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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT
FOR THE TRANSITION PERIOD FROM _______________ TO _______________
COMMISSION FILE NUMBER 000-30469
DECODE GENETICS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 04-3326704
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
STURLUGATA 8, REYKJAVIK, ICELAND
(Address of Principal Executive Offices)
+354-570-1900
(Registrant's Telephone Number, Including Area Code)
Indicate by check whether the registrant: (1) filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or such shorter period that the registrant is required to
file such reports), and (2) has been subject to such filing requirements for the
past 90 days.
Yes X No
--- ---
The aggregate number of shares of the registrant's common stock outstanding on
July 24, 2002 was 53,657,056 shares of common stock $.001 par value.
DECODE GENETICS, INC.
INDEX
Page Number
PART I. FINANCIAL INFORMATION ........................................ 2
Item 1. Financial Statements ......................................... 2
Condensed Consolidated Statements of Operations for the
three and six month periods ended June 30, 2002 and 2001.... 2
Condensed Consolidated Balance Sheets as of June 30, 2002
and December 31, 2001 ...................................... 3
Condensed Consolidated Statements of Cash Flows for the
six month periods ended June 30, 2002 and 2001.............. 4
Notes to Condensed Consolidated Financial Statements ......... 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................... 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk ... 19
PART II. OTHER INFORMATION ........................................... 20
Item 1. Legal proceedings ............................................ 20
Item 2. Changes in Securities and Use of Proceeds .................... 20
(c) Recent sales of unregistered securities................... 20
(d) Use of proceeds........................................... 20
Item 5. Other Information............................................. 21
Risk factors ................................................. 21
Item 6. Exhibits and Reports on Form 8-K ............................. 29
(a) Exhibits ................................................. 29
(b) Reports on Form 8-K ...................................... 30
Signatures ........................................................... 30
Index to Exhibits .................................................. 31
PAGE 1
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DECODE GENETICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------ ------------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
REVENUE ....................................... $ 13,409,787 $ 6,197,906 $ 22,895,946 $ 11,230,892
OPERATING EXPENSES
Research and development .................... 23,294,889 16,332,187 41,212,898 36,547,488
Selling, general and administrative ......... 5,839,753 3,727,291 9,366,890 6,730,847
------------ ------------ ------------ ------------
Total operating expense ............. 29,134,642 20,059,478 50,579,788 43,278,335
------------ ------------ ------------ ------------
Operating loss ................................ (15,724,855) (13,861,572) (27,683,842) (32,047,443)
Interest income ............................... 696,084 1,903,372 1,557,567 4,523,601
Other non-operating income and (expense), net . (1,803,077) (332,305) (2,232,756) (854,426)
Taxes ......................................... 0 0 0 0
------------ ------------ ------------ ------------
Net loss before cumulative effect of change
in accounting principle .................... (16,831,848) (12,290,505) (28,359,031) (28,378,268)
Cumulative effect of change in milestone
revenue recognition method ................. 0 0 333,333 0
------------ ------------ ------------ ------------
Net Loss ...................................... $(16,831,848) $(12,290,505) $(28,025,698) $(28,378,268)
============ ============ ============ ============
Basic and diluted net loss per share:
Net loss before cumulative effect of change
in accounting principle .................. $ (0.32) $ (0.28) $ (0.57) $ (0.64)
Cumulative effect of change in milestone
revenue recognition method ............... -- -- 0.01 --
Net Loss .................................... (0.32) (0.28) (0.56) (0.64)
Shares used in computing basic and
diluted net loss per share ............... 53,393,701 44,143,344 49,747,274 44,031,899
Pro forma amounts assuming new milestone
revenue recognition method is applied
retroactively:
Net Loss ................................. $(16,831,848) $(12,811,338) $(28,025,698) $(29,440,768)
Basic and diluted net loss per share ..... (0.32) (0.29) (0.56) (0.67)
The accompanying notes are an integral part of the
condensed consolidated financial statements.
PAGE 2
DECODE GENETICS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31,
2002 2001
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents ..................... $ 115,429,665 $ 153,061,132
Restricted cash ............................... 0 14,000,000
Receivables ................................... 17,944,239 16,826,958
Other current assets .......................... 16,088,527 9,216,071
------------- -------------
Total current assets .................. 149,462,431 193,104,161
Restricted cash ................................. 6,000,000 0
Property and equipment, net ..................... 98,026,781 61,207,537
Goodwill ........................................ 62,067,944 0
Other long-term assets and deferred charges ..... 8,641,573 2,047,471
------------- -------------
Total assets .......................... $ 324,198,729 $ 256,359,169
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses ......... $ 23,088,793 $ 21,164,576
Current portion of capital lease obligations
and long-term debt .......................... 8,022,028 7,426,849
Deferred research revenue ..................... 5,795,543 6,147,247
------------- -------------
Total current liabilities ............. 36,906,364 34,738,672
Capital lease obligations and long-term
debt, net of current portion .................. 49,061,742 38,850,889
Deferred research revenue ....................... 6,000,000 7,000,000
Other long-term liabilities ..................... 7,193 427,675
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.001 par value;
Authorized: 6,716,666 shares
Issued and outstanding: none ............... 0 0
Common stock, $0.001 par value;
Authorized: 60,000,000 shares;
Issued: 53,657,056 and 45,328,227 shares
at June 30, 2002 and December 31, 2001,
respectively;
Outstanding: 53,657,056 and 45,257,386
shares at June 30, 2002 and
December 31, 2001, respectively ............ 53,657 45,328
Additional paid-in capital .................... 431,740,134 351,960,182
Notes receivable .............................. (8,540,009) (10,788,635)
Deferred compensation ......................... (4,411,104) (6,173,592)
Accumulated deficit ........................... (186,617,869) (158,592,171)
Accumulated other comprehensive income (loss) . (1,379) 52,596
Treasury stock ................................ 0 (1,161,775)
------------- -------------
Total stockholders' equity ............ 232,223,430 175,341,933
------------- -------------
Total liabilities, and
stockholders' equity ............... $ 324,198,729 $ 256,359,169
============= =============
The accompanying notes are an integral part
of the condensed consolidated financial statements.
PAGE 3
DECODE GENETICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30,
--------------------------------
2002 2001
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ......................................... $ (28,025,698) $ (28,378,268)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization ................. 6,388,847 4,755,559
Purchased in-process research and development . 480,000 0
Equity in net earnings of affiliate ........... 100,000 144,311
Amortization of deferred stock compensation ... 1,757,472 2,352,627
Other stock-based remuneration and
Stock contributions ........................ 0 52,500
Loss on disposal of equipment ................. 0 1,607,583
Litigation settlement ......................... 0 1,292,642
Other ......................................... 144,195 0
Changes in operating assets and liabilities:
Receivables and other current assets ........... (3,492,663) 1,146,459
Accounts payable and accrued expenses .......... (2,634,236) 870,212
Deferred research revenue ...................... (2,179,106) 10,187,501
Unbilled research revenue ...................... 0 (5,000,000)
Other .......................................... (536,615) (521,683)
------------- -------------
Net cash used in operating activities ....... (27,997,804) (11,490,557)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ............ (13,206,885) (27,429,569)
Cash acquired in purchase of MediChem, net
of transaction costs ........................ (722,877) 0
------------- -------------
Net cash used in investing activities ....... (13,929,762) (27,429,569)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from building financings .............. 18,694,643 0
Repayment of mortgage on Woodridge, IL discovery
center ...................................... (11,644,106) 0
Forfeiture of common stock ..................... (125) (50)
Repayment of notes receivable for common stock . 83,190 231,939
Installment payments on capital lease
obligations .................................. (2,837,503) (863,789)
------------- -------------
Net cash provided by (used in)
financing activities ...................... 4,296,099 (631,900)
------------- -------------
Net decrease in cash ............................. (37,631,467) (39,552,026)
Cash and cash equivalents at beginning of period . 153,061,132 194,144,688
------------- -------------
Cash and cash equivalents at end of period ....... $ 115,429,665 $ 154,592,662
============= =============
The accompanying notes are an integral part
of the condensed consolidated financial statements.
PAGE 4
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THE COMPANY
References in this report to deCODE and "we" and "us" refer to deCODE genetics,
Inc., a Delaware company, and deCODE genetics, Inc.'s wholly owned subsidiary,
Islensk erfdagreining ehf., an Icelandic company registered in Reykjavik, and
its Icelandic subsidiaries Encode ehf., deCODE Cancer ehf. and Vetrargardurinn
ehf. as well as deCODE genetics, Inc.'s wholly owned subsidiary, MediChem Life
Sciences, Inc., a Delaware corporation, and its subsidiaries MediChem Research,
Inc., ThermoGen, Inc., Emerald BioStructures, Inc., Advanced X-Ray Analytical
Services, Inc. and MediChem Management, Inc.
deCODE is a genomics and health informatics company which applies and develops
modern informatics to collect and analyze data about the Icelandic population in
order to develop products and services for the healthcare industry. deCODE was
founded in 1996 in Reykjavik, Iceland.
In March 2002, deCODE completed the acquisition of MediChem Life Sciences, Inc.
(MediChem) in a stock-for-stock exchange accounted for as a purchase
transaction. The acquisition gives deCODE capabilities in chemistry and
structural proteomics that will be used in the implementation of its strategy of
turning its targets identified by applying population genomics to common
diseases into novel drugs for the market. Originally founded in 1987, MediChem
provides contract chemistry research services specializing in chemical synthesis
for new drug discovery and development for the global pharmaceutical,
biotechnology, agricultural, chemical and personal care industries.
deCODE's business is organized according to product development offerings and
services. deCODE's product development activities encompass the company's
population genetics programs aimed at creating new DNA-based diagnostics and
therapeutics (of which the pharmaceuticals group forms a part). deCODE's
services include pharmacogenomic and clinical trial services, the newly-acquired
chemistry services business of MediChem, which includes contract work in
structural biology, medicinal chemistry and scale up into the clinic, as well as
a range of bioinformatics services including the Clinical Genome Miner and other
bioinformatics tools developed in the course of deCODE's gene and drug target
research.
BASIS OF PRESENTATION
The condensed consolidated financial statements included herein have been
prepared by deCODE, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. The condensed balance sheet as of December 31, 2001 has
been derived from the audited financial statements as of that date, but does not
include all disclosures required by generally accepted accounting principles.
deCODE believes the disclosures included in the condensed consolidated financial
statements when read in conjunction with the financial statements and the notes
thereto included in deCODE's Annual Report on Form 10-K are adequate to make the
information presented not misleading.
The condensed consolidated financial statements have been prepared on the same
basis as the annual financial statements and, in the opinion of management,
reflect all adjustments, which include only normal recurring adjustments,
necessary for a fair presentation of deCODE's financial position, results of
operations and cash flows for the periods presented. The results of operations
for the three and six month periods ended June 30, 2002 and 2001 are not
necessarily indicative of the results that may be expected for any other interim
period or for the full fiscal year.
PRINCIPLES OF CONSOLIDATION
The unaudited condensed consolidated financial statements include the accounts
and operations of deCODE genetics, Inc. and its wholly owned subsidiaries,
Islensk erfdagreining ehf. and its subsidiaries, and MediChem Life Sciences,
Inc. and its subsidiaries. No dividends have been paid. All significant
intercompany accounts and transactions are eliminated upon consolidation.
Investments in which deCODE has significant influence, but does not control, are
accounted for using the equity method.
USE OF ESTIMATES
The preparation of the unaudited condensed consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make certain estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reported period. Actual results could differ from those
estimates.
PAGE 5
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
REVENUE RECOGNITION AND DEFERRED REVENUE
Revenues from research and development collaboration agreements are recorded and
recognized in accordance with the applicable performance requirements and terms
of the respective contracts either as contract research costs are incurred,
including the percentage of completion basis, or upon the achievement of certain
milestones. Such funding payments are not refundable in the event that the
related efforts are not successful. Non-refundable up-front payments are
deferred and recognized on a straight-line basis over the research term.
Contracted chemistry services revenue from negotiated rate contracts are
recognized on a per diem basis as services are rendered or on the percentage of
completion method based on the ratio of costs incurred to expected total costs
for fixed fee contracts based upon the terms of the underlying contract. Any
losses on contracts are provided for when they are determinable and estimable.
Included in revenue are billings to customers for the cost of materials
purchased for performance under the contract.
Prior to January 1, 2002, deCODE recorded all milestone payments received when
acknowledgement of having achieved applicable performance requirements was
received from the collaborator and recognized milestone payments as revenue on a
retrospective basis over the contractual term of the underlying agreement.
deCODE believes the milestone payment method to be a preferable method in
recognizing revenue for milestone payments made under particular contracts in
that it more closely relates to the underlying activity that results in the
revenue-generating milestone event under such contracts. Effective January 1,
2002, deCODE changed its method of recognizing milestone revenue to the
milestone payment method for contracts where (i) the milestone event is
substantive, (ii) there is substantial effort involved in achieving the
milestone, (iii) the milestone payment amount is commensurate with the magnitude
of the related achievement, and (iv) the associated follow-on revenue streams
bear a reasonable relationship to one another. Revenue under the milestone
payment method is recorded and recognized when acknowledgement of having
achieved applicable performance requirements is received from the collaborator.
As before, milestone payments without the above characteristics are recognized
on a retrospective basis over the contractual term of the underlying agreement.
