All percentage amounts and ratios were calculated using the underlying data in thousands. Operating results for the year ended December 31, 2008 are not necessarily indicative of the results that may be expected for future fiscal years. The following discussion and analysis should be read in conjunction with our historical financial statements and the notes to those financial statements that are included in Item 8 of Part II of this Annual Report on Form 10-K.

Overview

Since our inception, we have invested heavily in developing technology, laboratory systems and software to automate, accelerate and digitize traditional R&D and pursue high-throughput materials research. Our scientific team has deep technical expertise. Through Symyx Software, we offer customers integrated R&D collaboration, execution and analysis applications, and access to scientific content and industry-leading chemical informatics, logistics and decision-support applications. Through Symyx HPR, we provide research services to our customers and sometimes enter into longer-term, broad technical alliances for discovery and development of new materials. We also apply our expertise in high-throughput research technologies to offer automated tools to enable improved R&D execution in our customers' laboratories.

We generate revenue and cash flows from operations from licensing Symyx Software, subscriptions to certain scientific content and accompanying services and support; from selling and supporting Symyx HPR tools; from providing research services; and from licenses and royalties from our discovered materials and intellectual property.

Recent Events

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

· Impairment to goodwill, intangibles and other long-lived assets/valuation allowance -- In December 2008, we recorded a $90.3 million impairment charge to goodwill, intangible assets and other long-lived assets as discussed below under the heading of "Impairment to Goodwill, Intangibles and Other Long-Lived Assets." We also recorded in the fourth quarter a $12.5 million valuation allowance against certain deferred tax assets. The impact of these charges and allowance on our financials is disclosed in Note 1 of Notes to Consolidated Financial Statements.

· Restructuring -- In December 2008, we announced a reorganization of our business in which we combined our former Symyx Tools and Symyx Research business units into a single unit, Symyx HPR, moved from a single combined sales force to dedicated sales forces within our business units, and reduced our workforce by approximately 15%. We expect to savings from these action will be approximately $15 million in 2009. We recorded restructuring charges of $5.0 million in 2008, including approximately $4.4 million of cash charges, of which $0.4 million was paid as of December 31, 2008. With regard to the restructuring plan commenced in October 2007 that related to the acquisition of MDL Information Systems, Inc. ("MDL"), we made cash payments of approximately $1.7 million in 2008.

· Symyx Notebook 6.0 -- In April 2008, we announced the availability of Symyx Notebook 6.0, our new, enterprise ELN that is readily and easily configurable to meet the needs of biologists and analytical chemists, and enables R&D organizations to replace multiple discipline-specific ELNs with a single, multi-discipline application deployable across the enterprise. Symyx Notebook 6.1 became available in the fourth quarter of 2008, and was instrumental in customer successes with 2 of the top 15 worldwide pharmaceutical companies.

· Symyx Isentris 3.1 -- In September 2008, we announced a significant release of the Symyx Isentris informatics system that provides scientists the freedom to create, manage, and share fully searchable local databases and to work offline. Going well beyond our industry-leading ISIS software, Symyx Isentris 3.1 is a key release in our continuing ISIS-to-Isentris customer migration.

· Acquisition of Integrity Biosolution, LLC -- In August 2008, we used $10.2 million cash to acquire Integrity Biosolution, a Camarillo, California-based provider of protein formulation and fill/finish services to the biotechnology sector.

· Research Services for Life Sciences Launch -- In July 2008, we launched our new client-directed and collaborative research services for life sciences, providing clients access to our installed base of parallel experimentation and testing capabilities through packaged offerings for solubility studies, polymorph screening, salt selection, co-crystallization, API stability in liquid and solid formulations, excipient compatibility, organic synthesis and process optimization.

Impairment to Goodwill, Intangibles and Other Long-lived Assets

In the fourth quarter of 2008, pursuant to our accounting policy, we performed an annual impairment test of goodwill. As a result of this analysis, we concluded that the carrying amounts of goodwill included in our Symyx Software and Symyx HPR segments exceeded their implied fair values and recorded an impairment charge of approximately $76.5 million, which is included in the caption "Impairment to Goodwill, Intangibles and Other Long-Lived Assets." The impairment charge was determined by comparing the carrying value of goodwill assigned to the reporting units within these segments as of December 1, 2008, with the implied fair value of the goodwill. We considered both the income and market approaches in determining the implied fair value of the goodwill based upon a blended approach. The income approach uses estimates of future operating results and cash flows of each of the reporting units discounted at estimated discount rates ranging from 19% to 21%. The estimates of future operating results and cash flows were principally derived from an updated long-term financial forecast developed as part of our strategic planning cycle conducted annually during the fourth quarter of 2008. The decline in the implied fair value of the goodwill and resulting impairment charge was primarily driven by the updated long-term financial forecasts, which showed lower estimated near-term and longer-term profitability compared to estimates developed at the time of the completion of the MDL and IntegrityBio acquisitions. Refer to Note 1 of the Notes to the Consolidated Financial Statements for further details.

