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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 SEPTEMBER 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
November 6, 2002 was 53,538,399 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 nine-month periods ended September 30, 2002 and 2001.... 2
Condensed Consolidated Balance Sheets as of September 30, 2002
and December 31, 2001 ...................................... 3
Condensed Consolidated Statements of Cash Flows for the
nine-month periods ended September 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 .................................... 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk ... 23
Item 4. Controls and Procedures ...................................... 24
PART II. OTHER INFORMATION ........................................... 24
Item 1. Legal proceedings ............................................ 24
Item 4. Submission of Matters to a Vote of Security Holders .......... 24
Item 5. Other Information............................................. 25
(a) Stockholder Proposals for the 2003 Annual Meeting
of Stockholders .................................... 25
(b) Risk Factors and Forward Looking Statements and
Cautionary Factors That May Affect Future Results .. 25
Item 6. Exhibits and Reports on Form 8-K ............................. 34
(a) Exhibits ................................................. 34
(b) Reports on Form 8-K ...................................... 34
Signatures ........................................................... 35
Certifications ....................................................... 36
Index to Exhibits .................................................. 38
PAGE 1
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DECODE GENETICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------ ------------------------------
2002 2001 2002 2001
------------ ------------ ------------- ------------
REVENUE ....................................... $ 8,982,073 $ 9,720,955 $ 31,878,019 $ 20,951,848
OPERATING EXPENSES
Research and development .................... 23,466,980 16,836,656 64,679,878 53,384,144
Selling, general and administrative ......... 5,925,274 2,830,965 15,292,164 9,561,812
Impairment, employee termination benefits and
other charges ............................... 64,790,284 0 64,790,284 0
------------ ------------ ------------- ------------
Total operating expense ............. 94,182,538 19,667,621 144,762,326 62,945,956
------------ ------------ ------------- ------------
Operating loss ................................ (85,200,465) (9,946,666) (112,884,307) (41,994,108)
Interest income ............................... 711,658 1,514,099 2,269,225 6,037,700
Interest expense .............................. (812,072) (101,496) (2,422,044) (283,985)
Other non-operating income and (expense), net . (393,404) (333,360) (1,016,188) (1,005,297)
------------ ------------ ------------- ------------
Net loss before cumulative effect of change
in accounting principle .................... (85,694,283) (8,867,423) (114,053,314) (37,245,690)
Cumulative effect of change in milestone
revenue recognition method ................. 0 0 333,333 0
------------ ------------ ------------- ------------
Net Loss ...................................... $(85,694,283) $ (8,867,423) $(113,719,981) $(37,245,690)
============ ============ ============= ============
Basic and diluted net loss per share:
Net loss before cumulative effect of change
in accounting principle .................. $ (1.61) $ (0.20) $ (2.25) $ (0.84)
Cumulative effect of change in milestone
revenue recognition method ............... -- -- 0.01 --
Net Loss .................................... (1.61) (0.20) (2.24) (0.84)
Shares used in computing basic and
diluted net loss per share ............... 53,184,256 44,493,608 50,754,846 44,183,756
Pro forma amounts assuming new milestone
revenue recognition method is applied
retroactively:
Revenue................................... $ 8,982,073 $ 8,866,788 $ 31,878,019 $ 19,035,181
Net Loss ................................. (85,694,283) (9,721,590) (113,719,981) (39,162,357)
Basic and diluted net loss per share ..... (1.61) (0.22) (2.24) (0.89)
The accompanying notes are an integral part of the condensed consolidated
financial statements.
PAGE 2
DECODE GENETICS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents ..................... $ 98,912,864 $ 153,061,132
Restricted cash ............................... 0 14,000,000
Receivables ................................... 18,064,288 16,826,958
Assets held for sale .......................... 2,702,739 0
Other current assets .......................... 12,456,220 9,216,071
------------- -------------
Total current assets .................. 132,136,111 193,104,161
Restricted cash ................................. 6,000,000 0
Property and equipment, net ..................... 85,385,901 61,207,537
Goodwill ........................................ 8,862,739 0
Other long-term assets and deferred charges ..... 7,339,811 2,047,471
------------- -------------
Total assets .......................... $ 239,724,562 $ 256,359,169
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses ......... $ 19,972,057 $ 21,164,576
Current portion of capital lease obligations
and long-term debt .......................... 7,079,976 7,426,849
Deferred research revenue ..................... 7,289,078 6,147,247
------------- -------------
Total current liabilities ............. 34,341,111 34,738,672
Capital lease obligations and long-term
debt, net of current portion .................. 48,492,069 38,850,889
Deferred research revenue ....................... 9,500,000 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: 100,000,000 shares;
Issued: 53,657,056 and 45,328,227 shares
at September 30, 2002 and December 31, 2001,
respectively;
Outstanding: 53,538,399 and 45,257,386
shares at September 30, 2002 and
December 31, 2001, respectively ............ 53,657 45,328
Additional paid-in capital .................... 431,329,304 351,960,182
Notes receivable .............................. (7,707,584) (10,788,635)
Deferred compensation ......................... (3,114,069) (6,173,592)
Accumulated deficit ........................... (272,312,152) (158,592,171)
Accumulated other comprehensive income (loss) . (1,793) 52,596
Treasury stock, 118,657 and 70,841 shares
stated at cost at September 30, 2002 and
December 31, 2001, respectively ............ (863,174) (1,161,775)
------------- -------------
Total stockholders' equity ............ 147,384,189 175,341,933
------------- -------------
Total liabilities, and
stockholders' equity ............... $ 239,724,562 $ 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 NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------
2002 2001
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ......................................... $(113,719,981) $ (37,245,690)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization ................. 10,110,978 7,325,947
Purchased in-process research and development . 480,000 0
Equity in net loss of affiliate ............... 200,000 294,551
Amortization of deferred stock compensation ... 2,488,952 3,515,302
Other stock-based remuneration and
stock contributions ........................ 0 52,500
Loss on disposal of equipment ................. 399,325 1,607,583
Impairment of property, equipment and
intangibles ................................. 7,474,132 0
Impairment of goodwill ........................ 53,400,000 0
