10-Q

SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, DC 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2004

Commission File Number 000-31141

DISCOVERY PARTNERSINTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

Delaware	33-0655706
(State or other jurisdiction of incorporation or organization)	(I.R.S. employer identification number)
9640 Towne Centre Drive San Diego, California 92121	(858) 455-8600
(Address of principal executive offices and zip code)	(Registrant’s telephone number, including area code)

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 for 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 by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes  ý   No  o

As of November 4, 2004 a total of 26,119,309 shares of the Registrant’s Common Stock, $0.001 par value, were issued and outstanding.

DISCOVERY PARTNERS INTERNATIONAL, INC.

FORM 10-Q

TABLE OF CONTENTS

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Condensed Consolidated Balance Sheets At September 30, 2004 (unaudited) and December 31, 2003
	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2004 and 2003 (unaudited)
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and 2003 (unaudited)
	Notes to Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits

2

DISCOVERY PARTNERS INTERNATIONAL, INC.

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

Discovery Partners International, Inc.

Condensed Consolidated Balance Sheets

	September 30, 2004			December 31, 2003
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	7,028,848		$	7,846,026
Short-term investments	71,908,565			64,728,243
Accounts receivable, net	11,831,122			11,874,784
Inventories, net	3,968,080			4,148,230
Prepaid and other current assets	1,935,373			1,583,262
Total current assets	96,671,988			90,180,545
Restricted cash	1,246,508			1,196,672
Property and equipment, net	7,261,036			8,408,028
Prepaid royalty, net	5,129,447			6,034,643
Patent and license rights, net	2,379,369			2,620,839
Other assets, net	588,644			743,275
Total assets	$	113,276,992		$	109,184,002
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued expenses	$	2,240,109		$	1,880,553
Accrued compensation	2,364,050			3,908,475
Restructuring accrual	430,413			744,141
Deferred revenue	1,717,599			4,305,936
Total current liabilities	6,752,171			10,839,105
Deferred rent	147,593			97,964
Stockholders’ equity:
Preferred stock, $.001 par value, 1,000,000 shares authorized, no shares issued and outstanding at September 30, 2004 and  December 31, 2003	—			—
Common stock, $.001 par value, 100,000,000 shares authorized, 26,107,557 and 24,744,831 issued and outstanding at September 30, 2004 and December 31, 2003, respectively	26,108			24,745
Common stock issuable	2,656,600			1,026,000
Treasury stock, at cost, 228,702 and 216,886 shares at September 30, 2004 and December 31, 2003, respectively	(793,813		)	(775,451)
Additional paid-in capital	207,764,195			201,685,793
Deferred compensation	(2,532,677		)	(1,054,797)
Accumulated other comprehensive income	352,320			971,970
Accumulated deficit	(101,095,505		)	(103,631,327)
Total stockholders’ equity	106,377,228			98,246,933
Total liabilities and stockholders’ equity	$	113,276,992		$	109,184,002

See accompanying notes

3

Discovery Partners International, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

	Three Months Ended						Nine Months Ended
	September 30, 2004			September 30, 2003			September 30, 2004			September 30, 2003
Revenues:
Services	$	11,047,667		$	10,664,945		$	33,021,206		$	33,398,573
Products	1,527,696			744,346			4,360,673			1,962,059
Total revenues	12,575,363			11,409,291			37,381,879			35,360,632
Cost of revenues:
Services	5,921,393			6,359,175			18,648,184			21,488,785
Products	898,883			522,969			2,530,028			1,756,968
Total cost of revenues	6,820,276			6,882,144			21,178,212			23,245,753
Gross margin	5,755,087			4,527,147			16,203,667			12,114,879
Operating expenses:
Research and development	1,291,039			544,633			3,084,156			1,911,794
Selling, general and administrative	3,723,180			3,360,808			10,881,940			9,862,626
Restructuring	—			315,424			—			1,872,986
Amortization of stock-based compensation	339,564			177,808			643,946			337,762
Total operating expenses	5,353,783			4,398,673			14,610,042			13,985,168
Income (loss) from operations	401,304			128,474			1,593,625			(1,870,289		)
Interest income, net	372,135			437,349			1,005,543			1,430,432
Foreign currency transaction gains (losses), net	12,009			(43,576		)	20,586			(50,201		)
Other income (expense), net	(35,395		)	22,789			(83,932		)	51,525
Net income (loss)	$	750,053		$	545,036		$	2,535,822		$	(438,533	)
Net income (loss) per share, basic	$	0.03		$	0.02		$	0.10		$	(0.02	)
Weighted average shares outstanding, basic	25,800,374			24,333,739			25,169,764			24,318,088
Net income (loss) per share, diluted	$	0.03		$	0.02		$	0.10		$	(0.02	)
Weighted average shares outstanding, diluted	26,862,688			25,266,949			26,153,244			24,318,088
The composition of stock-based compensation is as follows:
Cost of revenues	$	—		$	567		$	233		$	2,651
Research and development	—			21,777			6,153			93,367
Selling, general and administrative	339,564			155,464			637,560			241,744
	$	339,564		$	177,808		$	643,946		$	337,762

See accompanying notes

4

Discovery Partners International, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

	Nine Months Ended
	September 30, 2004			September 30, 2003
OPERATING ACTIVITIES
Net income (loss)	$	2,535,822		$	(438,533	)
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization	4,180,769			3,678,786
Amortization of stock-based compensation	548,596			337,762
Restructuring expense	—			1,872,986
Realized (gain) loss on investments	146,799			(10,405		)
Impairment loss	58,184			—
Change in operating assets and liabilities:
Accounts receivable	(93,846		)	(519,456		)
Inventory	180,845			611,440
Other current assets	(355,587		)	(320,644		)
Accounts payable and accrued expenses	(1,428,421		)	970,494
Restructuring accrual	(313,728		)	(908,175		)
Contract loss accrual	—			(837,522		)
Deferred revenue	(2,552,268		)	207,753
Deferred rent	49,629			(2,464		)
Restricted cash	(49,836		)	378,019
Net cash provided by operating activities	2,906,958			5,020,041
INVESTING ACTIVITIES
Purchases of property and equipment	(1,398,026		)	(1,410,177		)
Other assets	27,294			325,587
Purchase of patents, license rights and prepaid royalties	(87,827		)	(2,105,597		)
Proceeds from sales and maturities of short-term investments	43,339,364			46,944,372
Purchases of short-term investments	(51,280,352		)	(52,358,398		)
Net cash used in investing activities	(9,399,547		)	(8,604,213		)
FINANCING ACTIVITIES
Principal payments on capital leases and line of credit, net	—			(1,076,313		)
Net proceeds from issuance of common stock	5,665,527			368,034
Purchase of treasury stock	—			(289,000		)
Net cash provided by (used in) financing activities	5,665,527			(997,279		)
Effect of exchange rate changes	9,884			(489,752		)
Net decrease in cash and cash equivalents	(817,178		)	(5,071,203		)
Cash and cash equivalents at beginning of period	7,846,026			8,309,269
Cash and cash equivalents at end of period	$	7,028,848		$	3,238,066
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid	$	10,054		$	149,027
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Unrealized loss on investments	$	238,053		$	545,386
Deferred compensation related to the issuance of restricted stock, net of forfeitures	$	2,075,347		$	1,309,500
Common stock received in payment of employee notes receivable	$	—		$	367,201

See accompanying notes

5

DISCOVERY PARTNERS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

SEPTEMBER 30, 2004

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete financial statements. The condensed consolidated balance sheet as of September 30, 2004, condensed consolidated statements of operations for the three and nine months ended September 30, 2004 and 2003, and the condensed consolidated statements of cash flows for the nine months ended September 30, 2004 and 2003 are unaudited, but include all adjustments (consisting of normal recurring adjustments), which Discovery Partners International, Inc. (the Company) considers necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented. The results of operations for the three and nine months ended September 30, 2004 shown herein are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For more complete financial information, these financial statements, and notes thereto, should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2003 included in the Company’s Form 10-K filed with the Securities and Exchange Commission.

The consolidated financial statements include all of the accounts of the Company and its wholly owned subsidiaries, Discovery Partners International AG (DPI AG), ChemRx Advanced Technologies, Inc., Xenometrix, Inc., Structural Proteomics, Inc., Discovery Partners International L.L.C. (DPI LLC), Systems Integration Drug Discovery Company, Inc. (substantially inactive) and Irori Europe, Ltd. (substantially inactive). All intercompany accounts and transactions have been eliminated.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, such as inventory, intangible assets and restructuring accruals, at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

2. Net Income (Loss) Per Share

Basic and diluted net income per share is presented in conformity with Statement of Financial Accounting Standard (SFAS) No. 128, Earnings per Share. In accordance with SFAS No. 128, basic net income per share has been computed by dividing net income by the weighted average number of shares of common stock outstanding during the period, less shares subject to repurchase. Diluted net income per share has been computed by dividing net income by the weighted-average number of common shares outstanding and common stock equivalent shares outstanding during the period calculated using the treasury stock method, less shares subject to repurchase. Common stock equivalent shares, composed of outstanding stock options and warrants, are included in diluted net income per share to the extent these shares are dilutive. The computations for basic and diluted earnings per share are as follows:

6

	Income (Numerator)		Shares (Denominator)	Earnings Per Share
Three Months Ended September 30, 2004
Basic earnings per share:
Net income	$	750,053	25,800,374	$	0.03
Diluted earnings per share:
Dilutive stock options	—		419,814	—
Common stock issuable	—		642,500	—
Net income plus assumed conversions	$	750,053	26,862,688	$	0.03
Three Months Ended September 30, 2003
Basic earnings per share:
Net income	$	545,036	24,333,739	$	0.02
Diluted earnings per share:
Dilutive stock options	—		780,330	—
Common stock issuable	—		152,880	—
Net income plus assumed conversions	$	545,036	25,266,949	$	0.02
Nine Months Ended September 30, 2004
Basic earnings per share:
Net income	$	2,535,822	25,169,764	$	0.10
Diluted earnings per share:
Dilutive stock options	—		340,980	—
Common stock issuable	—		642,500	—
Net income plus assumed conversions	$	2,535,822	26,153,244	$	0.10

The computations for basic and diluted earnings per share for the nine months ended September 2003 is not shown herein as all common stock equivalent shares were antidilutive.  The total number of shares issuable upon exercise of stock options and warrants excluded from the calculation of diluted earnings per share since they are anti-dilutive were 2,091,294 and 1,893,891 for the three and nine months ended September 30, 2004, respectively, and 1,801,235 and 2,503,984 for the three and nine months ended September 2003, respectively.

3. Stock-Based Compensation

As permitted by SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, the Company accounts for common stock options granted to employees and directors using the intrinsic value method and, thus, recognizes no compensation expense for such stock-based awards where the exercise prices are equal to or greater than the fair value of the Company’s common stock on the date of the grant. Pro forma information regarding net income or loss is required by SFAS No. 123 and SFAS No. 148, and has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS No. 123. The fair value of these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for option grants:

	Three and Nine Months Ended September 30,
	2004		2003
Risk-free interest rate	3.5	%	4.5	%
Dividend yield	0	%	0	%
Volatility factor	87	%	97	%
Weighted average life in years	6.7		6.6

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For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the vesting period. The Company’s pro forma information is as follows:

	Three Months Ended						Nine Months Ended
	September 30, 2004			September 30, 2003			September 30, 2004			September 30, 2003
Net Income (loss), as reported	$	750,053		$	545,036		$	2,535,822		$	(438,533	)
Deduct: Total stock-based compensation expense determined under fair value based method	(748,245		)	(717,997		)	(2,275,776		)	(2,257,694		)
Pro forma net income (loss)	$	1,808		$	(172,961	)	$	260,046		$	(2,696,227	)
Earnings (loss) per share:
Basic and diluted – as reported	$	0.03		$	0.02		$	0.10		$	(0.02	)
Basic and diluted – pro forma	$	0.00		$	(0.01	)	$	0.01		$	(0.11	)

4. Comprehensive Income (Loss)

SFAS No. 130, Reporting Comprehensive Income, requires the Company to report, in addition to net income (loss), comprehensive income (loss) and its components. A summary follows:

	Three Months Ended					Nine Months Ended
	September 30, 2004		September 30, 2003			September 30, 2004			September 30, 2003
Comprehensive income (loss):
Foreign currency translation adjustment	$	24,313	$	376,424		$	(381,597	)	$	469,338
Unrealized gain (loss) on investments	65,570		(231,237		)	(238,053		)	(545,386		)
Net income (loss)	750,053		545,036			2,535,822			(438,533		)
Comprehensive income (loss)	$	839,936	$	690,223		$	1,916,172		$	(514,581	)

5. Inventory

Inventories are recorded at the lower of weighted average cost or market. Inventories consist of the following:

	September 30, 2004			December 31, 2003
Raw materials	$	1,346,140		$	1,712,503
Work-in-process	4,054,662			3,555,779
Finished goods	17,462,974			17,961,132
	22,863,776			23,229,414
Less reserves	(18,895,696		)	(19,081,184		)
	$	3,968,080		$	4,148,230

6. Prepaid Royalty, Patents and License Rights

Prepaid royalty, patents and license rights consist of the following:

	September 30, 2004							December 31, 2003
	Gross Carrying Value		Accumulated Amortization			Net		Gross Carrying Value		Accumulated Amortization			Net
Prepaid royalty	$	6,034,643	$	(905,196	)	$	5,129,447	$	6,034,643	$	—		$	6,034,643
Patents	2,854,982		(896,445		)	1,958,537		2,765,804		(685,945		)	2,079,859
License rights	1,256,667		(835,835		)	420,832		1,585,862		(1,044,882		)	540,980
Other intangible assets	—		—			—		1,221,105		(1,221,105		)	—
Total intangible assets	$	10,146,292	$	(2,637,476	)	$	7,508,816	$	11,607,414	$	(2,951,932	)	$	8,655,482

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Amortization expense related to intangible assets was $398,570 and $1,235,843 for the three and nine months ended September 30, 2004, respectively and $271,476 and $651,388 for the three and nine months ended September 30, 2003, respectively. The Company began amortization in 2004 of the prepaid royalty of $6,034,643 for royalties the Company prepaid to Abbott Laboratories related to the µARCS screening technology.  This amortization is being recorded ratably over five years. The estimated amortization expense of intangible assets for the fourth quarter of fiscal 2004 is approximately $401,199 and for each of the five succeeding years ending December 31 is as shown in the following table. Actual amortization expense to be reported in future periods could differ from these estimates as a result of acquisitions, divestitures, asset impairments and other factors.

2005	$	1,604,795
2006	1,604,795
2007	1,604,795
2008	1,600,627
2009	297,866
Thereafter	394,739
	$	7,107,617

7. Deferred Stock Compensation

In conjunction with the Company’s initial public offering completed in July 2000, the Company recorded deferred stock compensation totaling approximately $2.7 million and $1.0 million during the years ended December 31, 2000 and 1999, respectively, representing the difference at the date of grant between the exercise or purchase price and estimated fair value of the Company’s common stock as estimated by the Company’s management. Additionally, the Company awarded 142,500 shares of restricted stock and rights to acquire 500,000 shares of restricted stock in August 2003 and July 2004, collectively, pursuant to the Company’s 2000 Stock Incentive Plan to certain of the Company’s key employees resulting in an increase in deferred compensation of $3.4 million. The restricted stock and rights to acquire restricted stock vest in annual installments over a four-year period. In accordance with APB No. 25, deferred compensation is included as a reduction of stockholders’ equity and is being amortized to expense on an accelerated basis in accordance with Financial Accounting Standards Board Interpretation No. 28 over the vesting period of the options, restricted stock and rights to acquire restricted stock. During the three and nine months ended September 30, 2004 and 2003, the Company recorded stock-based compensation expense of $339,564 and $643,946 and $177,808 and $337,762. respectively.

8. Restructuring Accrual

In April 2003, the Company announced that it would consolidate its domestic chemistry facilities into two centers of excellence: in South San Francisco for primary screening library design and synthesis programs and in San Diego for lead optimization and medicinal chemistry projects. At the same time, the Company announced its plans to establish new offshore chemistry capabilities to take advantage of lower cost structures. These actions resulted in the closure of its Tucson facility. In accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, severance and retention bonuses for involuntary employee terminations and the costs to exit certain contractual and lease obligations were accrued as of the restructuring date. Moving, relocation and other costs related to consolidation of facilities were expensed as incurred.  Under the restructuring plan 28 employees were involuntarily terminated, including scientific and administrative staff.  Restructuring charges totaled $1,872,986 for the year ended December 31, 2003 and were comprised of the following:

Severance and Retention Bonuses for Involuntary Employee Terminations	$	375,599
Costs to Exit Certain Contractual and Lease Obligations	919,171
Moving, Relocation and Other Costs Related to Consolidation of Facilities	578,216
Total Restructuring Expense	$	1,872,986

There were no additional costs incurred in the three months ended September 30, 2004. The following table summarizes the activity and balances of the restructuring reserve:

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	Severance and Retention Bonuses for Involuntary Employee Terminations			Costs to Exit Certain Contractual and Lease Obligations			Moving, Relocation and Other Costs Related to Consolidation of Facilities			Total
Balance at December 31, 2002	$	—		$	—		$	—		$	—
Reserve Established	375,599			919,171			578,216			1,872,986
Utilization of reserve:
Payments	(375,599		)	(175,030		)	(578,216		)	(1,128,845		)
Balance at December 31, 2003	$	—		$	744,141		$	—		$	744,141
Utilization of reserve:
Payments	—			(313,728		)	—			(313,728		)
Balance at September 30, 2004	$	—		$	430,413		$	—		$	430,413

The Company expects to complete the utilization of the reserve related to this restructuring by July 2005.

9. Revenues by Product Category

The Company operates in one industry segment: the development, manufacture and marketing of products and services to make the drug discovery process more efficient, less expensive and more likely to generate a drug target. Such products and services include libraries of drug-like compounds, proprietary instruments, consumable supplies, drug discovery services, computational tools to generate compound libraries, and testing and screening services to optimize potential drugs. Additionally, the Company licenses proprietary gene profiling systems. Our products and services are complementary, and share the same customers, distribution and marketing strategies. In addition, in making operating and strategic decisions, the Company’s management evaluates revenues based on the worldwide revenues of each major product line and type of service, and profitability on an enterprise-wide basis. Revenue by product and service category is as follows:

	Three Months Ended				Nine Months Ended
	September 30, 2004		September 30, 2003		September 30, 2004		September 30, 2003
Chemistry services	$	8,410,913	$	8,280,781	$	25,046,221	$	26,612,518
Screening services	2,438,626		1,826,993		6,696,376		4,702,110
Products	1,527,696		744,346		4,360,673		1,962,059
Other licenses and services	198,128		557,171		1,278,609		2,083,945
Total revenues	$	12,575,363	$	11,409,291	$	37,381,879	$	35,360,632

A total of 53% and 54% for the three and nine months ended September 30, 2004, respectively, and 66% and 61% for the three and nine months ended September 30, 2003, respectively, of revenue came from the Company’s chemistry contracts with Pfizer.