In the fourth quarter of 2008, due to the significant decline of our market capitalization, we also performed an impairment test of long-lived assets. As a result of this analysis, we concluded that the carrying amounts of intangibles and other long-lived assets in Symyx HPR segments exceeded their implied fair values and recorded an impairment charge of approximately $13.8 million, which is also included in the caption "Impairment to Goodwill, Intangibles and Other Long-Lived Assets."

Business Acquisitions

Acquisition of Integrity Biosolution, LLC

On August 13, 2008, we acquired Integrity Biosolution, LLC ("IntegrityBio"), a privately-held research service company based in Camarillo, California for approximately $10.2 million, with additional contingent compensations as described below. By acquiring IntegrityBio, we expanded our research service offerings in the life sciences industry into biologic formulations, complementing our existing chemical formulations services. The combination of Symyx and IntegrityBio creates a differentiated set of large molecule formulation services to customers in the pharmaceutical and biotechnology industries by combining IntegrityBio's formulation expertise with Symyx's advanced high-throughput research and informatics capabilities.

In accordance with Statement of Financial Accounting Standards No. 141, Business Combinations, we allocated the preliminary purchase price to the tangible assets, liabilities and intangible assets acquired, based on their estimated fair values. The excess purchase price over the fair values was recorded as goodwill. The fair value assigned to intangible assets acquired was based on estimates and assumptions determined by management. The acquired goodwill was assigned entirely to our research business. Purchased intangibles with finite lives are amortized on a straight-line basis over their respective useful lives.

The total preliminary purchase price recorded for this acquisition was $10.2 million, consisting of approximately $9.4 million paid in cash (net of cash acquired), working capital adjustments of $0.6 million paid in January 2009, and $0.2 million in transaction costs, consisting of legal and other professional service fees. The purchase price is preliminary because we will owe to the founder additional consideration calculated based on the revenue generated by IntegrityBio's operations during the period from September 2009 to August 2010.

The preliminary purchase price allocation is as follows (in thousands):

                                     Amount
Fair value of net assets acquired   $  1,948
Intangible assets                      2,860
Goodwill                               5,440
Total                               $ 10,248

The fair values of IntegrityBio's net assets as of the acquisition date were (in thousands):

                                                 Amount
Cash                                             $    32
Accounts receivable                                  789
Plant, property and equipment                      1,379
Accounts payable and other accrued liabilities      (127 )
Accrued compensation                                 (47 )
Deferred revenue                                     (78 )
Fair value of IntegrityBio's net assets          $ 1,948

Goodwill from the IntegrityBio acquisition is deductible for income tax purposes.

Acquisition of MDL Group Companies

On October 1, 2007, we acquired MDL for $123 million in cash. Of the $123 million cash paid, the parties placed $10 million in escrow pending their determination of any detriments suffered or benefits enjoyed by MDL as a result of pre-closing intercompany transactions between certain MDL group companies and the seller. The escrow account (including interest earned) was subsequently reduced to $1.7 million after a March 2008 net working capital adjustment payment of $5.0 million to Symyx, and June 2008 distributions of $1.6 million to Symyx for withholding tax and professional fee reimbursement and $1.7 million to the seller. The remaining $1.7 million in the escrow account is expected to be settled by June 2009.

The purchase price for this acquisition was $121.5 million, consisting of approximately $118.0 million in cash ($123 million cash paid, net of $5.0 million working capital adjustments received) and $3.5 million in transaction costs, consisting of banking, legal and other professional service fees (net of $325,000 reimbursement of transaction costs from the escrow account received in June 2008).

The purchase price allocation is as follows (in thousands):

                                         Amount
Fair value of net liabilities assumed   $  (4,594 )
Accrued restructuring costs                (6,823 )
In-process research and development         2,500
Intangible assets                          59,000
Deferred tax liabilities                  (17,710 )
Goodwill                                   89,101
Total                                   $ 121,474

The fair values of MDL's net liabilities as of the acquisition date were (in thousands):

                                                  Amount
Accounts receivable, net                         $   4,417
Prepaids and other assets                            3,549
Plant, property and equipment                        4,851
Accounts payable and other accrued liabilities      (2,046 )
Accrued compensation                                (4,961 )
Deferred revenue                                   (10,404 )
Fair value of MDL's net liabilities              $  (4,594 )

Goodwill from the MDL acquisition is not deductible for federal income tax purposes and partially deductible for state income tax purposes.

