**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-K**

| **(Mark One)**                                                                                                                     | ** ** | ** **                                                                                                              |
|------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|
| x                                                                                                                                  | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**      |
| **For the fiscal year ended December 31, 2005**                                                                               |
| **or**                                                                                                                             |
| o                                                                                                                                  | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT  OF 1934** |
| **For the transition period from                   to** |

 

**CommissionFile Number 000-30469**

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**deCODE genetics, Inc.**

(Exact name of registrantas specified in its charter)

| **Delaware**** **           | **04-3326704**       |
|----------------------------------|----------------------|
| (State or other  jurisdiction of | (I.R.S. Employer     |
| incorporation or  organization)  | Identification  No.) |

 

**Sturlugata 8, Reykjavik,Iceland**

(Address of principalexecutive offices)

**+ 354-570-1900**

(Registrant’s telephonenumber, including area code)

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**Securitiesregistered pursuant to Section 12(b) of the Act:**

|      | **Title of each class** | ** ** |  | **Name of each exchange on which registered** | ** ** |
|------|-------------------------|------------|--|-----------------------------------------------|------------|
| None | None                    |

 

**Securities registered pursuantto Section 12(g) of the Act:**

**Common Stock, $.001 parvalue**

(Title of Class)

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Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o   No x

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Exchange Act. Yes o   No x

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days. Yes x   No o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part IIIof this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer” and “large accelerated filer” in Rule 12b-2of the Exchange Act.

Large acceleratedfiler o      Accelerated filer x      Non-acceleratedfiler o

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). Yes o   No x

The aggregate market value of the voting and non-votingcommon equity held by non-affiliates of the registrant, based on the closingprice of the common stock ($9.39 per share), as of June 30, 2005,was $486,747,834.

Indicate the number ofshares outstanding of each of the registrant’s classes of common stock, as of February 28,2006.

|                                          | **Class**  | ** ** |  | **Number of Shares** | ** ** |
|------------------------------------------|------------|------------|--|----------------------|------------|
| Common Stock,  $.001 par value | 54,874,548 |

 

**DOCUMENTSINCORPORATED BY REFERENCE**

None

 

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**PART I**

**Item 1.**                        *Business*

**Overview**

Headquartered in Reykjavik, Iceland, deCODE is abiopharmaceutical company applying its discoveries in human genetics to developdrugs for common diseases. Our population approach and resources enable us toisolate genes and drug targets directly involved in the development of many ofthe diseases which are the biggest challenges to public health. We are turningthese discoveries into a growing pipeline of therapeutics aimed at combatingthe causes of disease, not just the signs and symptoms. As these diseases arecommon and current therapies are of limited effectiveness, we believe that ourstrategy represents a significant opportunity to create better medicine withmajor potential in the global marketplace.

We believe that deCODE’s advantage derives from ourpopulation approach to human genetics and the ability to apply this approachacross the drug development process. In Iceland, we have comprehensivepopulation resources that enable our scientists to efficiently conduct genome-and population-wide scans to identify key genes and gene variants contributingto common diseases. The proteins encoded by these genes, and other proteinswith which they interact in the disease pathway, offer drug targets that webelieve are directly involved in the onset and progression of disease. Small-moleculedrugs that target these proteins may therefore represent a direct means ofmodulating the onset or progression of the disease.

Through our medicinal chemistry and structural biologysubsidiaries based in the United States, we are able to discover novel small-moleculetherapeutic compounds, take candidate compounds through pre-clinical testing,and manufacture sufficient quantities for early-stage clinical trials.Our product development group designs and implements our clinical developmentprograms. By leveraging the capabilities of Encode, our wholly-ownedclinical research organization in Reykjavik, and our expertise in genetics anddrug and disease modeling, we are able to make the drug development process amore efficient and sensitive means of testing and optimizing the therapeuticand commercial potential of new drugs. In certain programs we have also takenadvantage of the fact that drug targets we have identified through our geneticsresearch have already been targeted by other companies to develop compounds forother indications. By licensing these compounds or entering into co-developmentarrangements, we have been able to bypass several years of drug discovery anddevelopment and enter directly into Phase II clinical trials.

At the beginning of 2006, we have five lead drugdiscovery and development programs, including three compounds in clinicaltrials. The most advanced of these programs are in heart attack, peripheralartery disease (PAD), and asthma. We have successfully completed a series ofPhase II clinical trials in Iceland for DG031, a compound we licensed fromBayer HealthCare AG that we are developing for the prevention of heart attack.In 2006, we plan to initiate a multi-center, Phase III clinical trial forDG031. In early 2006, we concluded the Phase I clinical program for DG041, ourcompound for PAD, a form of atherosclerosis that constricts blood flow to thelegs and arms. This program showed DG041 to be well-tolerated and toeffectively inhibit platelet aggregation without increasing bleeding time, andwe plan to begin a Phase II clinical trial in the first half of this year. Inasthma, we are conducting a Phase II trial on behalf of the developer of acompound originally designed as a treatment for a different disease. We expectto have data on this trial as early as the second quarter of 2006. Also, in2006, we expect to file Investigational New Drug applications (INDs) for DG051,our follow-on compound for the prevention of heart attack, and for DG061, anovel compound for the treatment of pain.

We are also applying our findings to create DNA-baseddiagnostics. Because such tests analyze the same links between geneticvariation and disease that we have used to identify drug targets, they can beemployed as an aid in developing more effective disease prevention strategiesby helping individuals to 

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better understand theirinherited risk of a given condition, as well as to identify patients likely torespond well to a given drug.

deCODE also leverages its capabilities to provideservices to fee-paying customers. Our services and products include medicinalchemistry, structural biology, clinical trials, genotyping, and instruments andsoftware. deCODE also provides services to fee-paying customers, enabling themto take advantage of deCODE’s capabilities. Revenue from these activities helpsto support our drug discovery and development infrastructure, and conserve ourcash resources for use in our proprietary therapeutics programs

deCODE, is a Delaware corporation, incorporated in1996. Our principal executive offices are located at Sturlugata 8, Reykjavik,Iceland. Our telephone number is +354-570-1900 and our websiteaddress is www.decode.com. We make available free of charge through theInvestor Relations section of our website our Annual Reports on Form 10-K,Quarterly Reports on Form 10-Q, Current Reports on Form 8-Kand all amendments to those reports as soon as reasonably practicable aftersuch material is electronically filed with or furnished to the Securities andExchange Commission, or the SEC. We include our website address in this AnnualReport on Form 10-K only as an inactive textual reference and do notintend it to be an active link to our website. You may read and copy materialswe file with the SEC at the SEC’s Public Reference Room at 100 F Street,NE, Room 1580, Washington, D.C. 20549. You may get information on theoperation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.The SEC maintains on internet site that contains reports, proxy and informationstatements, and other information regarding issuers that file electronicallywith the SEC at www.sec.gov.

References in this reportto deCODE, the “Company”, “we” and “us” refer to deCODE genetics, Inc., aDelaware company: to deCODE genetics, Inc.’s wholly owned subsidiary,Islensk erfdagreining ehf., an Icelandic company registered in Reykjavik, andits subsidiaries, as well as to deCODE genetics, Inc.’s wholly-ownedsubsidiaries deCODE chemistry, Inc. and deCODE biostructures, Inc.,Delaware corporations, and their subsidiaries.