10. Significant Events

Effective August 20, 2004, the Company entered into a multi-year contract with The National Institute of Mental Health (NIH) to set up and maintain a Small Molecule Repository to manage and provide up to one million chemical compounds to multiple NIH Screening Centers as part of the NIH Roadmap Initiative.The estimated funding available to the Company under this contract for the contract’s base period (August 2004 through December 2008) is approximately $24 million, assuming the contract continues for its full term, with options to extend the term subject to the availability of funding.  This contract is funded, in its entirety, by NIH, Department of Health and Human Services.

In July 2004, 400,000 restricted stock grants were awarded pursuant to the Company’s 2000 Stock Incentive Plan to certain of the Company’s key employees.  The restricted stock vests five years from grant date, with accelerated vesting upon achievement of specified Company stock price targets. Compensation expense of

10

$2,104,000 relating to this restricted stock grant will be recognized on an accelerated basis in accordance with Financial Accounting Standards Board Interpretation No. 28 over four years.

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PART I

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

THIS FORM 10-Q CONTAINS CERTAIN STATEMENTS THAT ARE NOT STRICTLY HISTORICAL AND ARE “FORWARD-LOOKING” STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 AND INVOLVE A HIGH DEGREE OF RISK AND UNCERTAINTY. SUCH STATEMENTS INCLUDE BUT ARE NOT LIMITED TO STATEMENTS REGARDING OUR ESTIMATED FUTURE AMORTIZATION EXPENSE, EXPECTED FUTURE REVENUES UNDER OUR CHEMISTRY CONTRACT WITH PFIZER, ESTIMATED FUTURE FUNDING UNDER THE CONTRACT WITH THE NIH, THE ESTIMATED COSTS TO CLOSE OUR TUCSON FACILITY, OUR EXPECTED DEFERRED COMPENSATION EXPENSE FOR 2004, OUR CASH RESOURCES, OUR FUTURE CASH FLOWS, OUR FUTURE CAPITAL EXPENDITURES, OUR FUTURE DEBT LEVELS AND STATEMENTS ABOUT OUR EXPECTATIONS RELATED TO PROFITABILITY.  OUR ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS DUE TO RISKS AND UNCERTAINTIES THAT EXIST IN OUR OPERATIONS, DEVELOPMENT EFFORTS AND BUSINESS ENVIRONMENT, INCLUDING THOSE DESCRIBED BELOW UNDER THE HEADING “RISKS AND UNCERTAINTIES” AND THOSE DESCRIBED IN OUR FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2003 AND OTHER REPORTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.

Web Site Access to SEC Filings

We maintain an Internet website at www.discoverypartners.com.  We make available free of charge on our Internet website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

Overview

We were founded in 1995 as IRORI. In October 1998, we changed our name to Discovery Partners International, Inc. and in July 2000 we completed our initial public offering and simultaneously reincorporated in the state of Delaware.

We sell a broad range of products and services to pharmaceutical and biopharmaceutical companies to make the drug discovery process for our customers faster, less expensive and more effective at generating drug candidates. We focus on the portion of the drug discovery process that begins after identification of a drug target through when a drug candidate is ready for pre-clinical studies. Our major products and services are as follows:

Products

Instrumentation and Related Consumables.  We sell, and provide access to, our proprietary instruments and consumables that automate the process of making and storing collections, or libraries, of chemical compounds. Our compound synthesis instruments are based on a patented core technology, which enables our customers to generate large collections of compounds with efficiency and speed.

Our current products that are based on proprietary technology were developed internally and include the X-Kan, NanoKan Systems,  high throughput chemistry systems that can generate from thousands to hundred of thousands discrete compounds per year, the AutoSort System, an automated chemistry system and a manual chemistry system. All of these systems include hardware and software platforms and use consumables that our customers purchase for every compound that is synthesized using these automation systems. We also offer

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Crystal Farm, our proprietary self contained crystallization and imaging system that provides automated high throughput incubation and imaging of thousands of protein crystallization experiments.

Chemistry Services

Compounds. As a result of internal development and our acquisitions of Axys Advanced Technologies, Inc. (AAT) in 2000 and Systems Integration Drug Discovery Company (SIDDCO), in 2001, we are able to offer a broad range of highly purified compound libraries that can be screened using assays. After compounds are screened, promising compounds, or hits, are then improved, or optimized, to generate drug candidates, or leads. These hits may be from our compound libraries, our customer’s internal compound collection or even from another compound library supplier.

Medicinal Chemistry. We also provide a wide range of medicinal chemistry and other lead optimization services. This includes the synthesis of compounds that modify the original hit for improved potency, selectivity and other pharmaceutical characteristics. In some cases we provide medicinal chemistry services in conjunction with our computational drug discovery efforts to design and construct small libraries of compounds to act on specific targets that have known chemical structures.

Drug Discovery Informatics; ADME and Toxicology. In connection with our acquisitions in 2000 of AAT and Structural Proteomics, we acquired and we are further developing computational tools that we believe will allow us to substantially increase our knowledge of the characteristics of targets and leads, and their interaction with certain molecules. We believe these tools could potentially be applied throughout the drug discovery process to significantly reduce the time and cost of developing a drug. We currently have computer algorithms that allow us to design libraries of compounds with high diversity, thereby increasing the likelihood of finding hits during screening.

We have developed novel algorithms to aid in the understanding and utilization of the data resulting from high throughput screening experiments. We have also developed a proprietary analysis tool which we believe will allow us to use screening data to identify the most likely type of drug target with which a compound may bind or interact. We use this tool to design highly effective compound libraries for our collaborators and customers. We expect to further use our computational tools and screening data to help predict absorption, distribution, metabolism, and excretion, or ADME, and toxicological reactions to classes of compounds. This could allow our customers to avoid spending money and time on hits and leads that will ultimately fail due to their unfavorable ADME and toxicological characteristics.

Compound Repository. We also provide services to establish, maintain and manage compound repositories.

Screening Services

Screening. We offer high throughput screening services through an experienced staff of scientists located at our facility near Basel, Switzerland. We also offer our customers access to chemical compounds from many compound suppliers as well as a significant collection of internally developed compounds. To improve the speed and cost effectiveness of the screening process, we have exclusively licensed from Abbott Laboratories and further developed ARCS, a next-generation high throughput screening technology. This platform provides rapid and cost effective, high performance, high throughput screening, while supporting a very broad range of biochemical and cellular assays. We initially acquired our ability to offer these screening services in our acquisition of Discovery Technologies, Ltd. in 1999 (now DPI AG) and have added to our capabilities through further internal development.

Assays. We design and conduct assays, or tests, that generate information about the effect of chemical compounds on a drug target. We believe that our assays help our customers better select drug candidates before moving to the more costly stages of pre-clinical and clinical testing. We develop our assays through our team of scientists who are experienced in working with major disease target classes in a number of significant therapeutic areas, such as cardiovascular, neurology, oncology and ophthalmology. We acquired the ability to provide assay development services through our acquisition of Discovery Technologies, Ltd. in 1999 and further internal development.

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Other licenses and services

Royalties. We license our proprietary gene profiling system, under the Xenometrix patent licensing agreements, that characterizes a cell’s response upon exposure to compounds and other agents by the pattern of gene expression in the cell.

Development Contracts. We collaborate with pharmaceutical and biopharmaceutical companies to develop customized drug discovery technologies to assist in the workflow of the laboratory environment such as in the development of two X-Kan Chemistry Synthesis Systems for GSK. X-Kans are chemical microreactors that combine the two-dimensional tagging features of the previously introduced NanoKan technology with an increased size and scale that are similar to the currently available MicroKan and MiniKan products.

Product Services and Warranty. In connection with our sales of instrumentation products and the related consumables, we provide from time to time related services and provide technical support of our instrumentation products.

We have made a number of acquisitions in recent years that have significantly expanded our overall size and have allowed us to offer customers this broad range of integrated drug discovery products and services from a single provider.  The pharmaceutical and biopharmaceutical industries provide substantially all of our revenues.

In the first nine months of 2004, 54% of our revenue came from our chemistry contract with Pfizer, and we anticipate that this contract will continue to provide for a significant percentage of our revenue throughout 2004 and 2005.

Critical Accounting Policies

This discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate our estimates. 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 the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates, and the estimates themselves might be different if we used different assumptions.

We believe the following critical accounting policies involve significant judgments and estimates that are used in the preparation of our financial statements.

Revenue recognition.  Revenue is recognized as follows:

Product sales.  Revenue from product sales, which include the sale of instruments and related consumables, is recorded as products are shipped if the costs of such shipments can be reasonably estimated and if all the customer’s acceptance criteria have been met. Certain of our contracts for product sales include customer acceptance provisions that give our customers the right of replacement if the delivered product does not meet specified criteria; however, we have historically demonstrated that the products meet the specified criteria and the number of customers exercising their right of replacement has been insignificant and therefore, once we have completed our internal testing, we recognize revenue without providing for such contingency upon shipment.

Chemistry services.  Revenue from the sale of chemical compounds delivered under our chemistry collaborations is recorded as the compounds are shipped.  Revenue under chemistry service agreements that are compensated on a full-time equivalent, or FTE, basis is recognized on a monthly basis and is based upon the number of FTE employees that actually worked on each project and the agreed-upon rate per FTE per month.  Beginning in April 2004, in accordance with our agreement with Pfizer, we are compensated based on predetermined limits to reserve

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sufficient resources to complete specific compound related activities, at the customer’s request, whether or not utilized.  Revenue for reserving these resources is recognized based on the predetermined limits stipulated in the contract.

Screening services.  High throughput screening service revenues are recognized on a percentage-of-completion basis. Advances received under these high throughput screening service agreements are initially recorded as deferred revenue, which is then recognized as costs are incurred over the term of the contract. Certain of these contracts may allow the customer the right to reject the work performed; however, we have no history of material rejections and historically we have been able to recognize revenue without providing for such contingency.

Other licenses and services.  Other licenses and services revenue includes royalty revenue due to us under the Xenometrix patent licensing agreements, development contract revenue, product related services revenue and warranty services revenue related to our instrumentation sales.  Royalty revenue is recognized upon receipt of monies, provided we have no future obligation with respect to such payments.  Development contract revenues are recognized on a percentage-of-completion basis.  Product related service revenues are recognized when the performance of the service is complete.  Warranty services revenue is recognized when the related product is shipped and extended warranty services revenue is recognized ratably over the service period.

Integrated drug discovery collaborations may provide chemistry services revenue, screening services revenue and milestone payments and other revenues.  Revenue for each of these elements of such collaborations is recognized as described above.  Revenue from milestone payments would be recognized upon receipt of monies.

From time to time we receive requests from customers to bill and hold goods for them. In these cases, as long as the specific revenue recognition criteria under accounting principles generally accepted in the United States at the time of the bill and hold are met, including the customer accepting the risk of loss and the transfer of ownership of such goods occurring prior to shipment, the revenue is recognized.

In February 2003, we entered into an agreement with GlaxoSmithKline, or GSK. In accordance with the agreement, we agreed to develop and supply to GSK two complete X-Kan Chemistry Synthesis Systems. X-Kans are chemical microreactors that combine the two-dimensional tagging features of the previously introduced NanoKan technology with an increased size and scale that are similar to the currently available MicroKan and MiniKan products. Revenue under this agreement is recognized on a percentage-of-completion basis, up to contractual limits and is included in other licenses and services revenue.  We completed this project in the first half of 2004.

In July 2003, we entered into an agreement with Bruker AXS Inc. Under the terms of the agreement, as amended, we appointed Bruker AXS the worldwide distributor for our Crystal Farm line of protein crystallography products. In consideration of the criteria set forth in SFAS No. 48, Revenue Recognition When Right of Return Exists, we recognize revenue as products are shipped.  Revenue from these sales is included in product sales.

Inventory.  Inventories are recorded at the lower of cost or market. We write-down our inventory for estimated obsolescence or non-marketability if there is an excess of cost of inventory over the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than we have projected, additional inventory write-downs may be required.  As of September 30, 2004, 93% of our inventory reserve is associated with our chemical compound finished goods inventory. A significant portion of our net inventory balance represents work-in-process related to two multi-year chemistry collaborations. Estimated losses on any deliverables are recorded when they become apparent. As of September 30, 2004, we have reserved approximately $410,000 against the work-in-process representing the anticipated losses on the sale of chemical compound libraries.

Long-lived assets.  In accounting for long-lived assets, we make estimates about the expected useful lives and the potential for impairment. Changes in the marketplace, technology or our operations could result in changes to these estimates. Our long-lived assets are evaluated for impairment when events and circumstances indicate that the assets may be impaired. If impairment is indicated, we reduce the carrying value of the asset to fair value. As of September 30, 2004, we have prepaid approximately $6.0 million to Abbott Laboratories for royalties related to the µARCS screening technology. This prepayment is carried on our balance sheet as prepaid royalty.  In the first quarter of 2004

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we began amortization of this asset using a five-year life as we have begun to derive value from the related technology.  This technology has been evaluated by several companies including a major pharmaceutical company and based on these evaluations and potential revenues from these and other potential customers, we believe that the carrying value of the asset is not impaired. If we are not successful in generating sufficient revenues in the future from this asset, we may be required to record impairment charges up to $5.1 million.

Results of Operations For The Three Months Ended September 30, 2004 and 2003

Revenue. Total revenues increased 10%, or $1.2 million, from $11.4 million for the three months ended September 30, 2003 to $12.6 million for the three months ended September 30, 2004.  The increase in revenue was primarily due to increases in screening services revenue and instrumentation product revenue.  The increase in screening services revenue was due primarily to new contracts as well as additional services provided under existing contracts in comparison to the third quarter of 2003.  The increase in instrumentation product revenue was due to the launch of the Crystal Farm product in 2003, which generated significantly more sales in the third quarter of 2004 compared to the third quarter of 2003.  This increase was partially offset by a decrease in revenues from consumables and a decrease in revenues generated from our X-Kan contract with GlaxoSmithKline as this project was completed in April 2004.

In the third quarter of 2004 and 2003, 53% and 66%, respectively, of our revenue came from our chemistry contract with Pfizer, and we anticipate that this contract will continue to provide for a significant percentage of our revenue throughout 2004 and 2005.  As of September 30, 2004, 53% of total potential revenue under our Pfizer agreement remains to be earned and recognized. Pfizer has the right to terminate the contract without cause after January 5, 2005 by giving six months’ notice.

Gross margin. Gross margin as a percentage of revenues increased from 40% for the three months ended September 30, 2003 to 46% for the three months ended September 30, 2004.  The increase in gross margin for the third quarter of 2004 is primarily due to improvement in gross margins on screening and chemistry services and on instrumentation products.  Gross margin as a percentage of chemistry services revenue increased due to higher margins on new revenue sources under the Pfizer agreement and the redeployment of scientists to research and development projects and business development initiatives partially offset by unabsorbed overhead resulting from lower production volumes.  Gross margin as a percentage of screening revenue increased due to an increase in volume.  Gross margin as a percentage of instrumentation product revenues increased due primarily to higher margins earned on new products compared to our historical product lines.    The amortization of our prepaid royalty for our µARCS technology, which began in the first quarter of 2004, has also had an offsetting impact on our overall gross margin improvement.

Research and development expenses. Research and development expenses consist primarily of salaries and benefits, supplies and expensed development materials, facilities costs and equipment depreciation. Research and development expenses increased 137%, or $746,000, from $545,000 for the three months ended September 30, 2003 to $1.3 million for the three months ended September 30, 2004. Research and development expenses increased primarily due to the completion of customer funded research and development activities and an increase in internal programs focused on Crystal Farm product, compound storage solutions and drug discovery process development.

Selling, general and administrative expenses. Selling, general and administrative expenses consist primarily of salaries and benefits for sales and marketing and administrative personnel, advertising and promotional expenses, professional services, and facilities costs. Selling, general and administrative expenses increased 11%, or $362,000, from $3.4 million for the three months ended September 30, 2003 to $3.7 million for the three months ended September 30, 2004 due primarily to an increase in business development activities, insurance costs and professional services fees.  These increases were partially offset by savings resulting from the closure of our Tucson facility in April 2003 and decreased incentive compensation costs.

Stock-based compensation.  During 1999 and 2000, we granted stock options with exercise prices that were less than the estimated fair value of the underlying shares of common stock on the date of grant.  Additionally, we awarded 142,500 shares of restricted stock and rights to acquire 500,000 shares of restricted stock in August 2003 and July 2004, collectively.  As a result, we have recorded deferred stock-based compensation to be amortized on an accelerated basis over the period that these options, restricted stock grants and rights to acquire restricted stock

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vest. The deferred stock-based compensation expense for the three months ended September 30, 2004 was approximately $340,000, compared to approximately $178,000 for the three months ended September 30, 2003.  We expect deferred compensation expense for 2004 to be approximately $900,000.

Interest income. Interest income, net, decreased 15%, or $65,000, from $437,000 for the three months ended September 30, 2003 to $372,000 for the three months ended September 30, 2004 due primarily to lower yields in the third quarter of 2004 compared to the third quarter of 2003.

Results of Operations For The Nine Months Ended September 30, 2004 and 2003

Revenue.  Total revenues increased 6%, or $2.0 million, from $35.4 million for the nine months ended September 30, 2003 to $37.4 million for the nine months ended September 30, 2004.  The increase in revenue was primarily due to increases in screening services revenue and instrumentation product revenue offset by decreases in chemistry services revenue and royalty revenues related to our Xenometrix patent licensing.  The increase in screening services revenue was due primarily to new contracts as well as additional services provided under existing contracts in comparison to the first nine months of 2003.  The increase in instrumentation product revenue was due to the launch of the Crystal Farm product in 2003, which generated significantly more sales in the first nine months of 2004 compared to the first nine months of 2003.  This increase was partially offset by a decrease in revenues generated from our X-Kan contract with GlaxoSmithKline as this project was completed in April 2004.  The decrease in chemistry services revenue was due to reductions in deliverables under a significant chemistry services agreement as well as the absence of a contract termination fee earned in the first quarter of 2003.

In the nine months ended September 30, 2004 and 2003, 54% and 61%, respectively, of our revenue came from our chemistry contract with Pfizer, and we anticipate that this contract will continue to provide for a significant percentage of our revenue throughout 2004 and 2005. As of September 30, 2004, 53% of total potential revenue under our Pfizer agreement remains to be earned and recognized.  Pfizer has the right to terminate the contract without cause after January 5, 2005 by giving six months’ notice.