Provision for obsolete and excess materials
and supplies................................. 1,758,439 0
Litigation settlement ......................... 0 1,292,642
Other ......................................... 148,967 0
Changes in operating assets and liabilities
net of effect of acquisition:
Receivables and other current assets ........... (1,682,154) 3,192,026
Accounts payable and accrued expenses .......... (5,750,980) 3,876,467
Deferred research revenue ...................... 2,814,429 9,430,341
Unbilled research revenue ...................... 0 (5,000,000)
Other .......................................... (544,019) (511,972)
------------- -------------
Net cash used in operating activities ....... (42,421,912) (12,170,303)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ............ (14,065,407) (37,159,254)
Transaction costs of MediChem acquisition,
net of cash acquired ........................ (570,511) 0
------------- -------------
Net cash used in investing activities ....... (14,635,918) (37,159,254)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from building financings .............. 18,694,643 0
Repayment of mortgage on Woodridge, IL discovery
center ...................................... (11,879,697) 0
Issuance of common stock ....................... 12,378 0
Forfeiture of common stock ..................... (259) (60)
Repayment of notes receivable for common stock . 193,473 331,617
Installment payments on capital lease
obligations .................................. (4,110,976) (1,303,505)
------------- -------------
Net cash provided by (used in)
financing activities ...................... 2,909,562 (971,948)
------------- -------------
Net decrease in cash ............................. (54,148,268) (50,301,505)
Cash and cash equivalents at beginning of period . 153,061,132 194,144,688
------------- -------------
Cash and cash equivalents at end of period ....... $ 98,912,864 $ 143,843,183
============= =============
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. 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 nine month periods ended September 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 nine month period ended
September 30, 2002. Had the retrospective basis of milestone revenue recognition
been continued for the nine month period ended September 30, 2002, revenue, net
loss and basic and diluted net loss per share would have been $32.2 million,
$(113.7) million and $(2.24), 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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------ ------------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Revenue recorded during
the period ............. $ 13,975,608 $ 8,963,795 $ 35,025,780 $ 30,382,189
Revenue recognized during
the period ............. (8,982,073) (9,720,955) (31,878,019) (20,951,848)
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
------------ ------------ ------------ ------------
4,993,535 (757,160) 3,641,831 9,430,341
Deferred revenue at
beginning of period .... 11,795,543 14,592,500 13,147,247 4,404,999
------------ ------------ ------------ ------------
Deferred revenue at
end of period .......... $ 16,789,078 $ 13,835,340 $ 16,789,078 $ 13,835,340
============ ============ ============ ============
PAGE 6
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Revenue for the nine-month period ended September 30, 2002 includes $97,786 in
services provided to Prokaria, a related party.
Roche accounted for 45% and 80% of consolidated revenue in the three-month
periods ended September 30, 2002 and 2001, respectively, and 38% and 89% of
consolidated revenue in the nine-month periods ended September 30, 2002 and
2001, respectively. ABG accounted for nil and 16% of consolidated revenue in the
three-month periods ended September 30, 2002 and 2001, respectively, and 26% and
7% of consolidated revenue in the nine-month periods ended September 30, 2002
and 2001, respectively.
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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Research and development expense... $ 498,244 $ 897,847 $1,686,967 $2,493,139
Selling, general and administrative
expense......................... 233,235 264,828 801,985 1,022,163
---------- ---------- ---------- ----------
Total.................... $ 731,479 $1,162,675 $2,488,952 $3,515,302
========== ========== ========== ==========
In addition, general and administrative expenses in the nine-month period ended
September 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. In July 2002, deCODE granted additional
options to purchase 136,352 shares of common stock to employees in connection
with the acquisition of MediChem. In August 2002, deCODE granted an option to
purchase 60,000 shares of common stock to a Director in connection with his
reelection to the deCODE Board of Directors. In August 2002, options to purchase
15,281 shares were exercised. As of September 30, 2002, 275,057 options to
purchase shares of common stock 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.
In June 2002, deCODE adopted the deCODE genetics, Inc. 2002 Equity Incentive
Plan (the "2002 Plan"). A total of 3,000,000 shares of common stock are reserved
for grants under the terms of the 2002 Plan. The 2002 Plan provides for grants
of stock options to employees, members of the Board of Directors, and
consultants who are not employees. As of September 30, 2002, 3,000,000 options
to purchase shares of common stock were available for grant under the 2002 Plan.
PAGE 7
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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:
SEPTEMBER 30, SEPTEMBER 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......... 2,580,662 1,501,312
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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------ -------------------------------
2002 2001 2002 2001
------------ ------------ ------------- ------------
Net loss ................. $(85,694,283) $ (8,867,423) $(113,719,981) $(37,245,690)
Other comprehensive income
(loss):
Foreign currency
translation ..... (414) (144,071) (54,389) 40,342
------------ ------------ ------------- ------------
Total comprehensive income
(loss) ................ $(85,694,697) $ (9,011,494) $(113,774,370) $(37,205,348)
============ ============ ============= ============
PAGE 8
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 $85.9 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 ($3.9 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 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 allocated the total
cost of the acquisition to the net assets of MediChem as follows (in millions):
Net tangible assets acquired................................ $17.0
In-process research and development......................... 0.5
Identifiable intangible assets.............................. 6.1
Goodwill.................................................... 62.3
-----
$85.9
=====
The in-process research and development has been charged to operations as a
research and development expense in the nine month period ended September 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 (see below).
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 is not
reflected in the following pro forma financial information but MediChem's
restructuring and impairment charges in 2001 are included. This pro forma
information is not intended to be indicative of future operating results (in
millions, except per share data).