***Our target discovery programs and drug developmentpipeline***

We have actively studied the genetics and pathology ofover 50 different common diseases using our population genetics approach. Ourclinical and pre-clinical programs include diseases where deCODE has mapped agene to genome-wide significance and diseases where deCODE has identifiedgenetic variations that are associated with increased risk of developing a disease.We validate genetic variations associated with elevated disease incidence inpopulations outside of Iceland and use a variety of biological methods toprioritize the most promising targets for drug discovery and development. Otherprioritization criteria include both medical and business considerations.

Based on our findings and prioritization criteria weare actively pursuing target discovery, pre-clinical and clinical developmentin 32 different therapeutic areas, including heart attack where we are developingtwo drugs. Our 5 most advanced programs that are in clinical development or ata late stage in pre-clinical development are listed in the following table.

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Datesreflect the earliest expected time based on deCODE’s own expectations that thecompound may be entered into development (following an Investigational New Drugapplication) or enter the given phase of clinical trials.

| **Therapy area**        | ** ** | ** ** | ** ** | **Compound** | ** ** | **IND** | ** ** | **Phase I** | ** ** | **Phase II** | ** ** | **Phase III** | ** ** |
|------------------------------|------------|------------|------------|--------------|------------|---------|------------|------------------|------------|-------------------|------------|--------------------|------------|
| *Cardiovascular*             |       |       |       |         |       |    |       |             |       |              |       |               |       |   |   |   |   |   |   |
| Heart attack                 |       |       | DG031      |         |       | n       |       |             | n          |              |       |               | n          |   |   |   | 2Q06 |   |   |
| Heart attack                 |       |       | DG051      |         |       | 3Q06    |       |             |       |              |       |               |       |   |   |   |   |   |   |
| Peripheral  Arterial Disease |       |       | DG041      |         |       | n       |       |             | n          |              |       |               | 1H06       |   |   |   |   |   |   |
| *Inflammatory*               |       |       |       |         |       |    |       |             |       |              |       |               |       |   |   |   |   |   |   |
| Asthma                       |       |       |       |         |       | n       |       |             | n          |              |       |               | «     |   |   |   |   |   |   |
| *Central  Nervous System*    |       |       |       |         |       |    |       |             |       |              |       |               |       |   |   |   |   |   |   |
| Pain                         |       |       | DG061      |         |       | 4Q06    |       |             |       |              |       |               |       |   |   |   |   |   |   |

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Legend:   n Phasecompleted   « Phaseexpected to end 2Q06

In addition to the latestage programs in drug discovery and development, deCODE is actively pursuinggene discovery and target validation in the following programs: addiction toalcohol, addiction to nicotine, Alzheimer’s disease, anxiety, atopy/allergy,autism, benign prostatic hypertrophy, chronic obstructive pulmonary disease,coronary artery restenosis, endometriosis, hypertension, infectious diseases,migraine, diabetes type 2, obesity, osteoporosis, Parkinson’s disease,polycystic ovary syndrome, preeclampsia, psoriasis, restless leg syndrome,rheumatoid arthritis, schizophrenia, sleep apnea, vascular disease/stroke andvarious forms of cancer.

***Our strategy and approach: From genes to drugs***

The primary focus of deCODE’s business strategy is thediscovery and commercialization of novel therapeutics based upon our genediscoveries. We believe our population approach and unique competence in humangenetics give us a competitive advantage, one which we are able to apply acrossthe breadth of drug development, from target discovery through clinical trials.

Human genetics offers several advantages as afoundation for developing better drugs. We believe most medicines today arecompounds that are aimed at treating the symptoms of disease, seldom theunderlying causes. The reason is that to date the basic biology andpathogenesis of most of the big public health challenges—such as heart attack,stroke, obesity, diabetes or asthma—are poorly understood. These diseases arecommon because of their complexity, and arise due to the interplay of bothgenetic and environmental factors. Human genetics offers a means of unravelingthis complexity and a window into the biology of disease. Through the identificationof key genes involved in predisposition to a given disease, it is possible tostudy the proteins these genes encode and to develop an understanding of thebiological pathway of the disease. Drugs targeting key elements in the pathwaymay be able to effectively disrupt the disease process.

Using our population approach and resources, we canefficiently conduct population- and genome-wide scans to hone in on keygenetic factors involved in any common disease. We believe deCODE is a worldleader in gene discovery in the common diseases. As of the beginning of 2006 wehad isolated fifteen key genes involved in eleven common diseases with majorunmet medical need. These genes have provided us with drug targets we believeare rooted in the basic biology of human disease, enabling us to pursue drugdiscovery and development work on a small number of targets with high potentialtherapeutic impact.

The isolation of genes contributing significant riskfor common diseases requires the ability to gather and correlate detailedinformation on disease and genetic variation across as large a group of peopleas possible: ideally, across an entire population. To do this effectively it isalso critical to have accurate and 

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comprehensive genealogicalrecords, the only means for tracing how the genetic components of diseasetravel between generations. We believe a population with all three sets of data—genetic,medical and genealogical—is the scarce resource in human genetics. In Iceland,deCODE has brought this information together. Along with its genealogy databasecovering the entire present day population and stretching back to the foundingof the country more than 1000 years ago, deCODE has gathered genotypic andmedical data from more than 110,000 volunteer participants in our gene researchin Iceland—over half of the adult population.

Using our genealogy database, our scientists can linktogether patients affected by any disease into large extended families.Applying high-throughput genotyping and proprietary data-mining instruments, wefirst “map” genes through linkage analysis, honing in on small segments ofparticular chromosomes that related patients share to a much higher degree thanwould be expected by chance. More detailed analysis of these regions withdenser sets of markers enables us to isolate the key genes associated with riskof the disease, as well as the variants or haplotypes of these genes that arehighly correlated with the disease.

Unlike companies studying predetermined genes, geneexpression patterns, or genes in animal models, deCODE’s approach allows for avirtually hypothesis-free discovery process that can pinpoint key inheritedcauses of human disease in a human population. Following the isolation of majorgenes, we analyze the proteins the genes encode, the biological function ofthese proteins, and the interaction of these with other proteins in an effortto identify the biological pathway of a given disease. In most cases, theproteins encoded by the disease-genes themselves serve as good drugtargets. If they do not, other points in the disease pathway may be selectedfor therapeutic intervention. The development of DG041 for atherosclerosis(PAD) is an example of how we have gone from the isolation of a disease gene toa compound in clinical trials using our own target and drug discoverycapabilities. The development of DG031 for heart attack is an example of how wecan accelerate the drug development process based upon our target discoverywork by in-licensing a promising existing compound. In our program in pain, ourchemistry group has utilized work in the pathway we identified in our PADprogram to rapidly advance a lead pre-clinical compound. With this compound,DG061, we aim to pursue the major opportunity that exists for developing effectivealternative drugs to the selective Cox-2 inhibitors and othernon-steroidal anti-inflammatory drugs (NSAIDs).

We are also applying our unique capabilities in humangenetics to make the clinical development process a more efficient andeffective means of evaluating the therapeutic potential of new drugs. In aninformation-rich clinical trial (IRCT) we can integrate the same data used toidentify drug targets to select participants whom we believe are susceptible toa particular disease. This enables trials that are smaller and more efficientthan traditional trials, and the results can be applied to understand not justwhether people respond to a drug but who responds best and why. We believe thisoffers a means for better managing risk in the development process; speedingdrug development; lowering cost; and maximizing the patient benefit from, andmarket potential of, new drugs.

deCODE has integrated capabilities for drug discoveryand development, ranging from *in vitro* andmodel organism-based biology through structure-based drug design,medicinal chemistry and Current Good Manufacturing Practices (cGMP)manufacturing. These capabilities enable us to speed the discovery ofdevelopmental compounds and maximize the value coming out of our gene discoverywork.

