Discovery Partners International, Inc.

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Discovery Partners International, Inc.

9640 Towne Centre Drive
San Diego, California 92121
U.S.A.
Telephone (858) 455-8600
Fax: (858) 546-3081
Web site: http://www.discoverypartners.com

Public Company
Incorporated: 1995 as IRORI Quantum Microchemistry
Employees: 236
Sales: $41.3 million (2002)
Stock Exchanges: NASDAQ
Ticker Symbol: DPII
NAIC: 541710 Research and Development in the Physical, Engineering, and Life Sciences

Discovery Partners International, Inc., is a San Diego-based research “tool box” company, offering products and services to pharmaceutical and biotech companies to accelerate the development of drugs. With the advent of genomics and proteomics, the study of genes and the proteins they encode, a large number of drug targets have become available. But a drug developer still needs to validate the target, a time-consuming and costly endeavor in which Discovery Partners assists on an outsourcing basis. The company’s integrated services span the entire spectrum of the drug discovery process: drug target characterization, high throughput screening, lead generation, lead optimization, high throughput synthesis automation, and gene expression analysis. Discovery Partners comprises three “discovery units.” The Integrated Drug Discovery unit is devoted to targeting possible new drugs. The Discovery Chemistry Unit offers chemistry services on an outsourced basis. Finally, the company’s Discovery Systems unit allows customers to use the company’s technologies in their own drug development efforts.

Company Roots in 1995

Discovery Partners was originally IRORI Quantum Microchemistry, founded in La Jolla, California, in April 1995 by researchers K.C. Nicolaou and Michael Philip Nova, with $7 million in venture capital provided by the California firms of Enterprise Partners, the Mayfield Fund, and Crosspoint Venture Partners. IRORI was involved in combinatorial chemistry, a new approach to developing new drugs. In essence, the strategy was to create a large number of chemical variants and then test them for suitability, including bioactivity, the ability to bind with a target, and other desired properties. The combinatorial chemistry experiments resulted in chemical “libraries,” collections of varied structures that could be used to screen future targets. IRORI’s major contribution to this field was its pioneering use of radiofrequency (RF) tags. Memory chips were coated or associated with a derivatized polymer during combinatorial synthesis, and information about the synthetic pathway was then transmitted by radio frequencies to a receiver that recorded the information. IRORI called this technique “Directed Sorting.” In 1996 the startup delivered its first product using the process: AccuTag Combinatorial Chemistry Systems. The following year AccuTag became automated, making the product more commercially viable, as sales were made in both Europe and Japan. Revenues were negligible in 1996, the company’s first full year, totaling just $413,000, for a net loss of more than $4 million. In 1997 IRORI lost another $4.8 million on sales of $3.1 million.

Riccardo Pigliucci Named CEO

IRORI reached a turning point in May 1998 when seasoned executive Riccardo Pigliucci took over as chief executive officer with the understanding that the company would change its business model. Instead of concentrating on a single biotech tool, he insisted on building an entire tool box, thereby achieving diversity and the size needed to effectively tap the stock market. He told Chemical Market Reporter, “It was clear from the start that while we could grow the company to the $10 million to $25 million range, it would be difficult to grow larger—the market is not big enough.” Pigliucci’s strategy was to use IRORI as a base from which he could create a portfolio of similar companies offering drug-discovery technologies to pharmaceutical and biotech companies through a single portal. The work would be done on a fee-for-service basis, freeing customers of royalty or milestone payments.

Pigliucci received a degree in industrial chemistry from the Chemical Institute of Milan, Italy, in 1966 and subsequently went to work as a chemist for Perkin-Elmer Corporation, a worldwide life science and analytical instrument company based in Norwalk, Connecticut. Over the next 30 years he held a variety of positions in both Europe and the United States, working in product development, sales, and marketing. He became corporate vice president in 1989 and president and chief operating officer in 1993, the same year that he was a leading strategist on a major acquisition of Applied Biosystems Inc. Piglucci appeared to be the heir apparent to CEO Gaynor N. Kelley as he approached the mandatory retirement age of 65, but in March 1995, a year early, Kelley announced that the company would conduct an outside search for his successor and that Pigliucci was just another candidate. As reported by the Wall Street Journal at the time, “A couple of big shareholders, including the George Soros fund and money manager Neuberger & Berman, have been rattling management’s cage, pushing for better stock performance.” Within two months Pigliucci resigned, admitting that the outside search was a contributing factor: “It made it a difficult working environment; it’s better to leave while you’re ahead. … I think it was easier for everyone that I disappear into the background.” Several months later Pigliucci resurfaced as the CEO of Life Sciences International PLC, a position he held until his involvement with IRORI.