Critical Accounting Policies

We prepare our financial statements and accompanying notes in accordance with generally accepted accounting principles in the United States (GAAP). Note 1 of the Notes to the Consolidated Financial Statements included under Item 8 in this Annual Report on Form 10-K describes the significant accounting policies and methods used in the preparation of the consolidated financial statements. Preparing financial statements and related disclosures requires management to exercise judgment in making estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. These estimates and assumptions are affected by management's application of accounting policies. Estimates include the assumptions used in determining the implied fair value of goodwill, the forfeiture rates for stock-based awards, the collectability of outstanding accounts receivables, reserve for excess or obsolete inventory, future warranty expenditures; assumptions such as the elements comprising a revenue arrangement, including the distinction between software upgrades/enhancements and new products, when our products achieve technological feasibility, the potential outcome of future tax consequences of events recognized in the our financial statements or tax returns and the fair value of acquired intangible assets. We evaluate our estimates, including those mentioned above, on an ongoing basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates under different assumptions or conditions.

Source of Revenue and Revenue Recognition Policy

We recognize revenue in accordance with the SEC's Staff Accounting Bulletin No. 104 ("SAB 104"), Revenue Recognition, the American Institute of Certified Public Accountants Statement of Position ("SOP") 97-2, Software Revenue Recognition, as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, Financial Accounting Standards Board Technical Bulletin 90-1, Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts, the Emerging Issues Task Force consensus on Issue 00-21 or EITF 00-21, Multiple-Deliverable Revenue Arrangements, and other authoritative accounting literature. We generate revenue from services provided under research collaborations, the sale of products, license of software, content subscriptions, provision of support and maintenance services, and the license of intellectual property. It is possible for our customers to work with us in multiple areas of our business and contracts may include multiple elements of service revenue, product revenue, and license and royalty revenue. In determining the basis for non-software product revenue recognition, we first determine the fair value of any extended warranty services and defer this revenue to be recognized over the service period. For those contracts that involve multiple element deliverables, we identify all deliverables and allocate revenue among the units of accounting in accordance with EITF 00-21. In an arrangement that includes software that is more than incidental to the products or services as a whole, we recognize revenue from the software and software-related elements, as well as any non-software deliverable(s) for which a software deliverable is essential to its functionality, in accordance with SOP 97-2.

Service revenue consists of research and development funding received from collaborative partners as well as support and maintenance or extended warranty agreements. Product revenue consists of payments from customers for our tools, comprising hardware, associated software and intellectual property licenses and consumables. Royalties and license fees include fees for licensing of our software, intellectual property, proprietary materials and technology license payments and royalties on laboratory systems and software sold under license by third parties.

Service Revenue

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

Non-refundable up-front payments received in connection with research and development collaboration agreements, including technology access fees, are deferred and recognized as earned upon performance of the services over the relevant periods specified in the agreement, generally the research term. Revenue from milestone payments, which are substantially at risk until the milestones are completed, is recognized upon completion of these milestone events. Milestone payments to date have been immaterial.

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

For those arrangements that require significant production, modification, or customization of the software, such services are considered essential to software functionality. Accordingly, revenue from the entire arrangement (i.e., software license, database subscriptions, post contract customer support ("PCS") and professional services) is deferred until final delivery and acceptance of the product and the revenue is recognized ratably over the remaining initial PCS period or upon final delivery and acceptance when the initial PCS period has already ended.

For many customers, we have developed custom registration and other tools that are typically delivered on a time and materials basis. These custom development projects are generally not sold in connection with a new software license deal, but rather to customers that have been using our software products for an extended period of time. Revenue from these arrangements is usually recognized on a monthly basis as the services are delivered and invoiced.

Product Sales

We recognize revenue from the sale of Symyx HPR tools and the license of associated software, and all related costs of products sold are expensed, once delivery has occurred and customer acceptance has been achieved. A determination is made for each system delivered as to whether software is incidental to the system as a whole. Revenue from the sale of HPR tools is earned and recognized when persuasive evidence of an arrangement exists, delivery of the product has occurred, no significant obligations with regard to implementation remain, the fee is fixed or determinable, and collectibility is reasonably assured. If there are extended payment terms, we recognize product revenue as these payments become due. We consider all arrangements with payment terms extending beyond 12 months not to be fixed or determinable. If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer. In multiple element arrangements, we use the residual method to allocate revenue to delivered elements once we have established fair value for all undelivered elements. A warranty expense accrual is established at the time of delivery for all tool sales.