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------
2002 2001
---------- ----------
Total revenues ................................. $ 36.0 $ 36.5
Net loss ....................................... (118.2) (85.1)
Basic and diluted net loss per share ........... (2.23) (1.62)
PAGE 9
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
IMPAIRMENT, EMPLOYEE TERMINATION BENEFITS AND OTHER CHARGES
In September of 2002, deCODE implemented a cost reduction program aimed at
achieving positive operating cashflow from existing operations by the end of
2003. In this regard, deCODE reduced total worldwide headcount by approximately
200 employees during the three-months ended September 30, 2002, focusing in
particular on utilizing ongoing process automation and increased productivity in
the core genetics operations in Reykjavik. Stemming from this initiative and
together with management's consideration of significant and pervasive declines
in the market environment for pharmaceutical and biotech industries, deCODE
determined that impairment tests of the carrying value of its goodwill and other
long-lived assets, including the long-lived assets acquired through the MediChem
acquisition, should be performed as of September 30, 2002. deCODE has completed
these tests and recorded the following impairment, employee termination benefits
and other charges during the three and nine-month periods ended September 30,
2002:
Employee termination benefits...................$ 2,157,713
Impairment of goodwill.......................... 53,400,000
Impairment of property and intangible asset..... 2,715,000
Write-down of assets held for sale.............. 2,706,379
Write-down of equipment......................... 2,052,753
Obsolete and excess materials and supplies...... 1,758,439
-------------
$ 64,790,284
=============
Charges related to termination benefits for 132 employees are accrued and
unpaid as of September 30, 2002 and are expected to be settled in cash over the
next 6 months.
For purposes of the goodwill impairment tests, deCODE identified its reporting
units, identified the assets and liabilities of the reporting units and
performed impairment tests on the net goodwill associated with them. Goodwill
that resulted from the acquisition of MediChem was assigned to the reporting
units based upon expectations of synergies to be gained from the integration of
the pharmaceutical and biostructures groups with deCODE. Goodwill impairment is
deemed to exist if the net book value of a reporting unit exceeds its estimated
fair value. To identify potential impairment, deCODE compares fair value of a
reporting unit with its carrying amount, including goodwill. For this purpose,
deCODE estimates fair value of a reporting unit using analyses of comparable
companies and recent comparable transactions. In measuring the amount of
impairment loss, deCODE compares the implied fair value of a reporting unit's
goodwill with the carrying amount of that goodwill, estimating the fair value of
an impaired reporting unit using discounted cash flow methodologies. The
goodwill impairment charge is associated solely with goodwill resulting from the
acquisition of MediChem and results largely from significant and pervasive
declines in the market environment for the pharmaceutical and biotech industries
impacting, among other things, market valuations of companies operating in those
industries.
In September 2002, deCODE committed to a plan to sell its Woodridge Discovery
Center and an agent was engaged and has initiated an active marketing program
to locate a buyer/investor in a sale and leaseback transaction. The sale and
leaseback transaction is expected to be completed by the early part of 2003.
Taking into account the estimated selling price of the building less estimated
costs to sell, deCODE recorded an impairment charge in the three and nine-month
periods ended September 30, 2002 amounting to $2.1 million. In addition,
certain intangible assets amounting to $0.6 million were determined to be
impaired utilizing a discounted cashflow methodology to estimate fair value.
In September 2002, deCODE committed to a plan to sell its former headquarters
facility that had been vacated in connection with the move to its new
headquarters facility in Reykjavik's University district earlier in the year.
In October 2002, an agent for the sale was engaged and an active marketing
program to locate a buyer was initiated. In November 2002, terms of sale were
agreed with a buyer in the amount of $2.8 million, that is contingent on
buyer-financing. Taking into account the expected selling price of the building
less estimated costs to sell, deCODE wrote-down the property in the three and
nine-month periods ended September 30, 2002 amounting to $2.7 million. The
remaining carrying value of the building ($2.7 million) is classified as an
asset held for sale in the September 30, 2002 consolidated balance sheet.
Ongoing process automation and increased productivity in the core genetics
operations in Reykjavik and changes in some of deCODE's target research
programs have affected deCODE's planned volume and timing of usage of its
materials and supplies. In this connection, management has recorded an
additional provision for excess and obsolete inventory in the three and
nine-month periods ended September 30, 2002.
Additionally, in September 2002 deCODE wrote-down the value of certain
laboratory equipment no longer in use.
PAGE 10
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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.
Merck. In September 2002, deCODE and Merck & Co., Inc. (Merck) entered into an
alliance aimed at developing new treatments for obesity. Under the alliance,
deCODE and Merck will combine their research efforts in the genetics of obesity
to identify, validate and prioritize a series of drug targets to take into
development. The goal of the alliance is to accelerate the discovery of new
drugs to fight obesity, a condition that now represents one of the
fastest-growing public health challenges in the industrialized world. . Under
the terms of the three-year agreement, deCODE will receive research funding,
technology access, license fees, milestone payments as compounds developed under
the alliance advance in the development process, and royalties on successfully
marketed alliance drugs.
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%.
PAGE 11
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 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. The Individual Defendants have been dismissed from the action
without prejudice. 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 12
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. deCODE has filed a
motion to dismiss these allegations. Judge Scheindlin heard oral argument on
this motion on November 1, 2002. deCODE does not know when Judge Scheindlin will
rule on this motion. At this juncture, the litigation remains in its 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. deCODE is required to adopt SFAS No. 146 for exit or
disposal activities that are initiated from fiscal year 2003 and does not
believe its adoption will have a significant impact on its financial position or
results of operations.
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 nine months ended September 30, 2001.
In 2002, deCODE completed the move to its new headquarters facility in
Reykjavik's University district. As of September 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 $0.8 million in the nine
month period ended September 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 13
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 September 30, 2002 and for the three and nine-month periods
ended September 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.