Our biology group, based in Reykjavik, conductsfunctional work on genes we have isolated, drawing out the biological pathwaysof disease and identifying optimal points for therapeutic intervention. Throughthe design of biological assays and screening of compound libraries we are ableto identify compounds that effectively block or stimulate target proteins.

Our structural biology group on Bainbridge Island,near Seattle, is one of the leading groups in the industry in proteinexpression and three-dimensional protein structure determination. Theanalysis of three-dimensional images of target proteins and how they arebound by therapeutic compounds provides 

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our drug discovery teamswith new insight into the nature of compounds that may be able to delivermaximum therapeutic effect. The structural biology group has also developedautomation hardware, software and protein crystallization products which wesell to research organizations and laboratories around the world. The groupalso provides fee-based services to a large number of clients.

deCODE’s chemistry group based outside Chicagoconducts lead discovery, medicinal chemistry and production of cGMP materialsin quantities sufficient for pre-clinical and clinical studies. The groupemploys advanced tools for absorption, distribution, metabolism and excretion(ADME) profiling, physicochemical property optimization and pre-formulation. Whilesome of these resources are used for our internal drug discovery projects, thechemistry group also provides a full range of services to external clients.

deCODE’s product development group based in Brighton,Michigan, is responsible for the design and execution of clinical developmentprograms. This group was expanded in 2005 to advance the rapidly expandingpipeline of developmental compounds coming out of deCODE’s target and drugdiscovery work. We bring genetic, biological and clinical data to bear on thebreadth of the drug development process which we believe makes our clinicaltrials sensitive and efficient instruments for testing new drugs and forreducing late stage attrition. The product development group also works withdeCODE’s informatics and statistics group to process, analyze, interpret, andreport clinical trial data.

This comprehensiveinfrastructure for drug discovery and clinical development allows deCODE topursue product development in-house; partner projects on favorable terms; andpursue in-licensing opportunities of existing compounds based on informationabout the specific qualities we wish to see in a developmental drug. With thestrengthening of our clinical development resources, deCODE is rapidly growingits capacity to leverage its genetics discoveries and develop innovative newdrugs and diagnostics, with the aim of using our knowledge of the pathology andbiology of disease to lower costs and cut development time. At the same time,we are also leveraging our capabilities in genotyping, structural biology andchemistry to generate revenue for the Company in the near-term through ourfee-for-service service offerings.

***Our clinical programs***

The descriptions below ofour clinical development programs of DG031, DG041 and our Phase II study of anasthma treatment illustrate what we believe to be the advantages of ourapproach for making better drugs.

***Our clinical programs: DG031 for the prevention ofheart attack***

Our program in heart attack (also called myocardialinfarction or MI) is an example of how our population genetics approach ispointing the way toward the discovery and effective clinical development ofnew, more effective drugs targeting the root biological causes of disease.

Heart attack is the leading killer in theindustrialized world. Nearly half of men and one-third of women who reach theage of forty will suffer a heart attack in their lifetime. Currently, there areeffective drugs for treating some of the contributing risk factors for heartattack, such as high-cholesterol, diabetes and hypertension. However, webelieve that there are no existing drugs aimed at preventing the pathogenesisof the disease itself. Our work is focused on meeting this need based upon abetter understanding of the biological processes that lead to heart attack.

Through a population-based, genome-wide studyinvolving hundreds of heart attack patients from across Iceland, deCODEscientists discovered common variants in the gene encoding FLAP, or 5-lipoxygenaseactivating protein, that confer a nearly twofold increased risk of the disease.This represents a risk at least as great as elevated cholesterol. The FLAPprotein regulates the synthesis of leukotrienes, 

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molecules known to bepotent drivers of inflammation. Our functional studies showed that the at-riskvariants of the FLAP gene led specifically to increased production ofleukotriene B4 (LTB4). LTB4 is produced by cells in the atherosclerotic plaquesthat build up inside artery walls. Inflammation in plaques contributes to theirinstability and propensity to rupture, the event directly preceding most heartattacks.

Our isolation of the FLAP gene therefore providedcompelling evidence that we had identified a basic mechanism increasing risk ofheart attack. Further genetics and functional research added weight to thisdiscovery. We found that individuals who had previously suffered a heart attackbut who did not have one of the at-risk versions of the FLAP gene also producedmore LTB4 compared to people with no history of heart disease. This findingsupports our belief that we have identified a major biological process involvedin heart attack in general—and a pathway through which both genetic andenvironmental risk factors act.

deCODE scientists also isolated another gene furtherdown the leukotriene pathway from FLAP. One variant of this gene in particular,which we refer to as HapK, confers increased risk of heart attack. The proteinencoded by this gene, the leukotriene A4 hydrolase (LTA4H), is directlyinvolved in producing LTB4. In line with the functional work on the at-riskvariants of the FLAP gene, HapK appears to confer increased risk of heart attackby increasing the production of LTB4. The role of the at-risk versions of boththe FLAP and LTA4H genes in increasing risk of heart attack has been confirmedin studies in Europe and the United States.

These findings have pointed us to a novel, direct andpotentially powerful therapeutic approach for preventing heart attack:inhibiting the activity of the branch of the leukotriene pathway that producesLTB4. In October of 2003, deCODE in-licensed a compound from Bayer AG, nowknown as DG031, that inhibits leukotriene synthesis through its binding toFLAP. Because of the extensive safety and clinical data already gathered on thecompound through previous clinical testing in another indication, in-licensingenabled us to advance directly into Phase II clinical testing.

In 2004 and 2005, deCODE conducted a series of PhaseII clinical trials for DG031. The main purpose of these trials was to examinewhether by inhibiting FLAP with various dose levels of DG031 it would bepossible to reduce levels of LTB4. These trials enrolled a total of 368patients with a history of heart attack and the at-risk variants of either orboth the FLAP and LTA4H genes. The results demonstrated that DG031 waswell-tolerated and reduced production of LTB4 in a dose-dependent manner. Thiseffect was on top of the effects of the current standard of care, including amajority of patients who were taking statins.

The Phase II program thus demonstrated that DG031 caneffectively help correct the biological process through which genetic predispositionto heart attack manifests itself. Moreover, the nature of this process has animportant bearing on the therapeutic potential of DG031 and other compoundstargeting the products of disease genes in common diseases. In our work inheart attack, as in virtually all of the programs in which we have identifiedgenes, genetic susceptibility appears to act primarily by either up-regulatingor down-regulating the activity of an important biological pathway. That is,the genetic variants correlated with common diseases appear to push individualsto one extreme or other of what is probably a normal distribution of theactivity of a given biological pathway. We believe that this is the reason whyin many instances we find both at-risk and protective variants of the samegenes.

This is important from a therapeutic perspectivebecause it means that while it may be most efficient and of greatest immediatemedical benefit to first develop such treatments for those at highest risk, inorder to bring them down the risk spectrum, the eventual therapeutic goal froma public health perspective may be much broader: to bring everyone, even thoseat “average” risk, down to the risk profile of those who are least likely tosuffer the disease. This is the paradigm that has, for example been followedwith the statin drugs. These were first developed to treat those with extremelyhigh levels of LDL cholesterol. However it is now widely accepted that thatthey may be of benefit to just about anyone middle aged or older who may be atrisk of cardiovascular disease and whose LDL levels are not already very low.

