibits and Reports on Form 8-K	16
Signature		17

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

Pharmacopeia, Inc.
Consolidated Balance Sheets
(Dollars in thousands)

				September 30, 2002			December 31, 2001
				(Unaudited)
ASSETS
Current assets:
	Cash and cash equivalents			$	21,169		$	68,891
	Marketable securities				120,568			86,937
	Trade receivables, net of allowance for doubtful accounts of $910 and $809, respectively				23,399			43,147
	Prepaid expenses and other current assets				6,102			7,263

		Total current assets			171,238			206,238
Property and equipment—net					14,834			11,726
Goodwill—net					36,823			36,823
Capitalized software—net					9,736			13,104
Other intangibles—net					342			1,022
Other assets					833			1,485

			Total assets	$	233,806		$	270,398

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Accounts payable			$	2,039		$	4,361
	Accrued liabilities				28,307			28,884
	Deferred revenue, current portion				23,434			34,565
	Notes payable, current portion				17			44

		Total current liabilities			53,797			67,854
Notes payable and long-term liabilities					11			34
Deferred revenue, long-term					3,777			4,521
Stockholders' equity:
	Capital stock				2			2
	Additional paid-in capital				283,758			281,553
	Treasury stock				(8,340	)		(1,316	)
	Accumulated deficit				(99,607	)		(82,194	)
	Accumulated comprehensive income				408			(56	)

		Total stockholders' equity			176,221			197,989

			Total liabilities and stockholders' equity	$	233,806		$	270,398

See accompanying notes to these unaudited financial statements.

Pharmacopeia, Inc.
Consolidated Statements of Operations
(Unaudited, dollars in thousands, except per share data)

			For the Three Months Ended September 30,						For the Nine Months Ended September 30,
			2002			2001			2002			2001
Revenues:
	Software license, service and other		$	22,872		$	21,456		$	63,906		$	60,957
	Drug discovery			8,036			7,044			23,142			20,323

		Total revenues		30,908			28,500			87,048			81,280
Cost of revenues:
	Software license, service and other			5,649			4,715			15,833			13,451
	Drug discovery			4,647			5,191			14,704			15,781

		Total cost of revenues		10,296			9,906			30,537			29,232

Gross margin				20,612			18,594			56,511			52,048
Operating costs and expenses:
	Research and development			7,503			8,043			21,809			24,187
	Sales, general and administrative			16,230			15,829			50,536			44,390
	Restructuring			4,340			—			4,340			—
	Amortization of goodwill			—			2,228			—			6,323

		Total operating costs and expenses		28,073			26,100			76,685			74,900

Operating loss from continuing operations				(7,461	)		(7,506	)		(20,174	)		(22,852	)
Discontinued acquisition costs				—			—			—			(428	)
Interest and other income, net				1,309			1,744			3,252			6,671

Loss from continuing operations before tax provision				(6,152	)		(5,762	)		(16,922	)		(16,609	)
Provision for income taxes				178			168			491			829

Loss from continuing operations				(6,330	)		(5,930	)		(17,413	)		(17,438	)
Discontinued operations:
	Income (loss) from discontinued operations			—			(23	)		—			297

Net loss			$	(6,330	)	$	(5,953	)	$	(17,413	)	$	(17,141	)

Loss per share from continuing operations—Basic and Diluted			$	(0.27	)	$	(0.25	)	$	(0.74	)	$	(0.73	)

Income per share from discontinued operations—Basic and Diluted			$	—		$	—		$	—		$	0.01

Net loss per share—Basic and Diluted			$	(0.27	)	$	(0.25	)	$	(0.74	)	$	(0.72	)

Weighted average number of common stock outstanding
Basic and Diluted				23,467			23,824			23,507			23,707

See accompanying notes to these unaudited financial statements.