The cumulative effect of the change in accounting principle on prior years
results ($333,333) is included in income in the six month period ended June 30,
2002. Had the retrospective basis of milestone revenue recognition been
continued for the six month period ended June 30, 2002, revenue, net loss and
basic and diluted net loss per share would have been $23.2 million, $(28.0)
million and $(0.56), respectively.
In general, prerequisites for billings are established by contractual terms
including predetermined payment schedules, the achievement of contract
milestones, or submission of appropriate billing detail. Unbilled costs and fees
arise when revenue has been recognized but customers have not been billed.
Contractual payments due to deCODE are recorded as deferred revenue until
earned. The following is a summary of deferred revenue:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------ ------------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Revenue recorded during
the period ............. $ 13,166,445 $ 16,927,074 $ 21,050,172 $ 21,418,393
Revenue recognized during
the period ............. (13,409,787) (6,197,906) (22,895,946) (11,230,892)
Deferred revenue recorded
on acquisition of
MediChem ............... 0 0 827,403 0
Cumulative effect of change
in milestone revenue
recognition policy ..... 0 0 (333,333) 0
------------ ------------ ------------ ------------
(243,342) 10,729,168 (1,351,704) 10,187,501
Deferred revenue at
beginning of period .... 12,038,885 3,863,332 13,147,247 4,404,999
------------ ------------ ------------ ------------
Deferred revenue at
end of period .......... $ 11,795,543 $ 14,592,500 $ 11,795,543 $ 14,592,500
============ ============ ============ ============
Revenue for the six month period ended June 30, 2002 includes $46,427, net in
services provided to Prokaria, a related party.
PAGE 6
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Roche accounted for 28% and 97% of consolidated revenue in the three month
periods ended June 30, 2002 and 2001, respectively, and ABG accounted for 30% of
consolidated revenue in the three month period ended June 30, 2002. Roche
accounted for 35% and 98% of consolidated revenue in the six month periods ended
June 30, 2002 and 2001, respectively, and ABG accounted for 36% of consolidated
revenue in the six month period ended June 30, 2002.
STOCK-BASED COMPENSATION AND REMUNERATION
Stock-based compensation represents the expense charged in the statements of
operations relating to employee and non-employee stock options granted.
Stock-based remuneration represents the expense charged in the statements of
operations relating to shares of stock issued to non-employees in exchange for
services provided. Stock-based compensation and remuneration are included in the
condensed consolidated statements of operations in the following captions:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Research and development expense... $ 606,446 $ 762,562 $1,188,723 $1,595,292
Selling, general and administrative
expense......................... 245,238 427,516 568,750 757,335
---------- ---------- ---------- ----------
Total.................... $ 851,684 $1,190,078 $1,757,473 $2,352,627
========== ========== ========== ==========
In addition, general and administrative expenses in the six month period ended
June 30, 2001 includes a charitable contribution of 5,000 shares of common stock
amounting to $52,500.
In March 2002, deCODE granted options to purchase 673,417 shares of common stock
to employees under the 1996 Equity Incentive Plan (the "Plan"), including
options to purchase 577,917 shares of common stock to employees in connection
with the acquisition of MediChem. As of June 30, 2002, 316,730 shares were
available for grant under the Plan.
In March 2002, 20,508 shares of deCODE common stock were issued to employees.
Compensation related to these shares has been expensed in December 2001 and is
included in accrued expenses at December 31, 2001.
COMPUTATION OF NET LOSS PER COMMON SHARE
Basic net loss per share is computed using net loss available to common
stockholders and the weighted-average number of common shares outstanding. The
weighted-average number of common shares outstanding during the period is the
number of shares determined by relating the portion of time within a reporting
period that common shares have been outstanding to the total time in that
period.
Diluted net loss per share is computed using the weighted-average number of
common shares outstanding during the period, plus the dilutive effect of
potential common shares. Diluted net loss per share does not differ from basic
net loss per share in all periods presented as potential common shares are
antidilutive for all such periods and are, therefore, excluded from the
calculation. Potential common shares excluded from the calculation of diluted
net loss per share as their inclusion would have been antidilutive were:
JUNE 30, JUNE 30,
2002 2001
------------ ------------
(SHARES) (SHARES)
Warrants to purchase shares of common stock........ 1,851,300 1,167,500
Options to purchase shares of common stock......... 2,554,270 1,526,000
PAGE 7
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
COMPREHENSIVE INCOME (LOSS)
Comprehensive income generally represents all changes in stockholders' equity
except those resulting from investments or contributions by stockholders.
Amounts reported in other comprehensive income include foreign currency
translation adjustments and gains and losses on derivative financial instruments
designated and effective as part of a foreign cash-flow hedge transaction. The
following table presents the calculation of comprehensive income:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------ ------------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Net loss ................. $(16,831,848) $(12,290,505) $(28,025,698) $(28,378,268)
Other comprehensive income
(loss):
Foreign currency
translation ..... 41,653 143,954 (53,975) 184,413
------------ ------------ ------------ ------------
Total comprehensive income
(loss) ................ $(16,790,195) $(12,146,551) $(28,079,673) $(28,193,855)
============ ============ ============ ============
ACQUISITION OF MEDICHEM LIFE SCIENCES, INC.
Under the terms of the merger agreement, MediChem shareholders received 0.3099
shares of newly issued deCODE common stock in exchange for each MediChem share
of common stock, or 8,362,893 shares of deCODE common stock. In addition,
options to purchase shares of MediChem common stock that vested immediately upon
consummation of the merger have been assumed by deCODE, resulting in the
issuance of 577,917 options to purchase deCODE common stock. In accordance with
the terms of the merger agreement, in July 2002 deCODE also granted a further
136,356 deCODE stock options to certain employees of MediChem under the 1996
Equity Incentive Plan.
The total consideration for the acquisition was approximately $86.0 million,
which consists of deCODE common stock issued in exchange for outstanding
MediChem common stock ($79.7 million), MediChem employee stock options assumed
($2.3 million) and estimated deCODE transaction costs ($4.0 million). deCODE's
common stock issued in the exchange has been valued using an average price for
the period from three days before to three days after the date the proposed
merger was announced. The fair value of options to be assumed is estimated using
the Black-Scholes method. The terms of MediChem's outstanding stock options
provided that the options fully vested upon a change of control; that is, there
were no unvested options upon consummation of this merger. deCODE's direct
transaction costs consist primarily of financial advisory, legal and accounting
fees.
Under the purchase method of accounting for business combinations as defined by
Statement of Financial Accounting Standard No. 141, "Business Combinations",
deCODE has preliminarily allocated the purchase price to the tangible and
identifiable intangible assets acquired and liabilities assumed on the basis of
their estimated fair values on the acquisition date. Based upon independent
valuations of the tangible and intangible assets acquired, deCODE has
preliminarily allocated the total cost of the acquisition to the net assets of
MediChem as follows (in millions):
Net tangible assets acquired................................ $17.3
In-process research and development......................... 0.5
Identifiable intangible assets.............................. 6.1
Goodwill.................................................... 62.1
-----
$86.0
=====
PAGE 8
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The in-process research and development has been charged to operations as a
research and development expense in the six month period ended June 30, 2002.
Intangible assets of MediChem identified include developed technology, patents,
customer and other contracts and agreements that have estimated useful lives
ranging from three to ten years. The aggregate amortization charge for these
identifiable intangibles recorded in the MediChem acquisition is estimated to
amount to approximately $1.2 million annually. Resulting goodwill will not be
amortized but will be subject to annual impairment testing.
deCODE's statements of operations include the results of MediChem from March 18,
2002, the date of acquisition. The following unaudited pro forma financial
information presents the consolidated results of deCODE as if the acquisition of
MediChem occurred at the beginning of 2001. Nonrecurring charges, such as the
acquired in-process research and development charge of $0.5 million, are not
reflected in the following pro forma financial information. This pro forma
information is not intended to be indicative of future operating results (in
millions, except per share data).
FOR THE SIX MONTHS
ENDED JUNE 30,
--------------------------
2002 2001
---------- ----------
Total revenues ................................. $ 27.0 $ 16.2
Net loss ....................................... (32.6) (32.6)
Basic and diluted net loss per share ........... (0.61) (0.62)
RECENT COLLABORATIONS
Pharmacia. In December 2001, deCODE formed a pharmacogenomics alliance with
Pharmacia Corporation (Pharmacia) to identify the role of genetics in the
development of advanced forms of heart disease. Under the amended and restated
agreement, deCODE will receive contract fees in exchange for employing its
population resources and Clinical Genome Miner discovery system to find genetic
markers that can be used to identify patients who are highly predisposed to
progressing from an early to an advanced form of heart disease.
F.Hoffman-La Roche. In January 2002, deCODE and Roche entered into a new
Collaboration and Cross-License Agreement. This new, three-year alliance
leverages deCODE's expanding capabilities in drug discovery into developing
novel treatments for common diseases. Under this new alliance, Roche will
provide research funding for a minimum of the next two years for deCODE to
conduct downstream research in a selection of four diseases, with the goal of
using the targets identified to discover and develop new therapeutic compounds
and to take these compounds into clinical trials. Also, deCODE may receive
development and regulatory approval milestone payments for therapeutic drug
compounds developed pursuant to the agreement as well as royalties on Roche's
sales of drugs developed under the agreement. Additionally, deCODE may pay Roche
royalties should deCODE develop and market drugs for certain common diseases.
DEBT
In December 2001, deCODE established a $27.5 million bridge loan with an
Icelandic financial institution to finance the construction of its new
headquarters facility. The borrowings under the bridge loan were repaid in
January and March 2002 with the proceeds from deCODE's Tier A $13.5 million bond
offering, Tier C $7.3 million offering of privately placed bonds and Tier D $6.7
bank loan.
The Tier A bonds are denominated in Icelandic krona and are linked to the
Icelandic Consumer Price Index. The principal amount is payable annually
beginning December 2002. The Tier A bonds bear annual interest of 8.5% that is
payable annually beginning December 2002. The Tier C bonds are denominated in
Icelandic krona and are linked to the Icelandic Consumer Price Index. The
principal amount is payable in March 2007. The Tier C bonds bear annual interest
of 12.0% that is payable beginning March 2003. The Tier D bank loan is
denominated in U.S. dollars. The principal amount is payable in March 2007. The
Tier D bank loan bears annual interest of three-month LIBOR plus 6.0% that is
payable quarterly beginning June 2002. Tier C bonds may be prepaid at each
interest payment date and the Tier D bank loan may be prepaid on the anniversary
date of the loan starting December 2003.
Concurrently, deCODE entered into a cross-currency swap as an economic hedge
against foreign exchange rate fluctuations that may occur on the Tier C bonds.
This contract with a face amount of $7.3 million expires in March 2007 and bears
annual interest of twelve-month LIBOR plus 6%.
In connection with the Tier C bonds and the Tier D bank loan, deCODE issued a
warrant giving the holder the right to purchase a total of 933,800 shares of
deCODE common stock at $15.00 per share, as adjusted. The warrants expire in
March 2007 and convert into shares of deCODE common stock automatically in the
event the market value of a share of deCODE common stock should exceed $24.00
for thirty
PAGE 9
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
consecutive days of trading. A portion of the proceeds from the Tier C bonds and
the Tier D bank loan has been allocated to the warrant ($0.7 million) and
recorded to additional paid-in capital. The resulting discount on the Tier C
bonds and the Tier D bank loan is being amortized to interest through March
2007.
In June 2002, MediChem Research Inc. executed a mortgage for $11.8 million with
a financial institution for its Woodridge, IL discovery center. The debt carries
an interest rate of three-month LIBOR + 1.75%, is payable $49,167 monthly for
five years with a final payment of $8.8 million due in 2007. The mortgage is
collateralized by restricted cash reserves totaling $6,000,000.
LITIGATION
In January 2000, Thorsteinn Jonsson and Genealogia Islandorum hf., the alleged
holders of copyrights to approximately 100 books of genealogical information,
commenced an action against deCODE in the District Court of Reykjavik in
Iceland. They allege that deCODE's genealogy database infringes their copyrights
and seek damages in the amount of approximately 616 million Icelandic kronas and
a declaratory judgment to prevent deCODE from using the allegedly infringing
data. deCODE believes the suit is without merit and intends to defend this
action vigorously; however, the ultimate resolution of this matter cannot yet be
determined.
In February 2000, Mannvernd, an organization known as the Association of
Icelanders for Ethics in Science and Medicine, issued a press release announcing
its intention to file lawsuits against the State of Iceland and any other
relevant parties, including deCODE, to test the constitutionality of the Act. In
its press release, Mannvernd indicated that it hopes to halt the construction
and/or operation of the Icelandic Health Sector Database. In April 2001, a
lawsuit was filed against the Icelandic Directorate of Public Health but
Mannvernd has not commenced litigation against deCODE; however, the ultimate
resolution of this matter cannot yet be determined.
On or about April 20, 2002, an amended class action complaint, captioned In re
deCODE genetics, Inc. Initial Public Offering Securities Litigation (01 Civ.
11219(SAS)), alleging violations of federal securities laws was filed in the
United States District Court for the Southern District of New York on behalf of
certain purchasers of deCODE common stock. The complaint names deCODE, two of
deCODE's current executive officers (the "Individual Defendants"), and the two
lead underwriters (the "Underwriter Defendants") for our initial public offering
in July 2000 (the "IPO") as defendants.