Gross margin.  Gross margin as a percentage of revenues increased from 34% for the nine months ended September 30, 2003 to 43% for the nine months ended September 30, 2004.  The increase in gross margin for the first nine months of 2004 is primarily due to improvement in gross margins on chemistry services, screening services and instrumentation products.  Gross margin as a percentage of chemistry services revenue increased primarily due to changes in our agreement with Pfizer.  Under our prior agreement with Pfizer, we were compensated separately for the development and delivery of the compounds, and accordingly, our development costs were expensed as incurred.  Under the amended agreement, we now bear the development risk of the compounds and are compensated upon delivery of the compounds.  A significant portion of the costs associated with the development of the compounds delivered to Pfizer in the first half of 2004 was expensed in prior periods in accordance with our accounting policies as applied to the prior agreement, improving our gross margin percentage in the first half of 2004 for these compounds.  Additionally, gross margin as a percentage of chemistry services revenue increased due to higher margins on new revenue sources under the Pfizer agreement and the redeployment of scientists to research and development projects and business development initiatives partially offset by unabsorbed overhead resulting from lower production volumes in the first nine months of 2004.  Gross margin as a percentage of screening revenue increased due to an increase in volume.  Gross margin as a percentage of instrumentation product revenues increased due primarily to higher margins earned on new products compared to our historical product lines.  The amortization of our prepaid royalty for our µARCS technology, which began in the first quarter of 2004, has also had an offsetting impact on our overall gross margin improvement.

Research and development expenses. Research and development expenses consist primarily of salaries and benefits, supplies and expensed development materials, and facilities costs and equipment depreciation. Research and development expenses increased 61%, or $1.2 million from $1.9 million for the nine months ended September 30, 2003 to $3.1 million for the nine months ended September 30, 2004. Research and development expenses increased primarily due to the completion of customer funded research and development activities and an increase in internal programs focused on Crystal Farm product, compound storage solutions and drug discovery process development.

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Selling, general and administrative expenses. Selling, general and administrative expenses consist primarily of salaries and benefits for sales and marketing and administrative personnel, advertising and promotional expenses, professional services, and facilities costs.  Selling, general and administrative expenses increased 10%, or $1.0 million, from $9.9 million for the nine months ended September 30, 2003 to $10.9 million for the nine months ended September 30, 2004 due primarily to an increase in business development activities, insurance costs and professional services fees.  These increases were partially offset by savings resulting from the closure of our Tucson facility in April 2003 and decreased incentive compensation costs.

Stock-based compensation. During 1999 and 2000, we granted stock options with exercise prices that were less than the estimated fair value of the underlying shares of common stock on the date of grant.  Additionally, we awarded 142,500 shares of restricted stock and rights to acquire 500,000 shares of restricted stock in August 2003 and July 2004, collectively.  As a result, we have recorded deferred stock-based compensation to be amortized on an accelerated basis over the period that these options, restricted stock grants and rights to acquire restricted stock vest. The deferred stock-based compensation expense for the nine months ended September 30, 2004 was approximately $644,000, compared to approximately $338,000 for the nine months ended September 30, 2003.  We expect deferred compensation expense for 2004 to be approximately $900,000.

Interest income. Interest income, net, decreased 30%, or $425,000, from $1.4 million for the nine months ended September 30, 2003 to $1.0 million for the nine months ended September 30, 2004 due primarily to lower yields in the first nine months of 2004 compared to the nine months of 2003.

Liquidity and Capital Resources

Since inception of the Company, we have funded our operations principally with $39.0 million of private equity financings and $94.7 million of net proceeds from our initial public offering in July 2000.  In May 2004, we raised approximately $5.1 million in net proceeds from the sale of 1,083,300 shares of common stock in a public offering.

At September 30, 2004, cash and cash equivalents and short-term investments totaled approximately $78.9 million, compared to $72.6 million at December 31, 2003.

Operating Activities.  We rely on cash flows from operations to provide working capital for current and future operations. We believe we have sufficient cash resources to fund existing operations through at least 2005. Cash flows from operating activities totaled $2.9 million and $5.0 million for the nine months ended September 30, 2004 and 2003, respectively.  The decrease in operating cash flows in 2004 compared to 2003 was primarily due to a significant increase in annual incentives paid to key employees in the first quarter of 2004 compared to 2003 and a significant decrease in prepayments received from our customers offset partially by improved operating results.

Investing Activities.  Cash used in investing activities totaled $9.4 million and $8.6 million for the nine months ended September 30, 2004 and 2003, respectively.  The increase in cash used in investing activities is due primarily to our investing the net proceeds from the sale of approximately 1.1 million shares of our common stock in short-term investments which occurred during the second quarter of 2004 offset by a $2.0 million royalty prepayment made in the first quarter of 2003 as required under our exclusive µARCS license agreement with Abbott Laboratories, which we carry on the balance sheet as prepaid royalty.  No additional prepayments are required under this agreement.

We currently anticipate investing up to $1.0 million during the remainder of 2004 for leasehold improvements and capital equipment necessary to support future revenue growth. Our actual future capital requirements will depend on a number of factors, including our success in increasing sales of both existing and new products and services, expenses associated with unforeseen litigation, regulatory changes, competition and technological developments, and potential future merger and acquisition activity as well as research and development spending.

Financing Activities.  Cash provided by financing activities totaled $5.7 million for the nine months ended September 30, 2004 compared to cash used in financing activities for the nine months ended September 30, 2003 of $1.0 million.  This change is primarily due to sale of approximately 1.1 million shares of our common stock generating $5.1 million in net proceeds during the second quarter of 2004.  Historically, we had debt obligations under lease and

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line of credit agreements. Net payments made under these agreements totaled $1.1 million in the first nine months of 2003. As of September 30, 2004, we have no debt obligations.  Absent any significant merger and acquisition activity, we do not expect to incur debt in 2004.

On October 4, 2001, our board of directors authorized a Stock Repurchase Plan, authorizing us to repurchase up to 2,000,000 shares of common stock at no more than $3.50 per share. In the nine months ended September 30, 2003, we purchased 115,000 shares under this Plan for $289,000.  We did not purchase any shares in the nine months ended September 30, 2004.  We have the authority to purchase additional shares in the future.

RISKS AND UNCERTAINTIES

In addition to the other information contained herein, you should carefully consider the following risk factors in evaluating our company.

We derive a significant percentage of our revenues from a single customer. If this customer relationship terminated, we could have difficulty finding customers that would purchase our products and services in sufficient amounts to replace the capacity and lost revenues resulting from this significant customer.

We anticipate that a significant portion of our revenues for 2004 and 2005 will be derived from the chemistry collaboration we entered into with Pfizer originally in December 2001. In February 2004, the agreement with Pfizer was amended. Under this agreement, Pfizer has a contractual right to terminate the contract, with or without cause, upon six months notice after January 5, 2005. Either party may also terminate the agreement upon the material, uncured breach of the other party, and Pfizer may terminate the agreement if we are acquired by a third party or in the event of a change in control of our company. During the first nine months of 2004, revenue from Pfizer represented 54% of our total revenue.  As of September 30, 2004, 53% of total potential revenue under the new Pfizer agreement remains to be earned and recognized.  If our relationship with Pfizer or our contracts with other customers to whom we provide significant products or services are terminated, we will have substantial capacity available until we are able to find new customers for our products and services to utilize that capacity. We may be delayed in entering or not able to enter into contracts with new customers to utilize any available capacity. We will continue to bear the costs of that capacity until we are able to enter into contracts with customers for those products or services. Revenues with respect to those products and services may be delayed or we may not recognize revenues at all to the extent we are delayed in entering or not able to enter into contracts with new customers to utilize available capacity.

The drug discovery industry is highly competitive and subject to technological change, and we may not have the resources necessary to compete successfully.

We compete with companies in the United States and abroad that engage in the development and production of drug discovery products and services. These competitors include companies engaged in the following areas of drug discovery:

•Assay development and screening;

•Combinatorial chemistry instruments;

•Crystallography incubation and imaging systems;

•Compound libraries and lead optimization;

•Informatics; and

•Gene expression profiling.

Academic institutions, governmental agencies and other research organizations also conduct research in areas in which we provide services, either on their own or through collaborative efforts. Also, substantially all of our

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pharmaceutical and biopharmaceutical company customers have internal departments that provide some or all of the products and services we sell, so these customers may have limited needs for our products and services. Many of our competitors have more experience and have access to greater financial, technical, research, marketing, sales, distribution, service and other resources than we do. We may not yet be large enough to achieve satisfactory market recognition or operating efficiencies, particularly in comparison to some competitors.

Moreover, the pharmaceutical and biopharmaceutical industries are characterized by continuous technological innovation. We anticipate that we will face increased competition in the future as new companies enter the market and our competitors make advanced technologies available. Technological advances or entirely different approaches that we or one or more of our competitors develop may render our products, services and expertise obsolete or uneconomical. For example, advances in informatics and virtual screening may render some of our technologies, such as our large compound libraries, obsolete. Additionally, the existing approaches of our competitors or new approaches or technologies that our competitors develop may be more effective than those we develop. We may not be able to compete successfully with existing or future competitors.

In addition, due to improvements in global communications, combined with the supply of lower cost PhD level scientific talent, we face the growing threat of competition for our chemistry and computational chemistry services from low-cost offshore locations such as China, India and Eastern Europe.

If we do not generate adequate revenues from our µARCS investment, we may have to record significant impairment charges.

We have prepaid approximately $6.0 million to Abbott Laboratories for royalties related to the µARCS screening technology. This prepayment is carried on our balance sheet as prepaid royalty net of $0.9 million of accumulated amortization. If we are not successful in generating revenues in the future from this asset, we may be required to record impairment charges up to $5.1 million, which would materially impact our profitability.

Our financial performance will depend on the prospects of the pharmaceutical and biopharmaceutical industries and the extent to which these industries engage outside parties to perform one or more aspects of their drug discovery process.

Our revenues depend to a large extent on research and development expenditures by the pharmaceutical and biopharmaceutical industries and companies in these industries outsourcing research and development projects. These expenditures are based on a wide variety of factors, including the resources available for purchasing research equipment, the spending priorities among various types of research and policies regarding expenditures during recessionary periods. In recent years, pharmaceutical companies have been attempting to contain spending on drug discovery and many biotechnology companies have found it difficult to raise capital to fund drug discovery activities. Geopolitical uncertainty or general economic downturns in our customers’ industries or any decrease in research and development expenditures could harm our operations, as could increased acceptance of management theories that counsel against outsourcing of critical business functions. Any decrease in drug discovery spending by pharmaceutical and biopharmaceutical companies could cause our revenues to decline and hurt our profitability.

The concentration of the pharmaceutical industry and the current trend toward increasing consolidation could hurt our business prospects.

The pharmaceutical customer segment of the market for our products and services is highly concentrated, with approximately 50 large pharmaceutical companies conducting drug discovery research. We have lost customers due to consolidation of pharmaceutical companies and the continuation of this trend may reduce the number of our current and potential customers even further. As a result, a small number of customers could account for a substantial portion of our revenues. In addition, because of the heavy concentration of the pharmaceutical industry and the relatively high cost of our systems, such as NanoKan and µARCS, we expect there will be only a limited number of potential buyers for these systems.

Additional risks associated with a concentrated customer base include:

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•larger companies may develop and utilize in-house technology and expertise rather than using our products and services; and

•larger customers may negotiate price discounts or other terms for our products and services that are unfavorable to us.

We may not achieve or maintain profitability in the future.

We have incurred significant operating and net losses since our inception. As of September 30, 2004, we had an accumulated deficit of $101.1 million. Although we generated net income for the three and nine months ended September 30, 2004 of approximately $750,000 and $2.5 million, respectively and for the year ended December 31, 2003 of $1.1 million, we had net losses of $62.1 million and $11.1 million for the years ended December 31, 2002 and 2001, respectively. We may also in the future incur operating and net losses and negative cash flow from operations. We did not achieve operating profitability until the third quarter of 2003 and we may not be able to achieve or maintain profitability in any quarter in the future. Moreover, if we do achieve profitability, the level of any profitability cannot be predicted and may vary significantly from quarter to quarter.

Our discontinuation of the development of chemical compounds to be sold out of inventory places more emphasis on integrated drug discovery collaborations, an area of higher risk and complexity.

As a result of our decision to limit access to our proprietary chemistry compounds and capabilities solely to companies that enter into integrated drug discovery, chemistry or screening and optimization collaborations with us, we now rely on this relatively complex form of customer engagement to generate revenue. As a result of the inherent complexity of such collaborations, we have an increased risk of being unable to reach agreement with the prospective customer for such collaborations or of structuring sub-optimal arrangements that fail to adequately compensate us for the risks inherent in such collaborations.

We may fail to expand customer relationships through the integration of products and services.

We may not be able to use existing relationships with customers in individual areas of our business to sell products and services in multiple areas of drug discovery. We may not be successful in selling our offerings in combination across the range of drug discovery disciplines we serve because integrated combinations of our products and services may not achieve time and cost efficiencies for our customers, especially our large pharmaceutical company customers. Biotechnology companies may desire our integrated offerings but are often not sufficiently capitalized to pay for these services. In addition, we may not succeed in further integrating our offerings. If we do not achieve integration of our products and services, we may not be able to take advantage of potential revenue opportunities and differentiate ourselves from competitors.

Our products, services and technologies may never help discover drugs that receive Food and Drug Administration approval, which may make it difficult for us to gain new business.

To date, we are not aware of any of our customers having used any of our drug discovery products, services or technologies to develop a drug that ultimately has been approved by the Food and Drug Administration, and our customers may never do so. Whether our customers use our drug discovery products, services and technologies to develop any drugs that ultimately receive Food and Drug Administration approval will depend heavily on our scientific success and our customers’ scientific success, as well as on our customers’ ability to meet applicable Food and Drug Administration regulatory requirements. Our products, services and technologies may fail to assist our customers in achieving their drug discovery objectives, either on a timely basis or at all. For example, when our customers deliver proteins to us for assay development or chemistry library design ideas for chemical compound development and production, we may design assays or develop chemical compound libraries that fail to fully characterize the applicable protein’s or compound’s therapeutic potential, which could cause its further development to be delayed or abandoned. Additionally, our customers may not deliver to us proteins for assay development or chemistry library design ideas for chemical compound development and production that yield promising lead compounds for further development. Our customers may also lack the resources or experience or be otherwise unable to comply with the Food and Drug Administration’s clinical trial requirements. Certain of our competitors are able to claim that their drug discovery products or services have been used in developing drugs that received Food and Drug

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Administration approval. To the extent that potential customers consider demonstrated therapeutic success an important factor in selecting between us and our competitors, we may be competitively disadvantaged, which would negatively impact our ability to generate new business.

Our financial performance will depend on improved market conditions in the segments of the drug discovery and development process in which we participate.

The drug discovery and development process can be broadly separated into the following stages: Target identification; target validation; lead discovery; lead optimization; pre-clinical development; IND filing; clinical trials, phases I-III; new drug application, or NDA; and post market surveillance. We currently participate in the areas of lead discovery and lead optimization. Based on current industry averages, the cost of acquiring a validated target plus the costs of lead discovery and lead optimization are greater than the expected proceeds of out-licensing a potential drug candidate during the pre-clinical phase of drug development. This is primarily due to the negative imbalance between the relatively high cost of obtaining pre-clinical drug candidates, the high failure rate of such pre-clinical candidates, and the relatively low demand for such pre-clinical candidates that exists at present. It is estimated that a positive expected return on investment is not obtained until a drug candidate has passed through phase II clinical trials, which requires a significant commitment of resources to attain. Therefore, many drug companies may be deterred from engaging in drug discovery unless they have the substantial financial resources necessary to fund the drug discovery process all the way through phase II clinical trials. Unless advances are made to either reduce the cost or improve the success rate of pre-clinical drug candidates, or unless the market demand for such pre-clinical drug candidates improves, we might continue to face difficult market conditions for our products and services which might inhibit our growth.

We may not be able to achieve and maintain success in our offshore operations.

We entered into a research and development collaboration agreement under which we utilize scientists and equipment at a subcontractor’s facility located in India to take advantage of a lower cost structure. However, we may not be able to achieve or maintain a successful relationship in this offshore location or realize lower costs. Additionally, such offshore business could suffer due to the geographical, time and distance challenges as well as cultural difficulties of managing such an operation, which could cause delays, customer dissatisfaction or other issues.

Many of our products and services have lengthy sales cycles, which could cause our operating results to fluctuate significantly from quarter to quarter.

Sales of many of our products and services typically involve significant technical evaluation and commitment of expense or capital by our customers. Accordingly, the sales cycles, or the time from finding a prospective customer through closing the sale, associated with these products or collaborations, typically range from six to eighteen months. Sales of these products and the formation of these collaborations are subject to a number of significant risks, including customers’ budgetary constraints and internal acceptance reviews that are beyond our control. Due to these lengthy and unpredictable sales cycles, our operating results could fluctuate significantly from quarter to quarter. We expect to continue to experience significant fluctuations in quarterly operating results due to a variety of factors, such as general and industry specific economic conditions, that may affect the research and development expenditures of pharmaceutical and biopharmaceutical companies.

Our products and services involve significant scientific risk of fulfillment.

A large portion of our revenues relies upon our and our customers’ scientific success. Our products, services and technologies may fail to assist our customers in achieving their drug discovery objectives, on a timely basis or at all. For example, when our customers deliver proteins to us for assay development or chemistry library design ideas for chemical compound development and production, we rely on our customers for timely delivery of those deliverables, and our customers rely on us for timely and effective assay design or compound library development and production that fulfills our scientific obligations to them. To the extent that either we experience delays or failures in receiving

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specific deliverables required for us to complete our objectives or we encounter delays in our ability to meet, or are unable to meet, our scientific obligations, we may be unable to receive and recognize revenues in accordance with our expectations.

If our revenues decline or do not grow as anticipated, we might not be able to correspondingly reduce our operating expenses.

A large portion of our expenses, including expenses for facilities, equipment and personnel, is relatively fixed. Accordingly, if revenues decline or do not grow as anticipated, we might not be able to correspondingly reduce our operating expenses. Failure to achieve anticipated levels of revenues could therefore significantly harm our operating results for a particular fiscal period.

Due to the possibility of fluctuations in our revenues (on an absolute basis and relative to our expenses), we believe that quarter-to-quarter comparisons of our operating results are not a reliable indication of our future performance.

If our products and services do not become widely used in the pharmaceutical and biopharmaceutical industries, it is unlikely that we will be profitable.

We have a limited history of offering our products and services, including informatics tools, biology services, µARCS, toxicology services, Crystal Farm and combinatorial chemistry instrumentation systems. It is uncertain whether our current customers will continue to use these products and services or whether new customers will use these products and services. In order to be successful, our products and services must meet the requirements of the pharmaceutical and biopharmaceutical industries, and we must convince potential customers to use our products and services instead of competing technologies and offerings. Moreover, we cannot thrive unless we can achieve economies of scale on our various offerings. Market acceptance will depend on many factors, including our ability to:

•convince potential customers that our technologies are attractive alternatives to other technologies for drug discovery;

•manufacture products and conduct services in sufficient quantities with acceptable quality and at an acceptable cost;

•convince potential customers to purchase drug discovery products and services from us rather than developing them internally; and

•place and service sufficient quantities of our products.