Pharmacopeia, Inc.
Consolidated Statements of Cash Flows
(Unaudited, dollars in thousands)

					For the Nine Months Ended September 30,
					2002			2001
CASH FLOWS FROM OPERATING ACTIVITIES:
	Net loss				$	(17,413	)	$	(17,141	)
	Adjustments to reconcile net loss to net cash provided by operations
		Depreciation				4,516			4,245
		Amortization				5,879			12,159
		Contribution of stock to 401 (k) members				909			1,141
		Changes in assets and liabilities:
			Accounts receivable			19,747			15,848
			Prepaid and other current assets			1,161			(1,322	)
			Other assets			652			551
			Accounts payable			(2,322	)		(169	)
			Accrued liabilities			(577	)		(9,043	)
			Deferred revenue			(11,875	)		(9,333	)

				Net cash provided by (used in) operating activities		677			(3,064	)
CASH FLOWS FROM INVESTING ACTIVITIES:
	Capital expenditures					(7,292	)		(3,270	)
	Increase in capitalized software development costs					(1,831	)		(2,739	)
	Purchases of marketable securities					(118,259	)		(145,353	)
	Proceeds from sales of marketable securities					84,802			125,806
	Acquisition of business, net of cash acquired					—			(3,855	)

				Net cash used in investing activities		(42,580	)		(29,411	)
CASH FLOWS FROM FINANCING ACTIVITIES:
	Proceeds from issuance of common stock					1,297			3,567
	Purchases of treasury stock					(7,024	)		(1,154	)
	Other					(50	)		36

				Net cash (used in) provided by financing activities		(5,777	)		2,449
Exchange rate effect on cash and equivalents						(42	)		317

Net decrease in cash and equivalents						(47,722	)		(29,709	)
Cash and equivalents, beginning of period						68,891			69,350

Cash and equivalents, end of period					$	21,169		$	39,641

SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION:
Cash paid during the period for:
		Interest			$	20		$	21

		Income taxes			$	434		$	827

See accompanying notes to these unaudited financial statements.

Pharmacopeia, Inc.
Notes to Consolidated Financial Statements
(Unaudited)

Note 1—Basis of Presentation

The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these unaudited financial statements do not include all of the information and disclosures required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial statements have been included.

Interim results are not necessarily indicative of the results that may be expected for the year. For further information, refer to the financial statements and disclosures thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2001.

In the fourth quarter of 2001, the Company discontinued computer hardware re-sale operations. As such, the revenue, net of expense, has been included as income from discontinued operations in the accompanying 2001 statements of operations.

Note 2—Net Loss Per Share

The Company computes net loss per share in accordance with Statement of Financial Accounting Standard (SFAS) No. 128, Earnings Per Share. Under the provisions of SFAS No. 128, basic net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted-average number of common and common equivalent shares outstanding during the period. Diluted earnings per share are required to be calculated to include the potentially-dilutive effect of the conversion of outstanding stock options. Because the Company has a net loss for all periods presented, the inclusion of potentially-dilutive stock options (common stock equivalents computed using the treasury stock method) would be anti-dilutive and therefore the weighted-average shares used to calculate both basic and diluted loss per share are the same.

Note 3—Segment Information

The Company operates in two industry segments. The Company's software segment, Accelrys Inc., provides molecular modeling and simulation, bioinformatics and cheminformatics software, and related consulting services that facilitate the discovery and development of new drug and chemical products and processes in the pharmaceutical, biotechnology, chemical, petrochemical and materials industries. The Company's drug discovery segment, Pharmacopeia Drug Discovery, Inc., provides drug discovery and optimization services to pharmaceutical and biotechnology companies based on proprietary combinatorial chemistry, high-throughput screening, medicinal chemistry, and molecular modeling using

Accelrys technologies. Summarized financial information concerning the industry segments follows (dollars in thousands):

		Three Months Ended September 30, 2002									Nine Months Ended September 30, 2002
		Accelrys			Drug Discovery			Total			Accelrys			Drug Discovery			Total
Revenue:
Software licenses, service and other		$	22,872		$	—		$	22,872		$	63,906		$	—		$	63,906
Drug discovery			—			8,036			8,036			—			23,142			23,142

	Total revenue	$	22,872		$	8,036		$	30,908		$	63,906		$	23,142		$	87,048

Operating loss from continuing operations		$	(7,132	)	$	(329	)	$	(7,461	)	$	(17,315	)	$	(2,859	)	$	(20,174	)

		Three Months Ended September 30, 2001									Nine Months Ended September 30, 2001
		Accelrys			Drug Discovery			Total			Accelrys			Drug Discovery			Total
Revenue:
Software licenses, service and other		$	21,456		$	—		$	21,456		$	60,957		$	—		$	60,957
Drug discovery			—			7,044			7,044			—			20,323			20,323