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.
OVERVIEW
deCODE was incorporated in August 1996. We are a population genetics company
that is providing and developing a range of 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 molecular genetics data from participants in our research into the
genetics of common diseases.
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 for common
diseases. 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 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 September 30, 2002 we had an accumulated deficit of $272
million. On the basis of our current range of activities, and following the
implementation in September of a plan to reduce headcount and maximize the use
of automation in our core genetics operations, we anticipate that we will be
able to achieve positive cashflow from operations by the end of 2003. At the
same time, we believe that the initiation of possible substantial new activities
within this timeframe, such as clinical trials of a drug against one of our
proprietary targets, would require additional expenditures that could delay for
some time our achievement of positive cashflow from operations. We anticipate
incurring additional net losses at least into the medium term, due to, among
other factors, depreciation and amortization, as well stock-based compensation
and other non-cash charges. We expect that our revenues and 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.
We believe that current conditions in the global financial markets and in the
pharmaceutical industry pose significant near-term challenges to biotechnology
companies such as ourselves, as well as important opportunities. The principal
challenge to us posed by the downturn in the market valuations of biotechnology
companies and of the equity markets more generally is that it restricts our
present ability to raise additional capital on favorable terms. In a very broad
sense, it appears that the equity markets are currently more risk-averse than
they have been in the recent past. The markets are therefore less willing to
ascribe value to companies such as ourselves which, although developing new
technologies that may have the potential for generating successful products, are
not currently selling products on the market and are not yet profitable. This is
a general trend affecting not only the biotechnology industry but all industries
involved in developing new technologies and products that are unproven in the
marketplace. Moreover, it is not certain how long this sentiment in the equity
markets will last.
PAGE 14
In order to mitigate the risk to our product development programs posed by the
current conditions in the financial markets, we have implemented measures aimed
at preserving our cash resources. We recently implemented a plan to reduce our
staffing and overhead costs to a level that the we anticipate will make it
possible to achieve positive cashflow from operations by the end of next year.
We believe that we have sufficient cash resources to continue to fund our
current research and operations for several years, and we are also investigating
the possibility of alternative avenues of financing for our product development
programs.
At the same time, the pharmaceutical industry, which is the principal customer
base for our gene-discovery and contract chemistry businesses, is experiencing
difficulties in maintaining historical rates of growth. This presents near-term
challenges and significant longer term opportunities. One of the main
challenges facing the pharmaceutical industry is developing pipelines of
effective new drugs to treat major indications. As many leading brand-name drugs
come off patent and face generic competition, the successful new medicines will
become critical for filling the gap. In the short term, the financial pressures
on pharmaceutical companies may be reflected in their research and development
spending, making it more difficult for us to sign corporate alliances with
significant upfront funding, or lengthening the time required to negotiate such
deals. This will likely also lead to pressure on budgets for the outsourcing of
chemistry services, which are an important source of revenue for us. In the
medium to longer term, however, companies such as ours may be well positioned to
play an important role in filling the gap in the pipeline of new drugs, either
on their own or as partners of pharmaceutical companies. Our gene discovery
programs are aimed at identifying novel drug targets that are involved in the
basic biology of common diseases and we are focused on discovering new drugs
against these targets, both on our own and with major pharmaceutical partners.
Our partnerships with Roche and Merck demonstrate that the industry is already
investing in the development of new therapeutics based on our approach.
Similarly, it is possible that the pharmaceutical industry, in the interest of
reducing internal overheads, may opt to increase its outsourcing of contract
chemistry services.
Collaborations and further growth in our medicinal chemistry, pharmacogenetics
and informatics services 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. It is also dependent on our ability to maintain and grow our service lines
of business. 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, sign additional
subscribers to our database services, or successfully expand our medicinal
chemistry or pharamacogenetics businesses. 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 in the near
term. It may be several years before product revenues materialize, if they do at
all.
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 related 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.
PAGE 15
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 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.
In September 2002, we entered into an alliance with Merck & Co., Inc. aimed at
developing new treatments for obesity. Under the alliance, we will combine our
research efforts in the genetics of obesity to identify, validate and prioritize
a series of drug targets to take into development. The goal of the alliance is
to accelerate the discovery of new drugs to fight obesity, a condition that now
represents one of the fastest-growing public health challenges in the
industrialized world. Under the terms of the three-year agreement, we will
receive research funding, technology access, license fees, milestone payments as
compounds developed under the alliance advance in the development process, and
royalties on successfully marketed alliance drugs.
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 $85.9 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 ($3.9 million).
PAGE 16
We have recorded the transaction as a purchase for accounting purposes and have
allocated the purchase price, based upon independent valuations, to the assets
purchased and liabilities assumed based upon their respective estimated fair
values. We have 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 ($62.3 million) will not be amortized but is subject to
annual impairment testing (refer below).
Our consolidated financial statements include the cash flows and results of
MediChem from March 18, 2002. The integration of MediChem has impacted and will
continue to impact our results of operations and our financial position. With
MediChem, our revenues have increased and will increase but our operating
expenses have increased and will further increase and, at least for the near
term, likely our net losses will increase. In addition, we expect to continue 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 the extent that
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 is not reflected in
the following pro forma financial information but MediChem's restructuring and
impairment charges in 2001 are included. This pro forma information is not
intended to be indicative of future operating results (in millions, except per
share data).
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------
2002 2001
---------- ----------
Total revenues ................................. $ 36.0 $ 36.5
Net loss ....................................... (118.2) (85.1)
Basic and diluted net loss per share ........... (2.23) (1.62)
RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30,
2002 AND 2001
Our revenues and 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 the extent
to which 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.
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.
PAGE 17
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 nine-month period ended
September 30, 2002. Had the retrospective basis of milestone revenue recognition
been continued for the nine-month period ended September 30, 2002, revenue, net
loss and basic and diluted net loss per share would have been $32.2 million,
$(113.7) million and $(2.24), respectively.