Because of these and other factors, some of which are beyond our control, our products and services may not gain sufficient market acceptance.

The intellectual property rights on which we rely to protect the technology underlying our products and techniques may not be adequate, which could enable third parties to use our technology or very similar technology and could reduce our ability to compete in the market.

Our success will depend, in part, on our ability to obtain, protect and enforce patents on our technology and to protect our trade secrets. We also depend, in part, on patent rights that third parties license to us. Any patents we own or license may not afford meaningful protection for our technology and products. Others may challenge our patents or the patents of our licensors and, as a result, these patents could be narrowed, invalidated or rendered unenforceable. In addition, current and future patent applications on which we depend may not result in the issuance of patents in the United States or foreign countries. Competitors may develop products similar to ours that are not covered by our patents. Further, since there is a substantial backlog of patent applications at the U.S. Patent and Trademark Office, the approval or rejection of our or our competitors’ patent applications may take several years.

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Our European eukaryotic gene profiling patent was opposed by various companies. Oral proceedings were held before the Opposition Division of the European Patent Office in January 2003. At the conclusion of the hearing, the Opposition Division maintained our patent in amended form. The period during which an appeal of the Opposition Division decision could be made has expired. As amended, the patent claims kits and methods for identifying and characterizing the potential toxicity of a compound using expression profiles of four categories of stress.

In addition to patent protection, we also rely on copyright protection, trade secrets, know-how, continuing technological innovation and licensing opportunities. In an effort to maintain the confidentiality and ownership of our trade secrets and proprietary information, we require our employees, consultants and advisors to execute confidentiality and proprietary information agreements. However, these agreements may not provide us with adequate protection against improper use or disclosure of confidential information, and there may not be adequate remedies in the event of unauthorized use or disclosure. Furthermore, like many technology companies, we may from time to time hire scientific personnel formerly employed by other companies involved in one or more areas similar to the activities conducted by us. In some situations, our confidentiality and proprietary information agreements may conflict with, or be subject to, the rights of third parties with whom our employees, consultants or advisors have prior employment or consulting relationships.

We acquired an exclusive license to the µARCS technology from Abbott Laboratories. The µARCS technology provides high throughput screening of compounds against a very broad range of drug discovery targets. Under the license agreement, Abbott is required to seek patent coverage for the licensed technology. If any license disputes arise between us and Abbott relating to the µARCS technology and we are not able to resolve those disputes, or if Abbott is unsuccessful in obtaining adequate patent coverage for the µARCS technology, our ability to screen compounds may be compromised and we may not be able to prevent competitors, including Abbott, from using the µARCS technology, which could have a material adverse effect on our financial condition and results of operations.

Although we require our employees and consultants to maintain the confidentiality of all confidential information of previous employers, their prior affiliations may subject us or these individuals to allegations of trade secret misappropriation or other similar claims. Finally, others may independently develop substantially equivalent proprietary information and techniques, or otherwise gain access to our trade secrets. Our failure to protect our proprietary information and techniques may inhibit or limit our ability to exclude certain competitors from the market.

The drug discovery industry has a history of intellectual property litigation and we may be involved in intellectual property lawsuits, which may be lengthy and expensive.

In order to protect or enforce our patent rights, we may have to initiate legal or administrative proceedings against third parties. In addition, others may sue us or initiate interference proceedings against us for infringing their intellectual property rights, or we may find it necessary to initiate a lawsuit seeking a declaration from a court that we are not infringing the proprietary rights of others. The patent positions of pharmaceutical, biopharmaceutical and drug discovery companies are generally uncertain. A number of pharmaceutical companies, biopharmaceutical companies, independent researchers, universities and research institutions may have filed patent applications or may have been granted patents that cover technologies similar to the technologies owned by, or licensed to, us or our collaborators. A number of patents may have been issued or may be issued in the future that could cover certain aspects of our technology and that could prevent us from using technology that we use or expect to use. In addition, we are unable to determine all of the patents or patent applications that may materially affect our ability to make, use or sell any potential products. Legal or administrative proceedings relating to intellectual property would be expensive, take significant time and divert management’s attention from other business concerns, no matter whether we win or lose. The cost of such litigation, interference or administrative proceedings could hurt our profitability.

Further, an unfavorable judgment in an administrative proceeding, interference or infringement lawsuit brought against us, in addition to any damages we might have to pay, could prevent us from obtaining intellectual property protection for our technology, require us to stop the infringing activity or obtain a license. Any required license may not be available to us on acceptable terms, or at all. In addition, some licenses may be nonexclusive, and therefore, our competitors may have access to the same technology that is licensed to us. If we fail to obtain a required license or are unable to design around a patent, we may be unable to sell some of our products or services.

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Our stock price will likely be volatile.

The trading price of our common stock has been and will likely continue to be volatile and could be subject to fluctuations in price in response to various factors, many of which are beyond our control, including:

•actual or anticipated variations in quarterly operating results;

•announcements of technological innovations by us or our competitors;

•new products or services introduced or announced by us or our competitors;

•changes in financial estimates by (or the beginning or cessation of research coverage by) securities analysts;

•the announcements by us or our competitors of financial results that do not meet or exceed the results anticipated by the public markets;

•conditions or trends in the pharmaceutical and biopharmaceutical industries or in the drug discovery services industry;

•announcements by us or our competitors of significant acquisitions, collaborations, joint ventures or capital commitments, or terminations of collaborations or joint ventures;

•the implementation or wind-down of stock buyback programs;

•additions or departures of key personnel;

•economic and political factors; and

•sales of our common stock, including sales by any of our stockholders who beneficially own more than 5% of our common stock and who could potentially sell large amounts of our common stock at any one time.

In addition, price and volume fluctuations in the stock market in general, and the Nasdaq National Market and the market for technology companies in particular, have often been unrelated or disproportionate to the operating performance of those companies. Further, the market prices of securities of life sciences companies have been particularly volatile. Conditions or trends in the pharmaceutical and biopharmaceutical industries generally may cause further volatility in the trading price of our common stock, because the market may incorrectly perceive us as a pharmaceutical or biopharmaceutical company and our customers are pharmaceutical and biopharmaceutical companies. These broad market and industry factors may harm the market price of our common stock, regardless of our operating performance. In the past, plaintiffs have often instituted securities class action litigation following instances of volatility in the market price of a company’s securities. A securities class action suit against us could result in potential liabilities, substantial costs and the diversion of management’s attention and resources, regardless of whether we win or lose.

Our customers may restrict our use of scientific information, which could prevent us from using this information for additional revenue.

We plan to generate and use information that is not proprietary to our customers and which we derive from performing drug discovery services for our customers. However, our customers may not allow us to use information such as the general interaction between types of chemistries and types of drug targets that we generate when performing drug discovery services for them. Our current contracts typically restrict our use of certain scientific information we generate for our customers, such as the biological activity of chemical compounds with respect to drug targets, and future contracts also may restrict our use of additional scientific information. To the extent that our use of

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information is restricted, we may not be able to collect and aggregate scientific data and take advantage of potential revenue opportunities.

Our ability to grow will depend on our attracting and retaining key executives, experienced scientists and sales personnel.

Our future success will depend to a significant extent on our ability to attract, retain and motivate highly skilled scientists and sales personnel. In addition, our business would be significantly harmed if we lost the services of Riccardo Pigliucci, our chief executive officer. We do not maintain life insurance on any of our officers. Our ability to maintain, expand or renew existing collaborations with our customers, enter into new collaborations and provide additional services to our existing customers depends, in large part, on our ability to hire and retain scientists with the skills necessary to keep pace with continuing changes in drug discovery technologies and sales personnel who are highly motivated. Additionally, it is difficult for us to find qualified sales personnel in light of the fact that our sales personnel generally hold PhD’s in scientific fields. Our U.S. employees are “at will,” which means that they may resign at any time, and we may dismiss them at any time (subject, in some cases, to severance payment obligations). We believe that there is a shortage of, and significant competition for, scientists with the skills and experience in the sciences necessary to perform the services we offer. We compete with pharmaceutical companies, biopharmaceutical companies, combinatorial chemistry companies, contract research companies and academic institutions for new personnel. If we do not attract new scientists or sales personnel or retain or motivate our existing personnel, we will not be able to grow.

We have acquired several businesses and face risks associated with integrating these businesses and potential future acquisitions.

We have acquired several businesses and plan to continue to review potential acquisition candidates in the ordinary course of our business, and our strategy includes building our business through acquisitions. Acquisitions involve numerous risks, including, among others, difficulties and expenses incurred in the consummation of acquisitions and assimilation of the operations, personnel and services or products of the acquired companies, difficulties of operating new businesses, the diversion of management’s attention from other business concerns and the potential loss of key employees of the acquired company. In addition, acquired businesses may have management structures incompatible with our own and may experience difficulties in maintaining their existing levels of business after joining us. If we do not successfully integrate and grow the businesses we have acquired or any businesses we may acquire in the future, our business will suffer. Additionally, acquisition candidates may not be available in the future or may not be available on terms and conditions acceptable to us. Acquisitions of foreign companies also may involve additional risks of assimilating different business practices, overcoming language and cultural barriers and foreign currency translation. We currently have no agreements or commitments with respect to any acquisition, and we may never successfully complete any additional acquisitions.

We may incur write-downs or write-offs in connection with potential future acquisitions, and exit costs, losses and liabilities in connection with potential future business divestitures or shut-downs.

We incurred a $50.9 million goodwill impairment charge during the fourth quarter of 2002, which represented the write-off of goodwill that we had accumulated in connection with several acquisitions. In the event that we make future acquisitions, we may take additional write-downs or write-offs associated with acquired assets, which could have a material adverse effect on our results of operations and financial condition. Any future acquisitions we make may also not improve our business as much as we expect, or be accretive to our earnings, which could cause the trading price of our common stock to decline. In addition, if any future acquisitions we make do not improve our business as much as we expect, we may choose to discontinue the businesses associated with those acquisitions by divestiture or by shutting those businesses down. We may also choose to divest or shut down existing businesses or product or service lines for strategic reasons. We may incur substantial exit costs, losses and liabilities in connection with any such divestiture or shut-down.

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Our success will depend on our ability to manage growth and expansion.

Growth in our operations has placed and, if we grow in the future, will continue to place a significant strain on our operational, human and financial resources. We intend to continue to grow our business internally and by acquisition. As and if we expand our operations we will not necessarily have in place infrastructure and personnel sufficient to accommodate the increased size of our business. Our ability to effectively manage any growth through acquisitions or any internal growth will depend, in large part, on our ability to hire, train and assimilate additional management, professional, scientific and technical personnel and our ability to expand, improve and effectively use our operating, management, marketing and financial systems to accommodate our expanded operations. These tasks are made more difficult as we acquire businesses in geographically disparate locations.

Our operations could be interrupted by damage to our facilities.

Our results of operations are dependent upon the continued use of our highly specialized laboratories and equipment. Our operations are primarily concentrated in facilities in San Diego, California, South San Francisco, California and Allschwil, Switzerland. Natural disasters, such as earthquakes or fires, or terrorist acts could damage our laboratories or equipment and these events may materially interrupt our business. We maintain business interruption insurance to cover lost revenues caused by such occurrences. However, this insurance would not compensate us for the loss of opportunity and potential adverse impact on relations with existing customers created by an inability to meet our customers’ needs in a timely manner, and may not compensate us for the physical damage to our facilities.

We have accrued significant net operating loss carryforwards that we believe we will not be able to fully use.

At December 31, 2003, we had federal and California income tax net operating loss carryforwards of approximately $21.8 million and $14.5 million, respectively. The federal and California tax loss carryforwards will begin to expire in 2010 and 2005, respectively, unless previously utilized. We believe that our ability to utilize our net operating loss carryforwards may be substantially restricted by the limitations of Section 382 of the Internal Revenue Code which apply when there are certain changes in ownership of a corporation. To the extent we begin to realize significant taxable income, these limitations may result in our incurring federal income tax liability notwithstanding the existence of otherwise available carryforwards. To date we have not quantified the potential impact of these limitations.

We are subject to foreign currency risk related to conducting business in multiple currencies.

Currency fluctuations between the U.S. dollar and the currencies in which we do business, including the British pound, the Japanese yen, the Swiss franc, the Euro and the Indian rupee, will cause foreign currency translation gains and losses. We cannot predict the effects of exchange rate fluctuations on our future operating results because of the number of currencies involved, changes in the percentage of our revenue that will be invoiced in foreign currencies, the variability of currency exposure and the potential volatility of currency exchange rates. Because we conduct business in multiple currencies we are subjected to economic and earnings risk. We do not currently engage in foreign exchange hedging transactions to manage our foreign currency exposure; however, we may begin to hedge certain transactions between the Swiss franc and other currencies that are invoiced from our Swiss affiliate in order to minimize foreign exchange transaction gains and losses.

We may be subject to liability regarding hazardous materials.

Our products and services as well as our research and development processes involve the controlled use of hazardous materials. For example, we often use dangerous acids, bases, oxidants, radio isotopic and flammable materials. We are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of such materials and certain waste products. We cannot completely eliminate the risk of accidental contamination or injury from these materials. In the event of such an accident, we could be held liable for any damages that result, and any such liability could exceed our resources and disrupt our business. In addition, we may have to incur significant costs to comply with environmental laws and regulations related to the handling or disposal of such materials or waste products in the future, which would require us to spend substantial amounts of money.

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Because it is unlikely that we will pay dividends, our stockholders will only be able to benefit from holding our stock if the stock price appreciates.

We have never paid cash dividends on our capital stock and do not anticipate paying any cash dividends in the foreseeable future.

Anti-takeover provisions in our stockholder rights plan and in our charter and bylaws could make a third-party acquisition of us difficult.

In 2003 we adopted a stockholder rights plan (a so-called “poison pill”). Also, our certificate of incorporation and bylaws contain provisions that could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Short-term investments.  Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since a significant portion of our investments are and will be in short-term marketable securities, U.S. government securities and corporate bonds. Due to the nature and maturity of our short-term investments, we have concluded that there is no material market risk exposure to our principal. The average maturity of our investment portfolio is six months. A 1% change in interest rates would have an effect of approximately $384,000 on the value of our portfolio.

Foreign currency rate fluctuations.  The functional currency for our Discovery Partners International AG (DPI AG) group is the Swiss franc. DPI AG accounts are translated from their local currency to the U.S. dollar using the current exchange rate in effect at the balance sheet date for the balance sheet accounts, and using the average exchange rate during the period for revenues and expense accounts. The effects of translation for our DPI AG group are recorded as a separate component of stockholders’ equity (accumulated other comprehensive income (loss)). DPI AG conducts its business with customers in local currencies. Exchange gains and losses arising from these transactions are recorded using the actual exchange differences on the date the transaction is settled.

The functional currency for our Discovery Partners International LLC (DPI LLC) group is the Japanese yen. DPI LLC accounts are translated from their local currency to the U.S. dollar using the current exchange rate in effect at the balance sheet date for the balance sheet accounts, and using the average exchange rate during the period for revenues and expense accounts. The effects of translation for our DPI LLC group are recorded as a separate component of stockholders’ equity (accumulated other comprehensive income (loss)). DPI LLC conducts its business in local currencies. Exchange gains and losses arising from these transactions are recorded using the actual exchange differences on the date the transaction is settled.

We have not in the past taken any action to reduce our exposure to changes in foreign currency exchange rates, such as options or futures contracts, with respect to transactions with DPI AG, DPI LLC or transactions with our worldwide customers, but anticipate that we could begin to hedge against foreign exchange transaction gains and losses resulting from non-Swiss franc invoices issued to customers by DPI AG in the future. A 10% change in the value of the Swiss franc and Japanese Yen, collectively, relative to the U.S. dollar throughout 2004 would have resulted in a 2% change in revenue for the nine months ended September 30, 2004.

Inflation.  We do not believe that inflation has had a material impact on our business or operating results during the periods presented.

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Item 4. Controls and Procedures

(a)  Controls and Procedures

We have carried out an evaluation, under the supervision and the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the fiscal quarter covered by this report. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in providing reasonable assurance that (a) the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (b) such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

We are evaluating the effectiveness of our internal controls over financial reporting in order to comply with Section 404 of the Sarbanes-Oxley Act of 2002. Section 404 requires us to evaluate annually the effectiveness of our internal controls over financial reporting as of the end of each fiscal year beginning in 2004, and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports beginning with our Annual Report on Form 10-K for the fiscal year ending on December 31, 2004. Section 404 also requires our independent accountant to attest to, and report on, management’s assessment of our internal controls over financial reporting. In evaluating our internal controls over financial reporting, we have identified a number of changes that need to made to our internal controls, primarily related to better documentation of our controls, including information systems used in financial reporting and formalization of policies and procedures. We began making these changes during the third quarter of 2004. The changes during the third quarter of 2004 did not, individually or in the aggregate, have a material effect on our internal controls over financial reporting.

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PART II

OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The registration statement (File No. 333-36638) for our initial public offering was declared effective by the SEC on July 27, 2000. We received net proceeds from the offering of approximately $94.7 million. Through September 30, 2004, we had used approximately $17.0 million of the net proceeds for acquisitions of companies, $6.0 million for prepaid µARCS royalties, $11.3 million for capital expenditures and $1.1 million for costs associated with restructuring.

Item 3. Defaults Upon Senior Securities

None.

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

None.

Item 5. Other Information

None.