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Weare also applying our genetics discoveries to optimize the late-stage clinicaldevelopment process. The most striking replication of the at-risk variant ofthe LTA4H gene, known as HapK, was made through analysis of genotypic and heartdisease data in African American participants in deCODE’s studies in the UnitedStates. Among African Americans the at-risk variant is less common than it isamong Americans of European descent, but whereas people of European origin whocarry HapK are at a 16% increased risk of heart attack compared to controls,African Americans with HapK are at an approximately 250% increased risk. Thisis a major discovery from a public health perspective, and it is one we areusing to help us to design an effective Phase III clinical trial for DG031. Byfocusing recruitment on the group of patients who are at highest risk throughthe pathway targeted by the compound, we believe we can design a small and highlysensitive trial with the highest possible likelihood of success, at the sametime testing the drug in the group that should derive the greatest immediatebenefit from a new drug.

Weare designing the Phase III trial under a Special Protocol Assessment with theFDA. The trial we have proposed is a multicenter Phase III study that willfocus on African Americans who carry HapK and have a history of heart disease.We hope to initiate enrollment for this trial in the second quarter of 2006.Theprimary endpoint of the trial will be to measure DG031’s effectiveness inreducing the composite endpoint of cardiovascular death, non-fatal heartattack, stroke, hospitalization for heart attack and the need for urgentrevascularization.

Beforea Phase III study can be conducted we must obtain regulatory approvals as wellas the approval of institutional review boards for patient recruitment at thevarious sites participating in the multi-center trial. We need tocontract with an outside party who will be responsible for recruitingparticipating physicians and patients. We also need to contract withmanufacturers for the supply of the drug substance and drug tablets, conformingto our time constraints and regulatory standards, which in turn depends on thetimely availability of ingredients and the successful manufacture of theclinical supplies. We are in the process of obtaining the proper approvals, andhave contracted with outside suppliers for production and packaging of theclinical supplies and with a contract research organization for organization ofthe study.

As a follow-on to DG031, we are developing DG051, aninhibitor of LTA4H, a different target in the leukotriene pathway. DG051 isalso aimed at decreasing the production of LTB4. It appears to provide potentinhibition of LTB4 production, is orally bioavailable, and appears to haveminimal potential for drug-drug interaction. We anticipate filing aninvestigational new drug (IND) application on DG051 in 2006.

***Ourclinical programs: DG041 for the treatment of PAD***

In our program in peripheral artery disease (PAD), wewent from the isolation of a disease gene to the conclusion of a Phase Iclinical program in little over four years. This represents a significantimprovement on the average development time for comparable compounds in thepharmaceutical industry.(1) We believe that our efficiency in this programis the result of two strengths in our approach: our use of human genetics fortarget discovery, which provides us with a small number of targets directly implicatedin the cause of disease and the focus and quality of our drug discovery groups.

PADis a vascular disorder that affects over 10% of the population and one in fivepeople over the age of 70. The initial symptoms include intermittent pain inthe legs while walking or exercising, due to the narrowing by atheroscleroticplaques of one or more major arteries in the legs. The restriction of bloodflow leads to insufficient oxygenation of muscle tissue. As the disease worsensit can lead to tissue damage, ulceration and gangrene, and in extreme cases mayrequire the amputation of the affected limb. The disease is under-diagnosed,and the current mainstay of treatment is surgery to bypass the occludedvessels. Currently, no drug treatment is available that targets the underlyingcauses of PAD or prevents its progression.

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(1)          J.A.DiMasi et al., Journal of Health Economics 22 (2003) 151—185.

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With our developmentalcompound DG041 we hope to directly address this need. Our population geneticsstudies identified versions of the gene encoding the EP3 receptor forprostaglandin E2 (PGE2) that correlate with a significantly increased risk ofthe disease. Functional analysis underscores the important role of EP3 inmodulating the biology of the platelet. Binding of PGE2 to EP3 is known toincrease platelet aggregation, a process we believe may play a role in thedisease.

DG041 is an inhibitor ofthe EP3 receptor, and the first clinical candidate developed entirely throughdeCODE’s own capabilities in gene discovery and drug development. It is anovel, first-in-class, orally-administered small molecule for thetreatment of PAD. In early 2005, deCODE submitted an IND for DG041 to the FDAand initiated a Phase I clinical development program. Early results in Phase Itrials showed DG041 to be well-tolerated and to effectively inhibit plateletaggregation in a dose-dependent manner without increasing bleeding time. Basedon our findings in the fall of 2005 our chemistry unit developed a newformulation that increased the bioavailability of DG041 by nearly four fold.Consequently we initiated subsequent dose escalation studies on thisformulation and concluded the Phase I trials in February 2006. Nearly 200healthy subjects were exposed to DG041 in these studies at doses up to1600mg/day for seven days. The results of the Phase I program showed DG041 tobe well-tolerated, without any drug-related significant adverse events noted,and that DG041 can effectively inhibit platelet aggregation in a dose-dependentmanner without increasing bleeding time. We expect to begin a Phase II clinicaltrial in the first half of 2006.

***Our clinicalprograms: Third party compound in asthma***

In 2005, deCODE began aPhase II clinical trial in asthma on behalf of the developer of a compoundinitially developed for another indication. This compound targets a genepreviously isolated by deCODE that plays an important role in the inflammatorycascade involved in the development of asthma. The Phase II trial, which isbeing conducted in Iceland by our subsidiary Encode, is a randomized,double-blind and placebo-controlled trial that examines safety and tolerabilityof the drug, as well as the effectiveness of the drug in improving lungfunction and reducing airway inflammation at the various dose levels asmeasured by various clinical tests and biomarkers. Under the terms of theagreement with the developer of the compound, deCODE will receive milestonepayments based on success in clinical development and royalties on sales of amarketed drug.

***Diagnostics***

We believe diagnosticsrepresent an additional avenue for creating value from our gene discoveries.Since genetic variants linked to disease are by definition markers of diseasesusceptibility, we can apply the same findings we employ in our drug discoveryefforts to the development of DNA-based diagnostic tests. We believe that suchtests may be useful as a means for identifying patients who are likely torespond well to drugs that target the same disease pathway, and to identifyindividuals who are at a particularly high risk of a given disease. We alsohave expertise for developing diagnostics to gauge individual responsiveness toexisting drugs, which are commonly referred to as pharmacogenomic tests. Wehave not commercialized any diagnostic products and we may never do so.

***Drug discovery anddevelopment services***

Inorder to offset the cost of maintaining its proprietary drug developmentinfrastructure, deCODE utilizes its capabilities in medicinal chemistry,structural biology and clinical trials to offer contract services to fee-payingcustomers, principally pharmaceutical and biotechnology companies.

·       Ourmedicinal chemistry subsidiary, deCODE chemistry, Inc., based inWoodridge, Illinois, provides a full range of drug discovery technology and servicesusing multiple integrated high-throughput technologies to streamline the drugdiscovery process.

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·       Ourstructural biology subsidiary, deCODE biostructures, Inc., based inBainbridge Island, near Seattle, determines three-dimensional X-raycrystal structures of target proteins for structure-based drug design anddevelopment.

·       Our clinical researchorganization subsidiary Encode conducts information-rich clinical trials forour proprietary programs and for contract customers, principally pharmaceuticaland biotechnology companies.