In the amended pleading, the plaintiff alleges violations of Section 11 of the
Securities Act of 1933 and violations of Section 10(b) of the Securities
Exchange Act of 1934 (and Rule 10b-5 promulgated thereunder) against deCODE, the
Individual Defendants and the Underwriter Defendants. In addition, the amended
complaint alleges violations of Section 15 of the Securities Act of 1933, and
Section 20(a) of the Securities Exchange Act of 1934 against the Individual
Defendants. Generally, the amended complaint alleges that the Underwriter
Defendants: (i) solicited and received excessive and undisclosed commissions
from certain investors in exchange for which the Underwriter Defendants
allocated to those investors material portions of the shares of our stock sold
in the IPO; (ii) entered into agreements with customers whereby the Underwriter
Defendants agreed to allocate shares of our stock sold in the IPO to those
customers in exchange for which the customers agreed to purchase additional
shares of our stock in the aftermarket at pre-determined prices; and (iii)
improperly used their analysts, who purportedly suffered from conflicts of
interest, to manipulate the market. The amended complaint further alleges that
the prospectus incorporated into the registration statement for the IPO was
materially false and misleading in that it failed to disclose these
arrangements. The amended complaint also alleges that deCODE and the Individual
Defendants had numerous interactions and contacts with the Underwriters from
which deCODE and the Individual Defendants either knew of, or recklessly
disregarded, the Underwriters' purported wrongful acts. The suit seeks
unspecified monetary and recissionary damages and certification of a plaintiff
class consisting of all persons who purchased shares of our common stock from
July 17, 2000 to December 6, 2000.
deCODE is aware that similar allegations have been made in hundreds of other
lawsuits filed (many by some of the same plaintiff law firms) against numerous
underwriter defendants and issuer companies (and certain of their current and
former officers) in connection with various public offerings conducted in recent
years. All of the lawsuits that have been filed in the Southern District of New
York have been consolidated for pretrial purposes before Honorable Judge Shira
A. Scheindlin. Pursuant to the underwriting agreement executed in connection
with deCODE's IPO, deCODE has demanded indemnification from the Underwriter
Defendants. The Underwriter Defendants have asserted that deCODE's request for
indemnification is premature.
PAGE 10
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
deCODE believes that the allegations against deCODE and deCODE's officers are
without merit and deCODE intends to contest them vigorously. The litigation is,
however, in the preliminary stage, and deCODE cannot predict its outcome and the
ultimate effect, if any, on its financial condition. In addition, it is possible
that further lawsuits alleging substantially similar claims will be filed
against deCODE and its officers. If deCODE is required to pay significant
monetary damages as a result of such litigation, deCODE's business could be
significantly harmed. Even if such suit or suits conclude in deCODE's favor,
deCODE may be required to expend significant funds to defend against the
allegations. deCODE is unable to estimate the range of possible loss from the
litigation and no amounts have been provided for such matters in these financial
statements.
RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations". SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. It requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset. deCODE is required to adopt SFAS No. 143 for fiscal
year 2003 and does not believe its adoption will have a significant impact on
its financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
SFAS No. 145 rescinds FASB Statement No. 4 (FAS 4), "Reporting Gains and Losses
from Extinguishment of Debt", the amendment to FAS 4, FASB Statement No. 64 (FAS
64), "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements", and
FASB Statement No. 44, "Accounting for Intangible Assets of Motor Carriers". In
addition, SFAS No. 145 amends paragraph 14(a) of FASB Statement No. 13,
Accounting for Leases, to eliminate an inconsistency between the accounting for
sale-leaseback transactions and certain lease modifications that have economic
effects that are similar to sale-leaseback transactions and makes several other
technical corrections to existing pronouncements. deCODE is required to adopt
FAS 145 for fiscal year 2003 and does not believe its adoption will have a
significant impact on its financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). This statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" ("EITF 94-3"). SFAS 146
requires that a liability for a cost associated with an exit cost liability to
be recognized at the date of an entity's commitment to an exit plan. SFAS 146
also requires that liabilities recorded in connection with exit plans be
initially measured at fair value. The provisions of SFAS 146 are effective for
exit or disposal activities that are initiated after December 31, 2002, with
early adoption encouraged.
OTHER
In February 2001, deCODE settled a payable for laboratory equipment of
$13,150,000, which amount is included in investing cash flows for the purchase
of property and equipment during the three months ended March 31, 2001.
In 2002, deCODE completed the move to its new headquarters facility in
Reykjavik's University district. As of June 30, 2002, a portion ($0.9 million)
of the amount remaining owed the contractor on the building is payable in
December 2002 and may be satisfied, according to agreed terms and at deCODE's
option, upon the issuance of deCODE common stock; the number of which will be
determined based upon the then fair market value of deCODE common stock.
deCODE has operating lease commitments for facilities that deCODE has or will be
vacating during 2002 as a result of the move to the new headquarters facility.
Management has assessed its alternatives in respect of these leased facilities,
including sub-leasing, and has recorded a provision of $0.6 million in the six
month period ended June 30, 2002 with respect to the remaining commitments.
In May 2002, deCODE issued 141,665 shares of common stock upon the exercise of
warrants to purchase shares of common stock.
PAGE 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This Management's Discussion and Analysis of Financial Condition and Results of
Operations as of June 30, 2002 and for the three and six month periods ended
June 30, 2002 and 2001 should be read in conjunction with the unaudited
condensed consolidated financial statements and notes thereto set forth in Item
1 of this report.
This quarterly report on Form 10-Q contains forward-looking statements,
including our expectations of future industry conditions, strategic plans and
forecasts of operational results. Various risks may cause our actual results to
differ materially. A list and description of some of the risks and uncertainties
is contained below and in the summary of risk factors included in Item 5 - Other
Information.
OVERVIEW
deCODE was incorporated in August 1996. We are a genomics and health informatics
company that provides products and services for the healthcare industry. Our
approach to the discovery of healthcare knowledge brings together three key
types of non-personally identifiable population data derived from the Icelandic
nation: information from the healthcare system, information about genealogical
relationships among individuals covered by this system and associated molecular
genetics data.
Our business is organized according to product development offerings and
services. Our product development activities encompass our population genetics
programs aimed at creating new DNA-based diagnostics and therapeutics (of which
the pharmaceuticals group forms a part). Our services include pharmacogenomic
and clinical trial services, the newly-acquired chemistry services business of
MediChem, which includes contract work in structural biology, medicinal
chemistry and scale up into the clinic, as well as a range of bioinformatics
services including the Clinical Genome Miner and other bioinformatics tools
developed in the course of our gene and drug target research.
We have incurred losses since our inception, principally as a result of research
and development and general and administrative expenses in support of our
operations. As of June 30, 2002 we had an accumulated deficit of $187 million.
We anticipate incurring additional losses over at least the next several years
as we expand our internal and collaborative gene discovery efforts, continue our
commercialization of discovery efforts, technology development, drug discovery
and construction of database services and informatics. We expect that our losses
will fluctuate from quarter to quarter and that such fluctuations may be
substantial especially because progress in our scientific work and milestone
payments that are related to progress can fluctuate between quarters.
COLLABORATIONS AND ALLIANCES
In February 1998, we entered into a research collaboration and cross-license
agreement with F. Hoffmann-La Roche, or Roche, regarding research into the
genetic causes of twelve diseases. Under the terms of the agreement, Roche has
made equity investments and funded gene discovery programs in the twelve
diseases through January 2002 when the term of the agreement expired.
In June 2001, we entered into a collaboration and cross-license agreement with
Roche regarding diagnostics. Under the terms of this new agreement, we are
collaborating on the development and marketing of DNA-based diagnostics for
major diseases. We are working with Roche to identify and validate molecular
targets which are useful for developing products and services that accurately
establish a patient's current diagnosis, predict future risk of disease, predict
drug response and determine responses to treatment or the health status of
individuals and enable early prevention or treatment of disease. We will also be
focusing on developing informatics products and services, which will include
software tools and databases. Under the agreement we will receive payments
including research funding, research milestones and royalties on any products
that are commercialized. The research term under the agreement is five years.
In June 2001, we entered into a collaboration agreement with Genmab A/S and
Medarex, Inc. pursuant to which we are collaborating on the research,
development, and commercialization of new antibody therapeutic products. Under
this five-year collaboration, we are utilizing novel targets discovered in our
research on the genetics of common diseases along with Genmab's human antibody
technology. The collaboration covers a broad range of disease areas including
cardiovascular disease, inflammatory disease and cancer. Together with Genmab
and Medarex, we will share equally in the development costs and revenues
generated from the outlicensing or sales of products developed under the
agreement. Under the terms of this collaboration, Medarex will also contribute
resources and will share certain costs and commercial rights.
In June 2001, we entered into an agreement to provide Genmab A/S with research
and development services to develop DNA-based tests to predict individual
clinical response to Genmab's antibody treatment for rheumatoid arthritis and
possible related novel therapeutics. We will be paid as stages of the research
program are completed.
In July 2001, we entered into a pharmacogenomics collaboration and license
agreement with Affymetrix, Inc. Under the terms of the agreement the parties are
collaborating in the research and development of gene expression tests and
nucleic acid based tests to predict the response of
PAGE 12
individual patients to various drugs. We are undertaking the initial research
activities to be performed with respect to the initial ten drugs to be studied
under the collaboration. Affymetrix will supply various chips in connection with
the research. We will share revenues resulting from the collaboration, including
those from licensing and product commercialization, with Affymetrix.
In July 2001, we entered into a joint development and commercialization
agreement with Applied Biosystems Group, or ABG. Under the terms of the
agreement, we are working with ABG to jointly develop and commercialize software
products for the collection, organization and analysis of genotyping
information. The agreement provides for the development to be overseen by a
joint steering committee that has specific responsibilities for the
implementation and management of the joint development and joint
commercialization programs. Under this agreement, ABG and we have granted to
each other licenses to products developed under the joint development program.
In December 2001, we formed a pharmacogenomics alliance with Pharmacia
Corporation to identify the role of genetics in the development of advanced
forms of heart disease. Under the amended and restated agreement, we will
receive contract fees in exchange for employing our population resources and
Clinical Genome Miner discovery system to find genetic markers that can be used
to identify patients who are highly predisposed to progressing from an early to
an advanced form of heart disease.
In January 2002, we entered into a new Collaboration and Cross-License Agreement
with Roche. This new, three-year alliance leverages our expanding capabilities
in drug discovery into developing novel treatments for common diseases. Under
this new alliance, Roche will provide research funding for a minimum of the next
two years for us to conduct downstream research in a selection of four diseases,
with the goal of using the targets identified to discover and develop new
therapeutic compounds and to take these compounds into clinical trials. Also, we
may receive development and regulatory approval milestone payments for
therapeutic drug compounds developed pursuant to the agreement as well as
royalties on Roche's sales of drugs developed under the agreement. Additionally,
we may pay Roche royalties should we develop and market drugs for certain common
diseases.
We have a number of collaborative agreements with local medical institutions and
doctors regarding particular disease research. These agreements generally extend
for a period of five years. Under the agreements, these institutions and/or
physicians contribute data or other clinical information and we contribute
equipment, research supplies and our molecular genetics and experimental design
expertise. The agreements also require us to reimburse all project-related
expenses. If we sell project results, the agreements require us to make
specified payments and pay a portion of performance-based milestone payments
that we receive.
We have a settlement agreement with a U.S. medical institution whereby we are
committed to pay royalties and milestone payments if we are successful in
developing and commercializing products that result from a particular technology
jointly owned by the medical institution and us.
ACQUISITION OF MEDICHEM
On March 18, 2002, we acquired MediChem Life Sciences, Inc. in a stock-for-stock
exchange accounted for as a purchase transaction. The acquisition gives us
capabilities in chemistry and structural proteomics that will be used in the
implementation of its strategy of turning its targets identified by applying
population genomics to common diseases into novel drugs for the market. Building
upon the acquisition of MediChem, we will be creating an integrated
biopharmaceutical company capable of bringing our own targets into proprietary
drug discovery. Through the acquisition we added approximately 160 new employees
and facilities in Illinois and Washington.
The total consideration for the acquisition was approximately $86.0 million,
which consists of deCODE common stock issued in exchange for outstanding
MediChem common stock ($79.7 million), MediChem employee stock options assumed
($2.3 million) and estimated deCODE transaction costs ($4.0 million).
We have recorded the transaction as a purchase for accounting purposes and have
preliminarily allocated the purchase price, based upon independent valuations,
to the assets purchased and liabilities assumed based upon their respective
estimated fair values. We have preliminarily allocated the excess of the
purchase price over the estimated fair market value of net tangible assets
acquired to identified intangibles, including developed technology, patents,
customer and other contracts and agreements that have estimated useful lives
ranging from three to ten years. In the first quarter 2002 we recorded a charge
to earnings for acquired in-process research and development amounting $0.5
million. In addition, amortization charges for other identifiable intangibles
recorded in the MediChem acquisition will amount to approximately $1.2 million
annually. Under SFAS No. 142, resulting goodwill ($62.1 million) will not be
amortized but will be subject to annual impairment testing.
Our consolidated financial statements include the cash flows and results of
MediChem from March 18, 2002. The integration of MediChem will impact our
results of operations and our financial position. With MediChem, our revenues
will increase but our operating expenses will increase and, at least for the
near term, likely our net losses will increase. In addition, we expect to fund
the working capital needs and operating activities of MediChem in the near term.