The following is a summary of deferred revenue:
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------ ------------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Revenue recorded during
the period ............. $ 13,975,608 $ 8,963,795 $ 35,025,780 $ 30,382,189
Revenue recognized during
the period ............. (8,982,073) (9,720,955) (31,878,019) (20,951,848)
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
------------ ------------ ------------ ------------
4,993,535 (757,160) 3,641,831 9,430,341
Deferred revenue at
beginning of period .... 11,795,543 14,592,500 13,147,247 4,404,999
------------ ------------ ------------ ------------
Deferred revenue at
end of period .......... $ 16,789,078 $ 13,835,340 $ 16,789,078 $ 13,835,340
============ ============ ============ ============
Our revenues decreased to $8,982,073 for the three-month period ended September
30, 2002 as compared to $9,720,955 for the three-month period ended September
30, 2001, an decrease of 8%. Our revenues increased to $31,878,019 for the
nine-month period ended September 30, 2002 as compared to $20,951,848 for the
nine-month period ended September 30, 2001, an increase of 52%. The increase in
the nine-month period ended September 30, 2002 as compared to the same period in
2001 is attributable to the addition of deCODE's recently acquired
pharmaceuticals and biostructures groups and to the work conducted under the
joint development and commercialization agreement with ABG. The decrease in the
three-month period ended September 30, 2002 is due to there being no revenue
recognized from the joint development and commercialization agreement with ABG
under the percentage-of-completion basis of revenue recognition. The decrease in
the three-month period ended September 30, 2002 as compared to the same period
in 2001 is also due to that fact but also reflects the recognition of revenue
from milestone achievements under the 1998 research collaboration with Roche
during 2001. We are evaluating our collaboration with ABG. Depending upon the
outcome of our evaluation, we may not recognize ABG collaboration revenue in the
future to the extent or in the manner that we have in the past. In addition, we
expect that our revenues will fluctuate from quarter to quarter and that such
fluctuations may be substantial especially because progress in our scientific
work, including milestone payments that are related to progress, can fluctuate
between quarters.
PAGE 18
At September 30, 2002, the total amount of deferred research revenue that will
be recognized in future periods aggregated $16,789,078. Revenues recorded
increased to $13,975,608 for the three-month period ended September 30, 2002 as
compared to $8,963,795 for the three-month period ended September 30, 2001 and
increased to $35,025,780 for the nine-month period ended September 30, 2002 as
compared to $30,382,189 for the nine-month period ended September 30, 2001. We
recorded significant revenues in the three and nine-month periods ended
September 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 in the three-month period ended
September 30, 2002 notably includes access fees and research funding under the
alliance with Merck. Work completed under the joint development and
commercialization agreement with ABG and under the therapeutics and diagnostics
collaborations with Roche largely account for the remainder of revenues recorded
to-date in 2002.
Research and Development Expenses. Our research and development expenses
increased to $23,466,980 for the three-month period ended September 30, 2002 as
compared to $16,836,656 for the three-month period ended September 30, 2001, an
increase of 39%. Our research and development expenses increased to $64,679,878
for the nine-month period ended September 30, 2002 as compared to $53,384,144
for the nine-month period ended September 30, 2001, an increase of 21%. The
change period-to-period is largely attributable to the addition of our
newly-acquired pharmaceutical and biostructures groups from March 2002 and
atypical charges in the nine-month period ended September 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 costs
attributed to our pharmaceutical and biostructures groups in the three and
nine-month periods ended September 30, 2002 and to atypical charges in the
nine-month period September 30, 2001 our research and development expenditures
have increased 20% and 25% in the three and nine-month periods ended September
30, 2002 as compared to the same periods in 2001. The increases reflect spending
related to the range of our disease-gene research programs and the initiation of
downstream work on targets already identified.
Selling, General and Administrative Expenses. Our selling, general and
administrative expenses increased to $5,925,274 for the three-month period ended
September 30, 2002 as compared to $2,830,965 for the three-month period ended
September 30, 2001, an increase of 109%. Our selling, general and administrative
expenses increased to $15,292,164 for the nine-month period ended September 30,
2002 as compared to $9,561,812 for the nine-month period ended September 30,
2001, an increase of 60%. The change period-to-period is largely attributable to
the addition of selling, general and administrative costs of our pharmaceutical
and biostructures groups offset somewhat by a one-time litigation settlement for
the three and nine-month periods ended September 30, 2001. Without regard to the
additional costs attributed to our pharmaceutical and biostructures groups in
the three and nine-month periods ended September 30, 2002 and to the litigation
settlement during the nine-month period ended September 30, 2001, our general
and administrative expenses increased 26% and 17% in the three and nine-month
periods ended September 30, 2002, respectively as compared to those same periods
in 2001 largely as a result of expanded sales efforts across our businesses and
contractor services.
Stock-Based Compensation and Remuneration. Stock-based compensation and
remuneration expense was $731,479 for the three-month period ended September 30,
2002 as compared to $1,162,675 for the three-month period ended September 30,
2001, a decrease of 37%. Stock-based compensation and remuneration expense was
$2,488,952 for the nine-month period ended September 30, 2002 as compared to
$3,515,302 for the nine-month period ended September 30, 2001, a decrease of
29%. With little compensation being attributed to our more recent stock option
grants, stock-based compensation and remuneration expense has been decreasing as
grants made to employees in earlier years become fully vested. Historical
stock-based compensation and remuneration is not necessarily representative of
the effects on reported income or loss for future years due to, among other
things, the vesting period of the stock options, the value of stock options that
have been granted in recent times and the value of additional options that may
be granted in future years.