Item 6. Exhibits

Exhibit Number	Exhibit Description
3.1	Certificate of Incorporation of the Company (1)
3.2	Bylaws of the Company (1)
4.1	Specimen common stock certificate (2)
4.2	Rights Agreement, dated as of February 13, 2003, including the form of Certificate of Designation, the form of Rights Certificate and the Summary of Rights (3)
10.81†	Agreement, dated August 20, 2004, between us and National Institute of Mental Health
31.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of the 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	Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(1)Incorporated by Reference to the Company’s Registration Statement No. 333-36638 on Form S-1 filed with the Securities and Exchange Commission on June 23, 2000

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(2)Incorporated by Reference to the Company’s Registration Statement No. 333-36638 on Form S-1 filed with the Securities and Exchange Commission on July 26, 2000

(3)Incorporated by Reference to the Company’s Report on Form 8-K filed with the Securities and Exchange Commission on February 24, 2003

†Certain confidential portions of this Exhibit were omitted by means of redacting a portion of the text (the “Mark”). This Exhibit has been filed separately with the Secretary of the Commission without the Mark pursuant to the Company’s Application Requesting Confidential Treatment under Rule 24b-2 under the Securities Exchange Act of 1934.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	DISCOVERY PARTNERS INTERNATIONAL, INC.
Date: November 9, 2004	By:	/s/	Riccardo Pigliucci
		Riccardo Pigliucci
		Chief Executive Officer (Duly Authorized Officer)
Date: November 9, 2004	By:	/s/		Craig Kussman
		Craig Kussman
		Chief Financial Officer,
		Senior Vice President Finance and Administration and Secretary (Principal Financial and Accounting Officer)

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EXHIBIT INDEX

Exhibit Number	Exhibit Description
3.1	Certificate of Incorporation of the Company (1)
3.2	Bylaws of the Company (1)
4.1	Specimen common stock certificate (2)
4.2	Rights Agreement, dated as of February 13, 2003, including the form of Certificate of Designation, the form of Rights Certificate and the Summary of Rights (3)
10.81†	Agreement, dated August 20, 2004, between us and National Institute of Mental Health
31.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of the 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	Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(1)Incorporated by Reference to the Company’s Registration Statement No. 333-36638 on Form S-1 filed with the Securities and Exchange Commission on June 23, 2000

(2)Incorporated by Reference to the Company’s Registration Statement No. 333-36638 on Form S-1 filed with the Securities and Exchange Commission on July 26, 2000

(3)Incorporated by Reference to the Company’s Report on Form 8-K filed with the Securities and Exchange Commission on February 24, 2003

†Certain confidential portions of this Exhibit were omitted by means of redacting a portion of the text (the “Mark”). This Exhibit has been filed separately with the Secretary of the Commission without the Mark pursuant to the Company’s Application Requesting Confidential Treatment under Rule 24b-2 under the Securities Exchange Act of 1934.

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EX-10.81

Exhibit 10.81

*** CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT (INDICATED BY ASTERISKS) HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT UNDER 17 C.F.R. SECTIONS 200.80(B)(4) AND 240.24B-2.

Contract No. N01MH41001

HHS-N-278-2004-41001C

SECTION B - SUPPLIES OR SERVICES AND PRICES/COSTS

ARTICLE B.1.  BRIEF DESCRIPTION OF SUPPLIES OR SERVICES

Title:“Molecular Libraries Small Molecule Repository (A Roadmap Initiative)”

The Molecular Libraries Small Molecule Repository will handle, store, distribute a chemically diverse small molecule collection of up to 1,000,000 compounds with the goal of progressively populating biologically relevant chemical space with compounds having >5,000 chemical scaffolds. The objectives of the contract are:  (1) To identify and acquire, in coordination with the NIH and scientific advisory groups, candidate compounds from government, academic, industry, and commercial sources and assemble a collection of compounds meeting specified criteria; (2) to array all compounds in sets suitable for high-throughput screening (HTS) and long-term storage; (3) to distribute compound arrays to the Molecular Libraries Screening Centers, and to other interested HTS facilities; (4) to array and distribute subsets of compounds to extramural investigators on a fee for service basis; (5) to store maintain and track the compound collection inventory, and to monitor the stability of compounds in the library; (6) to monitor the compound inventory to ensure that sufficient quantities of all compounds are available to support screening needs and to re-purchase or synthesize sufficient quantities of depleted compounds to replenish the inventory; and (7) to provide the necessary informatics support to track compound inventory and distribution.

ARTICLE B.2.  ESTIMATED COST, FIXED FEE AND INCENTIVE FEE(S)

a.The estimated cost of the Base Period of this contract is $[...***...], which includes partial exercise of Option – 04 for FY04 ($[...***...]).

b.The fixed fee for Base Period of this contract is $[...***...].  The fixed fee shall be subject to the withholding provisions of the clauses ALLOWABLE COST AND PAYMENT and FIXED FEE referenced in the General Clause Listing in Part II, ARTICLE I.1.of this contract.  Payment of fixed fee shall be made in equal monthly installments.

c.The above estimated cost and fixed fee is based upon acquiring, storing and processing a compound library size of

approximately 500,000 compounds. In addition to options to extend the Period of Performance in subparagraph e. below, there are options in subparagraph i. which may revise the above estimated cost and fee, as follows:

Option 03 - option to utilize an [...***...], at a [...***...], including incentive fee

Option 04 - option to increase funding for acquisition of compound samples

Option 05 - option for funding library collections above 500,000 compounds

d.The Government’s total obligation, represented by the sum of the estimated cost and fixed fee for the Base Period is $23,790,782, as specified in the following chart:

Base Periods 1-5

FY	Base Periods 1-5	Estimated Costs	Option – 04		Fixed Fee	Estimated Cost Plus Fixed Fee
04	Period 1 (8/23/04 -12/23/04)	[***]	$	[***]	[***]	[***]
05	Period 2 (12/24/04-12/23/05)	[***]			[***]	[***]
06	Period 3 (12/24/05-12/23/06)	[***]			[***]	[***]
07	Period 4 (12/24/06-12/23/07)	[***]			[***]	[***]
08	Period 5 (12/24/07-12/23/08)	[***]			[***]	[***]
	Total Base Period	[***]	[***]		[***]	[***]

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e.If the Government exercises its option pursuant to ARTICLE H.1.of this contract, the Government’s total obligation represented by the sum of the estimated cost plus the fixed fee will be increased as follows:

Options 01 and 02  – Option to Extend the Term of the Contract

Option Periods 6-10

FY	Option Periods	Estimated Costs	Fixed Fee	Estimated Cost Plus Fixed Fee
	Option – 01
09	Period 6 (12/24/08-12/23/09)	[***]	[***]	[***]
10	Period 7 (12/24/09-12/23/10)	[***]	[***]	[***]
	Total Option – 01	[***]	[***]	[***]
	Option – 02
11	Period 8 (12/24/10-12/23/11)	[***]	[***]	[***]
12	Period 9 (12/24/11-12/23/12)	[***]	[***]	[***]
13	Period 10 (12/24/12-12/23/13)	[***]	[***]	[***]
	Total Option 02	[***]	[***]	[***]
	Total Option Periods	[***]	[***]	$	21,785,630
	Grand Total Base and Options	[***]	[***]	$	45,576,412

f.Total funds currently available for payment and allotted to this contract are [...***...], of which [...***...] represents the estimated costs (which includes partial exercise of Option 04 in the amount of $[...***...]), and [...***...] represents the fixed-fee.  For further provisions on funding, see the LIMITATION OF FUNDS clause referenced in Part II, ARTICLE I.2. Authorized Substitutions of Clauses.

g.It is estimated that the amount currently allotted will cover performance of the contract through December 23, 2004.

h.The Contracting Officer may allot additional funds to the contract without the concurrence of the Contractor.

i.Other Options

(1)  Option 03 ([...***...])

(a)If, upon further evaluation of the Contractor’s [...***...], it is accepted for use under this contract, the Government shall give the Contractor written preliminary notice to order this [...***...] no later than [...***...] in order to avoid possible delays in contract performance.  The Contractor shall have [...***...]) to accept or reject the order.

(b)If the order is accepted by the Contractor and the [...***...] successfully installed, the estimated costs for performance of this contract are revised as follows:

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Option 03 - Alternate Compound Storage System

	Estimated Cost	Option 04	Fixed Fee	Incentive Fee	Total Cost Plus |Fees
Total Periods 1-5	[***]	[***]	[***]	[***]	[***]
Total Periods 6-10	[***]		[***]	[***]	[***]
Total Base Plus Options	[***]	[***]	[***]	[***]	$	44,986,742

(c)Incentive Fee – the Contractor shall be entitled to incentive fee, as specified herein, if the Government is provided with an [...***...] that (1) is [...***...] on or about the same date when the [...***...] would have been available; (2) offers [...***...] as the [...***...]; and (3) offers [...***...] compared to the [...***...], at a [...***...] to the Government. No incentive fee will be available if the [...***...] is ultimately used.

(d)Methodology for Incentive Fee Evaluation/Determination

(i)Initial recovery of this fee shall be an amount retroactive to the start date of the contract, in one

lump sum, and in equal monthly installments thereafter.  Incentive fee will be recovered as an

addition to the fixed fee (and in the same manner as fixed fee).

(ii)The Government shall have [...***...] after the [...***...] is installed to inspect and provide acceptance of the [...***...] for the purpose of initiating the Incentive fee, in accordance with the Section E of this contract.

(iii)The amount of the incentive fee for this Option, available for the Base Period, is [...***...]

(iv)If the Contractor continues to utilize a similar [...***...] through out the option periods, as in the Base Period, the Contractor shall recover incentive fee, but only for each option period exercised by the Government (total amount available for Periods 6-10 is [...***...]).

(e)[...***...]Warranty and Service Contracts - If this option is exercised the Contractor will provide a warranty and annual service contract on the [...***...] substantially similar in [...***...] to the warranty and annual service contracts provided by the vendor of the [...***...]. Should the Contractor at any time replace the [...***...] with the [...***...], the Contractor shall forfeit any unrecovered incentive fee; the depreciation schedule shall be modified to delete the [...***...] and include the [...***...] (i.e., depreciation costs shall cease on the [...***...] and begin for the [...***...], with no overlapping payments).

(2)Option 04  (Increased Funds for Compound Acquisition Costs)

(a)Due to the uncertainty of actual compound purchase and re-supply prices/costs during the contract, the Government must have some flexibility to adjust the funding of costs directly associated with  purchase and re-supply of compounds, in order to achieve contract objectives.

(b)Therefore, at any time during the contract, the Government shall have the unilateral option to increase

 the funding of direct compound purchases, for the then applicable targeted number of compounds,  from the budgeted amount of [...***...], up to a ceiling amount of [...***...].

(c)Funding for purchase of compounds is hereby increased by [...***...], from [...***...] to [...***...].

(3)Option 05 – Increased library Collection Sizes (Costs plus Incentive Fee)

(a)The negotiated costs for this contract include options for the acquisition, storage, processing and distribution of library collections above 500,000 compounds (i.e., 750,000 and 1,000,000 compounds

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respectively). The Government shall have the option of providing additional funds, if necessary, to reach a new target size (up to 1,000,000 compounds).

(b)Any costs and fee associated with increased compound collections above 500,000 compounds shall be negotiated based upon the Contractor’s estimated costs (below), contract achievements in relation to the effort, and projected benefit to the Government of larger library sizes. Agreement will be reached and shall be represented in a bilateral modification to the contract prior to the increased library size taking effect.

(c)If increased funding is not required to initially exceed 500,000 compounds, the Contractor shall continue to acquire compounds at the direction of the GPO, and in accordance with the Limitation of Funds clause, until such a time that additional compounds precipitate, or are projected to precipitate, an increase in the overall effort negotiated for achieving the 500,000 compound target to operate this repository.   At that time the Contractor and the Government shall negotiate a modification to the contract as in (b) above.

(d)If increased funding is required at any time, the Contractor must notify the Government in accordance with the Limitations of Funds clause.

Option 05 - Increased library Sizes (with commercial compound storage system)

750,000 compounds	Estimated Total Costs (Excluding FCCM)
Base Periods 1-5	[***]
Option Periods 6-10	[***]
Total Base and Options	$	45,155,782

1,000,000 compounds	Estimated Total Costs (Excluding FCCM)
Base Periods 1-5	[***]
Option Periods 6-10	[***]
Total Base and Options	$	48,161,431

ARTICLE B.3.  PROVISIONS APPLICABLE TO DIRECT COSTS

a.Items Unallowable Unless Otherwise Provided

Notwithstanding the clauses, ALLOWABLE COST AND PAYMENT and FIXED FEE incorporated in this contract, unless authorized in writing by the Contracting Officer, the costs of the following items or activities shall be unallowable as direct costs:

(1)Acquisition, by purchase or lease, of any interest in real property;

(2)Special rearrangement or alteration of facilities, except those alterations or rearrangements that are related to preparation of the Contractor’s facilities for, and the installation of equipment related to, the performance of this contract;

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(3)Purchase or lease of any item of general-purpose office furniture or office equipment regardless of dollar value. (General purpose equipment is defined as any items of personal property which are usable for purposes other than research, such as office equipment and furnishings, pocket calculators, etc.);

(4)Accountable Government property (defined as both real and personal property with an acquisition cost of $1,000 or more and a life expectancy of more than two years) and “sensitive items” (defined and listed in the Contractor’s Guide for Control of Government Property), 1990, regardless of acquisition value.

b.Travel Costs

The Contractor shall invoice and be reimbursed for all travel costs in accordance with Federal Acquisition Regulations (FAR) 31.205-46.

ARTICLE B.4.  ADVANCE UNDERSTANDINGS

a.The Contractor shall not use repository samples (being the compound material/sample that have been acquired or synthesized or received from other sources, under this contract) in the Molecular Libraries Small Molecular Repository, for non-contract related research; repository samples shall be used only for the purposes required by this contract.

b.The Government shall own all repository samples acquired and produced under this contract, with the possible exception of any repository samples of proprietary compounds.

c.Throughout the contract term the Contractor shall actively identify and recommend to the NIH compounds that may be acquired as repository samples and prioritize their acquisition based upon the needs of the research community, availability, and cost.  The acquisition of repository samples, (either by purchase, donation, or other means) shall be an ongoing endeavor.

d.The Contractor shall acquire repository samples only after receiving approval by the Government Project Officer (GPO) or his/her designee(s).  Approvals will be deemed to have been granted for the acquisition of repository samples 30 days after submission by the Contractor to the GPO, of the proposed acquisition.

e.The Contractor may be asked to sign agreements such as Confidentiality and Nondisclosure Agreements or Material Transfer Agreements,  etc.  (see http://ott.od.nih.gov for examples) and the Contractor agrees to do so;  compound recipients may also be asked to sign these, and the Contractor agrees to ensure this is accomplished prior to the provision of any material to the compound recipient.

f.Compounds purchased shall be acquired through a competitive process whenever practicable/possible in accordance with FAR Part 13 Small Purchase Procedures (with special attention to the provisions of FAR 13.106-3, Award and Documentation). The contractor shall keep proper documentation on file supporting: (1) the criteria for evaluation and selection of all sources for compound acquisitions; (2) the price reasonableness for all acquisitions;  (3) special terms and conditions, including discounts, re-supply provisions, QC, etc., and (4) results of any negotiations.

g.The purchase of compound storage equipment and associated software that will be funded as a direct cost under this contract  shall be made only upon approval from the GPO, and only as needed to accommodate current and projected storage and processing requirements.

h.The Contractor agrees to provide, at all times, reasonable security and safeguards to avoid any loss, destruction, damage to all Government compounds and data maintained in the facility.

i.The Contractor, as directed by the GPO, may be required to perform higher levels of QC on compounds received.

j.As specified in the contract’s Statement of Work, the NIH may seek a Determination of Exceptional Circumstances (DEC)  to modify the standard Patent Rights clause incorporated into this contract (FAR 52.227-11 Patent Rights-Retention by the Contractor (Short Form), and the Contractor agrees to the provisions of the deviated patents rights clause, if implemented. Upon approval of the DEC, the attached deviated patent rights clause is incorporated into the contract, without any further action by the NIMH.

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k.Outside investigators shall not be given access to repository samples in the facility without approval from the GPO or his/her

designee(s).

l.As more fully described in G.3, the NIMH and the Contractor may agree upon a schedule of fees to be charged by, and payable to, the Contractor for access by outside investigators to compound samples. The Contractor shall establish a process, with CO approval, to ensure that all such fees are promptly collected and accounted for accurately.  Any such income received from fees charged for access to compounds shall be utilized to offset total contract costs, and as such reflected as a credit on the contractor’s invoice for the month it is received.  Labor for the completion of this service shall be included as part of the regular monthly invoice.

m.Indirect Costs

Prior to the establishment of an indirect rate agreement with the DHHS, the Contractor shall bill at the following rates:

Rate Type	Percentage	Allocation Base
Overhead:	[***]	Total direct labor & fringe benefits
G&A	[***]	Total direct costs, excluding direct materials and compounds
Materials G&A	[***]	Total direct materials & compounds purchased
FCCM	[***]	Total costs, excluding G&A

The Contractor agrees to initiate within 90 days of the contract date, and expeditiously complete, the process of negotiating an indirect rate agreement after contract award.  If it is determined that the Contractor is not using reasonable efforts to prepare, submit or negotiate a rate agreement, the Government may withhold payment of all indirect costs.  Once established, the rates in the executed rate agreement shall supplant the rates specified above.

n.Depreciation/Equipment Costs

It is agreed and understood that depreciation/usage charges for equipment shall be allowable as a direct cost to this contract.  It is agreed that the indirect rate agreement may provide an alternative way for the Contractor to fully recover the depreciation/equipment costs of equipment that is dedicated to this contract, provided that the recovery schedule is allowable for the type of equipment proposed by any applicable IRS regulations.  Any subsequent rate agreement shall take precedence over this advance understanding regarding the treatment of direct and indirect costs under this contract.

Recovery of the depreciation/equipment costs during the contract is subject to periodic adjustment to reflect actual costs, if equipment is acquired on a different schedule than estimated.

o.Confidential Treatment of Sensitive Information

The Contractor shall guarantee strict confidentiality of the information/data (specified below) that it is provided by the Government, or generated by the Contractor, during the performance of the contract.  The Government has determined that the information/data is of a sensitive nature.  The Contractor, can only make disclosure of the information/data, in whole or in part, after receiving prior written approval from the Contracting Officer.  Whenever the Contractor is uncertain with regard to the proper handling of information/data under the contract, the Contractor shall obtain a written determination from the Contracting Officer. The following information/data is considered sensitive:

•Names of any investigators who received compounds

•Chemical structures of designated proprietary compounds.

p.Price Protection

The Contractor agrees that any equipment provided to the Government for use on this contract, which the Contractor also sells commercially to other customers, shall be at provided to the Government at prices, terms and conditions, that on the whole, are at least as favorable as any other customer to date that has purchased identically configured equipment.

q.Source Code and Object Code

Unless otherwise specified herein, the Contractor shall deliver to the Government, upon the expiration date of the contract, all/any source code and object code developed, modified, and/or enhanced under this contract (as applicable).

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r.Quality Control related to the Storage, Handling, and Distribution of Repository Samples

The Contractor and GPO agree to work together to identify any issues that may relate storage, handling and distribution of repository samples.  If the GPO identifies a failure to meet the agreed quality control/assurance standards relating to storage, handling and distribution of repository samples, the Contractor shall cooperate fully with the GPO to resolve the issues.  In the event that a quality control or assurance issue(s) cannot be resolved between the Contractor and GPO, a scientific advisory group chosen by the GPO shall be asked to review the storage, handling and distribution protocols of the repository sample(s) in question and make recommendations to resolve the issue(s).

SECTION C - DESCRIPTION/SPECIFICATIONS/WORK STATEMENT

ARTICLE C.1.  STATEMENT OF WORK

Independently and not as an agent of the Government, the Contractor shall furnish all the services, qualified personnel, material, equipment, and facilities, not otherwise provided by the Government, reasonably necessary to fulfill the Contractor’s obligations set forth in the Statement of Work, SECTION J, ATTACHMENT 1, dated August 23, 2004, attached hereto and made a part of this contract.