Pigliucci took steps to convert IRORI into an umbrella company, changing its name to Discovery Partners International in October 1998 and relocating its headquarters to San Diego. Another round of venture capital financing was conducted, totaling $12 million. In addition IRORI signed strategic partnership agreements with Bristol-Myers Squibb and Aventis (formerly Rhone-Poulenc Rorer) that brought in another $9 million. They signed on to make use of IRORI’s recent development, NanoKan Technology, which could quickly produce massive libraries: 10,000 discrete compounds in ten days, 100,000 compounds in 36 days, and more than one million compounds in a year. Furthermore, in 1998 IRORI spun off ChemRx, a company that made chemical libraries on a contract basis using IRORI technology. The IRORI-ChemRx combination was intended to be a paradigm for future Discovery Partner arrangements: a drug discovery technology developer coupled with a service company employing the technologies. Furthermore, as Pigliucci told Chemical Market Reporter, “At the operational level, the companies will remain very independent, free to work with the customer and do their own transactions. At the marketing level, we will present ourselves to major accounts as Discovery Partners International to showcase all of the capabilities that our organization can bring to bear for a pharmaceutical company.”

Discovery Partners’ first acquisition came in June 1999 when it signed a letter of intent to acquire Switzerland-based Discovery Technologies Ltd. (DTL), picking up a 40 percent interest in June and the balance at the end of the year. DTL was spun off from Novartis in 1997. Not only did the acquisition provide a toehold in Europe for Discovery partners, but DTL’s high-throughput screening and assay development services were also a good fit with technologies developed by IRORI and greatly expanded the company’s existing chemical libraries. Other developments in 1999 included an agreement with Ontogen Corp. to use patents related to the RF tagging of chemical libraries; a collaboration agreement with Afferent Systems Inc. allowing IRORI to distribute Afferent’s combinatorial chemistry design software products; and a ChemRx agreement with DuPont Pharmaceuticals Co. to develop exclusive libraries for DuPont’s drug discovery and lead optimization programs. Revenues for 1999 were almost double the amount of the previous year, growing from $6.2 million to more than $13 million. The company, as expected, was still losing money: nearly $6.3 million in 1998 and more than $3.3 million in 1999.

Discovery Partners added to its portfolio of biotech tool companies in 2000. It acquired Axys Advanced Technologies in a cash, stock, and promissory note transaction in April, a deal that allowed ChemRx to offer large compound libraries. A month later, Discovery Partners acquired a 75 percent stake in Structural Proteomics for $1 million in cash and 150,000 shares of stock, thereby adding Structural Proteomics computational software and services.

Company Taken Public in 2000

From the outset, Pagliucci planned to take Discovery Partners public. This goal was realized in July 2000 when the company was simultaneously reincorporated in Delaware and an initial public offering of stock was conducted. Co-leading the IPO were San Francisco’s Chase Hambrecht & Quist and Lehman Brothers in New York. New York’s UBS Warburg also co-managed the underwriting. The offering, priced at $18 per share of common stock, raised $103.5 million, resulting in a net of $94.7 million for Discovery Partners. At the end of 2000 Discovery Partners again recorded an impressive increase in revenues over the previous year, a total of nearly $36.3 million. Although it lost an additional $11.7 million, the company following its IPO appeared to have enough cash in the bank to grow the business until it reached the point of profitability.

Company Perspectives

The mission of Discovery Partners International is to be the world’s leading, technology driven, Drug Discovery Company complementing the internal capabilities of pharmaceutical and biopharmaceutical companies.