The extent to which MediChem will ultimately impact our results of operations
and financial condition is largely dependant upon how quickly and in what
proportion MediChem's capacity is brought to bear on our in-house programs and
how much of their existing contract services business is maintained and
developed.
Our statements of operations include the results of MediChem from March 18,
2002, the date of acquisition. The following unaudited pro forma financial
information presents our consolidated results as if the acquisition of MediChem
occurred at the beginning of 2001. Nonrecurring charges, such as the acquired
in-process research and development charge of $0.5 million, are not reflected
in the following pro forma financial information. This pro forma information is
not intended to be indicative of future operating results (in millions, except
per share data).
FOR THE SIX MONTHS
ENDED JUNE 30,
--------------------------
2002 2001
---------- ----------
Total revenues ................................. $ 27.0 $ 16.2
Net loss ....................................... (32.6) (32.6)
Basic and diluted net loss per share ........... (0.61) (0.62)
PAGE 13
GENERAL
We anticipate that collaborations will remain an important element of our
business strategy and future revenues. Our ability to generate revenue growth
and become profitable is dependent, in part, on our ability to enter into
additional collaborative arrangements, and on our ability and our collaborative
partners' ability to successfully commercialize products incorporating, or based
on, our work. There can be no assurance that we will be able to maintain or
expand our existing collaborations, enter into future collaborations to develop
applications based on existing or future research agreements or successfully
commercialize the deCODE Combined Data Processing system.
We intend to invest in discovery services, database services and healthcare
informatics, and expect to report net losses for the next several years. If the
costs of these investments are greater than anticipated, or if they take longer
to complete, or if losses are incurred from strategic investments, we may incur
losses for a longer period of time.
Our failure to successfully develop and market products over the next several
years, or to realize product revenues, would have a material adverse effect on
our business, financial condition and results of operations. We do not expect to
receive royalties or other revenues from commercial sales of products developed
using our technologies for at least several years, if at all.
We have made and intend to continue to make strategic equity investments in, and
acquisitions of, technologies and businesses that are complementary to our
business. As a result, we may record losses or expenses related to our
proportionate ownership interest in such long-term equity investments, record
charges for the acquisition of in-process technologies, or record charges for
the recognition of the impairment in the value of the securities underlying such
investments.
Our operating results through June 30, 2002 reflect the expenses incurred in our
gene discovery and other activities, partly offset by the revenues received in
connection with these activities. We will continue these activities, but our
operating results will also reflect the substantial costs we expect to incur in
building technology and services for the Clinical Genome Miner and commencing
the development of the Icelandic Health Sector Database and the deCODE Combined
Data Processing system. While we intend to enter into collaborations to help
fund and develop the these database services, until we do so there will be no
revenue from our database service activities to offset against these costs.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with generally accepted
accounting principles requires us to make certain estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reported period. On an
ongoing basis we evaluate our estimates, which include, among others, those
related to collaborative arrangements, property and equipment, income taxes,
litigation and other contingencies, materials and supplies, derivatives,
intangible assets, and bad debts. We base our estimates on historical experience
and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form our basis for making judgments about
carrying values of assets and liabilities that are not readily apparent from
other sources. The impact and any associated risks related to these and our
other accounting policies on our business or operations is discussed throughout
Management's Discussion and Analysis of Financial Condition and Results of
Operations where such policies affect our reported and expected financial
results. For a detailed discussion on the application of these and other
accounting policies, please refer to our notes to the Consolidated Financial
Statements. There can be no assurance that actual results may not differ from
the estimates referred to above.
RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2002
AND 2001
Our results of operations have fluctuated from period to period and may continue
to fluctuate in the future based upon, among other things, the timing and
composition of funding under our various collaborative agreements, as well as
the progress of our own research and development efforts and how quickly and in
what proportion MediChem's capacity is brought to bear on our in-house programs.
Results of operations for any period may be unrelated to results of operations
for any other period. In addition, historical results should not be viewed as
indicative of future operating results. We are subject to risks common to
companies in our industry and at our stage of development, including risks
inherent in our research and development efforts, reliance upon collaborative
partners, development by us or our competitors of new technological innovations,
ability to market products or services, dependence on key personnel, dependence
on key suppliers, protection of proprietary technology, ability to obtain
additional financing, ability to negotiate collaborative arrangements, reliance
on the license to create and run the Icelandic Health Sector Database, and
compliance with governmental and other regulations. In order for a product to be
commercialized based on our research, we and our collaborators must conduct
preclinical tests and clinical trials, demonstrate the efficacy and safety of
our product candidates, obtain regulatory approvals or clearances and enter into
manufacturing, distribution and marketing arrangements, as well as obtain market
acceptance. We do not expect to receive revenues or royalties based on
therapeutic or diagnostic products for a period of years, if at all.
PAGE 14
Revenues. Our revenues from research and development collaboration agreements
are recorded and recognized in accordance with the applicable performance
requirements and terms of the respective contracts either as contract research
costs are incurred, including the percentage of completion basis, or upon the
achievement of certain milestones. Such funding payments are not refundable in
the event that the related efforts are not successful. Non-refundable up-front
payments we receive are deferred and recognized on a straight-line basis over
the research term. Our contracted chemistry services revenue from negotiated
rate contracts are recognized on a per diem basis as services are rendered or on
the percentage of completion method based on the ratio of costs incurred to
expected total costs for fixed fee contracts based upon the terms of the
underlying contract. Any losses on contracts are provided for when they are
determinable and estimable. Included in revenue are billings to customers for
the cost of materials purchased for performance under the contract.
Prior to January 1, 2002, we recorded all milestone payments received when
acknowledgement of having achieved applicable performance requirements was
received from the collaborator and we recognized milestone payments as revenue
on a retrospective basis over the contractual term of the underlying agreement.
We believe the milestone payment method to be a preferable method in recognizing
revenue for milestone payments made under particular contracts in that it more
closely relates to the underlying activity that results in the
revenue-generating milestone event under such contracts. Effective January 1,
2002, we changed our method of recognizing milestone revenue to the milestone
payment method for contracts where (i) the milestone event is substantive, (ii)
there is substantial effort involved in achieving the milestone, (iii) the
milestone payment amount is commensurate with the magnitude of the related
achievement, and (iv) the associated follow-on revenue streams bear a reasonable
relationship to one another. Under the milestone payment method we record
revenue when the milestone has been achieved and payment is due and payable
under the terms of the respective agreement and we recognize revenue when
acknowledgement of having achieved applicable performance requirements is
received from the collaborator. As before, milestone payments without the above
characteristics are recognized on a retrospective basis over the contractual
term of the underlying agreement.
The cumulative effect of the change in accounting principle on prior years
results ($333,333) is included in income in the six month period ended June 30,
2002. Had the retrospective basis of milestone revenue recognition been
continued for the six month period ended June 30, 2002, revenue, net loss and
basic and diluted net loss per share would have been $23.2 million, $(28.0)
million and $(0.56), respectively.
The following is a summary of deferred revenue:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------- -------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Revenue recorded during
the period............... $13,166,445 $16,927,074 $21,050,172 $21,418,393
Revenue recognized during
the period............... (13,409,787) (6,197,906) (22,895,946) (11,230,892)
Deferred revenue recorded
on acquisition of
MediChem................. 0 0 827,403 0
Cumulative effect of change
in milestone revenue
recognition policy....... 0 0 (333,333) 0
----------- ----------- ----------- -----------
(243,342) 10,729,168 (1,351,704) 10,187,501
Deferred revenue at
beginning of period...... 12,038,885 3,863,332 13,147,247 4,404,999
----------- ----------- ----------- -----------
Deferred revenue at
end of period............ $11,795,543 $14,592,500 $11,795,543 $14,592,500
=========== =========== =========== ===========
Our revenues increased to $13,409,787 for the three month period ended June 30,
2002 as compared to $6,197,906 for the three month period ended June 30, 2001,
an increase of 116%. Our revenues increased to $22,895,946 for the six month
period ended June 30, 2002 as compared to $11,230,892 for the six month period
ended June 30, 2001, an increase of 104%. The increase period-to-period is
principally attributable to the addition of MediChem and to the work conducted
under the joint development and commercialization agreement with ABG but also
from the new diagnostics and therapeutics collaborations underway with Roche.
PAGE 15
At June 30, 2002, the total amount of deferred research revenue that will be
recognized in future periods aggregated $11,795,543. Revenues recorded decreased
to $13,166,445 for the three month period ended June 30, 2002 as compared to
$16,927,074 for the three month period ended June 30, 2001 and were $21,050,172
for the six month period ended June 30, 2002 as compared to $21,418,393 for the
six month period ended June 30, 2001. We recorded significant revenues in the
three and six month periods ended June 30, 2001 principally as a result of the
then new diagnostics collaboration with Roche and also milestone achievements
under our 1998 research collaboration with Roche. Revenue recorded to-date in
2002 is largely attributable to the work completed under the joint development
and commercialization agreement with ABG and under the therapeutics and
diagnostics collaborations with Roche.
Research and Development Expenses. Our research and development expenses
increased to $23,294,889 for the three month period ended June 30, 2002 as
compared to $16,332,187 for the three month period ended June 30, 2001, an
increase of 43%. Our research and development expenses increased to $41,212,898
for the six month period ended June 30, 2002 as compared to $36,547,488 for the
six month period ended June 30, 2001, an increase of 13%. The change
period-to-period is largely attributable to the addition of MediChem and the
costs of contract chemistry services provided offset somewhat in the six month
period comparison by atypical charges in the six month period June 30, 2001 for
consumables in support of, among other things, our then new ABI Prism 3700 DNA
Analyzers and the disposal of laboratory equipment. Without regard to the
MediChem costs of contract services provided in the three and six month periods
ended June 30, 2002 and to atypical charges in the six month period June 30,
2001 our research and development expenditures have increased 20% in 2002 as
compared to 2001.
Selling, General and Administrative Expenses. Our selling, general and
administrative expenses increased to $5,839,753 for the three month period ended
June 30, 2002 as compared to $3,727,291 for the three month period ended June
30, 2001, an increase of 57%. Our selling, general and administrative expenses
increased to $9,366,890 for the six month period ended June 30, 2002 as compared
to $6,730,847 for the six month period ended June 30, 2001, an increase of 39%.
The change period-to-period is largely attributable to the addition of selling,
general and administrative costs of MediChem offset somewhat by a one-time
litigation settlement for the three and six month periods ended June 30, 2001.
Without regard to the additional MediChem costs in the three and six month
periods ended June 30, 2002 and to the litigation settlement for the same
periods in 2001 our general and administrative expenses increased 17% and 12% in
the three and six month periods ended June 30, 2002 as compared to those same
periods in 2001.
Stock-Based Compensation and Remuneration. Stock-based compensation and
remuneration expense was $851,684 for the three month period ended June 30, 2002
as compared to $1,190,078 for the three month period ended June 30, 2001, a
decrease of 28%. Stock-based compensation and remuneration expense was
$1,757,473 for the six month period ended June 30, 2002 as compared to
$2,352,627 for the six month period ended June 30, 2001, a decrease of 25%. With
little compensation being attributed to our more recent stock option grants,
stock-based compensation and remuneration expense has been decreasing as grants
made to employees in earlier years become fully vested. Historical stock-based
compensation and remuneration is not necessarily representative of the effects
on reported income or loss for future years due to, among other things, the
vesting period of the stock options, the value of stock options that have been
granted in recent times and the value of additional options that may be granted
in future years.
Interest Income. Our interest income was $696,084 for the three month period
ended June 30, 2002 as compared to $1,903,372 for the three month period ended
June 30, 2001, a decrease of 63%. Our interest income was $1,557,567 for the six
month period ended June 30, 2002 as compared to $4,523,601 for the six month
period ended June 30, 2001, a decrease of 66%. In general, the decreased returns
are attributable to the decline of prevailing interest rates but also from an
overall decrease in our cash balance as we continue to use the proceeds of our
initial public offering for operations.
Other non-operating income and (expense), net. Our other non-operating income
and (expense), net was $(1,803,077) for the three month period ended June 30,
2002 as compared to $(332,305) for the three month period ended June 30, 2001,
and was $(2,232,756) for the six month period ended June 30, 2002 as compared to
$(854,426) for the six month period ended June 30, 2001. Our other non-operating
income and (expense), net is principally comprised of interest expense, our
share in the earnings (losses) of eMR and foreign exchange differences. The
significant increase period-on-period largely results from foreign exchange
movements but it also attributable to interest expense on new borrowings. The
weakening of the U.S dollar vis-a-vis the Icelandic krona during 2002 has been
significant and these currency fluctuations may continue to adversely affect our
financial results.
Income Taxes. As of June 30, 2002, we had an accumulated deficit of $187 million
and did not owe any Icelandic or U.S. federal income taxes nor did we pay any in
the three and six month periods ended June 30, 2002 or 2001. Realization of
deferred tax assets is dependent on future earnings, if any. As of December 31,
2001, we had net operating losses able to be carried forward for U.S. federal
income tax purposes of approximately $4.1 million to offset future taxable
income in the United States that expire at various dates through 2021. Also, as
of December 31, 2001 our foreign subsidiaries had net operating loss
carryforwards of approximately $22.0 million that expire in varying amounts
beginning in 2004.