ARTICLE C.2.  REPORTING REQUIREMENTS

Technical Reports

In addition to those reports required by the other terms of this contract (as applicable), the Contractor shall prepare and submit the reports specified below, in the manner so stated, and in accordance with ARTICLE F.2.DELIVERIES of this contract.

All technical reports shall be submitted to the GPO electronically, in Microsoft Excel or Microsoft Word format for PCs (the most recent versions released or that have been released within the 18 months prior to the period for which the report is submitted) or comparable programs that are compatible with NIMH systems.

The Contracting Officer shall also receive electronic copies of all weekly, monthly, annual, and final technical reports, in addition to signed hard copies of each annual report and the final report.

1.   Weekly Reports

Weekly reports shall be submitted to the GPO at the end of each week.  If a weekly report is due the same time as a monthly report, both shall be submitted.  The weekly report (covering such weekly period) shall include:

(a)A summary of the repository samples acquired or synthesized, requests received, and shipments made over the course of the week.

(b)A summary of compounds requiring replenishment and plans to obtain them.

(c)Clear documentation of unsuccessful efforts to obtain or synthesize a compound.

2.    Monthly Reports

The report shall include a brief narrative summary/overview of progress under the contract, any difficulties encountered and steps taken to resolve the problems, and activities planned for the ensuing reporting period.

The first reporting period consists of the first full month of performance plus any fractional part of the initial month.  Thereafter, the reporting period shall consist of each calendar month.  Monthly Reports shall be submitted to the GPO and CO electronically within 7 calendar days after the end of each contract month.  In addition to the above, the following (covering such monthly period) shall be included:

(a) A list of candidate compounds identified over the course of the month including all supporting information pertaining to the compound selection criteria.

(b) A summary of all compounds obtained for inclusion in the collection.

(c) A copy of the cumulative Distribution Log.

(d) A summary of compounds requiring replenishment and plans to obtain them.

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(e) A summary of completed compound syntheses and synthesis reports as specified below, and a summary of compounds    received from other sources.

(f) A copy of all quality control reports.

(g) Clear documentation of unsuccessful efforts to obtain or synthesize a compound.

(h) A cumulative summary of charges to outside investigators for repository services/compounds (when there is any             activity of this nature)

(i)  A list of individuals who have completed the required computer security training (and a list of those who still need to      complete the training) (see Article H.6)

3. Annual Reports

Annual reports shall be submitted to the GPO electronically (and to the CO in hard-copy) within 14 calendar days after the end of each contract year.  The report shall include a narrative summary/overview of progress under the contract, any difficulties encountered, and steps taken to resolve the problems.  The annual report shall be compiled to summarize the information contained in that year’s monthly reports (see Monthly Reports, above).  Include a copy of the Annual Utilization Report (see Article C.3., below). An annual report shall be submitted for the last year of the contract, in addition to the Final Report, below.  Submit the 1^st annual report at the end of Period 2; thereafter at the end of each Period.

4. Synthesis Reports

Synthesis Reports shall be submitted to the GPO electronically within 2 weeks of completion of synthesis.

(a) Each Synthesis Report shall include:

(1) the compound name, formula, identification number, and batch number

(2) molecular weight

(3) chemical structure

(4) date of synthesis

(5) date and method of purity analysis

(6) purity of the compound

(7) amount of the compound

(8) physical appearance

(9) physical constants

(10) recommended storage conditions

(11) toxicity and potential hazards (if known)

(12) disposal information (if known)

(13) synthesis protocol and yield

(b) The synthesis report shall be reviewed, assured for quality control, and approved by the contract Principal Investigator prior to submission to the GPO.

(c) The GPO shall review the synthesis report and determine the acceptability of the synthesized compound prior to the acceptance of the compound and its addition to the ML Small Molecule Collection/Repository.

5.Transition Plan(s)

(a)At least twelve (12) months prior to the completion date of this contract, the Contractor shall submit a written plan/system to the GPO for the potential transfer of all compounds and Government property to an offsite storage facility (potentially a successor contractor or the NIH).  A general inventory of compounds and other Government property shall be included.

(b)Upon request by the GPO, at least three (3) months prior to the completion of the contract, a full and complete inventory of compounds in the repository and all Government-owned property including scientific equipment, software programs and databases, data files, etc., shall be provided.  At this time, the Contractor shall also describe their specific plans for packaging and shipping all such compounds, data and Government property to a successor contractor or the NIH, and a cost estimate for this transition.

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(c )The Contractor,  shall fully cooperate with any successor contractor and NIMH to ensure the smooth and efficient transfer

of all such data and Government property.  The cost of any such effort shall be an allowable cost under the contract, to the extent that the Contractor presented a budget in advance, which was approved by the Contracting Officer.

6.Final Report

(a)The Final Report shall be submitted to the GPO electronically (and to the CO in hardcopy) on or before the effective contract completion date.

(b) The Final Report shall include an executive summary/evaluation of the contract’s achievements, in comparison to original objectives, problems encountered, etc.; in addition it shall include:  (1) the cumulative Distribution and Inventory Logs; (2) a summary of compounds identified as candidates for inclusion in the collection; (3) a summary of completed synthesis and synthesis reports; and (4) a summary of repository samples acquired for inclusion in the Repository.

ARTICLE C.3.  INVENTION REPORTING REQUIREMENT

All reports and documentation required by FAR CLAUSE 52.227-11 including, but not limited to, the invention disclosure report, the confirmatory license, and the government support certification, shall be directed to the Extramural Inventions and Technology Resources Branch, OPERA, NIH, 6705 Rockledge Drive, Room 1040-A, MSC 7980, Bethesda, Maryland 20892-7980 (Telephone: 301-435-1986).  In addition, one copy of an annual utilization report, and a copy of the final invention statement,  shall be submitted to the Contracting Officer.  The final invention statement (see FAR 27.303(a)(2)(ii)) shall be submitted to the Contracting Officer on the expiration date of the contract.

The Annual Utilization Report shall be submitted as part of the Annual Report and in accordance with ARTICLE F.2.DELIVERIES of this contract.  The final invention statement (see FAR 27.303(a)(2)(ii)) shall be submitted on the expiration date of the contract to the following address:

Contracting Officer

National Institutes of Health

National Institute of Mental Health

Contracts Management Branch, ORM

6001 Executive Blvd., Rm. 8154 (MSC 9661)

Bethesda, Maryland 20892-9661

If no invention is disclosed or no activity has occurred on a previously disclosed invention during the applicable reporting period, a negative report shall be submitted to the Contracting Officer at the address listed above.

To assist contractors in complying with invention reporting requirements of the clause, the NIH has developed “Interagency Edison,” an electronic invention reporting system.  Use of Interagency Edison is encouraged as it streamlines the reporting process and greatly reduces paperwork.  Access to the system is through a secure interactive Web site to ensure that all information submitted is protected.  Interagency Edison and information relating to the capabilities of the system can be obtained from the Web (http://www.iedison.gov), or by contacting the Extramural Inventions and Technology Resources Branch, OPERA, NIH.

SECTION D - PACKAGING, MARKING AND SHIPPING

The Contractor shall package and ship all materials and compounds in accordance with all local, state and federal safety and shipping regulations.

SECTION E - INSPECTION AND ACCEPTANCE

a.The Contracting Officer or the duly authorized representative will perform inspection and acceptance of the reports and any other deliverables described in Article F.2 to be provided under this contract.

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b.For the purpose of this SECTION the Government Project Officer (GPO) is the authorized representative of the Contracting Officer.

c.Inspection and acceptance will be performed at:

6001 Executive Blvd., Room 7187 (MSC 9641)

Bethesda MD 20892-9641

(use Rockville MD 20852 for overnight, courier, etc.)

Acceptance may be presumed unless otherwise indicated in writing by the Contracting Officer or the duly authorized

representative within 30 days of receipt.

d.This contract incorporates the following clause by reference, with the same force and effect as if it were given in full text.  Upon request, the Contracting Officer will make its full text available.

FAR Clause No 52.246-8, INSPECTION OF RESEARCH AND DEVELOPMENT - COST REIMBURSEMENT (MAY 2001).

SECTION F - DELIVERIES OR PERFORMANCE

ARTICLE F.1.  PERIOD OF PERFORMANCE

a.The period of performance of this contract shall be from 8/23/04 through 12/23/08.

b.The Government shall have two options to extend the term of the contract.  The first term extension option shall be for a 24-month term and shall cover periods 6 and 7 inclusively.  The second term extension option shall be for a 36-month  term and shall cover periods 8, 9, and 10 inclusively.   If the Government exercises its option(s) pursuant to Article H.1.of this contract, the period of performance will be increased as listed below:

Option #	Option Period
Option 01	Periods 6 - 7	12/24/08-12/23/10
Option 02	Periods 8-10	12/24/10-12/23/13

ARTICLE F.2.  DELIVERIES

Satisfactory performance of the final contract shall be deemed to occur upon performance of the work described in Article C.1. and upon delivery of the and acceptance by the Contracting Officer, or the duly authorized representative, of the following items in accordance with the stated delivery schedule:

a.The items specified below as described in SECTION C, ARTICLE C.2. will be required to be delivered in accordance with and by the date(s) specified below:

Item	Description	Quantity	Delivery Schedule
(a)	Weekly Reports	Electronic	At end of each calendar week
(b)	Monthly Reports	Electronic	7 calendar days after each calendar month
(c)	Annual Reports*	Electronic	14 calendar days after end of each contract year
(d)	Transition Plan(s)	Electronic	12 months before completion date
			3 months before completion date (a follow-up detailed report, if requested by the GPO)
(e)	Final Report*	Electronic	By completion date of the contract
(f)	Synthesis Reports	Electronic	14 calendar days after completion of each synthesis
(g)	Compound Collection	Entire library	Upon completion of the contract, if so directed by the GPO
(h)	All other Government property (including data, software, etc.)	1 each	By completion date (same as above)
(i)	Alternate CompoundStorage System	0-2	If requested, delivery date to be agreed upon

*also Provide a signed hard-copy to the CO

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b.The above items shall be addressed and delivered to:

(For items a-e)	(For items a-h)
Contracting Officer	Project Officer
National Institute of Mental Health (NIMH), NIH, DHHS	National Institute of Mental Health (NIMH), NIH, DHHS
6 001 Executive Blvd., Rm. 8154 (MSC 9661)	6001 Executive Blvd., Rm. 7187 (MSC 9641)
Bethesda, Maryland 20892 - 9661	Bethesda, Maryland 20892 - 9641
E-Mail: ba9i@nih.gov	Email: jd366b@nih.gov
Voice: (301) 443-2234	Voice: (301) 443-3636
Fax: (301) 443-0501	Fax: (301) 402-4740

ARTICLE F.3.  CLAUSES INCORPORATED BY REFERENCE, FAR 52.252-2 (FEBRUARY 1998)

This contract incorporates the following clause by reference, with the same force and effect as if it were given in full text.  Upon request, the Contracting Officer will make its full text available.  Also, the full text of a clause may be accessed electronically at this address:  http://www.arnet.gov/far/.

FEDERAL ACQUISITION REGULATION (48 CFR CHAPTER 1) CLAUSE:

52.242-15, Stop Work Order (AUGUST 1989), with ALTERNATE I (APRIL 1984).

SECTION G - CONTRACT ADMINISTRATION DATA

ARTICLE G.1.  PROJECT OFFICER

The following Project Officer(s) will represent the Government for the purpose of this contract:

Project Officer	*Alternate Project Officer
[***]	[***]

*The Alternate Project Officer has the full authority to act in the absence of, or in place of, the Project Officer.

The Project Officer is responsible for: (1) monitoring the Contractor’s technical progress, including the surveillance and assessment of performance and recommending to the Contracting Officer changes in requirements; (2) interpreting the Statement of Work and any other technical performance requirements; (3) performing technical evaluation as required; (4) performing technical inspections and acceptances required by this contract; and (5) assisting in the resolution of technical problems encountered during performance.

The Contracting Officer is the only person with authority to act as agent of the Government under this contract.  Only the Contracting Officer has authority to: (1) direct or negotiate any changes in the Statement of Work; (2) modify or extend the

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period of performance; (3) change the delivery schedule; (4) authorize reimbursement to the Contractor any costs incurred during the performance of this contract; or (5) otherwise change any terms and conditions of this contract.

The Government may unilaterally change its Project Officer designation.

ARTICLE G.2.  KEY PERSONNEL

Pursuant to the Key Personnel clause incorporated in Section I of this contract, the following individual(s) is/are considered to be essential to the work being performed hereunder:

Name	Title
[***]	Principle Investigator
[***]	Project Manager

ARTICLE G.3.  RECIPIENTS REIMBURSEMENT PROCEDURES

a.During the course of this contract, the Contracting Officer or his duly designated representative may notify the Contractor to make certain shipments from the repository samples directly to specified outside investigators and, subject to G.3.b below, the Contractor shall make such shipments as directed.

b.The Contractor shall bill recipients directly for the preparation/plating and shipping provided.  The charges for these services and the materials shipped shall be based upon a fee schedule  agreed to in advance between the GPO and the Contractor.  The fees shall represent an estimate of the actual costs involved.  Under no circumstances shall the Contractor bill prices other than those agreed upon prices.  Prices charged are subject to change, as agreed to between the Contractor and the Government.

c.The Contractor shall keep an accurate account of all payments received from recipients of repository samples separate from other fiscal aspects of the contract.  The Contractor shall record as credits on monthly invoices to the Government, all payments received from the outside investigators.  The income from recipients must be credited to the Government in the billing period actually received.  Thus, the Contractor shall bill the Government directly for payment of contract costs and shall subtract as a credit all payments received from recipients.  The actual collections from sales shall be offset against the gross billing, leaving a net amount due on the invoice. The NIMH Project Officer may direct from time to time that shipments be made entirely at Government expense.

d.The Contractor shall account for the contract related income separately in accordance with its own double entry accounting system.  The Contractor shall submit to the Government a Summary Sheet of Sales, which is listed as an Attachment in Section J of this contract, with each invoice and Monthly Report where there is activity of this nature. The administration of the contract related income shall be subject to the terms of this contract, including specifically and without limitation, FAR Clause 52.215-2, AUDIT—NEGOTIATION of the General Clauses, and the applicable cost principles of the Federal Acquisition Regulation.

e.The Contractor shall use the following procedures for collection of delinquent accounts:

Step 1 - Accounts 30 days past due.  A copy of the invoice shall be sent to the recipient with a notation that the account is overdue and request payment.

Step 2 - Accounts 60 days past due.  The Contractor shall turn the account over to a collection agency.

f.When the completion (final) invoice is submitted on this contract, a listing of all outstanding recipient invoices shall be provided along with details as to what disposition is expected on each.

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ARTICLE G.4.  INVOICE SUBMISSION/CONTRACT FINANCING REQUEST

a.Invoice/Financing Request Instructions for NIH Cost-Reimbursement Type Contracts NIH(RC)-1 are attached and made part of this contract.  The instructions and the following directions for the submission of invoices/financing request must be followed to meet the requirements of a “proper” payment request pursuant to FAR 32.9.

b.Invoices/financing requests shall be submitted as follows:

(1)To be considered a “proper” invoice in accordance with FAR 32.9, Prompt Payment, each invoice shall clearly

identify the two contract numbers that appear on the face page of the contract as follows:

•	HHS-N-278-2004-41001-C	This is the DHHS contract number, 17 digits (Block 2 of the SF-26)
•	N01MH41001	This is the ADB contract number, 10 digits (upper left hand corner of the SF-26)

(2) An original and two copies to the following designated billing office:

Contracting Officer

Contracts Management Branch

National Institute of Mental Health, NIH, DHHS

Neuroscience Center Building, 8154 (MSC 9661)

6001 Executive Blvd.

Bethesda, MD  20892-9661

E-mail:  ba9i@nih.gov

Phone (301) 443-2696 or 2234

Fax at (301) 443-0501

(3) Inquiries regarding payment of invoices should be directed to the designated billing office, (301) 443-2234.  

c.At a minimum, the Contractor agrees to include the following information on each invoice:

(1)Contractor’s name and invoice date

(2)Contract number(s), or other authorization for delivery of property and/or services

(3)Description, cost or price, and quantity of property and/or services actually delivered or rendered

(4)Shipping and payment terms

(5)Other substantiating documentation or information as required by the contract (see paragraph G.4.d, “NIMH

(6)Supplemental Billing Instructions” below

(7)Name where practicable, title, phone number, and complete mailing address of responsible official to whom payment is to be sent.

d.NIMH Supplemental Billing Instructions

(1)The contractor agrees to provide, as applicable, a detailed breakdown on each invoice of the following cost categories:

(a)Direct Labor - List individuals by name, title/position, hours expended and amount claimed.

(b)Fringe Benefits - Cite rate and amount

(c)Overhead - Cite rate and amount

(d)Materials & Supplies - Include general categories

(e)Compound Purchases - include amount (with subcategory of costs for synthesis and for re-purchase)

(f)Travel - Identify travelers, dates, destination, purpose of trip, and amount.

(g)Consultant Fees - Identify individuals and amounts.

(h)Equipment Depreciation - Cite amount.

(i)G&A - Cite rate(s) and amount (both the regular G&A rate and amount and the materials G&A rate and amount).

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(j)FCCOM - - Cite rate and amount

(k)Total Cost

(l)Fee(s)(segregate into fixed-fee and incentive fee, if applicable)

(m)Total Cost & Fee(s)

(n)Credit(s) for Income (as applicable)

(o)Net Financing Request

(2)Monthly invoices must include a column for the cumulative total expended to date, adjusted (as applicable) to show any amounts suspended or disallowed by the Government.

(3)The Contractor agrees to immediately notify the Contracting Officer in writing if there is an anticipated overrun (any amount), and the reasons for the variance.  Also refer to the requirements of the Limitation of Funds and Limitation of Cost Clauses in the contract.

ARTICLE G.5.  INDIRECT COST RATES

In accordance with Federal Acquisition Regulation (FAR) (48 CFR Chapter 1) Clause 52.216-7 (d)(2), Allowable Cost and Payment incorporated by reference in this contract in Part II, Section I, the cognizant Contracting Officer representative responsible for negotiating provisional and/or final indirect cost rates is identified as follows:

Director, Division of Financial Advisory Services

Office of Acquisition Management and Policy

National Institutes of Health

6100 Building, Room 6B05

6100 EXECUTIVE BLVD MSC-7540

BETHESDA MD 20892-7540

These rates are hereby incorporated without further action of the Contracting Officer.