***Additional serviceofferings***

At our research facilityin Reykjavik, we have what we believe is the highest-throughputmicrosatellite genotyping laboratory in the world, capable of generating tensof millions of genotypes per month. In addition to the capability to genotype alarge number of microsatellite markers in parallel, both rapidly andefficiently, the laboratory has efficient procedures to type focused subsets ofboth microsatellites and single nucleotide polymorphisms (SNPs). We also havein place efficient, automated systems for all stages of the genotyping process,from DNA isolation and amplification to plate preparation and the generation,storage and analysis of genotypic data. Our customers for genotyping servicesinclude pharmaceutical companies, research consortia and academic institutions.

**Collaborations**

*F. Hoffmann-La Roche (Roche).*

*Therapeutics.**  *In 2002, we entered into an agreement with Roche tocollaborate on four diseases that had been the subject of an earliercollaboration with Roche. Under this agreement, which expired on February 1,2005, we are entitled to receive royalties on the sales of any drugs that aredeveloped coming out of work conducted under this alliance. Under thisagreement we discovered genes linked to diabetes and Roche continues drugdiscovery based on one of these discoveries. We may receive milestone paymentsas Roche advances compounds through the development process as well asroyalties on successfully marketed drugs.

In November 2004, wesigned a new three-year agreement with Roche to co-develop inhibitors of PDE4for the prevention and treatment of vascular disease, including stroke. Thisagreement continues work advanced under the 2002 agreement, and we will focuson optimizing lead compounds identified under the previous agreement andbeginning clinical development. Under the agreement, as of the end of 2005, wereceived $2.0 million of research funding. We and Roche will share drugdiscovery and clinical trials costs under this new agreement, and we mayreceive an additional $4.0 million of research funding over the remaining termof the agreement as well as milestone payments and royalties based on drugsales.

*Diagnostics.**  *In June 2001, we signed a five-year alliancewith Roche’s diagnostics division to develop and market DNA-based diagnosticsto gauge predisposition to major diseases and to predict responsiveness tomajor therapeutics used to treat those diseases. Under the agreement we have,as of the end of 2005, we received $41.1 million in research funding, up-frontfees and milestone payments. We may receive $3.1 million in additional researchfunding over the remainder of the term of the agreement as well as milestonepayments upon the achievement of research and development milestones androyalties on the sales of diagnostic products developed.

*Merck & Co, Inc. (Merck).*

*Obesity.**  *In September 2002, we entered into an alliancewith Merck aimed at developing new treatments for obesity. The research anddevelopment portion of the agreement expired in September 2005. Under thisagreement we discovered three genes linked to obesity, and Merck has generatedlead series of compounds against one of the targets we have validated throughour genetics research. We may receive milestone payments as Merck advancescompounds developed under the alliance through the development process, as wellas royalties on successfully marketed drugs.

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*Information-Rich ClinicalTrials.**  *In February 2004,we entered into an agreement with Merck to conduct information-rich clinicaltrials on a range of Merck’s developmental compounds that Merck selects forinclusion in the program. The term of the alliance is seven years, subject totermination by Merck after five years. Under the terms of the agreement, we mayreceive royalties on sales of drugs and diagnostics developed as part of thealliance. We received a one-time technology access fee of $10.0 million, willshare research funding for the clinical development of compounds andpharmacogenomic analysis, and will receive milestone payments as compounds orpharmacogenomic tests reach the market. To date, Merck has not selected anycompounds for development under the agreement.

*National Institute of Allergy and Infectious Diseases(NIAID).*

In September 2004, wewere awarded a five-year $23.9 million contract by the NIAID, part of theU.S. National Institutes of Health (NIH). Under the contract, we are applyingour population approach and resources to discover genetic factors associatedwith susceptibility to certain infectious diseases and with responsiveness tovaccines targeting such diseases. The University of New Mexico will be workingwith us to conduct functional validation of biological pathways discoveredthrough our genetic research. The National Center for Genome Resources willprovide bioinformatics resources to make study information and resultsavailable to the scientific community.

*Bayer HealthCare AG (Bayer).*

In 2003, Bayer granted usan exclusive worldwide license to develop, make and sell a compound that hadbeen developed and tested against a drug target that we had discovered mightplay a role in myocardial infarction. The compound had been developed as apotential treatment for asthma and subjected to substantial clinicaldevelopment work on behalf of Bayer. During the previous clinical testing ofthe compound, now named DG031, more than 1,000 people were dosed with the drug,without any significant safety or tolerability issues. In connection with thelicense, Bayer transferred ownership of its IND associated with this compoundto deCODE. As a result, we have been able to use the data that Bayer compiledand submitted in support of its IND. Under the agreement, we will pay Bayermilestone payments upon the achievement of specified developmental milestonesand royalties on sales of the drug. The agreement gives Bayer the right offirst negotiation to be our manufacturer of the compound.

**Patentsand Proprietary Rights**

Patents and otherproprietary rights protections are an essential element of our business. Werely on patents, trade secret law and contractual non-disclosure andconfidentiality arrangements to protect our proprietary information andtechnology. We will be able to protect our proprietary rights from unauthorizeduse by third parties only to the extent that our proprietary rights are coveredby valid and enforceable patents, contractual confidentiality obligations, orif they are effectively maintained as trade secrets.

Accordingly, we activelyseek patent protection in the United States and other jurisdictions to protecttechnology, inventions and improvements to inventions that are commerciallyimportant to the development of our business. These include, among otherthings, the compounds that we invent and will develop as potential drugs, thegenes and related drug targets we discover; mutations and variants of genes andrelated processes; new uses of existing third party compounds that may be usedto manipulate those genes, mutations and drug targets; technologies which maybe used to discover and characterize genes; therapeutic or diagnosticprocesses, tests and other inventions based on those genes; as well as methodsdeveloped in our biostructures and pharmaceutical groups for the discovery anddevelopment of drugs. As of year-end 2005, we had approximately 29 issued U.S.patents and approximately 11 issued patents in non-US jurisdictions. We alsohad approximately 57 pending patent applications in the US, and in most casescorresponding pending international PCT or national patent applications innon-US jurisdictions that we have deemed to be of commercial interest.

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We have filed series of composition of matter typepatent applications for the compounds we have discovered ourselves, that arethe main focus of our pre-clinical and clinical development, including DG041,DG051 and DG061.

We have licensed from Bayer a composition of matterpatent and a manufacturing process patent for DG031. The licensed patentsexpire in 2009 and 2012, respectively.

We have also applied for additional patents on ourown, claiming specific uses of DG031 and for other compounds with similar modeof action, and methods for selecting those patients that we believe are mostlikely to benefit from administration of those compounds due to their specificgenetic makeup. Such patents that would cover approved uses of DG031, if issuedand found to be valid and enforceable if challenged, could extend the lifecycleof DG031 for several years beyond the expiry of the patents that we licensedfrom Bayer. However, it is not certain that such patents will ultimately beissued, and even if issued, that they will be enforceable in infringementproceedings before the courts.

The United States Drug Price Competition and PatentTerm Restoration Act of 1984, known as the Hatch-Waxman Act, provides forthe restoration of up to 5 years of patent term for a patent that covers anew product or its use, to compensate for time lost from the effective life ofthe patent due to the regulatory review process of the FDA. An application forpatent term restoration is subject to approval by the U.S. Patent and TrademarkOffice in conjunction with the FDA. If our clinical trials of DG031 aresuccessful and we ultimately receive the FDA’s approval to market the drug, weexpect to seek to extend the term of one of the patents we licensed from Bayer.However, there can be no assurance that we will receive a patent termextension.