Impairment, Employee Termination Benefits and Other Costs. In September of 2002,
we implemented a cost reduction program aimed at achieving positive operating
cashflow from existing operations by the end of 2003. In this regard, we reduced
total worldwide headcount by approximately 200 employees during the three-months
ended September 30, 2002, focusing in particular on utilizing ongoing process
automation and increased productivity in the core genetics operations in
Reykjavik. Stemming from this initiative and together with our consideration of
significant and pervasive declines in the market environment for pharmaceutical
and biotech industries, we determined that impairment tests of the carrying
value of our goodwill and other long-lived assets, including the long-lived
assets acquired through the MediChem acquisition, should be performed as of
September 30, 2002. We have completed these tests and recorded the following
impairment, employee termination benefits and other charges during the three and
nine-month periods ended September 30, 2002:
Employee termination benefits...................$ 2,157,713
Impairment of goodwill.......................... 53,400,000
Impairment of property and intangible asset..... 2,715,000
Write-down of assets held for sale.............. 2,706,379
Write-down of equipment......................... 2,052,753
Obsolete and excess materials and supplies...... 1,758,439
-----------
$64,790,284
===========
PAGE 19
Charges related to termination benefits for 132 employees are accrued and
unpaid as of September 30, 2002 and are expected to be settled in cash over the
next 6 months.
For purposes of the goodwill impairment tests, we identified our reporting
units, identified the assets and liabilities of the reporting units and
performed impairment tests on the net goodwill associated with them. Goodwill
that resulted from the acquisition of MediChem was assigned to the reporting
units based upon expectations of synergies to be gained from the integration of
the pharmaceutical and biostructures groups with the overall group. Goodwill
impairment is deemed to exist if the net book value of a reporting unit exceeds
its estimated fair value. To identify potential impairment, we compare fair
value of a reporting unit with its carrying amount, including goodwill. For this
purpose, we estimate fair value of a reporting unit using analyses of comparable
companies and recent comparable transactions. In measuring the amount of
impairment loss, we compare the implied fair value of a reporting unit's
goodwill with the carrying amount of that goodwill, estimating the fair value of
an impaired reporting unit using discounted cash flow methodologies. The
goodwill impairment charge is associated solely with goodwill resulting from the
acquisition of MediChem and results largely from significant and pervasive
declines in the market environment for the pharmaceutical and biotech industries
impacting, among other things, market valuations of companies operating in those
industries.
In September 2002, we committed to a plan to sell our Woodridge Discovery
Center and an agent was engaged and has initiated an active marketing program
to locate a buyer/investor in a sale and leaseback transaction. The sale and
leaseback transaction is expected to be completed by the early part of 2003.
Taking into account the estimated selling price of the building less estimated
costs to sell, we recorded an impairment charge in the three and nine-month
periods ended September 30, 2002 amounting to $2.1 million. In addition,
certain intangible assets amounting to $0.6 million were determined to be
impaired utilizing a discounted cashflow methodology to estimate fair value.
In September 2002, we committed to a plan to sell our former headquarters
facility that had been vacated in connection with the move to our new
headquarters facility in Reykjavik's University district earlier in the year.
In October 2002, an agent for the sale was engaged and an active marketing
program to locate a buyer was initiated. In November 2002, terms of sale were
agreed with a buyer in the amount of $2.8 million, that is contingent on
buyer-financing. Taking into account the expected selling price of the building
less estimated costs to sell, we wrote-down the property in the three and
nine-month periods ended September 30, 2002 amounting to $2.7 million. The
remaining carrying value of the building ($2.7 million) is classified as an
asset held for sale in the September 30, 2002 consolidated balance sheet.
Ongoing process automation and increased productivity in the core genetics
operations in Reykjavik and changes in some of our target research programs have
affected our planned volume and timing of usage of its materials and supplies.
In this connection, we have recorded an additional provision for excess and
obsolete inventory in the three and nine-month periods ended September 30, 2002.
Additionally, in September 2002 we wrote-down the value of certain laboratory
equipment no longer in use.
Interest Income. Our interest income was $711,658 for the three-month period
ended September 30, 2002 as compared to $1,514,099 for the three-month period
ended September 30, 2001, a decrease of 53%. Our interest income was $2,269,225
for the nine-month period ended September 30, 2002 as compared to $6,037,700 for
the nine-month period ended September 30, 2001, a decrease of 62%. In general,
the decreased returns are attributable to the decline of prevailing interest
rates but also from an overall decrease in the amount of our cash.
Interest Expense. Our interest expense was $812,072 for the three-month period
ended September 30, 2002 as compared to $101,496 for the three-month period
ended September 30, 2001. Our interest expense was $2,422,044 for the nine-month
period ended September 30, 2002 as compared to $283,985 for the nine-month
period ended September 30, 2001. The increases in interest expense reflect the
cost of financings put into place during the late part of 2001 and early part of
2002.
Other non-operating income and (expense), net. Our other non-operating income
and (expense), net was $(393,404) for the three-month period ended September 30,
2002 as compared to $(333,360) for the three-month period ended September 30,
2001, and was $(1,016,188) for the nine-month period ended September 30, 2002 as
compared to $(1,005,297) for the nine-month period ended September 30, 2001. Our
other non-operating income and (expense), net is principally comprised of our
share in the earnings (losses) of eMR and foreign exchange differences. 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.
PAGE 20
Income Taxes. As of September 30, 2002, we had an accumulated deficit of $272
million and did not owe any Icelandic or U.S. federal income taxes nor did we
pay any in the three and nine-month periods ended September 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.
Net Loss and Basic and Diluted Net Loss Per Share. Net loss and basic and
diluted net loss per share were $85,694,283 and $1.61 for the three-months ended
September 30, 2002, respectively, as compared to $8,867,423 and $0.20 for the
three-months ended September 30, 2001, respectively. Net loss and basic and
diluted net loss per share were $113,719,981 and $2.24 for the nine-months ended
September 30, 2002, respectively, as compared to $37,245,690 and $0.84 for the
nine-months ended September 30, 2001, respectively. The increases in net loss
and basic and diluted net loss per share are primarily attributable to the
impairment, employee termination benefits and other charges recorded in the
three and nine-month periods ended September 30, 2002 offset in part by the
higher average number of shares outstanding for the 2002 periods. The
difference in the average number of shares outstanding is the result of our
acquisition of MediChem in March 2002.