In January 2001 Discovery Partners closed on a deal initiated at the tail end of 2000: the $12.5 million cash purchase of Systems Integration Drug Discovery Company. SIDDCO was a privately held company based in Tucson, Arizona, that provided an array of complementary chemistry services and compound libraries to pharmaceuticals and biotechs. SIDDCO technologies included combinatorial chemistry like IRORI; high density miniaturized screening, which had the ability to test hundreds of thousands of compounds in a day; and multi-array plate screenings, a proprietary method that permitted the simultaneous screening of large number of targets. The acquisition positioned Discovery Partners as one of the largest providers of discovery chemistry. When the deal was announced, Pigliucci commented, “SIDDCO has a strong group of chemists—there are more than 50—and half have a Ph.D. They have a different chemistry than we have, so we will increase our portfolio, increase our size, and add customers.” Further, the plan was to maintain the Tucson facility and perhaps expand it. In May 2001 Discovery Partners completed another acquisition, paying approximately $1.8 million in cash for Xenometrix, Inc., based in Boulder, Colorado. Xenometrix was founded in 1991 and went public in 1995. It offered proprietary gene expression profiling technology and genotoxicology technology to assist drugmakers in the selection of target compounds. As was the case with other acquisitions, XENometrix helped to broaden the services Discovery Partners could offer to clients.

Other advances made by Discovery Partners in 2001 included the establishment of a European headquarters in Basel, Switzerland, and a partnership agreement with the Swiss-based Genetics Co. to identify drug leads as part of an effort to develop colon cancer treatments. While the Genetics Co. would retain patent rights on any discoveries, Discovery Partners was to receive milestone payments for the use of its library of compounds. Despite Discovery Partners’ steady progress in establishing itself, signing deals with 18 companies in the second half of 2001 alone, the company’s stock languished in the $5 range. According to press accounts, Discovery Partners’ undervalued stock resulted in a buyout offer, at a time when shares were trading around $8, from an undisclosed drugmaker. The bid was quickly rejected for obvious reasons. The company had $80 million in the bank, or $3.30 a share, and analysts estimated that the stock was worth $15 in a buyout. A spokesperson for Discovery Partners maintained that the company was more concerned about its own acquisitions than in being acquired itself.

That next acquisition, however, was not forthcoming. As the economy slipped into recession, Discovery Partners was adversely impacted when drug companies cut their research budgets. In 2001 revenues improved to $41.1 million, a modest increase over 2000, while the company posted another loss of $11.1 million. Results were even worse in 2002. Sales were essentially flat, totaling little more than $41.3 million, and the net loss ballooned to $62.1 million in 2002, the result of a $51.1 million goodwill write-off of earlier acquisitions. In an effort to improve business in 2002 the company discontinued some products and changed its policy on the use of its proprietary library, now requiring clients to enter into collaborative deals rather than selling access to its chemical library on a nonexclusive basis. In effect, Discovery Partners was looking to avoid small library sales that were costly to service in favor of broader deals with larger customers.

Discovery Partners took further steps in 2003 to rein in costs and improve efficiency. It closed the Tucson facility and integrated the operations into offices in San Diego and San Francisco. Management also looked overseas, to India and China, where chemists could be hired at far lower rates than in the United States. In India, Discovery Partners entered into a long-term research and development agreement with a new facility that allowed the use of its scientists and equipment at a much lower cost than could be attained domestically. The company also adopted a shareholders rights plan, a “poison pill,” to ward off any unwanted takeover attempts, although management insisted that there was no attempt to acquire the company underway. In addition, in 2003, Discovery Partners signed a number of important collaborative deals with drugmakers, leading management to declare that the steps the company had taken in response to the poor economy were starting to pay off.

Principal Subsidiaries

ChemRx Advances Technologies, Inc.; Structural Proteomics, Inc. (75%); IRORI Europe, Ltd.; Systems Integration Drug Discovery Company, Inc.; Discovery Partners International AG; Xenometrix, Inc.

Principal Competitors

Affymetrix, Inc.; ArQule, Inc.; Pharmacopeia, Inc.

Key Dates

1995:: IRORI founded.
1998:: Riccardo Pigliucci named CEO; IRORI becomes Discovery Partners International.
2000:: Company goes public.
2001:: SIDDCO acquired.