The Hatch­Waxman Act alsoestablishes a 5 year period of marketing exclusivity from the date of NDAapproval for new chemical entities (NCE) approved after September 24,1984. We believe that DG031 is an NCE, and if the NDA for DG031 is approved, weexpect to receive such marketing exclusivity. Under the Hatch-Waxman Actgeneric versions of innovative medicines may be approved without the completesafety and efficacy studies contained in an NDA. Instead, the genericmanufacturer may submit an Abbreviated New Drug Application (ANDA) or aso-called Section 505(b)(2) (or “paper”) NDA. During the 5 year  marketing exclusivity period for an NCE, amanufacturer that proposes to sell a generic version of DG031 may not submit tothe FDA an ANDA or a paper NDA except that such applications may be submittedafter 4 years if they contain a certification of patent invalidity ornoninfringement. If at the time such an application is submitted we havereceived a use patent for DG031 that is listed in the FDA’s Approved DrugProducts with Therapeutic Equivalence Evaluations, or Orange Book, and if wecommence a suit alleging patent infringement in a timely manner after the ANDAor paper NDA for a generic drug is submitted, FDA approval of the generic drugwill automatically be stayed for up to 30 months from the expiration of the 5year marketing exclusivity period to allow a judicial resolution of theinfringement action. Thus, under the Hatch-Waxman Act, the combination of NCEmarketing exclusivity and the 30 month stay may create as much as a 7 1/2exclusivity period for our marketing and sale of DG031.

Other jurisdictions havestatutory provisions similar to those of the Hatch-Waxman Act, thatafford both patent extensions and market exclusivity for drugs that haveobtained market authorizations, such as European Supplementary ProtectionCertificates that extend effective patent life and European data exclusivity rules thatcreate marketing exclusivity for certain time periods following marketingauthorization. European data exclusivity in more generous than the equivalentNCE marketing exclusivity in the US, possibly as long as 11 years. We believethat if we obtain marketing authorization for DG031 in Europe or other jurisdictionswith similar statutory provisions, DG031 may be eligible for patent termextension and marketing exclusivity under these provisions and we plan to seeksuch privileges.

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**Competition**

We face, and will continue to face, intensecompetition in our gene discovery programs from pharmaceutical companies,biotechnology companies, universities and other research institutions. A numberof entities are attempting to rapidly identify and patent genes responsible forcausing diseases or an increased susceptibility to diseases and to developproducts based on these discoveries.

We also face intense competition in drug development,particularly from pharmaceutical and biotechnology companies. Certain of thesecompanies may, using other approaches, identify and decide to pursue thediscovery and development of new drugs targets or disease pathways that we haveidentified through our human population genetics research. Many of ourcompetitors, either alone or together with their collaborative partners, havesubstantially greater financial resources and larger research and developmentoperations than we do. These competitors may discover, characterize or developimportant genes, drug targets or drug leads before we or our collaborators door may obtain regulatory approvals of their drugs more rapidly than we or ourcollaborators do.

Developments by others may render pharmaceuticalproduct candidates or technologies that we or our collaborators developobsolete or non-competitive. Any product candidate that we or our collaboratorssuccessfully develop may compete with existing therapies that have longhistories of safe and effective use.

Our competitors may obtain patent protection or otherintellectual property rights that could limit our rights, or our customers’ability, to use our technologies or databases, or commercialize therapeutic ordiagnostics products. In addition, we face, and will continue to face, intensecompetition from other companies for collaborative arrangements withpharmaceutical and biotechnology companies, for establishing relationships withacademic and research institutions and for licenses to proprietary technology.

Our ability to competesuccessfully will depend, in part, on our ability, and that of ourcollaborators, to: develop proprietary products; develop and maintain productsthat reach the market first, and are technologically superior to and more costeffective than other products on the market; obtain patent or other proprietaryprotection for our products and technologies; attract and retain scientific andproduct development personnel; obtain required regulatory approvals; andmanufacture, market and sell products that we develop.

**Government Regulation**

Regulation by governmental authorities will be asignificant factor in our ongoing research and development activities. Inaddition, the development, production and marketing of any pharmaceutical anddiagnostic products which we or a partner may develop is subject to regulationby governmental authorities. Strict regulatory controls govern the pre-clinicaland clinical testing, design, manufacture, labeling, supply, distribution,recordkeeping, reporting, sale, advertising and marketing of the products.These regulatory controls will influence our and our partners’ ability tosuccessfully manufacture and market therapeutic or diagnostic products.

Our success will depend, in part, on the developmentand marketing of products based on our research and development. Most countriesrequire a company to obtain and maintain regulatory approval for a product fromthe relevant regulatory authority to enable the product to be marketed.Obtaining regulatory approval and complying with appropriate statutes andregulations is time-consuming and requires the expenditure of substantialresources.

In the United States we and our products are subjectto comprehensive regulation by the United States Food and Drug Administration(FDA). The process required by the FDA before our drug products may be approvedfor marketing in the United States generally involves (i) pre-clinical newdrug laboratory and animal tests, (ii) submission to the FDA of aninvestigational new drug (IND) application, which must 

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become effective beforeclinical trials may begin, (iii) adequate and well-controlled humanclinical trials to establish the safety and efficacy of the drug for itsintended indication, (iv) submission to the FDA of a new drug application(NDA), (v) review by an advisory committee to FDA for recommendationsregarding whether the NDA should be approved, and (vi) FDA review of theNDA in order to determine, among other things, whether the drug is safe andeffective for its intended uses. There is no assurance that the FDA reviewprocess will result in product approval on a timely basis, if at all.

Pre-clinical tests include laboratory evaluation ofproduct chemistry and formulation, as well as animal studies to assess thepotential safety and efficacy of the product. Pre-clinical tests are generallysubject to FDA regulations regarding Good Laboratory Practice. The results ofthe pre-clinical tests are submitted to the FDA as part of an IND and arereviewed by the FDA prior to the commencement of clinical trials or during theconduct of the clinical trials, as appropriate.

Clinical trials are conducted under protocols thatdetail such matters as the objectives of the study, the parameters to be usedto monitor safety and the efficacy criteria to be evaluated. Each protocol mustbe submitted to the FDA as part of the IND. Further, each protocol must bereviewed and approved by an institutional review board (IRB), and studysubjects must provide informed consent to participation in the study. Clinicaltrials are subject to oversight by the IRB at each study site and by the FDA. AnIRB or the FDA may prevent a study from being initiated, or may suspend orterminate studies once initiated.

Clinical trials are typically conducted in threesequential phases, which may overlap. During Phase I, when the drug isinitially given to human subjects, the product is tested for safety, dosagetolerance, absorption, distribution, metabolism and excretion. Phase IIinvolves safety, tolerability and efficacy of the product across a range ofdoses with the goal of identifying appropriate doses and patients for furtherstudy. Phase III trials are undertaken in order to further evaluate clinicalefficacy and to further test for safety within an expanded patient population.The FDA may suspend clinical trials at any point in this process if itconcludes that clinical subjects are being exposed to an unacceptable healthrisk.

Clinical trials must be conducted and monitored inaccordance with good clinical practice (GCP) and other regulatory requirements.For applications to the FDA, clinical studies must be adequate and wellcontrolled. Following the clinical trials, we will analyze the data anddetermine whether the clinical trials successfully demonstrated the safety andefficacy of the product. If they do, we will prepare and submit a new drugapplication (NDA). The FDA conducts a preliminary review of the NDA todetermine whether to file the application and begin substantive review, or torefuse to file the application on the ground that FDA considers it incomplete.