	Total revenue	$	21,456		$	7,044		$	28,500		$	60,957		$	20,323		$	81,280

Operating loss from continuing operations		$	(5,718	)	$	(1,788	)	$	(7,506	)	$	(15,020	)	$	(7,832	)	$	(22,852	)

	Accelrys		Drug Discovery		Total
Total assets—September 30, 2002	$	93,205	$	140,601	$	233,806

Total assets—December 31, 2001	$	119,538	$	150,860	$	270,398

Note 4—Goodwill and Other Intangible Assets—Adoption of Statement 142

In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations" ("SFAS 141") and SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under SFAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. The Company adopted SFAS 142 effective January 1, 2002 and completed the first step of the transitional goodwill impairment test during the quarter ended March 31, 2002 and concluded that goodwill was not impaired at January 1, 2002. During 2002, there have been no indications of impairment and, accordingly, the value of the goodwill recorded on the Company's books is not impaired as of September 30, 2002.

As required by SFAS 141, during the quarter ended March 31, 2002, the Company reclassified $1.8 million of intangible assets with indefinite lives to goodwill. The related amortization expense in the prior period, which had been previously classified as sales, general and administrative expense, has been reclassified to amortization of goodwill. All such reclassified intangibles and related amortization are associated with Accelrys.

The effect of excluding amortization of goodwill on the Company's net loss and net loss per share, based on the implementation of SFAS 142, is as follows (dollars in thousands, except per share amounts):

		Three Months Ended September 30,						Nine Months Ended September 30,
		2002			2001			2002			2001
Reported net loss		$	(6,330	)	$	(5,953	)	$	(17,413	)	$	(17,141	)
Addback: Goodwill amortization			—			2,228			—			6,323

Adjusted net loss		$	(6,330	)	$	(3,725	)	$	(17,413	)	$	(10,818	)

Basic and Diluted net loss per share
	Reported net loss per share	$	(0.27	)	$	(0.25	)	$	(0.74	)	$	(0.72	)
	Addback: Goodwill amortization		—			0.09			—			0.27

	Adjusted net loss per share	$	(0.27	)	$	(0.16	)	$	(0.74	)	$	(0.45	)

Note 5—Treasury Stock

During the third quarter of 2001, the Company's Board of Directors authorized a stock repurchase program under which up to 1,000,000 shares of Pharmacopeia common stock with a market value up to $16 million may be acquired in the open market. As of September 30, 2002, the Company had repurchased a total of 643,900 shares for $8.3 million.

Note 6—New Accounting Pronouncement

In June 2002, the Financial Accounting Standards Board issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal" ("SFAS No. 146"). SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" ("EITF 94-3"). The principal difference between SFAS No. 146 and EITF 94-3 relates to SFAS No. 146's requirements for recognition of a liability for a cost associated with an exit or disposal activity. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost as generally defined in EITF 94-3 was recognized at the date of an entity's commitment to an exit plan. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The Company does not expect that the adoption of SFAS No. 146 will have a material impact on the consolidated financial statements.

Note 7—Restructuring

During the third quarter of 2002, the Company announced that it was undertaking various actions to restructure its operations to improve its overall financial performance. The restructuring effort included a reduction in force of 71 employees, of which 67 were terminated as of September 30, 2002 and the closure of certain facilities. As a result of this plan, restructuring related charges of approximately $4.3 million were recognized as operating expense in the third quarter of 2002.

The following table summarizes the balance of the accrued restructuring reserve, which has been included in accrued liabilities at September 30, 2002 (dollars in thousands):

		Severance Costs for Involuntary Employee Terminations			Costs to Exit Certain Lease Obligations			Total
Balance at August 6, 2002		$	2,367		$	1,973		$	4,340
Utilization of Reserves:
	Cash		(1,296	)		(127	)		(1,423	)

Balance at September 30, 2002		$	1,071		$	1,846		$	2,917

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of financial condition and results of operations of Pharmacopeia, Inc. ("Pharmacopeia" or the "Company") should be read in conjunction with the Unaudited Financial Statements and related disclosures included elsewhere in this Form 10-Q, and als