ARTICLE G.6.  POST AWARD EVALUATION OF CONTRACTOR PERFORMANCE

a.Contractor Performance Evaluations

Interim and final evaluations of contractor performance will be prepared on this contract in accordance with FAR 42.15.  The final performance evaluation will be prepared at the time of completion of work.  In addition to the final evaluation, interim evaluations will be prepared annually to coincide with the anniversary date of the contract.

Interim and final evaluations will be provided to the Contractor as soon as practicable after completion of the evaluation.  The Contractor will be permitted thirty days to review the document and to submit additional information or a rebutting statement.  If agreement cannot be reached between the parties, the matter will be referred to an individual one level above the Contracting Officer, whose decision will be final.

Copies of the evaluations, contractor responses, and review comments, if any, will be retained as part of the contract file, and may be used to support future award decisions.

b.Electronic Access to Contractor Performance Evaluations

Contractors that have Internet capability may access evaluations through a secure Web site for review and comment by completing the registration form that can be obtained at the following address:

[...***...]

The registration process requires the contractor to identify an individual that will serve as a primary contact and who will be authorized access to the evaluation for review and comment.  In addition, the contractor will be required to

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identify an alternate contact who will be responsible for notifying the cognizant contracting official in the event the primary contact is unavailable to process the evaluation within the required 30-day time frame.

SECTION H - SPECIAL CONTRACT REQUIREMENTS

ARTICLE H.1.  OPTION PROVISION

Unless the Government exercises its option pursuant to the Option Clause set forth in ARTICLE I.3., the contract will consist only of the Base Period of the Statement of Work (Periods 1-5), as defined in Sections C and F of the contract.  Pursuant to clause 52.217-9 set forth in ARTICLE I.3. of  this contract, the Government may, by unilateral contract modification, require the Contractor to perform Option Periods of the Statement of Work (Periods 6-10) as also defined in Sections C and F of the contract.

If the Government exercises this option, preliminary notice must be given at least [...***...] prior to the expiration date of this contract, with the option exercised at least [...***...] prior to the expiration date of the contract, and the estimated cost plus fixed fee (and possible incentive fee) of the contract will be increased as set forth in ARTICLE B.2.

ARTICLE H.2.  REIMBURSEMENT OF COSTS FOR INDEPENDENT RESEARCH AND DEVELOPMENT PROJECTS

The primary purpose of the Public Health Service (PHS) is to support and advance independent research within the scientific community.  PHS has established effective, time tested and well recognized procedures for stimulating and supporting this independent research by selecting from multitudes of applications those research projects most worthy of support within the constraints of its appropriations.  The reimbursement through the indirect cost mechanism of independent research and development costs not incidental to product improvement would circumvent this competitive process.

To ensure that all research and development projects receive similar and equal consideration, all organizations may compete for direct funding of independent research and development projects they consider worthy of support by submitting those projects to the appropriate Public Health Service grant office for review.  Since these projects may be submitted for direct funding, the Contractor agrees that no costs for any independent research and development project, including all applicable indirect costs, will be claimed under this contract.

ARTICLE H.3.  HUMAN SUBJECTS

It is hereby understood and agreed that research involving human subjects shall not be conducted under this contract without the prior written approval of the Contracting Officer.

ARTICLE H.4.  NEEDLE EXCHANGE

a.Pursuant to Public Law(s) cited in paragraph b., below, contract funds shall not be used to carry out any program of distributing sterile needles or syringes for the hypodermic injection of any illegal drug.

b.	Public Law and Section No.	Fiscal Year	Period Covered
	P.L. 108-199, Title V-General Provisions, Section 505	2004	10/1/03 - 9/30/04

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ARTICLE H.5.  SALARY RATE LIMITATION LEGISLATION PROVISIONS

a.Pursuant to public law (s) cited in paragraph b., below, no NIH Fiscal Year funds may be used to pay the direct salary of an individual through this contract at a rate in excess of applicable amount shown for the fiscal year covered.  Direct salary is exclusive of fringe benefits, overhead, and general and administrative expenses (also referred to as “indirect cost” or “facilities and administrative (F&A) costs”).  Direct salary has the same meaning as the term “institutional base salary.”  An individual’s direct salary (or institutional base salary) is the annual compensation that the contractor pays for an individual’s appointment whether that individual’s time is spent on research, teaching, patient care or other activities.  Direct salary (or institutional base salary) excludes any income that an individual may be permitted to earn outside of duties to the contractor.  The per year salary rate limit also applies to individuals proposed under subcontracts.  It does not apply to fees paid to consultants.  If this is a multiple year contract, it may be subject to unilateral modifications by the Government if an individual’s salary rate exceeds any salary rate ceiling established in future HHS appropriation acts.

b.	Public Law No	Fiscal Year	Dollar Amount of Salary Limitation*
	P.L. 108-199 Title II, General Provisions, Section 204	2004	Executive Level I

c.Direct salaries, which will be paid with FY-04 funds, are limited to the Executive Level I rate that was in effect on the date(s) the expense was incurred.

*For contract expenditures using FY-04 funds, the Executive Level I rate for the period 10/1/03 - 12/31/03 is $171,900.  Effective 1/1/04, for contract expenditures using FY-04 funds, the Executive Level I rate is $175,700, and will remain at that level until such time as it is determined to raise the Executive Schedule annual rates.  See the web site listed below for Executive Schedule rates of pay.

LINK to EXECUTIVE LEVEL SALARIES:   http://www .opm.gov/oca/PAYRATES/index.htm

(Click on “Executive Schedule” for the current Fiscal Year’s salary rate or scroll down to the “General Schedule Salary Tables from Previous Years” to locate the Executive Level salary rates from previous years.)

ARTICLE H.6.  INFORMATION TECHNOLOGY SYSTEMS SECURITY SPECIFICATIONS

a.The contractor agrees to comply with the Information Technology (IT) systems security and/or privacy specifications

set forth herein; the Computer Security Act of 1987; Office of Management and Budget (OMB) Circular A-130, Appendix III, A “Security of Federal Automated Information Systems”, and the DHHS Automated Information Systems Security Program (AISSP) Handbook, which may be found at the following websites:

Computer Security Act of 1987:  http://csrc.ncsl.nist.gov/secplcy/csa_87.txt

OMB A-130, Appendix III: http://csrc.ncsl.nist.gov/secplcy/a130app3.txt

DHHS AISSP Handbook: http://irm.cit.nih.gov/policy/aissp.html

The contractor further agrees to include this provision in any subcontract awarded pursuant to this prime contract.

Failure to comply with these requirements shall constitute cause for termination.

b.The contractor shall be responsible for properly protecting all information used, gathered, or developed as a result of the SOW.  The contractor shall establish and implement reasonable and appropriate administrative, technical, and physical safeguards to ensure the security and confidentiality of sensitive Government information, data, and/or equipment.

In addition, during all activities and operations on Government premises, the contractor shall comply with DHHS,

including National Institutes of Health (NIH), rules of conduct.

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c.Required IT Systems Security Training

The contractor shall assure that each employee has completed the NIH Computer Security Awareness Training (http://irtsectraining.nih.gov/) prior to performing any work under this contract.

The contractor shall maintain a listing by name and title of each individual working under this contract who has completed the NIH required training.  Any additional security training completed by contractor staff shall be included on this listing.  The listing of completed training shall be included in the first Monthly technical progress report, and updated as needed until all employees have the required training (see Article C.2. Reporting Requirements). Any revisions to this listing as a result of staffing changes shall be submitted with next required technical progress report.

d.Position Sensitivity Designations

The Government has determined that the following position sensitivity designations and associated clearance and investigation requirements apply under this contract:

Table 3 - Position Sensitivity Designations for Individuals Accessing Agency Information

[...***...]

Contractor employees assigned to a [...***...] position are subject to a National Agency Check and Inquiry Investigation (NACI).  This applies to:  All Contractor employees who have access to Government data under this contract, maintained in a computer system/database

Contractor employees in AIS-related positions shall comply with the DHHS criteria for the assigned position sensitivity designations prior to performing any work under this contract.

Contractor employees who have met investigative requirements within the past five years may only require an updated or upgraded investigation.  Verifications of previous investigations (e.g. copies of certificates of investigations or security clearances), as well as requests for new investigations, shall be submitted to the Project Officer.

e.Commitment to Protect Sensitive Information

(1)Contractor Agreement

The Contractor shall not release, publish, or disclose sensitive information to unauthorized personnel, and shall protect such information in accordance with provisions of the following laws and any other pertinent laws and regulations governing the confidentiality of sensitive information:

-18 U.S.C. 641 (Criminal Code: Public Money, Property or Records)

-18 U.S.C. 1905 (Criminal Code: Disclosure of Confidential Information)

-Public Law 96-511 (Paperwork Reduction Act)

(2)Contractor-Employee Non-Disclosure Agreements

Each contractor employee who may have access to sensitive information under this contract shall complete the attachment entitled, “A Commitment To Protect Non-Public Information - Contractor Agreement”, which is referenced in Section J of this contract and available at:  http://irm.cit.nih.gov/security/Nondisclosure.pdf

A copy of each signed and witnessed Non-Disclosure agreement shall be submitted to the Project Officer prior to performing any work under the contract.

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ARTICLE H.7.  PUBLICATION AND PUBLICITY

The contractor shall acknowledge the support of the National Institutes of Health whenever publicizing the work under this contract in any media by including an acknowledgment substantially as follows:

“This project has been funded in whole or in part with Federal funds from the National Institutes of Health, Department of Health and Human Services, under Contract No. HHS-N-278-2004-41001C;

When citing the title of this contract, use the following specific language:  “Molecular Libraries Small Molecule Repository (A Roadmap Initiative)”

ARTICLE H.8.  PRESS RELEASES

a.Pursuant to Public Law(s) cited in paragraph b., below, the contractor shall clearly state, when issuing statements, press releases, requests for proposals, bid solicitations and other documents describing projects or programs funded in whole or in part with Federal money: (1) the percentage of the total costs of the program or project which will be financed with Federal money; (2) the dollar amount of Federal funds for the project or program; and (3) the percentage and dollar amount of the total costs of the project or program that will be financed by nongovernmental sources.

b.	Public Law and Section No.	Fiscal Year	Period Covered
	P.L. 108-199, Title V-General Provisions, Section 507	2004	10/1/03 - 9/30/04

ARTICLE H.9. REPORTING MATTERS INVOLVING FRAUD, WASTE AND ABUSE

Anyone who becomes aware of the existence or apparent existence of fraud, waste and abuse in NIH funded programs is encouraged to report such matters to the HHS Inspector General’s Office in writing or on the Inspector General’s Hotline.  The toll free number is 1-800-HHS-TIPS (1-800-447-8477).   All telephone calls will be handled confidentially.  The e-mail address is Htips@os.dhhs.gov and the mailing address is:

Office of Inspector General

Department of Health and Human Services

TIPS HOTLINE

P.O. Box 23489

Washington, D.C.  20026

ARTICLE H.10.  ANTI -LOBBYING

a.Pursuant to public law (s) cited in paragraph c., below, contract funds shall only be used for normal and recognized executive-legislative relationships.  Contract funds shall not be used, for publicity or propaganda purposes; or for the preparation, distribution, or use of any kit, pamphlet, booklet, publication, radio, television, or video presentation designed to support or defeat legislation pending before the Congress or any State legislature, except in presentation to the Congress or any State legislature itself.

b.Contract funds shall not be used to pay salary or expenses of the contractor or any agent acting for the contractor, related to any activity designed to influence legislation or appropriations pending before the Congress or any State legislature.

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c.	Public Law and Section No.	Fiscal Year	Period Covered
	for a., above: P.L. 108-199, Title V- General Provisions, Section 503a	2004	10/1/03 - 9/30/04
	for b., above: P.L. 108-199, Title V- General Provisions, Section 503b	2004	10/1/03 - 9/30/04

ARTICLE H.11.  CONTINUED BAN ON FUNDING OF HUMAN EMBRYO RESEARCH

a.Pursuant to Public Law(s) cited in paragraph b., below, NIH is prohibited from using appropriated funds to support human embryo research.  Contract funds may not be used for (1) the creation of a human embryo or embryos for research purposes; or (2) research in which a human embryo or embryos are destroyed, discarded, or knowingly subjected to risk of injury or death greater than that allowed for research on fetuses in utero under 45 CFR 46.208(a)(2) and Section 498(b) of the Public Health Service Act (42 U.S.C. 289g(b)).  The term “human embryo or embryos” includes any organism, not protected as a human subject under 45 CFR 46 as of the date of the enactment of this Act, that is derived by fertilization, parthenogenesis, cloning, or any other means from one or more human gametes or human diploid cells.

Additionally, in accordance with a March 4, 1997 Presidential Memorandum, Federal funds may not be used for cloning of human beings.

c.	Public Law and Section No.	Fiscal Year	Period Covered
	P.L. 108-199, Title V-General Provisions, Section 510	2004	10/1/03 - 9/30/04

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PART II - CONTRACT CLAUSES

SECTION I - CONTRACT CLAUSES

ARTICLE I.1.  GENERAL CLAUSES FOR A COST-REIMBURSEMENT RESEARCH AND DEVELOPMENT CONTRACT - FAR 52.252-2, CLAUSES INCORPORATED BY REFERENCE (FEBRUARY 1998)

This contract incorporates the following clauses by reference, with the same force and effect as if they were given in full text. Upon request, the Contracting Officer will make their full text available.  Also, the full text of a clause may be accessed electronically at this address:  http://www.arnet.gov/far/.

a.FEDERAL ACQUISITION REGULATION (FAR) (48 CFR CHAPTER 1) CLAUSES:

FAR CLAUSE NO.	DATE	TITLE
52.202-1	Jul 2004	Definitions
52.203-3	Apr 1984	Gratuities (Over $100,000)
52.203-5	Apr 1984	Covenant Against Contingent Fees (Over $100,000)
52.203-6	Jul 1995	Restrictions on Subcontractor Sales to the Government (Over $100,000)
52.203-7	Jul 1995	Anti-Kickback Procedures (Over $100,000)
52.203-8	Jan 1997	Cancellation, Rescission, and Recovery of Funds for Illegal or Improper Activity (Over 100,000)
52.203-10	Jan 1997	Price or Fee Adjustment for Illegal or Improper Activity (Over $100,000)
52.203-12	Jun 2003	Limitation on Payments to Influence Certain Federal Transactions (Over 100,000)
52.204-4	Aug 2000	Printed or Copied Double-Sided on Recycled Paper (Over $100,000)
52.204-7	Oct 2003	Central Contractor Registration
52.209-6	Jul 1995	Protecting the Government’s Interests When Subcontracting With Contractors Debarred, Suspended, or Proposed for Debarment (Over $25,000)
52.215-2	Jun 1999	Audit and Records - Negotiation (Over $100,000)
52.215-8	Oct 1997	Order of Precedence - Uniform Contract Format
52.215-10	Oct 1997	Price Reduction for Defective Cost or Pricing Data
52.215-12	Oct 1997	Subcontractor Cost or Pricing Data (Over $500,000)
52.215-14	Oct 1997	Integrity of Unit Prices (Over $100,000)
52.215-15	Jan 2004	Pension Adjustments and Asset Reversions
52.215-18	Oct 1997	Reversion or Adjustment of Plans for Post-Retirement Benefits (PRB) other than Pensions
52.215-19	Oct 1997	Notification of Ownership Changes
52.215-21	Oct 1997	Requirements for Cost or Pricing Data or Information Other Than Cost or Pricing Data - Modifications
52.216-7	Dec 2002	Allowable Cost and Payment
52.216-8	Mar 1997	Fixed Fee
52.219-8	May 2004	Utilization of Small Business Concerns (Over $100,000)
52.219-9	Jan 2002	Small Business Subcontracting Plan (Over $500,000)
52.219-16	Jan 1999	Liquidated Damages - Subcontracting Plan (Over $500,000)

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52.222-2	Jul 1990	Payment for Overtime Premium (Over $100,000) (Note: The dollar amount in paragraph (a) of this clause is $0 unless otherwise specified in the contract.)
52.222-3	Jun 2003	Convict Labor
52.222-26	Apr 2002	Equal Opportunity
52.222-35	Dec 2001	Equal Opportunity for Special Disabled Veterans, Veterans of the Vietnam Era, and Other Eligible Veterans
52.222-36	Jun 1998	Affirmative Action for Workers with Disabilities
52.222-37	Dec 2001	Employment Reports on Special Disabled Veterans, Veterans of the Vietnam Era, and Other Eligible Veterans
52.223-6	May 2001	Drug-Free Workplace
52.223-14	Aug 2003	Toxic Chemical Release Reporting (Over $100,000)
52.225-1	Jun 2003	Buy American Act - Supplies
52.225-13	Dec 2003	Restrictions on Certain Foreign Purchases
52.227-1	Jul 1995	Authorization and Consent, Alternate I (Apr 1984)
52.227-2	Aug 1996	Notice and Assistance Regarding Patent and Copyright Infringement (Over $100,000)
52.227-11	June 1997	Patent Rights - Retention by the Contractor (Short Form) (Note: In accordance with FAR 27.303(a)(2), paragraph (f) is modified to include the requirements in FAR 27.303(a)(2)(i) through (iv). The frequency of reporting in (i) is annual.
52.227-14	Jun 1987	Rights in Data - General
52.232-9	Apr 1984	Limitation on Withholding of Payments
52.232-17	Jun 1996	Interest (Over $100,000)
52.232-20	Apr 1984	Limitation of Cost
52.232-23	Jan 1986	Assignment of Claims
52.232-25	Oct 2003	Prompt Payment, Alternate I (Feb 2002)
52.232-33	Oct 2003	Payment by Electronic Funds Transfer—Central Contractor Registration
52.233-1	Jul 2002	Disputes
52.233-3	Aug 1996	Protest After Award, Alternate I (Jun 1985)
52.242-1	Apr 1984	Notice of Intent to Disallow Costs
52.242-3	May 2001	Penalties for Unallowable Costs (Over $500,000)
52.242-4	Jan 1997	Certification of Final Indirect Costs
52.242-13	Jul 1995	Bankruptcy (Over $100,000)
52.243-2	Aug 1987	Changes - Cost Reimbursement, Alternate V (Apr 1984)
52.244-2	Aug 1998	Subcontracts, Alternate II (Aug 1998) *If written consent to subcontract is required, the identified subcontracts are listed in ARTICLE B, Advance Understandings.
52.244-5	Dec 1996	Competition in Subcontracting (Over $100,000)
52.245-5	May 2004	Government Property (Cost-Reimbursement, Time and Material, or Labor-Hour Contract)
52.246-23	Feb 1997	Limitation of Liability (Over $100,000)
52.249-6	Sep 1996	Termination (Cost-Reimbursement)
52.249-14	Apr 1984	Excusable Delays
52.253-1	Jan 1991	Computer Generated Forms

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b.DEPARTMENT OF HEALTH AND HUMAN SERVICES ACQUISITION REGULATION (HHSAR) (48 CFR CHAPTER 3) CLAUSES:

The HHSAR is available online at:  http://www.hhs.gov/ogam/oam/procurement/hhsar.html

HHSAR CLAUSE NO.	DATE	TITLE
352.202-1	Jan 2001	Definitions - with Alternate paragraph (h) (Jan 2001)
352.216-72	Oct 1990	Additional Cost Principles
352.228-7	Dec 1991	Insurance - Liability to Third Persons
352.232-9	Apr 1984	Withholding of Contract Payments
352.233-70	Apr 1984	Litigation and Claims
352.242-71	Apr 1984	Final Decisions on Audit Findings
352.270-5	Apr 1984	Key Personnel
352.270-6	Jul 1991	Publications and Publicity
352.270-7	Jan 2001	Paperwork Reduction Act

[End of GENERAL CLAUSES FOR A COST-REIMBURSEMENT RESEARCH AND DEVELOPMENT CONTRACT - Rev. 07/2004].