PAGE 16
Net Loss and Basic and Diluted Net Loss Per Share. Net loss and basic and
diluted net loss per share were $16,831,848 and $0.32 for the three months ended
June 30, 2002, respectively, as compared to $12,290,505 and $0.28 for the three
months ended June 30, 2001, respectively. This is an increase of 37% in net loss
and an increase of 14% in basic and diluted net loss per share. Net loss and
basic and diluted net loss per share were $28,025,698 and $0.56 for the six
months ended June 30, 2002, respectively, as compared to $28,378,268 and $0.64
for the six months ended June 30, 2001, respectively. This is a decrease of 1%
in net loss and a decrease of 13% in basic and diluted net loss per share.
Pro Forma Net Loss and Basic and Diluted Net Loss Per Share. Net loss and basic
and diluted net loss per share were $16,831,848 and $0.32, respectively, for the
three months ended June 30, 2002 as compared to pro forma net loss and basic and
diluted net loss per share calculated assuming our new milestone revenue
recognition method is applied retroactively of $12,811,338 and $0.29,
respectively, for the three months ended June 30, 2001. Net loss and basic and
diluted net loss per share were $28,025,698 and $0.56, respectively, for the six
months ended June 30, 2002, as compared to pro forma net loss and basic and
diluted net loss per share calculated assuming our new milestone revenue
recognition method is applied retroactively of $29,440,768 and $0.67,
respectively, for the six months ended June 30, 2001.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations primarily through funding from collaborative
agreements and the issuance of equity securities and debt instruments. From the
beginning of 1999 to-date, we have received cash of approximately $79 million
from collaborative research agreements, $183 million from the issuance of common
stock, $76 million from the issuance of preferred stock and warrants, and $64
million from privately placed bonds, bank loans and equipment financing. To-date
we have received approximately $70 million in research and development funding
from Roche. As of June 30, 2002 future funding under terms of our existing
agreements is approximately $50 million excluding milestone payments and
royalties that we may earn under such collaborations.
Cash and Cash Equivalents. As of June 30, 2002, we had $115.4 million in cash
and cash equivalents. Available cash is invested in accordance with our
investment policy's primary objectives of liquidity, safety of principal and
diversity of investments. Our cash is deposited only with financial institutions
in Iceland, the United Kingdom and the United States having a high credit
standing. This cash is largely invested in U.S. dollar denominated money market
and checking accounts and also in Icelandic krona denominated accounts.
Operating Activities. Working capital needs resulted in the net use of $8.8
million of funds in the six month period ended June 30, 2002 as compared to $6.7
million that was provided by working capital sources in the six month period
ended June 30, 2001. As a result, although net loss decreased $0.4 million for
the six month period ended June 30, 2002 as compared to the six month period
ended June 30, 2001, net cash used in operating activities increased $16.5
million in the six month period ended June 30, 2002 as compared to the six month
period ended June 30, 2001. Most notably, in the six month period ended June 30,
2002 we made significant payments to our vendors and particularly to ABG for
reagents, other supplies and DNA analyzers. At June 30, 2002, we have a
remaining commitment to ABG for purchases through September 2002 of $7.1
million.
Investing Activities. Our investing activities have consisted of capital
expenditures and long-term strategic equity investments in, and acquisitions of,
technologies and businesses that are complementary to our business. Purchases of
property and equipment during the six month period ended June 30, 2002 were
$13,206,885 as compared to $27,429,569 in the six month period ended June 30,
2001. Notably, during the six month period ended June 30, 2002 we expended $5.7
million in respect of the new building to house our operations in the University
District of Reykjavik and purchased new DNA analyzers under our supply agreement
with ABG in the total amount of $2.8 million. During the six month period ended
June 30, 2001 we expended $7.1 million in respect of our new headquarters
building and we paid $13.1 million for DNA analyzers acquired late in 2000. Cash
acquired in the purchase of MediChem was $3.3 million and we paid $4.0 million
of transaction costs, resulting in a net cash outlay for the six month period
ended June 30, 2002 in connection with the acquisition of $722,877. Net cash
used in investing activities may in the future fluctuate significantly from
period to period due to the timing of our capital expenditures and other
investments.
Financing Activities. Net cash of $4,296,099 was provided in financing
activities in the six month period ended June 30, 2002 as compared to $631,900
used in the six month period ended June 30, 2001. $14 million of cash that was
restricted as of December 31, 2001 was provided in the six month period ended
June 30, 2002 in the final financing (Tiers C and D) of our new headquarters
facility. In addition, we repaid the existing mortgage on our Woodridge, IL
discovery center ($11.6 million) and re-financed the property in June 2002,
resulting in proceeds of $5.8 million. Installment payments on capital lease
obligations have increased with new financings that were put into place during
2001. Total capital lease payments were $2,837,503 for the six month period
ended June 30, 2002 as compared to $863,789 for the same period in 2001. We
expect to continue to finance future property and equipment purchases through
similar such leasing arrangements.
In December 2001, we established a $27.5 million bridge loan with an Icelandic
financial institution to finance the construction of our new headquarters
facility. We repaid the borrowings under the bridge loan in January and March
2002 with the proceeds from our Tier A $13.5 million bond offering, Tier C $7.3
million offering of privately placed bonds and Tier D $6.7 bank loan.
PAGE 17
The Tier A bonds are denominated in Icelandic krona and are linked to the
Icelandic Consumer Price Index. The principal amount is payable annually
beginning December 2002. The Tier A bonds bear annual interest of 8.5% that is
payable annually beginning December 2002. The Tier C bonds are denominated in
Icelandic krona and are linked to the Icelandic Consumer Price Index. The
principal amount is payable in March 2007. The Tier C bonds bear annual interest
of 12.0% that is payable beginning March 2003. The Tier D bank loan is
denominated in U.S. dollars. The principal amount is payable in March 2007. The
Tier D bank loan bears annual interest of three-month LIBOR plus 6.0% that is
payable quarterly beginning June 2002. Tier C bonds may be prepaid at each
interest payment date and the Tier D bank loan may be prepaid on the anniversary
date of the loan starting December 2003.
In connection with the Tier C bonds and the Tier D bank loan, we issued a
warrant giving the holder the right to purchase a total of 933,800 shares of our
common stock at $15.00 per share, as adjusted. The warrants expire in March 2007
and convert into shares of our common stock automatically in the event the
market value of a share of our common stock should exceed $24.00 for thirty
consecutive days of trading.
In June 2002, we executed a mortgage with a financial institution for our
Woodridge, IL discovery center. The debt carries an interest rate of three-month
LIBOR + 1.75%, matures in 2007 and is collateralized by restricted cash reserves
totaling $6,000,000.
General. We expect cash requirements may continue to increase significantly as
we: invest in genotyping, sequencing and bioinformatics capabilities; continue
to integrate MediChem into our operations, invest in software and hardware to
support the continuing development of the database services; continue to seek
access to technologies through investments, research and development alliances,
license agreements and/or acquisitions; and continue to make improvements in
existing facilities and invest in new facilities. We do recurrently consider the
pace of our expenditures and are increasingly controlling the use of our capital
resources in-light of our assessments of future capital needs and sources of
funds.
Based upon our current plans, and taking into consideration the proceeds of the
initial public offering and recent debt financings, we believe that our existing
resources will be adequate to satisfy our capital needs for several years. Our
cash requirements depend on numerous factors, including our ability to obtain
new research collaboration agreements, to obtain subscription and collaboration
agreements for the database services; expenditures in connection with alliances,
license agreements and acquisitions of and investments in complementary
technologies and businesses; competing technological and market developments;
the cost of filing, prosecuting, defending and enforcing patent claims and other
intellectual property rights; the purchase of additional capital equipment,
including capital equipment necessary to ensure that our sequencing and
genotyping operations remain competitive; and capital expenditures required to
expand our facilities. Changes in our research and development plans or other
changes affecting our operating expenses may result in changes in the timing and
amount of expenditures of our capital resources.
We will require significant additional capital in the future, which we may seek
to raise through further public or private equity offerings, additional debt
financing or added collaborations and licensing arrangements. No assurance can
be given that additional financing or collaborations and licensing arrangements
will be available when needed, or that if available, will be obtained on
favorable terms. If adequate funds are not available when needed, we may have to
curtail operations or attempt to raise funds on unattractive terms.
RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. It requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset. We are required to adopt SFAS No. 143 for fiscal year
2003 and we do not believe its adoption will have a significant impact on our
financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
SFAS No. 145 rescinds FASB Statement No. 4 (FAS 4), "Reporting Gains and Losses
from Extinguishment of Debt", the amendment to FAS 4, FASB Statement No. 64 (FAS
64), "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements", and
FASB Statement No. 44, "Accounting for Intangible Assets of Motor Carriers". In
addition, SFAS No. 145 amends paragraph 14(a) of FASB Statement No. 13,
Accounting for Leases, to eliminate an inconsistency between the accounting for
sale-leaseback transactions and certain lease modifications that have economic
effects that are similar to sale-leaseback transactions and makes several other
technical corrections to existing pronouncements. We are required to adopt FAS
145 for our fiscal year 2003 and we do not believe its adoption will have a
significant impact on our financial position or results of operations.
PAGE 18
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," or SFAS 146. This statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)," or EITF 94-3. SFAS 146 requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. EITF 94-3 allowed for an exit cost
liability to be recognized at the date of an entity's commitment to an exit
plan. SFAS 146 also requires that liabilities recorded in connection with exit
plans be initially measured at fair value. The provisions of SFAS 146 are
effective for exit or disposal activities that are initiated after December 31,
2002, with early adoption encouraged.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary objective of our investment activities is to preserve principal
while maximizing income we receive from our investments without significantly
increasing risk. Some of the securities in our investment portfolio may be
subject to market risk. This means that a change in prevailing interest rates
may cause the market value of the investment to fluctuate. For example, if we
hold a security that was issued with a fixed interest rate at the
then-prevailing rate and the prevailing interest rate later rises, the market
value of our investment will probably decline. To minimize this risk in the
future, we intend to maintain our portfolio of cash equivalents and short-term
investments in a variety of securities, including commercial paper, money market
funds and government and non-government debt securities. In general, money
market funds are not subject to market risk because the interest paid on such
funds fluctuates with the prevailing interest rate. As of June 30, 2002, all of
our cash and cash equivalents were in money market and checking accounts.
We are exposed to market risks from changes in foreign currency exchange rates,
interest rates and investment prices. These changes may adversely affect our
operating results and financial condition. We seek to manage these risks through
regular operating and financing activities and, when deemed appropriate, through
the use of derivative financial instruments. We control and manage foreign
exchange risk, interest rate risk, and investment price risk by continually
monitoring changes in key economic indicators and market information.
As a consequence of the nature our business and operations our reported
financial results and cash flows are exposed to the risks associated with
fluctuations in the exchange rates of the U.S. dollar, the Icelandic krona and
other world currencies. We continue to monitor our exposure to currency risk but
have not yet purchased instruments to hedge these general risks through the use
of derivative financial instruments.
We hold various interest rate sensitive assets and liabilities to manage the
liquidity and cash needs of our day-to-day operations. As a result, we are
exposed to risks due to changes in interest rates. In order to mitigate risks
associated with interest rate sensitive liabilities we use interest rate
derivative instruments, such as cross currency interest rate swaps, and may in
future use other instruments to achieve the desired interest rate maturities and
asset/liability structures.
We are exposed to credit (or repayment) risk, as well as market risk from the
use of derivative instruments. If the counterparty fails to fulfill its
performance obligations under a derivative contract, our credit risk will equal
the positive market value in a derivative. Consequently, when the fair market
value of a derivative contract is positive, this indicates that the counterparty
owes us, thus creating a repayment risk for us. When the fair market value of a
derivative contract is negative, we owe the counterparty and therefore, assume
no repayment risk.
In order to minimize the credit risk in derivative instruments, we enter into
transactions with high quality counterparties such as financial institutions
that satisfy our established credit approval criteria. We review the credit
ratings of such counterparties on a regular basis.
PAGE 19
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There has been no change in the matters reported in deCODE's quarterly report on
Form 10-Q for the quarter ended March 31, 2002.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) RECENT SALES OF UNREGISTERED SECURITIES
During the period covered by this quarterly report on Form 10-Q, we sold the
following securities that were not registered under the Securities Act:
In May, 2002, we issued an aggregate of 141,665 shares of common stock to Advent
Performance Materials Limited Partnership, Advent Partners Limited Partnership
and Rovent II Limited Partnership upon the net exercise of warrants for 150,000
shares of common stock with an exercise price of $1 per share.
The sale and issuance of securities in the transactions described above were
deemed to be exempt from registration under the Securities Act of 1933, as
amended, by virtue of Section 4(2) as transactions not involving any public
offering. Where appropriate, the purchasers represented their intention to
acquire the securities for investment only and not with a view to the
distribution thereof. The shares issued upon exercise of the warrants were
eligible for resale pursuant to Rule 144(k) under the Securities Act of 1933, as
amended, and accordingly no legend was affixed to the stock certificates issued
in the transactions. The purchasers had or had access to adequate information
about deCODE.
(d) USE OF PROCEEDS
We commenced an initial public offering of our common stock, $.001 par value, on
July 17, 2000 pursuant to registration statements on Form S-1 (Registration Nos.