Software License and Database Content Fees

For database content and software licensed on an annual right to use basis, revenue is recognized on a straight-line basis over the term of the license. For revenue allocable to the software portion of a multiple element arrangement or licensed on a perpetual basis, we recognize revenue upon delivery of the software product to the end-user and commencement of the license, unless we have ongoing obligations for which fair value cannot be established or the fee is not fixed or determinable or collectibility is not probable, in which case we recognize revenue only when each of these criteria have been met. By way of example, for our ELN software products and the software products we acquired from MDL, we have not yet established the fair value of certain ongoing obligations and accordingly, any perpetual license fees are recognized ratably over the period of the ongoing obligations (typically a bundled support and maintenance commitment of one year). The only software product for which we have established Vendor Specific Objective Evidence of fair value is our LEA software product maintenance and annual licenses. We consider all arrangements with payment terms longer than 12 months not to be fixed or determinable. If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer. If evidence of the fair value of one or more undelivered elements does not exist, the total revenue is deferred and recognized when delivery of those elements occurs or when fair value for any remaining undelivered elements can be established.

Intellectual Property License Fees and Royalties

We recognize license fee revenue for licenses to our intellectual property when earned under the terms of the agreements. Generally, revenue is recognized upon transfer of the license unless we have continuing obligations for which fair value cannot be established, in which case the revenue is recognized over the period of the obligation. If there are extended payment terms, we recognize license fee revenue as these payments become due. We consider all arrangements with payment terms extending beyond 12 months not to be fixed or determinable. In certain licensing arrangements there is provision for a variable fee as well as a non-refundable minimum amount. In such arrangements, the amount of the non-refundable minimum guarantee is recognized upon transfer of the license unless we have continuing obligations for which fair value cannot be established, and the amount of the variable fee in excess of the guaranteed minimum is recognized as revenue when it is fixed or determinable.

We recognize royalty revenue based on reported sales by third party licensees of products containing our materials and intellectual property. If there are extended payment terms, royalty revenue is recognized as these payments become due. Non-refundable royalties, for which there are no further performance obligations, are recognized when due under the terms of the agreements.

See Note 1 of the Notes to Consolidated Financial Statements for a further discussion of our revenue recognition policies.

Accounts Receivable and Allowance for Doubtful Accounts

Trade accounts receivable are recorded at the invoiced amount and do not bear interest.

We assess our allowance for doubtful accounts based on a combination of factors. In cases where we are aware of circumstances that may impair a specific customer's ability to meet its financial obligations to us, we record a specific allowance against amounts due to us and thereby reduce the net recognized receivable to the amount we reasonably believe will be collected. For all other customers, we record allowances for doubtful accounts based on the length of time the receivables are past due, the current business environment and our historical experience.

We recorded an allowance for doubtful accounts in the amount of $53,000 upon the acquisition of MDL Group Companies on October 1, 2007. As of December 31, 2008, we had an allowance for doubtful accounts of $356,000.

Stock-Based Compensation

We adopted SFAS 123R, effective January 1, 2006, using the modified prospective transition method. Under that transition method, stock-based compensation expense recognized during the years after January 1, 2006 includes: (a) ESPP awards with offering periods commencing, and stock options granted or assumed, prior to, but not yet vested as of December 31, 2005, based on the grant-date fair value estimated in accordance with the original provisions of Statement of Financial Accounting Standard No. 123 ("SFAS 123"); (b) ESPP awards with offering periods commencing subsequent to December 31, 2005 in accordance with the provisions of SFAS 123R; and (c) restricted stock units, restricted stock and stock options awarded subsequent to December 31, 2005 based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. Under the modified prospective transition method, results for prior periods are not restated. See Note 4 of the Notes to Consolidated Financial Statements for further details.

Accrued Warranty

A warranty expense accrual is established at the time of customer acceptance of a Symyx tools system and is included as a cost of product sold. Management is required to exercise judgment in establishing the appropriate level of warranty expense accrual for each Symyx tools system delivered and establishes the accrual based, in part, on reference to actual warranty costs incurred on similar systems. The actual results with regard to warranty expenditures could have a material impact on our financial statements. When actual warranty costs are anticipated to be higher than our original estimates, an additional expense is charged to cost of products sold in the period in which such a determination is made. When actual warranty costs are lower than our original estimates, the difference will have a favorable impact to cost of products sold at the time the warranty expires for the systems. In 2008, 2007 and 2006, we recorded favorable adjustments of approximately $702,000, $128,000 and $200,000, respectively.

Inventory

We carry our inventory at the lower of cost or market, cost generally being determined on a specific identification basis. We apply judgment in determining the provisions for slow-moving, excess and obsolete inventories based on historical experience and anticipated product demand.

Goodwill, Intangible Assets and Other Long-Lived Assets

We account for goodwill in accordance with Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). As required by SFAS No. 142, we test goodwill of its reporting units for impairment annually during its fourth quarter or whenever events occur or circumstances change, such as an adverse change in business climate or a decline in the overall industry, that would more likely than not reduce the fair value of a reporting unit below its carrying amount. We used three reporting units in our 2008 impairment analysis: Symyx Software, Symyx Research and Symyx Tools.

In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets (SFAS No. 144), we tests other long-lived assets, including . . .