Pro Forma Net Loss and Basic and Diluted Net Loss Per Share. Net loss and basic
and diluted net loss per share were $85,694,283 and $1.61, respectively, for the
three months ended September 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 $9,721,590 and $0.22,
respectively, for the three-months ended September 30, 2001. Net loss and basic
and diluted net loss per share were $113,719,981 and $2.24, respectively, for
the nine-months ended September 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 $39,162,357 and $0.89,
respectively, for the nine-months ended September 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 $88 million
from collaborative research agreements, $183 million from the issuance of common
stock, $79 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 $79 million in research and development funding
from Roche. As of September 30, 2002 future funding under terms of our existing
agreements is approximately $64 million excluding milestone payments and
royalties that we may earn under such collaborations.
Cash and Cash Equivalents. As of September 30, 2002, we had $98.9 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 $5.2
million of funds in the nine-month period ended September 30, 2002 as compared
to $11.0 million that was provided by working capital sources in the nine-month
period ended September 30, 2001. On account of this and significant non-cash
impairment and other charges in the nine-month period ended September 30, 2002,
although net loss increased $76.5 million for the nine-month period ended
September 30, 2002 as compared to the nine-month period ended September 30,
2001, net cash used in operating activities increased $30.3 million in the
nine-month period ended September 30, 2002 as compared to the nine-month period
ended September 30, 2001. Notably, in the nine-month period ended September 30,
2002 we made significant payments to our vendors and particularly to ABG for
reagents, other supplies and DNA analyzers. On the basis of our current range of
activities, and following the implementation in September of a plan to reduce
headcount and maximize the use of automation in our core genetics operations, we
anticipate that we will be able to achieve positive cashflow from operations by
the end of 2003. At the same time, we believe that the initiation of possible
substantial new activities within this timeframe, such as clinical trials of a
drug against one of our proprietary targets, would require additional
expenditures that could delay for some time our achievement of positive cashflow
from operations.
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 nine-month period ended September 30, 2002
were $14,065,407 as compared to $37,159,254 in the nine-month period ended
September 30, 2001. Notably, during the nine-month period ended September 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 nine-month period ended September 30, 2001 we expended $15.2
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 $3.9 million of transaction costs,
resulting in a net
PAGE 21
cash outlay for the nine-month period ended September 30, 2002 in connection
with the acquisition of $570,511. 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 $2,909,562 was provided in financing
activities in the nine-month period ended September 30, 2002 as compared to
$971,948 used in the nine-month period ended September 30, 2001. $14 million of
cash that was restricted as of December 31, 2001 was provided in the nine-month
period ended September 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 ($11.9 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 $4,110,976 for the
nine-month period ended September 30, 2002 as compared to $1,303,505 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.
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. Following the implementation in September of a plan to reduce headcount
and maximize the use of automation in our core genetics operations and based
upon current plans, 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; to obtain and maintain contract service agreements in our chemistry
services and clinical research trials groups; 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, the entry into clinical trials of a drug based on our
discoveries, 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.
PAGE 22
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.
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. We are required to adopt SFAS No. 146
for exit or disposal activities that are initiated from fiscal year 2003 and do
not believe its adoption will have a significant impact on our financial
position or results of operations.
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 September 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 23
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Within the 90 days prior
to the date of this Quarterly Report on Form 10-Q, our Chief Executive Officer
and our Chief Financial Officer evaluated the effectiveness of deCODE's
disclosure controls and procedures as defined in Rule 13a-14(c) under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). Based upon
that evaluation, the Chief Executive Officer and the Chief Financial Officer
have concluded that deCODE's current disclosure controls and procedures are
adequate and effective to ensure that information required to be disclosed in
the reports deCODE files under the Exchange Act is recorded, processed,
summarized and reported on a timely basis.
(b) Changes in internal controls. There have been no significant changes in
deCODE's internal controls or in other factors that could significantly affect
internal controls subsequent to the date of their evaluation by the Chief
Executive Officer and the Chief Financial Officer.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There has been no change in the matters reported in our quarterly report on Form
10-Q for the quarter ended March 31, 2002.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On August 30, 2002, we held our annual meeting of stockholders. The results of
the voting on the proposals submitted to the stockholders at this meeting were
as follows:
1. Election of one Class I Director
NAME FOR WITHHELD
---- --- --------
Sir John Vane 31,002,433 5,499,658
2. Ratification of the appointment of PricewaterhouseCoopers LLP. as our
independent accountants for the fiscal year ending December 31, 2002.
FOR AGAINST ABSTAIN
--- ------- -------
36,114,091 365,554 22,446
3. Approval of the amendment of our Amended and Restated Certificate of
Incorporation to increase the number of authorized shares of common stock from
60,000,000 to 100,000,000.
FOR AGAINST ABSTAIN
--- ------- -------
32,916,717 3,192,201 393,173
4. Approval of our 2002 Equity Incentive Plan
FOR AGAINST ABSTAIN BROKER NON-VOTES
14,664,194 7,775,525 451,025 13,611,347
Page 24
ITEM 5. OTHER INFORMATION
(a) Stockholder Proposals for the 2003 Annual Meeting of Stockholders
Rule 14a-8 under the Securities Exchange Act of 1934, as amended (the
"Act"), requires that a stockholder intending to submit a proposal to be
considered at a company's annual meeting notify the company of such proposal not
less than 120 calendar days before the date of the proxy statement that the
company released to stockholders the previous year, or, if the date of the
annual meeting has been changed by more than 30 days from the date of the
previous year's meeting, a reasonable time before the company begins to print
and mail the proxy statement for the current year's annual meeting. deCODE has
not yet selected the date for its 2003 Annual Meeting of Stockholders but
anticipates that it will be held on or about June 15, 2003, which is more than
30 days earlier than the date of its 2002 Annual Meeting of Stockholders. deCODE
believes that the proxy statement for its 2003 Annual Meeting of Stockholders
will be mailed on or about April 30, 2003 and that a reasonable time before such
mailing for the purpose of any stockholder proposal is a deadline of December
31, 2002.