333-31984 and 333-41598), which were declared effective by the Securities and
Exchange Commission on July 17, 2000. Net proceeds to us after deduction of
expenses were approximately $182.0 million. We have used the proceeds as
follows:
Discovery and research programs....................................... $ 94.9
ABI DNA Analyzers..................................................... 15.9
Construction of executive office and laboratory facilities............ 29.4
Construction of other laboratory facilities........................... 2.7
Computer equipment.................................................... 4.5
Other laboratory equipment............................................ 6.3
Other property and equipment.......................................... 2.1
General and administrative activities................................. 17.5
Installment payments on capital lease obligations..................... 4.6
Interest.............................................................. 2.0
MediChem transaction costs............................................ 2.1
------
$182.0
======
PAGE 20
ITEM 5. OTHER INFORMATION
RISK FACTORS
FORWARD LOOKING STATEMENTS AND CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
This report contains forward-looking statements. These statements relate to
future events or our future financial performance. In some cases,
forward-looking statements can be identified by terminology such as "may,"
"will," "should," "could," "expect," "plan," "anticipate," "believe,"
"estimate," "predict," "intend," "potential" or "continue" or the negative of
such terms or other comparable terminology. These statements are only
predictions. Actual events or results may differ materially due to a number of
factors, including those set forth in this section and elsewhere in this Form
10-Q. These factors include, but are not limited to, the risks set forth below.
DECODE MAY NOT SUCCESSFULLY DEVELOP OR DERIVE REVENUES FROM ANY PRODUCTS OR
SERVICES.
DISCOVERY SERVICES
deCODE is still in the early stages of its gene discovery programs. deCODE uses
its technology and research capabilities primarily to identify genes or gene
fragments that are responsible for certain diseases, indicate the presence of
certain diseases or cause or predispose individuals to certain complex diseases.
Although deCODE has identified some genes that it believes are likely to cause
certain diseases, deCODE may not be correct and may not be successful in
identifying any other similar genes. Many experts believe that some of the
diseases deCODE is targeting are caused by both genetic and environmental
factors. Even if deCODE identifies specific genes that are partly responsible
for causing diseases, any gene-based therapeutic or diagnostic products may not
detect, prevent or cure a particular disease. Accordingly, even if deCODE is
successful in identifying specific genes, its discoveries may not lead to the
development of commercial products.
In March 2002, deCODE acquired MediChem Life Sciences Inc., or MediChem, with
the expectation that the combination of deCODE's unique population genomics
approach to identifying novel targets in major therapeutic areas with MediChem's
high-throughput integrated chemistry platform would facilitate drug discovery
and development. Realization of this expectation and development and
commercialization of potential drug candidates will depend not only on deCODE's
successful integration of MediChem's business and the achievement of research
objectives by MediChem and its collaborators, but also on each of MediChem's
client's own financial, competitive, marketing and strategic considerations, all
of which are beyond deCODE's control.
Any pharmaceutical products that deCODE or its collaborators are able to develop
will fail to produce revenues unless deCODE:
- establishes that they are safe and effective;
- successfully competes with other technologies and products;
- ensures that they do not infringe on the proprietary rights of
others;
- establishes that they can be manufactured in sufficient
quantities at reasonable costs; and
- can market them successfully.
deCODE may not be able to meet these conditions. deCODE expects that it will be
years, if ever, before it will recognize revenue from the development of
therapeutic or diagnostic products.
DATABASE SERVICES
deCODE received a license to create and operate the Icelandic Health Sector
Database, or the Database License, in January 2000, and deCODE is still in the
early stages of developing this database and the deCODE Combined Data Processing
system, a tool which, subject to ongoing compliance with regulatory
requirements, will cross-reference genealogical records, data from the Icelandic
Health Sector Database and genotypes of consenting participants. deCODE expects
it will be several years before it fully develops the deCODE Combined Data
Processing system. deCODE expects to devote substantial resources to the
development of these systems and their components for the foreseeable future.
Database Services include the Clinical Genome Miner which contains tools to
discover or validate disease linked genes based on non-personally identifiable
genotypic, genealogical and phenotypic data. deCODE cannot be sure that
marketing the Clinical Genome Miner will lead to collaborations with potential
clients nor that the deCODE Combined Data Processing system will result in
marketable products or services. Although deCODE's intended method for
cross-referencing genealogical, genotypic and healthcare data is central to the
development of the deCODE Combined Data Processing system, it is unproven.
PAGE 21
The success of deCODE's database services depends on its ability to:
- create database and cross reference software that is free from
design defects or errors;
- obtain the cooperation of the Icelandic healthcare system;
- obtain blood samples from Icelanders and their consent to use
their genotypic data;
- effectively use the information derived from the deCODE
Combined Data Processing system in disease management, analysis of drug
response, gene discovery and drug target validation; and
- develop marketing and pricing methods that the intended users
of the deCODE Combined Data Processing system will accept.
deCODE's development of the Icelandic Health Sector Database will be impaired if
individual Icelanders refuse to allow information from their medical records to
be included in the Icelandic Health Sector Database. As of June 30, 2002,
approximately 7% of the population has exercised their rights to exclude their
medical records from the database. Because only a small portion of the Icelandic
population may carry certain mutations, the unwillingness of even a small
portion of the population to participate in deCODE's programs could diminish its
ability to develop and market information based on the use of genotypic data. If
deCODE fails to successfully commercialize its database services, it will not
realize revenues from this part of its business.
HEALTHCARE INFORMATICS
Only deCODE has tested most of its informatics products. These products may not
meet the needs of potential customers. deCODE has generated little revenues from
sales or licenses of informatics products. deCODE cannot assure you that it can
successfully develop or commercialize, or that there will be a market for, its
informatics products.
IF THE COSTS ASSOCIATED WITH THE MEDICHEM ACQUISITION EXCEED THE BENEFITS,
DECODE MAY EXPERIENCE ADVERSE FINANCIAL RESULTS, INCLUDING INCREASED LOSSES.
deCODE will incur consolidation and integration expenses which it cannot
accurately estimate at this time. Actual integration costs may substantially
exceed deCODE's current estimates and may affect its financial condition and
operating results negatively. If the benefits of the acquisition do not exceed
the costs associated with the acquisition, deCODE's financial results could be
adversely affected, including increased losses.
IF DECODE CONTINUES TO INCUR OPERATING LOSSES LONGER THAN ANTICIPATED, OR IN
AMOUNTS GREATER THAN ANTICIPATED, IT MAY BE UNABLE TO CONTINUE ITS OPERATIONS.
deCODE incurred a net loss of $28 million for the six months ended June 30, 2002
and has an accumulated deficit of $187 million at June 30, 2002. deCODE has
never generated a profit and it has not generated revenues except for payments
received in connection with its research and development collaborations with
Roche, other recent collaborations and interest revenues. deCODE must increase
its expenditures substantially over the next several years to develop its
technologies and its internal research programs and to prepare the Clinical
Genome Miner Service, the Icelandic Health Sector Database, the deCODE Combined
Data Processing system and informatics. In addition, the integration of MediChem
has and will continue to impact our results of operations and our financial
position. With MediChem, our revenues will increase but our operating expenses
and, at least for the near term, likely our net losses will increase. In
addition, we expect to fund the working capital needs and operating activities
of MediChem in the near term. The extent to which MediChem will ultimately
impact our results of operations and financial condition is largely dependant
upon how quickly and in what proportion MediChem's capacity is brought to bear
on our in-house programs and how much of their existing contract services
business is maintained and developed. As a result, deCODE expects to incur
operating losses for several years. If the time required to generate product
revenues and achieve profitability is longer than deCODE currently anticipates
or the level of operating losses is greater than deCODE currently anticipates,
deCODE may not be able to continue its operations.
IF DECODE'S ASSUMPTION ABOUT THE ROLE OF GENES IN DISEASE IS WRONG, IT MAY NOT
BE ABLE TO DEVELOP USEFUL PRODUCTS.
The products deCODE hopes to develop involve new and unproven approaches. They
are based on the assumption that information about genes may help scientists to
better understand complex disease processes. Scientists generally have a limited
understanding of the role of genes in diseases, and few products based on gene
discoveries have been developed. Of the products that exist, all are diagnostic
products. To date, deCODE knows of no therapeutic products based on disease gene
discoveries. If deCODE's assumption about the role of genes in the disease
process is wrong, its gene discovery programs may not result in products, the
genetic data included in its database and informatics products may not be useful
to its customers and those products may lose any competitive advantage.
PAGE 22
IF DECODE IS NOT ABLE TO OBTAIN SUFFICIENT ADDITIONAL FUNDING TO MEET ITS
EXPANDING CAPITAL REQUIREMENTS, DECODE MAY BE FORCED TO REDUCE OR TERMINATE ITS
RESEARCH PROGRAMS AND PRODUCT DEVELOPMENT.
deCODE has spent substantial amounts of cash to fund its research and
development activities and expects to spend substantially more over the next
several years for research and development activities. deCODE expects to use
cash to continue its research and development activities, develop the Clinical
Genome Miner, construct the Icelandic Health Sector Database and the deCODE
Combined Data Processing system, collect the genotype data, develop healthcare
informatics products and conduct drug discovery and development activities. Many
factors will influence its future capital needs, including:
- the number, breadth and progress of its discovery and research
programs;
- its ability to attract customers;
- its ability to commercialize its discoveries and the resources
it devotes to commercialization;
- the amount it spends to enforce patent claims and other
intellectual property rights; and
- the costs and timing of regulatory approvals.
deCODE intends to rely on Roche and other existing and future collaborators for
significant funding of its research efforts. In addition, deCODE may seek
additional funding through public or private equity offerings and debt
financings. deCODE may not be able to obtain additional financing when it needs
it or the financing may not be on terms favorable to deCODE or its stockholders.
Stockholders' ownership will be diluted if deCODE raises additional capital by
issuing equity securities.
If deCODE raises additional funds through collaborations and licensing
arrangements, it may have to relinquish rights to some of its technologies or
product candidates, or grant licenses on unfavorable terms. If adequate funds
are not available, deCODE would have to scale back or terminate its discovery
and research programs and product development.
DECODE MAY NOT BE ABLE TO FORM AND MAINTAIN THE COLLABORATIVE RELATIONSHIPS THAT
ITS BUSINESS STRATEGY REQUIRES AND THE RELATIONSHIPS MAY LEAD TO DISPUTES OVER
TECHNOLOGY RIGHTS.
deCODE must form research collaborations and licensing arrangements with several
partners at the same time to operate its business strategy. deCODE currently has
only six substantial collaborative relationships, including two with Roche. To
succeed, deCODE will have to maintain these relationships and establish
additional collaborations. deCODE cannot be sure that it will be able to
establish the additional research collaborations or licensing arrangements
necessary to develop and commercialize products using its technology or that it
can do so on terms favorable to deCODE. If deCODE's collaborations are not
successful or deCODE is not able to manage multiple collaborations successfully,
its programs will suffer. If deCODE increases the number of collaborations, it
will become more difficult to manage the various collaborations successfully and
the potential for conflicts among the collaborators will increase.
DEPENDENCE ON COLLABORATIVE RELATIONSHIPS MAY LEAD TO DELAYS IN PRODUCT
DEVELOPMENT AND DISPUTES OVER RIGHTS TO TECHNOLOGY.
deCODE is dependent on collaborators for the pre-clinical study and clinical
development of therapeutic and diagnostic products and for regulatory approval,
manufacturing and marketing of any products that result from its technology.
deCODE's agreements with collaborators typically allow them significant
discretion in electing whether to pursue such activities. deCODE cannot control
the amount and timing of resources collaborators will devote to its programs or
potential products.
AGREEMENTS WITH COLLABORATORS MAY HAVE THE EFFECT OF LIMITING THE AREAS OF
RESEARCH THAT DECODE MAY PURSUE EITHER ALONE OR WITH OTHERS.
deCODE's arrangements may place responsibility for key aspects of information
technology product development and marketing on its collaborative partners. If
deCODE's collaborators fail to perform their obligations, deCODE's information
technology products could contain erroneous data, design defects, viruses or
software defects that are difficult to detect and correct and may adversely
affect its revenues and the market acceptance of its products. deCODE's
collaborators may stop supporting its products or providing services to it if
they develop or obtain rights to competing products. Disputes may arise in the
future over the ownership of rights to any technology developed with
collaborators. These and other possible disagreements between deCODE's
collaborators and deCODE could lead to delays in the collaborative research,
development or commercialization of products. Such disagreements could also
result in litigation or require arbitration to resolve.
DECODE'S CURRENT FACILITIES AND STAFF ARE INADEQUATE FOR COMMERCIAL PRODUCTION
AND DISTRIBUTION OF PRODUCTS.
If deCODE chooses in the future to engage directly in the development,
manufacturing and marketing of certain products, it will require substantial
additional funds, personnel and production facilities.
PAGE 23
BECAUSE REVENUES ARE CONCENTRATED, THE LOSS OF A SIGNIFICANT CUSTOMER WOULD HARM
DECODE'S BUSINESS.
Historically, a substantial portion of deCODE's and MediChem's revenue has been
derived from contracts with a limited number of significant customers. deCODE's
largest customer, Roche, accounted for approximately 80% of its consolidated
revenue in 2001. MediChem's ten largest customers accounted for approximately
71% of its total contract revenues in 2001. The loss of any significant customer
would significantly lower deCODE's revenues and affect deCODE's progression to
profitability.