ARTICLE I.2 AUTHORIZED SUBSTITUTION OF CLAUSES

ARTICLE I.1.of this SECTION is hereby modified as follows:

a.FAR Clause 52.215-15, PENSION ADJUSTMENTS AND ASSET REVERSIONS  (DECEMBER 1998), FAR Clause 52.215-18, REVERSION OR ADJUSTMENT OF PLANS FOR POST RETIREMENT BENEFITS(PRB) OTHER THAN PENSIONS  (OCTOBER 1997) and 52.215-19, NOTIFICATION OF OWNERSHIP CHANGES (OCTOBER 1997), are deleted in their entirety.

b.ALTERNATE IV (OCTOBER 1997) of FAR Clause 52.215-21, REQUIREMENTS FOR COST OR PRICING DATA OR INFORMATION OTHER THAN COST OR PRICING DATA—MODIFICATIONS (OCTOBER 1997) is added.

c.FAR Clause 52.232-20, LIMITATION OF COST, is deleted in its entirety and FAR Clause 52.232-22, LIMITATION OF FUNDS (APRIL 1984) is substituted therefore.  Note:  When this contract is fully funded, FAR Clause 52.232-22, LIMITATION OF FUNDS will no longer apply and FAR Clause 52.232-20, LIMITATION OF COST will become applicable.

ARTICLE I.3.  ADDITIONAL CONTRACT CLAUSES

This contract incorporates the following clauses by reference, with the same force and effect, as if they were given in full text.  Upon request, the contracting officer will make their full text available.

a.FEDERAL ACQUISITION REGULATION (FAR) (48 CFR CHAPTER 1) CLAUSES

(1)FAR 52.217-9, Option to Extend the Term of the Contract (MARCH 2000).

(a)The Government may extend the term of this contract by written notice to the Contractor within [...***...] of the expiration date; provided that the Government gives the Contractor a preliminary written notice of its intent to extend at least [...***...] before the contract expires.  The preliminary notice does not commit the Government to an extension.”

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(b)The total duration of this contract, including the exercise of any options under this clause, shall not exceed beyond December 23, 2013.

(2)FAR 52.217-7, Option for Increased Quantity - Separately Priced Line Item (MARCH 1989).

At the prices, terms and conditions specified, the Contracting Officer may exercise the option(s) by written notice to the Contractor.

Option 03(Alternate Compound Storage System)

Option 04(Increased Funds for Compound Acquisition Costs)

Option 05(Increased library Collection Sizes)

(3)FAR 52.227-14, Rights in Data - General (JUNE 1987).

b.DEPARTMENT OF HEALTH AND HUMAN SERVICES ACQUISITION REGULATION (HHSAR) (48 CHAPTER 3) CLAUSES:

(1)HHSAR 352.223-70, Safety and Health (JANUARY 2001).  This clause is provided in full text in SECTION J - ATTACHMENTS.

c.NATIONAL INSTITUTES OF HEALTH (NIH) RESEARCH CONTRACTING (RC) CLAUSES:

The following clauses are attached and made a part of this contract:

(1)NIH (RC)-7, Procurement of Certain Equipment (APRIL 1984).

ARTICLE I.4.  ADDITIONAL FAR CONTRACT CLAUSES INCLUDED IN FULL TEXT

This contract incorporates the following clauses in full text.

FEDERAL ACQUISITION REGULATION (FAR)(48 CFR CHAPTER 1) CLAUSES:

1.FAR Clause 52.244-6, SUBCONTRACTS FOR COMMERCIAL ITEMS (JULY 2004)

(a)Definitions.  As used in this clause—

Commercial item, has the meaning contained in Federal Acquisition Regulation 52.202-1, Definitions.

Subcontract, includes a transfer of commercial items between divisions, subsidiaries, or affiliates of the Contractor or subcontractor at any tier.

(b)To the maximum extent practicable, the Contractor shall incorporate, and require its subcontractors at all tiers to incorporate, commercial items or non-developmental items as components of items to be supplied under this contract.

(c)(1)The Contractor shall insert the following clauses in subcontracts for commercial items:

(i)52.219-8, Utilization of Small Business Concerns (MAY 2004) (15 U.S.C. 637(d)(2) and (3)), in all subcontracts that offer further subcontracting opportunities. If the subcontract (except subcontracts to small business concerns) exceeds $500,000 ($1,000,000 for construction of any public facility), the subcontractor must include 52.219-8 in lower tier subcontracts that offer subcontracting opportunities.

(ii)52.222-26, Equal Opportunity (APR 2002) (E.O. 11246).

23

(iii)52.222-35, Equal Opportunity for Special Disabled Veterans, Veterans of the Vietnam Era, and Other Eligible Veterans (DEC 2001) (38 U.S.C. 4212(a)).

(iv)52.222-36, Affirmative Action for Workers with Disabilities (JUN 1998) (29 U.S.C. 793).

(v)52.247-64, Preference for Privately Owned U.S.-Flag  Commercial Vessels (APR 2003) (46 U.S.C. Appx 1241 and 10 U.S.C. 2631) (flow down  required in accordance with paragraph (d) of FAR clause 52.247-64).

(2)While not required, the Contractor may flow down to subcontracts for commercial items a minimal number of additional clauses necessary to satisfy its contractual obligations.

(d)The Contractor shall include the terms of this clause, including this paragraph (d), in subcontracts awarded under this contract.

2.FAR clause, 52.232-22 LIMITATION OF FUNDS

(a) The parties estimate that performance of this contract will not cost the Government more than (1) the estimated cost specified in the Schedule or, (2) if this is a cost-sharing contract, the Government’s share of the estimated cost specified in the Schedule. The Contractor agrees to use its best efforts to perform the work specified in the Schedule and all obligations under this contract within the estimated cost, which, if this is a cost-sharing contract, includes both the Government’s and the Contractor’s share of the cost.

(b) The Schedule specifies the amount presently available for payment by the Government and allotted to this contract, the items covered, the Government’s share of the cost if this is a cost-sharing contract, and the period of performance it is estimated the allotted amount will cover. The parties contemplate that the Government will allot additional funds incrementally to the contract up to the full estimated cost to the Government specified in the Schedule, exclusive of any fee. The Contractor agrees to perform, or have performed, work on the contract up to the point at which the total amount paid and payable by the Government under the contract approximates but does not exceed the total amount actually allotted by the Government to the contract.

(c) The Contractor shall notify the Contracting Officer in writing whenever it has reason to believe that the costs it expects to incur under this contract in the next 60 days, when added to all costs previously incurred, will exceed 75 percent of (1) the total amount so far allotted to the contract by the Government or, (2) if this is a cost-sharing contract, the amount then allotted to the contract by the Government plus the Contractor’s corresponding share. The notice shall state the estimated amount of additional funds required to continue performance for the period specified in the Schedule.

(d) Sixty days before the end of the period specified in the Schedule, the Contractor shall notify the Contracting Officer in writing of the estimated amount of additional funds, if any, required to continue timely performance under the contract or for any further period specified in the Schedule or otherwise agreed upon, and when the funds will be required.

(e) If, after notification, additional funds are not allotted by the end of the period specified in the Schedule or another agreed-upon date, upon the Contractor’s written request the Contracting Officer will terminate this contract on that date in accordance with the provisions of the Termination clause of this contract. If the Contractor estimates that the funds available will allow it to continue to discharge its obligations beyond that date, it may specify a later date in its request, and the Contracting Officer may terminate this contract on that later date.

(f) Except as required by other provisions of this contract, specifically citing and stated to be an exception to this clause-

(1) The Government is not obligated to reimburse the Contractor for costs incurred in excess of the total amount allotted by the Government to this contract; and

24

(2) The Contractor is not obligated to continue performance under this contract (including actions under the Termination clause of this contract) or otherwise incur costs in excess of-

(i) The amount then allotted to the contract by the Government or;

(ii) If this is a cost-sharing contract, the amount then allotted by the Government to the contract plus the Contractor’s corresponding share, until the Contracting Officer notifies the Contractor in writing that the amount allotted by the Government has been increased and specifies an increased amount, which shall then constitute the total amount allotted by the Government to this contract.

(g) The estimated cost shall be increased to the extent that (1) the amount allotted by the Government or, (2) if this is a cost-sharing contract, the amount then allotted by the Government to the contract plus the Contractor’s corresponding share, exceeds the estimated cost specified in the Schedule. If this is a cost-sharing contract, the increase shall be allocated in accordance with the formula specified in the Schedule.

(h) No notice, communication, or representation in any form other than that specified in paragraph (f)(2) of this clause, or from any person other than the Contracting Officer, shall affect the amount allotted by the Government to this contract. In the absence of the specified notice, the Government is not obligated to reimburse the Contractor for any costs in excess of the total amount allotted by the Government to this contract, whether incurred during the course of the contract or as a result of termination.

(i) When and to the extent that the amount allotted by the Government to the contract is increased, any costs the Contractor incurs before the increase that are in excess of-

(1) The amount previously allotted by the Government or; (2) If this is a cost-sharing contract, the amount previously allotted by the Government to the contract plus the Contractor’s corresponding share, shall be allowable to the same extent as if incurred afterward, unless the Contracting Officer issues a termination or other notice and directs that the increase is solely to cover termination or other specified expenses.

(j) Change orders shall not be considered an authorization to exceed the amount allotted by the Government specified in the Schedule, unless they contain a statement increasing the amount allotted.

(k) Nothing in this clause shall affect the right of the Government to terminate this contract. If this contract is terminated, the Government and the Contractor shall negotiate an equitable distribution of all property produced or purchased under the contract, based upon the share of costs incurred by each.

(l) If the Government does not allot sufficient funds to allow completion of the work, the Contractor is entitled to a percentage of the fee specified in the Schedule equaling the percentage of completion of the work contemplated by this contract.

(End of clause)

25

PART III

SECTION J - LIST OF ATTACHMENTS

The following documents are attached and incorporated in this contract:

Attachment No.	Description
1.	Statement of Work, 6 pages.
2.	Molecular Libraries Initiative Organizational Model, 3 pages.
3.	Deviation FAR 227-11 Patent Rights, 4 pages.
4.	Invoice/Financing Request Instructions for NIH Cost-Reimbursement Type Contracts, NIH(RC)-1 (11/03), 4 pages.
5.	Monthly Summary Sheet of Sales, May 1991, 1 page.
6.	Safety and Health, HHSAR Clause 352.223-70, (1/01), 1 page.
7.	Procurement of Certain Equipment, NIH (RC)-7, 4/1/84, 1 page.
8.	Commitment To Protect Non-Public Information, 1 page.

26

PART IV

SECTION K - REPRESENTATIONS AND CERTIFICATIONS

The following document is incorporated by reference in this contract:

•Representations and Certifications, dated July 20, 2004.

END of the SCHEDULE

(CONTRACT)

27

ADB Number: N01MH41001 OMB No. 0990-0115

AWARD/CONTRACT

THIS CONTRACT IS RATED ORDER UNDER DPAS (15 CFR 350)

RATING

PAGE 1

OF PAGES 28

2. CONTRACT (Proc. Inst. Ident.) NO. HHS-N-278-2004-41001 C

3. EFFECTIVE DATE See Block 20C

4. REQUISITION/PURCHASE REQUEST/PROJECT NO.

5. ISSUED BY                                CODE National Institute of Mental Health, NIH Contract Management Branch, ORM 6001 Executive Blvd., Rm. 8154 (MSC 9661) Bethesda, Maryland 20892-9661

6. ADMINISTERED BY (If other than Item 5)

CODE

7. NAME AND ADDRESS OF CONTRACTOR (No., street, city, county, State and ZIP Code)Discovery Partners International, Inc. 9640 Towne Centre Drive San Diego, California 92121

8. DELIVERY o FOB ORIGIN o OTHER (See below)   N/A

9. DISCOUNT FOR PROMPT PAYMENT N/A

10. SUBMIT INVOICES (4 copies unless otherwise specified) TO THE ADDRESS SHOWN IN:

ITEM

CODE

FACILITY CODE

See Section G

11. SHIP TO/MARK FOR CODE: See Article F.2.

12. PAYMENT WILL BE MADE BY: See Article G.4

CODE

13. AUTHORITY FOR USING OTHER THAN FULL AND OPEN COMPETITION   N/A o 10 U.S.C. 2304(c)(     )     o  41 U.S.C. 253(o)(    )

14. ACCOUNTING AND APPROPRIATION DATA:

OD/DDF: APR: 75-4-0846  CAN: 4-8463591  OCC: 25.55 AMT:

$

1,135,000

NIGMS:   APR: 75-4-0851  CAN: 4-8464514  OCC: 25.55 AMT:

2,400,000

NIMH:     APR: 75-4-0892  CAN: 4-8464429  OCC: 25.55 AMT:

2,000,000

$

5,535,000

DUNS: 839387966  EIN: 1330655706A1

15A.ITEM NO.

15B. SUPPLIES/SERVICES

15C. QUANTITY

15D. UNIT

15E. UNIT PRICE

15F. AMOUNT

Title: Molecular Libraries Small Molecule Repository (A Roadmap Initiative) Contract Type: CPFF Type: 8/23/04 - 12/23/08 (Base Period) 12/24/08 - 12/23/10 (Option Period 01) 12/24/10 - 12/23/13 (Option Period 02)

Base:

$

5,340,184

Option 04

194,816

Funded Amount:

$

5,535,000

15G. TOTAL AMOUNT OF CONTRACT

$

23,790,782

16. TABLE OF CONTENTS

(...)

SEC.

DESCRIPTION

PAGE(S)

(...)

SEC.

DESCRIPTION

PAGE

PART I - THE SCHEDULE

PART II - CONTRACT CLAUSES

ý

A

SOLICITATION/CONTRACT FORM

1

ý

I

CONTRACT CLAUSES

21

ý

B

SUPPLIES OR SERVICES AND PRICES/COSTS

2

PART III - LIST OF DOCUMENTS, EXHIBITS AND OTHER ATTACHMENTS

ý

C

DESCRIPTION/SPECS./WORK STATEMENT

8

ý

J

LIST OF ATTACHMENTS

27

ý

D

PACKAGING AND MARKING

11

PART IV - REPRESENTATIONS AND INSTRUCTIONS

ý

E

INSPECTION AND ACCEPTANCE

11

ý

K

REPRESENTATIONS, CERTIFICATIONS AND OTHER STATEMENTS OF OFFERORS

28

ý

F

DELIVERIES OR PERFORMANCE

11

ý

G

CONTRACT ADMINISTRATION DATA

13

N/A

L

INSTRS. CONDS. AND NOTICES TO OFFERORS

ý

H

SPECIAL CONTRACT REQUIREMENTS

16

N/A

M

EVALUATION FACTORS FOR AWARD

CONTRACTING OFFICER WILL COMPLETE ITEM 17 OR 18 AS APPLICABLE

17. ý CONTRACTOR'S NEGOTIATED AGREEMENT (Contractor is required to sign this document and return three (3) copies to issuing office.) The Contractor agrees to furnish and deliver all items or perform all the services set forth or otherwise identified above and on any continuation sheets for the consideration stated herein. The rights and obligations of the parties to this contract shall be subject to and governed by the following documents; (a) this award/contract, (b) the solicitation, if any, and (c) such provisions, representations, certifications, and specifications, as are attached or incorporated by reference herein. (Attachments are listed herein.)

18.o AWARD (Contractor is not required to sign this document.) Your offer on Solicitation Number                   , including the additions or changes made by you which additions or changes are set forth in full above, is  hereby  accepted as to the items listed above and on any continuation sheets. This award consummates the contract which consists of the following documents (a) the Government's solicitation and your offer, and (b) this award/contract.  No further contractual document is necessary.

19A. NAME AND TITLE OF SIGNER (Type or print)

20A. NAME OF CONTRACTING OFFICER

Riccardo Pigliucci, Chairman & CEO

Bruce E. Anderson, Contracting Officer

19B. NAME OF CONTRACTOR

19C. DATE SIGNED 8-19-04

20B. UNITED STATES OF AMERICA

20C. DATE SIGNED 8-20-04

BY

/s/ Riccardo Pigliucci

BY

/s/ Bruce E. Anderson

(Signature of person authorized to sign)

(Signature of Contracting Officer)

NSN 7540-01-152-8069 26-107 PREVIOUS EDITION NOT USABLE FAR (48 CFR) 53.214(a)

STANDARD FORM 26 (REV 4-85) Prescribed by GSA

EX-31.1

Exhibit 31.1

CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Riccardo Pigliucci, certify that:

1.I have reviewed this quarterly report on Form 10-Q of Discovery Partners International, Inc.;

2.Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15e and 15d-15e) for the registrant and have:

a.Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b.Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosures and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and

c.Disclosed in this quarterly report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a.All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b.Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 9, 2004	/s/ Riccardo Pigliucci
	Riccardo Pigliucci Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Craig Kussman, certify that:

1.I have reviewed this quarterly report on Form 10-Q of Discovery Partners International, Inc.;

2.Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15e and 15d-15e) for the registrant and have:

a.Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b.Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosures and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and

c.Disclosed in this quarterly report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a.All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b.Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 9, 2004	/s/ Craig Kussman
	Craig Kussman Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION  906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Discovery Partners International, Inc. (the “Company”) on Form 10-Q for the period ended September 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Riccardo Pigliucci, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:

(1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)The information contained in the Report fairly presents, in all material respects, the financial condition of the Company at the end of the period covered by the Report and results of operations of the Company for the period covered by the Report.

/s/Riccardo Pigliucci

Riccardo Pigliucci

Chief Executive Officer

Date: November 9, 2004

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Discovery Partners International, Inc. (the “Company”) on Form 10-Q for the period ended September 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Craig Kussman, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:

(1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)The information contained in the Report fairly presents, in all material respects, the financial condition of the Company at the end of the period covered by the Report and results of operations of the Company for the period covered by the Report.

/s/Craig Kussman

Craig Kussman

Chief Financial Officer

Date: November 9, 2004