Similarly, pursuant to Rule 14a-4(c)(1) of the Act and deCODE's bylaws,
notice of a matter to be brought before an annual meeting will be untimely if
deCODE does not have notice of such matter at least 120 days before the date on
which it first mailed its proxy materials for the prior year's annual meeting of
stockholders, or, if the date of the annual meeting has been changed by more
than 30 days from the date of the previous year's meeting, a reasonable time
before deCODE begins to print and mail the proxy statement for the current
year's annual meeting. deCODE believes that a reasonable time before such
mailing for the purpose of notice of any matter to be brought before an annual
meeting is a deadline of December 31, 2002. If deCODE does not receive notice of
a matter by that date, such notice will be considered untimely. deCODE's proxy
for the 2003 Annual Meeting of Stockholders will grant discretionary authority
to the persons named therein to exercise their voting discretion with respect to
any matter of which deCODE does not receive timely notice.
(b) Risk Factors and 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.
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 therapeutic or diagnostic 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 or diagnostic 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.
PAGE 25
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.
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.
deCODE's Clinical Genome Miner 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.
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 September 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.
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 fully 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 $114 million for the nine-months ended September
30, 2002, including $65 million of employee termination, impairment and other
costs, and has an accumulated deficit of $272 million at September 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, Merck and other collaborations, and from contract services and
interest revenues. deCODE must continue to make substantial expenditures 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 and other informatics. The integration of MediChem has and will
continue to impact deCODE's results of operations and financial position. With
MediChem, deCODE's revenues have and will increase but operating expenses and,
at least for the near term, likely net losses will also increase. In addition,
deCODE expects to continue to fund the working capital needs and operating
activities of MediChem in the near term. The extent to which MediChem will
ultimately impact deCODE's results of operations and financial condition is
largely dependant upon the extent to which MediChem's capacity is brought to
bear on deCODE's in-house programs and how much of their existing contract
services business is maintained and developed. . As a result, deCODE expects to
incur net 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 losses is greater than deCODE currently anticipates, deCODE may
not be able to continue its operations.
PAGE 26
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.
IF DECODE IS NOT ABLE TO OBTAIN SUFFICIENT ADDITIONAL FUNDING TO MEET ITS
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 continue to spend 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, Merck 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.
PAGE 27
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.
BECAUSE REVENUES ARE CONCENTRATED, THE LOSS OF A SIGNIFICANT CUSTOMER WOULD HARM
DECODE'S BUSINESS.
Historically, a substantial portion of deCODE'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 and Roche accounted for 38% of consolidated revenue in the nine-month
period ended September 30, 2002. Revenues under the joint development and
commercialization agreement with ABG accounted for 17% and 26% of consolidated
revenue in 2001 and the nine-month period ended September 30, 2002,
respectively, but under the percentage-of-completion basis of revenue
recognition none of the revenues in the three-month period ended September 30,
2002 were attributable to ABG. 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.
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.
PAGE 28
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.
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.
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;
PAGE 29
- - 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.
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.
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 drug discovery and
development as well as database services and healthcare informatics, 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 and
Merck, 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.
PAGE 30
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. 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.
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. If deCODE is unable to obtain
patent protection for its technology or discoveries, the value of its
proprietary resources will be adversely affected.
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.
PAGE 31
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.
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. These alliances and arrangements are both
time consuming and complex and we face substantial competition in establishing
these relationships. In addition, our ability to generate new business could be
impaired by general economic downturns in our customers' industries.
PAGE 32
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.
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.
PAGE 33
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 Certificate of Amendment to Amended and Restated Certificate
of Incorporation dated August 30, 2002
3.3 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 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.)
4.2 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* Research Collaboration and License Agreement dated September
26, 2002 between deCODE genetics, Inc., deCODE genetics, ehf.
and Merck & Co., Inc.
99.1 Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
* Confidential treatment has been requested for a portion of this Exhibit.
(b) REPORTS ON FORM 8-K.
No reports on Form 8-K were filed during the period covered by the Quarterly
Report on Form 10-Q.
PAGE 34
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 November 14, 2002
deCODE genetics, Inc.
/s/ Kari Stefansson
-----------------------------------------
Kari Stefansson
Chairman, President, and
Chief Executive Officer
/s/ Lance Thibault
-----------------------------------------
Lance Thibault
Chief Financial Officer
and Treasurer
PAGE 35
I, Kari Stefansson, Chief Executive Officer, certify
that:
1. I have reviewed this quarterly report on Form 10-Q of deCODE
genetics, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations
and cash flows of the registrant as of, and for, the periods
presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant,
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Dated November 14, 2002
/s/ Kari Stefansson
- ---------------------------
Kari Stefansson
Chief Executive Officer
Page 36
I, Lance E. Thibault, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of deCODE
genetics, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations
and cash flows of the registrant as of, and for, the periods
presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant,
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Dated November 14, 2002
/s/ Lance Thibault
- ---------------------------
Lance Thibault
Chief Financial Officer
Page 37
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 Certificate of Amendment to Amended and Restated Certificate of
Incorporation dated August 30, 2002
3.3 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 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.)
4.2 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* Research Collaboration and License Agreement dated September 26, 2002
between deCODE genetics, Inc., deCODE genetics, ehf. and Merck & Co.,
Inc.
99.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
* Confidential treatment has been requested for a portion of this Exhibit.
PAGE 38