DECODE'S RELIANCE ON THE ICELANDIC POPULATION MAY LIMIT THE APPLICABILITY OF ITS
DISCOVERIES TO CERTAIN POPULATIONS
The genetic make-up and prevalence of disease generally varies across
populations around the world. Common complex diseases generally occur with a
similar frequency in Iceland and other western countries. However, the
populations of other western nations may be genetically predisposed to certain
diseases because of mutations not present in the Icelandic population. As a
result, deCODE and its partners may be unable to develop diagnostic and
therapeutic products that are effective on all or a portion of the people with
such diseases. Any difference between the Icelandic population and other
populations may have an effect on the usefulness of the Icelandic Health Sector
Database and the Clinical Genome Miner in studying populations outside of
Iceland. For deCODE's business to succeed, it must be able to apply discoveries
that it makes on the basis of the Icelandic population to other markets.
DECODE'S CREATION AND OPERATION OF THE ICELANDIC HEALTH SECTOR DATABASE DEPENDS
ON ITS DATABASE LICENSE FROM THE ICELANDIC GOVERNMENT AND IS SUBJECT TO
SUPERVISION AND REGULATION, WHICH MAY MAKE ITS DEVELOPMENT OF DATABASE PRODUCTS
MORE EXPENSIVE AND TIME-CONSUMING THAN DECODE ANTICIPATES
deCODE's construction and use of the Icelandic Health Sector Database is subject
to the stipulations of the Database License. The Database License was granted to
deCODE by the Ministry of Health and Social Security of Iceland, or the Health
Ministry, pursuant to the Act on the Health Sector Database, no. 139/1998, or
the Database Act. The Database License permits the processing of healthcare data
from healthcare records and other relevant data into the Icelandic Health Sector
Database. deCODE's data collection and use activities will be supervised by the
Icelandic Health Sector Database Monitoring Committee, the Data Protection
Authority of Iceland and an Interdisciplinary Ethics Committee. In addition, the
Icelandic Bioethics Committee will review deCODE's operation of the database.
Due to this oversight, deCODE is subject to the following additional risks:
- the Health Ministry may withdraw the Database License in the event
that deCODE violates the terms and conditions of the Database License, the
Database Act or its rules;
- the Icelandic parliament may amend the Database Act in ways which
would adversely affect deCODE's ability to develop or market the database;
- there is no precedent interpreting the Database Act or the rules on
which deCODE can rely, which may delay regulatory approval and greatly affect
the creation and marketing of the Icelandic Health Sector Database;
- deCODE may fail to comply with existing data confidentiality
requirements of the Database Act or the Database License, resulting in a loss of
the Database License;
- the Data Protection Authority may modify or impose additional
technical requirements covering areas such as data encryption and privacy
protection and may require greater technical capabilities than deCODE currently
has or able to procure at reasonable cost to deCODE; and
- the Interdisciplinary Ethics Committee may withdraw permission for
any type of research program in the Icelandic Health Sector Database not
conducted in accordance with international rules of bioethics.
Compliance with these requirements can be expensive and time-consuming and may
delay or increase the cost of development of the Icelandic Health Sector
Database and the deCODE Combined Data Processing system and may limit their
usefulness, which may negatively influence the commercial potential of the
Processing System. Iceland is subject to both European Free Trade Association
and European Union competition and public procurement rules. If it is determined
that the Database Act or the Database License breaches such rules, the Database
License could be revoked or diluted.
Even if deCODE is able to successfully create and market the Icelandic Health
Sector Database and the deCODE Combined Data Processing system, the Database
License will expire in January 2012. There is no assurance that deCODE will
obtain further access rights on favorable terms, if at all.
PAGE 24
IF DECODE FAILS TO PROTECT CONFIDENTIAL DATA ADEQUATELY, IT COULD INCUR
LIABILITY OR LOSE ITS DATABASE LICENSE.
deCODE is required, under the Database Act and the Database License, to encrypt
all patient data and to take other actions to ensure the confidentiality of data
included in the Icelandic Health Sector Database and to restrict access to it.
deCODE must develop the Icelandic Health Sector Database in accordance with the
terms regarding technology, security and organizational established by the Data
Protection Authority of Iceland. The Database Protection Authority may
periodically review and amend such terms in light of new technology or change of
circumstances. The customers for deCODE's products also may impose additional
confidentiality requirements. deCODE may accidentally disclose confidential data
as a result of technical failures or human error by its employees or those of
its customers or collaborators. Any failure to comply fully with all
confidentiality requirements could lead to liability for damages incurred by
individuals whose privacy is violated, the loss of the Database License, the
loss of its customers and reputation and the loss of the goodwill and
cooperation of the Icelandic population, including healthcare professionals,
which could materially adversely affect all other deCODE projects conducted in
Iceland.
IF DECODE IS NOT ABLE TO ENTER INTO AGREEMENTS WITH MORE ICELANDIC HEALTH
INSTITUTIONS IN ORDER TO COLLECT DATA, DECODE WILL NOT BE ABLE TO CONSTRUCT AND
OPERATE THE ICELANDIC HEALTH SECTOR DATABASE.
deCODE is required by the Database License to enter into agreements with
Icelandic health institutions and self-employed health service professionals
regarding access to and the processing of information from medical records. To
date, deCODE has only entered into agreements with 26 Icelandic health
institutions. deCODE cannot be certain that it will enter into agreements with
enough additional health institutions or on terms favorable to it. deCODE's
inability to enter into additional agreements on favorable terms or in a timely
manner could have material adverse effect on its ability to construct and
operate the Icelandic Health Sector Database.
ETHICAL CONCERNS MAY LIMIT DECODE'S ABILITY TO DEVELOP AND USE THE ICELANDIC
HEALTH SECTOR DATABASE AND THE DECODE COMBINED DATA PROCESSING SYSTEM AND MAY
LEAD TO LITIGATION AGAINST DECODE OR THE ICELANDIC GOVERNMENT.
The Icelandic parliament's passage of the Database Act and the Health Ministry's
granting of the Database License have raised ethical concerns in Iceland and
internationally. These concerns may lead to litigation in U.S., Icelandic or
other national or international courts (for example, on the basis of an alleged
breach of the patient-doctor confidentiality, constitutional privacy issues,
international conventions dealing with protection of privacy issues or human
rights conventions). In February 2000, an Icelandic organization known as
Mannvernd, or The Association of Icelanders for Ethics in Science and Medicine,
and a group of physicians and other citizens issued a press release announcing
their intention to file lawsuits against the State of Iceland and any other
relevant parties, including deCODE, to test the constitutionality of the
Database Act. According to the press release, the lawsuit will allege human
rights violations and challenge the validity of provisions of the Database Act.
To date no such suit has been brought against deCODE. One lawsuit has been
brought in Icelandic courts against the Directorate of Public Health in Iceland
challenging the constitutionality of the Database Act. In the event that the
Icelandic State by a final judgment is found to be liable or subject to payment
to any third party as a result of the passage of legislation on the Icelandic
Health Sector Database and/or the issuance of the Database License, deCODE's
agreement with the Health Ministry requires deCODE to indemnify the Icelandic
State against all damages and costs incurred in connection with such litigation.
In addition, the pendency of such litigation could lead to delay in the
development of the Icelandic Health Sector Database and the deCODE Combined Data
Processing system, and an unfavorable outcome could prevent deCODE from
developing and operating the Icelandic Health Sector Database and the deCODE
Combined Data Processing system.
DECODE HAS AGREED TO INDEMNIFY AND HOLD HARMLESS THE ICELANDIC GOVERNMENT, WHICH
MAY CAUSE DECODE TO INCUR DAMAGES AND MAY LIMIT ITS RIGHT TO TAKE CERTAIN LEGAL
ACTIONS AGAINST THE GOVERNMENT.
deCODE is subject to a very extensive indemnity clause in its agreement
with the Health Ministry, pursuant to which deCODE has agreed:
- not to make any claim against the government if the Database Act or
the Database License is amended as a result of the Database Act or rules
relating to the Icelandic Health Sector Database are found to be inconsistent
with the rules of the European Economic Area, or other international rules and
agreements to which Iceland is or becomes a party;
- that if the Icelandic State, by a final judgment, is found to be
liable or subject to payment to any third party as a result of the passage of
the Database Act and/or issuance of the Database License, deCODE will indemnify
the state against all damages and costs in connection with the litigation; and
- to compensate any third parties with whom the Icelandic government
negotiates a settlement of liability claims arising from the Database Act and/or
the issuance of the Database License, provided that the Icelandic government
demonstrates that it was justified in agreeing to make payments pursuant to the
settlement.
PAGE 25
CONCERNS REGARDING THE USE OF GENETIC TESTING RESULTS MAY LIMIT THE COMMERCIAL
VIABILITY OF ANY PRODUCTS DECODE DEVELOPS.
Other companies have developed genetic predisposition tests that have raised
ethical concerns. It is possible that employers or others could discriminate
against people who have a genetic predisposition to certain diseases. Concern
regarding possible discrimination may result in governmental authorities
enacting restrictions or bans on the use of all, or certain types of, genetic
testing. Similarly, such concerns may lead individuals to refuse to use genetic
tests even if permissible. These factors may limit the market for, and therefore
the commercial viability of, products that deCODE's collaborators and deCODE
genetics, Inc. develops.
DECODE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY WITH OTHER COMPANIES AND
GOVERNMENT AGENCIES IN THE DEVELOPMENT AND MARKETING OF PRODUCTS AND SERVICES.
A number of companies are attempting to rapidly identify and patent genes that
cause diseases or an increased susceptibility to diseases. Competition in this
field and deCODE's other areas of business, including database services,
healthcare informatics and drug discovery and development, is intense and is
expected to increase. deCODE has numerous competitors, including major
pharmaceutical and diagnostic companies, specialized biotechnology firms,
universities and other research institutions, the United States-funded Human
Genome Project and other government-sponsored entities and companies providing
healthcare information products. deCODE's collaborators, including Roche, may
also compete with deCODE. Many of deCODE's competitors have considerably greater
capital resources, research and development staffs and facilities, and technical
and other resources than deCODE does, which may allow them to discover important
genes before deCODE does. deCODE believes that a number of its competitors are
developing competing products and services that may be commercially successful
and that are further advanced in development than its potential products and
services. To succeed, deCODE, together with its collaborators, must discover
disease-predisposing genes, characterize their functions, develop genetic tests
or therapeutic products and related information services based on such
discoveries, obtain regulatory and other approvals, and launch such services or
products before competitors. Even if deCODE's collaborators or deCODE is
successful in developing effective products or services, deCODE's products and
services may not successfully compete with those of its competitors. deCODE's
competitors may succeed in developing and marketing products and services that
are more effective than deCODE's or that are marketed before deCODE's.
Competitors have established, and in the future may establish, patent positions
with respect to gene sequences related to deCODE's research projects. Such
patent positions or the public availability of gene sequences comprising
substantial portions of the human genome could decrease the potential value of
deCODE's research projects and make it more difficult for deCODE to compete.
deCODE may also face competition from other entities in gaining access to DNA
samples used for research and development purposes.
deCODE expects competition to intensify as technical advances are made and
become more widely known. deCODE's future success will depend in large part on
maintaining a competitive position in the genomics field. Others' or deCODE's
rapid technological development may result in products or technologies becoming
obsolete before deCODE recovers the expenses it incurs in developing them. Less
expensive or more effective technologies could make future products obsolete.
deCODE cannot be certain that it will be able to make the necessary enhancements
to any products it develops to compete successfully with newly emerging
technologies.
OTHERS MAY CLAIM INTELLECTUAL PROPERTY RIGHTS TO DECODE'S GENEALOGY DATABASE,
WHICH COULD PREVENT DECODE FROM USING SOME OR ALL OF ITS DATABASE AND IMPAIR ITS
ABILITY TO DERIVE REVENUES FROM ITS DATABASE AND GENE DISCOVERY SERVICES.
There are other firms and agencies that have prepared, or are currently
preparing, genealogy databases similar to the one deCODE has developed. If any
parties claim that any of deCODE's databases infringes on their intellectual
property rights, deCODE would have to defend against their claim, cease using
the infringing property or pay them for the use of the infringing property. Two
parties have filed a copyright infringement suit against deCODE in Iceland. They
claim to hold copyrights to approximately 100 Icelandic genealogy books and
claim that deCODE has used data from these books in the creation of its
genealogy database, in violation of their rights. The claimants seek to prevent
deCODE's use of its genealogy database. They also seek monetary damages in the
amount of approximately 616 million Icelandic kronas (approximately $7.2
million, based on the exchange rate of 86 kronas to $1.00 as of June 30, 2002).
deCODE believes that this suit is without merit and intends to defend it
vigorously, but if it were successful it could have a material adverse effect on
deCODE's database and gene discovery services.
PAGE 26
DECODE MAY NOT BE ABLE TO PROTECT THE PROPRIETARY RIGHTS THAT ARE CRITICAL TO
ITS SUCCESS.
deCODE's success will depend on its ability to protect its genealogy database
and genotypic data and any other proprietary databases that it develops and its
proprietary software and other proprietary methods and technologies. Despite
deCODE's efforts to protect its proprietary rights, unauthorized parties may be
able to obtain and use information that deCODE regards as proprietary. deCODE's
commercial success will depend in part on obtaining patent protection. The
patent positions of pharmaceutical, biopharmaceutical and biotechnology
companies, including deCODE's, are generally uncertain and involve complex legal
and factual considerations. deCODE cannot be sure that any of its pending patent
applications will result in issued patents, that it will develop additional
proprietary technologies that are patentable, that any patents issued to deCODE
genetics, Inc. or deCODE's partners will provide a basis for commercially viable
products, will provide deCODE with any competitive advantages or will not be
challenged by third parties, or that the patents of others will not have an
adverse effect on deCODE's ability to do business.