We will need FDA approval of our products, including apre-approval inspection of the manufacturing processes and facilities used toproduce such products to assess conformance with current good manufacturingpractices (cGMP), before such products may be marketed in the United States.The FDA may also inspect the clinical trial sites to ensure their conformancewith GCP. The process of obtaining approvals from the FDA can be costly,time-consuming and subject to unanticipated delays. There can be no assurancethat the FDA will grant approvals of our proposed products, processes or facilitieson a timely basis, if at all. Any delay or failure to obtain such approvalswould have a material adverse effect on our business, financial condition andresults of operations. Moreover, even if regulatory approval is granted, suchapproval may include conditions of approval such as additional studies orsignificant limitations on indicated uses for which a product could bemarketed.

Among the conditions for NDA approval is therequirement that the prospective manufacturer’s operating procedures conform tocGMP requirements, which must be followed at all times. In complying with thoserequirements, manufacturers (including a drug sponsor’s third party contractmanufacturers) must continue to expend time, money and effort in the area ofproduction and quality control to ensure compliance. Domestic manufacturingestablishments are subject to periodic inspections by the FDA in order toassess, among other things, cGMP compliance. To supply a product for use in theUnited States, 

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foreign manufacturingestablishments also must comply with cGMP and are subject to periodicinspection by the FDA or by regulatory authorities in certain of such countriesunder reciprocal agreements with the FDA.

Both before and after approval is obtained, a product,its manufacturer and the holder of the NDA for the product are subject tocomprehensive regulatory oversight. FDA regulations impose requirements forrecordkeeping, periodic reporting, and reporting of adverse experiences withthe product. Violations of regulatory requirements at any stage, including thepre-clinical and clinical testing process, the approval process, or thereafter(including after approval) may result in various adverse consequences,including the FDA’s delay in approving or refusal to approve a product, withdrawalof an approved product from the market, seizure of the product, injunctionagainst the company, and/or the imposition of criminal penalties against themanufacturer and/or NDA holder and/or officers and employees. In addition,later discovery of previously unknown problems may result in restrictions onsuch product, manufacturer or NDA holder, including withdrawal of the productfrom the market. Also, new government requirements may be established thatcould delay or prevent regulatory approval of our products under development.

The FDA has implemented accelerated approvalprocedures for certain pharmaceutical agents that treat serious orlife-threatening diseases and conditions, especially where no satisfactoryalternative therapy exists. We cannot predict the ultimate impact, however, ofthe FDA’s accelerated approval procedures on the timing or likelihood ofapproval of any of our potential products or those of any competitor. Inaddition, the approval of a product under the accelerated approval proceduresmay be subject to various conditions, including the requirement to verifyclinical benefit in post-marketing studies, and the authority on the part ofthe FDA to withdraw approval under streamlined procedures if such studies donot verify clinical benefit.

Diagnostic products are regulated as medical devicesin the United States. Devices are subject to similar types of FDA regulatorycontrols and enforcement actions as apply to drugs, but many aspects of deviceregulation differ. Medical devices are classified into one of three classes, Class I, IIor III, on the basis of their risk and the controls deemed necessary to assuretheir safety and effectiveness, with Class I presenting the least risk.Regulatory controls for devices include labeling, recordkeeping, reporting, andadherence to the FDA’s quality system requirements, or QSR, including goodmanufacturing practices.

Most Class I devices and some Class IIdevices are exempt from FDA premarket review. Most Class II devices andsome Class III devices require FDA review and clearance of a premarketnotification under Section 510(k) of the Federal Food, Drug, andCosmetic Act (FDC Act) prior to marketing. A 510(k) notification mustdemonstrate that the device is substantially equivalent to a predicate device,which is a device marketed prior to 1976 or to a marketed device shown to besubstantially equivalent under the 510(k) notification process. Inaddition, Class II devices are subject to special controls, such asperformance standards, patient registries, and FDA guidances. Class IIIdevices, and devices determined to be not substantially equivalent to apredicate device, require FDA approval of a premarket approval application(PMA) prior to marketing. A PMA must contain manufacturing data, pre-clinicaldata, and data from clinical testing that demonstrates the device is safe andeffective for its intended use. The FDA may refer a PMA for review by anadvisory panel of outside experts for a recommendation regarding approval. FDAapproval of the PMA is required prior to marketing and distribution. The FDAmay impose conditions of approval or restrictions on the sale, distribution, oruse of the device.

The conduct of device clinical trials is subject toFDA regulation, including requirements for IRB approval, informed consent,recordkeeping, and reporting. In addition, a significant risk device requiresFDA approval of an investigational device exemption (IDE) application. Anonsignificant risk device does not require IDE approval and is subject toabbreviated recordkeeping and reporting requirements. Significant risk devicesinclude implants, life-supporting and life-sustaining devices, devices ofsubstantial 

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importance in diagnosing,curing, mitigating or treating disease, and devices that otherwise present apotential for serious risk to the health, safety, or welfare of a subject.

To the extent our diagnostic products may be intendedfor use as prognostic tests for selecting patients most likely to benefit fromdrug therapies, such products may be studied in the clinical trials of therelated drug product under the regulatory provisions governing pharmaceuticalclinical trials, but require a separate PMA approval or 510(k) clearanceunder the medical device requirements. The FDA’s policy for co-development oftherapeutic and diagnostic products is evolving, and changes in FDA’sregulatory policy can affect the development, testing, regulatory approvalpathway, and marketing of our products.

FDA has developed special rules for *in vitro* reagents that are not approved orcleared as diagnostic products. FDA has imposed restrictions on themanufacture, labeling, sale, distribution, advertising, promotion and use ofanalyte specific reagents (ASRs). FDA defines ASRs as antibodies, specificreceptor proteins, ligands, nucleic acid sequences, and similar reagents which,through specific binding or chemical reaction with substances in a specimen,are intended for use in a diagnostic application for identification andquantification of an individual chemical substance or ligand in biologicalspecimens. An ASR can be used by a clinical laboratory to develop in-house (“homebrew”) laboratory assays if the laboratory is certified for high complexitytesting under the Clinical Laboratory Improvement Act of 1998 as amended(CLIA). Most, but not all, ASRs are exempt from 510(k) premarketnotification or PMA approval, and all are subject to good manufacturingpractices (GMP) requirements and to the restrictions on their sale,distribution and use imposed by FDA regulation. In addition, FDA regulatesResearch Use Only (RUO) diagnostic products, which by their mandatory labelingare not intended for use in diagnostic procedures. The clinical usefulness ofRUO products is unknown and thus their use is limited to research purposesonly. Diagnostic products and reagents that we develop now and in the futuremay be subject to these and other applicable FDA regulations.

For devices with an approved PMA, the manufacturermust submit periodic reports containing information on safety and effectivenessand other information specified in FDA regulations, and modifications to theproduct or its intended use can trigger the need to file a PMA Supplementfor approval by FDA. For devices with a cleared 510(k) notification,modifications to the device that can affect its safety or effectiveness mayrequire the submission of a new 510(k) prior to marketing the modifieddevice. All devices are subject to continuing regulation by the FDA, includingrecord-keeping and reporting requirements, and reporting when a devicemay have caused or contributed to a death or serious injury or hasmalfunctioned in a way that would be likely to cause or contribute to a deathor serious injury if the malfunction were to recur.

Product labeling and promotional activities for drugand device products are subject to scrutiny by the FDA, and products may bepromoted only for their approved indications. Violations of promotionalrequirements for drugs and devices may also involve violations of the federalFalse Claims Act, anti-kickback laws, and other federal or state laws. Inaddition to the government bringing claims under the federal False Claims Act, *qui tam*, or “whistleblower,” actions maybe brought by private individuals on behalf of the government. Also, competitorsmay bring litigation under the Lanham Act or challenges under industryself-regulation groups relating to product advertising.