In addition, patent law relating to the scope of claims in the area of genetics
and gene discovery is still evolving. There is substantial uncertainty regarding
the patentability of genes or gene fragments without known functions. The laws
of some European countries provide that genes and gene fragments may not be
patented. The Commission of the EU has passed a directive that prevents the
patenting of genes in their natural state. The U.S. Patent and Trademark Office
initially rejected a patent application by the National Institutes of Health on
partial genes. Accordingly, the degree of future protection for deCODE's
proprietary rights is uncertain and, deCODE cannot predict the breadth of claims
allowed in any patents issued to it to others. deCODE could also incur
substantial costs in litigation if it is required to defend itself in patent
suits brought by third parties or if it initiates such suits.
Others may have filed and in the future are likely to file patent applications
covering genes or gene products that are similar or identical to deCODE's
products. deCODE cannot be certain that its patent applications will have
priority over any patent applications of others. The mere issuance of a patent
does not guarantee that it is valid or enforceable; thus even if deCODE is
holding or is granted patents it cannot be sure that they would be valid and
enforceable against third parties. Further, a patent does not provide the patent
holder with freedom to operate in a way that infringes the patent rights of
others. Any legal action against deCODE or its partners claiming damages and
seeking to enjoin commercial activities relating to the affected products and
processes could, in addition to subjecting deCODE to potential liability for
damages, require deCODE or its partners to obtain a license in order to continue
to manufacture or market the affected products and processes. There can be no
assurance that its partners or deCODE would prevail in any action or that any
license required under any patent would be made available on commercially
acceptable terms, if at all. If licenses are not available, its partners or
deCODE may be required to cease marketing its products or practicing its
methods.
If expressed sequence tags, single nucleotide polymorphisms, or SNPs, or other
sequence information become publicly available before deCODE applies for patent
protection on a corresponding full-length or partial gene, deCODE's ability to
obtain patent protection for those genes or gene sequences could be adversely
affected. In addition, other parties are attempting to rapidly identify and
characterize genes through the use of gene expression analysis and other
technologies. If any patents are issued to other parties on these partial or
full-length genes or gene products or uses for such genes or gene products, the
risk increases that the sale of deCODE's or its collaborators' potential
products or processes may give rise to claims of patent infringement. The amount
of supportive data required for issuance of patents for human therapeutics is
highly uncertain. If more data than deCODE has available is required, our
ability to obtain patent protection could be delayed or otherwise adversely
affected. Even with supportive data, the ability to obtain patents is uncertain
in view of evolving examination guidelines, such as the utility and written
description guidelines that the U.S. Patent and Trademark Office has adopted.
While deCODE requires employees, academic collaborators and consultants to enter
into confidentiality agreements, there can be no assurance that proprietary
information will not be disclosed, that others will not independently develop
substantially equivalent proprietary information and techniques, otherwise gain
access to our trade secrets or disclose such technology, or that deCODE can
meaningfully protect its trade secrets. If the information processed by the
deCODE Combined Data Processing system is disclosed without deCODE's
authorization, demand for its products and services may be adversely affected.
REGULATORY APPROVALS FOR PRODUCTS RESULTING FROM DECODE'S GENE DISCOVERY
PROGRAMS MUST BE OBTAINED OR DECODE WILL NOT BE ABLE TO DERIVE REVENUES FROM
THESE PRODUCTS.
Government agencies must approve new drugs and diagnostic products in the
countries in which they are to be marketed. deCODE cannot be certain that we can
obtain regulatory approval for any drugs or diagnostic products resulting from
its gene discovery programs. The regulatory process can take many years and
require substantial resources. Because some of the products likely to result
from deCODE's disease research programs involve the application of new
technologies and may be based upon a new therapeutic approach, various
government regulatory authorities may subject such products to substantial
additional review. As a result, these authorities may grant regulatory approvals
for these products more slowly than for products using more conventional
technologies. Furthermore, regulatory approval may impose limitations on the use
of a drug or diagnostic product.
PAGE 27
After initial regulatory approval, a marketed product and its manufacturer must
undergo continuing review. Discovery of previously unknown problems with a
product may have adverse effects on deCODE's business, financial condition and
results of operations, including withdrawal of the product from the market.
EFFORTS TO REDUCE HEALTHCARE COSTS MAY REDUCE MARKET ACCEPTANCE OF DECODE'S
PRODUCTS.
deCODE's success will depend in part on the price and extent to which it will be
paid for its products by government and health administration authorities,
private health insurers and other third party payors. Reimbursement for newly
approved healthcare products is uncertain. Third party payors, including
Medicare in the United States, are increasingly challenging the prices charged
for medical products and services. They are increasingly attempting to contain
healthcare costs by limiting both coverage and the level of reimbursement for
new therapeutic products. deCODE cannot be certain that any third party
insurance coverage will be available to patients for any products deCODE
genetics, Inc. discovers or develops. If third party payors do not provide
adequate coverage and reimbursement levels for deCODE's products, the market
acceptance of these products may be materially reduced.
Numerous governments have undertaken efforts to control growing healthcare costs
through legislation, regulation and voluntary agreements with medical care
providers and pharmaceutical companies. If cost containment efforts limit the
profits that can be derived from new drugs, deCODE's customers may reduce their
research and development spending which could reduce the business they outsource
to deCODE.
CHANGES IN OUTSOURCING TRENDS AND ECONOMIC CONDITIONS IN THE PHARMACEUTICAL AND
BIOTECHNOLOGY INDUSTRIES COULD ADVERSELY AFFECT DECODE'S GROWTH
Economic factors and industry trends that affect deCODE's primary customers,
pharmaceutical and biotechnology companies, also affect deCODE's business. For
example, the practice of many companies in these industries has been to
outsource to organizations like deCODE to conduct genetic research, clinical
research, sales and marketing projects and chemistry research and development
projects. If these industries reduce their present tendency to outsource those
projects, deCODE's operations, financial condition and growth rate could be
materially and adversely affected. In addition, our ability to generate new
business could be impaired by general economic downturns in our customers'
industries.
SOME PARTS OF DECODE'S PRODUCT DEVELOPMENT SERVICES CREATE A RISK OF LIABILITY
FROM CLINICAL TRIAL PARTICIPANTS AND THE PARTIES WITH WHOM IT CONTRACTS.
deCODE, through its subsidiary Encode ehf., contracts with drug companies to
perform a wide range of services to assist them in bringing new drugs to market.
deCODE also contracts with physicians to serve as investigators in conducting
clinical trials. deCODE's services include:
- supervising clinical trials;
- data and laboratory analysis;
- patient recruitment;
- acting as investigators in conducting clinical trials; and
- engaging in Phase I clinical trials.
If, in the course of these trials or activities:
- deCODE does not perform its services to contractual or regulatory
standards;
- patients or volunteers suffer personal injury caused by or death from
adverse reactions to the test drugs or otherwise;
- there are deficiencies in the professional conduct of the
investigators with whom deCODE contracts;
- one of deCODE's laboratories inaccurately reports or fails to report
lab results; or
- deCODE's informatics products violate rights of third parties; then,
deCODE would have a risk of liability from the drug companies with whom it
contracts or the study participants. deCODE maintains insurance to cover
ordinary risks but any insurance might not be adequate, and it would not cover
the risk of a customer deciding not to do business with deCODE as a result of
poor performance.
USE OF THERAPEUTIC OR DIAGNOSTIC PRODUCTS DEVELOPED AS A RESULT OF DECODE'S
PROGRAMS MAY RESULT IN PRODUCT LIABILITY CLAIMS FOR WHICH DECODE HAS INADEQUATE
INSURANCE.
The users of any therapeutic or diagnostic products developed as a result of
deCODE's discovery or research programs or the use of its database or medical
decision-support products may bring product liability claims against deCODE.
deCODE currently does not carry liability insurance to cover such claims. deCODE
is not certain that its collaborators or it will be able to obtain such
insurance or, if obtained, that sufficient coverage can be acquired at a
reasonable cost. If deCODE cannot protect against potential liability claims,
deCODE's collaborators or deCODE may find it difficult or impossible to
commercialize products.
PAGE 28
DECODE MAY BE UNABLE TO HIRE AND RETAIN THE KEY PERSONNEL UPON WHOM ITS SUCCESS
DEPENDS.
deCODE depends on the principal members of its management and scientific staff,
including Dr. Kari Stefansson, Chairman, President and Chief Executive Officer,
Hannes Smarason, Executive Vice President and Senior Business Officer, and Dr.
Jeffrey Gulcher, Vice President, Research and Development. deCODE genetics, Inc.
has not entered into agreements with any of the named persons that bind them to
a specific period of employment. If any of these people leaves deCODE, deCODE's
ability to conduct its operations may be negatively affected. deCODE's future
success also will depend in part on its ability to attract, hire and retain
additional personnel. There is intense competition for such qualified personnel
and deCODE cannot be certain that it will be able to continue to attract and
retain such personnel. Failure to attract and retain key personnel could have a
material adverse effect on deCODE.
CURRENCY FLUCTUATIONS MAY NEGATIVELY AFFECT DECODE'S FINANCIAL CONDITION.
deCODE publishes its consolidated financial statements in U.S. dollars. Currency
fluctuations can affect its financial results because a portion of its cash
reserves and its operating costs are in Icelandic kronas. A fluctuation of the
exchange rates of the Icelandic krona against the U.S. dollar can thus adversely
affect the "buying power" of deCODE's cash reserves and revenues. Most of
deCODE's long-term liabilities are U.S. dollar denominated. However, deCODE may
enter into hedging transactions if it has substantial foreign currency exposure
in the future. deCODE may have increased exposure as a result of investments or
payments from collaborative partners.
DECODE'S CONTRACTS MAY BE TERMINABLE UPON SHORT NOTICE.
deCODE's contracts are subject to termination for numerous reasons, any of which
may be beyond its control such as a reduction or reallocation of a customer's
research and development budget or a change in a customer's overall financial
condition. Specifically, MediChem's contracts are generally terminable upon 10
to 90 days' notice. The loss of a large contract or multiple smaller contracts,
or a significant decrease in revenue derived from a contract, could
significantly reduce deCODE's profitability and require it to reallocate
under-utilized physical and professional resources.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
The following is a list of exhibits filed as part of this Quarterly Report on
Form 10-Q.
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
3.1 Amended and Restated Certificate of Incorporation, as further
amended (Incorporated by reference to Exhibit 3.1 and Exhibit
3.3 to the Company's Registration Statement on Form S-1
(Registration No. 333-31984) which became effective on July
17, 2000)
3.2 Bylaws, as amended (Incorporated by reference to Exhibit 3.2
to Company's Registration Statement on Form S-1 (Registration
No. 333-31984) which became effective on July 17, 2000)
4.1 Warrant Certificate, dated May 6, 2002 issued to
Islandsbanki-FBA, hf. (Incorporated by reference to Exhibit
4.1 to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2002, filed on May 15, 2002.)
4.2 Form of Indexed Bond (Tier A) (Incorporated by reference to
Exhibit 4.2 to the Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 2002, filed on May 15, 2002.)
4.3 Form of Indexed Bond (Tier C) (Incorporated by reference to
Exhibit 4.3 to the Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 2002, filed on May 15, 2002.)
10.1 Promissory Note, dated May 27, 2002 from Hakon Gudbjartsson to
the Company
99.1 Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
PAGE 29
(b) REPORTS ON FORM 8-K.
On May 30, 2002, deCODE filed an amended current report on Form 8-K/A for the
purpose of amending its current report on Form 8-K dated March 18, 2002, and
filed March 21, 2002, which reported the acquisition of MediChem Life Sciences,
Inc., to add Item 7 consisting of financial statements for MediChem Life
Sciences, Inc. and unaudited pro forma financial statements.
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.
Dated August 14, 2002
deCODE genetics, Inc.
/s/ Kari Stefansson
-----------------------------------------
Kari Stefansson
Chairman, President,
Chief Executive Officer
/s/ Lance Thibault
-----------------------------------------
Lance Thibault
Chief Financial Officer and
Treasurer (principal financial
officer and principal accounting officer)
PAGE 30
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
3.1 Amended and Restated Certificate of Incorporation, as further amended
(Incorporated by reference to Exhibit 3.1 and Exhibit 3.3 to the
Company's Registration Statement on Form S-1 (Registration No.
333-31984) which became effective on July 17, 2000)
3.2 Bylaws, as amended (Incorporated by reference to Exhibit 3.2 to
Company's Registration Statement on Form S-1 (Registration No.
333-31984) which became effective on July 17, 2000)
4.1 Warrant Certificate, dated May 6, 2002 issued to Islandsbanki-FBA, hf.
(Incorporated by reference to Exhibit 4.1 to the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2002, filed on May
15, 2002.)
4.2 Form of Indexed Bond (Tier A) (Incorporated by reference to Exhibit 4.2
to the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 2002, filed on May 15, 2002.)
4.3 Form of Indexed Bond (Tier C) (Incorporated by reference to Exhibit 4.3
to the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 2002, filed on May 15, 2002.)
10.1 Promissory Note, dated May 27, 2002 from Hakon Gudbjartsson to the
Company
99.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
PAGE 31