The European Community (EC) and EC member statesmaintain drug regulatory systems for medicinal products and medical devicesthat are comparable in their rigor to those in the United States. Clinicaltrials of medicinal products require government authorizations (based onevidence of safety from pre-clinical tests and other sources), must be reviewedand approved by ethics committees, and must be carried out in compliance withgood clinical practice. There is no guarantee that permission will be grantedfor clinical trials of new medicinal products, and permission can be withdrawnif safety issues arise during a clinical trial.

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Medicinal products may not be introduced to the marketin the EC unless a marketing authorization has been granted by a competentauthority. Marketing authorization applications for new chemical entities maybe submitted to multiple EC member states under the mutual recognition system(which results in harmonized conditions of approval) or to the EuropeanMedicines Agency (EMEA), which administers a system that leads to a singlemarketing authorization that is valid in all EC member states. For certain newchemical entities, as well as all biotechnology products, submission to theEMEA is mandatory. Requirements for marketing authorization applications aresimilar to those for NDAs in the United States, including requirements forproof of safety, efficacy and quality. These requirements are demanding, andthere is no assurance that a product for which a marketing authorizationapplication is submitted will be approved. Manufacturing facilities must alsocomply with EC requirements for good manufacturing practice, and if located inthe EC must be licensed by the competent authority of the relevant memberstate. Requirements may be imposed for post-marketing studies, and there aredetailed requirements for post-market surveillance of safety (pharmacovigilance).Advertising and promotion are scrutinized by authorities in each member state,and in some cases by the EMEA as well. Products may be removed from the market,permanently or temporarily, if safety questions arise, and there are onlylimited procedural requirements before such actions can be taken.

In addition to these controls under Medicines Law,most EC member states maintain some form of control over the pricing orreimbursement of medicinal products. In many member states, marketing may notcommence until a price or reimbursement level has been determined, and in somemember states products are also subject to cost-effectiveness reviews that can,for practical purposes, determine whether they will be utilized.

The EC maintains aseparate system for medical devices, including *invitro* diagnostic devices that may be developed in conjunction withmedicinal products whose use depends on biomarkers. Manufacturers must meetrequirements for quality control, which may entail interaction with quasi-governmentalNotified Bodies, and comply with essential requirements and standards adoptedunder EC law. There is no harmonized system of control on the advertising andpromotion of medical devices, and requirements vary from country to country. Inaddition, many EC member states maintain systems to evaluate new medicaldevices to determine whether they are cost-effective or otherwise appropriatefor use in national health systems, other maintain other systems to controlpricing or reimbursement of medical devices.

**Environmental**

deCODE’s primary research facilities and laboratoryare located in Reykjavik, Iceland. We operate under applicable Icelandic andEuropean Union laws and standards, with which we believe that we comply,relating to environmental, hazardous materials and other safety matters. Ourresearch and manufacturing activities involve the generation, use and disposalof hazardous materials and wastes, including various chemicals and radioactivecompounds. These activities are subject to standards prescribed by Iceland andthe EU. We do not believe that compliance with these laws and standards willhave any material effect upon our capital expenditures, earnings or competitiveposition, or that we will have any material capital expenditures in relation toenvironmental control facilities for the remainder of this fiscal year or anysucceeding fiscal year.

Our activities in the U.S.involve the controlled use of hazardous materials. We are subject to U.S.federal, state and local laws and regulations governing the use, manufacture,storage, handling and disposal of such materials and certain waste products.Although we believe that our activities in the U.S. currently comply with thestandards prescribed by such laws and regulations, the risk of accidental contaminationor injury from these materials cannot be eliminated. In the event of such anaccident, we could be held liable for any damages that result and any suchliability could exceed our resources. In addition, there can be no assurancethat we will not be required to incur significant costs to comply withenvironmental laws and regulations in the future.

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**Employees**

As of December 31,2005, deCODE and all of its subsidiaries employed 480 full-time staff. Of thetotal number, approximately 153 were employed in the United States and 327 inIceland. More than 113 held Ph.D. or M.D. degrees and approximately 410 heldcollege degrees. 369 employees were engaged in, or directly supported, researchand development activities, of whom 300 worked within the laboratory facilitiesand 69 held positions associated with the development and support ofinformatics. 71 employees were engaged in various professional supportfunctions such as Finance, Business Development, Legal, Communications, HumanResources and Clinical Collaborations, and 41 were employed in administrativesupport, facilities management, cleaning and security. In addition, we utilizedpart-time employees and outside contractors and consultants as needed and planto continue to do so.

**Certain Financial Information**

***Research and Development Expenses***

Cost of revenue, including costs incurred inconnection with collaborative programs for 2005, 2004 and 2003, were $37.3million, $43.4 million and $45.9 million, respectively. The cost ofrevenue, including costs incurred in connection with collaborative programsrepresent our customer-sponsored research and development activities.

Our costs of research anddevelopment for proprietary programs for 2005, 2004 and 2003, was $43.7million, $24.9 million and $17.6 million, respectively.

***Geographic Information***

Long-lived assets located in the United States andIceland were $26,231,000 and $13,494,000, respectively at December 31,2005 and $22,955,000 and $55,115,000, respectively at December 31, 2004.

Revenues attributed to theUnited States and to Iceland were $15,486,000 and $28,469,000, respectively,for 2005, $13,680,000 and $28,447,000, respectively for 2004, and $13,744,000and $33,067,000, respectively, for 2003.

***Significant Customers***

Historically, asubstantial portion of deCODE’s revenue has been derived from contracts with alimited number of significant customers. deCODE’s largest customer, Roche,accounted for approximately 23%, 30% and 43% of the company’s consolidatedrevenue in 2005, 2004 and 2003, respectively. Merck accounted for approximately15%, 22% and 18% of the company’s consolidated revenue in 2005, 2004 and 2003,respectively. During the year ended December 31, 2005, divisions of theNational Institutes of Health (NIH) represented 13% of consolidated revenue.The loss of any significant customer may significantly lower deCODE’s revenueswhich could affect the resources available to support our drug discoveryprograms.

**Item 1A.****                RiskFactors**

In Addition to the other information contained in thisForm 10-K, you should consider the following risk factors inevaluating our business and prospects. We also note that this annual report on Form 10-Kcontains forward-looking statements. These statements relate to futureevents or our future financial performance. In some cases, forward-lookingstatements can be identified by terminology such as “may, “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 expectations. We cannot assure our investors that ourexpectations and assumptions will prove to have been correct. We undertake nointention or obligation to update or revise any forward-lookingstatements, 

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whether as a result offuture events, new information or otherwise. Actual events or results maydiffer materially due to a number of factors, including those set forth in thissection and elsewhere in this Form 10-K. These factors include, butare not limited to, the risks set forth below.

**RisksRelated to Our Development of DG031**

***The Phase IIIclinical trial for DG031 will require the recruitment of patients based onethnicity and haplotype status; recruitment rates may be lower than we expectthus delaying the trial and hurting our commercial prospects.***

In our Phase III clinicaltrial for DG031, we will be testing the hypothesis whether African Americanpatients who (a) carry the HapK haplotype in LTA4H and (b) haveexperienced a hospitalization and/or admission for procedures and testing forunstable angina or myocardial infarction will experience reduced rates of acutecardiovascular events when treated with DG031, as compared to placebo on top ofconcomitantly administered standard of care. In order to recruit a sufficientnumber of patients to obtain statistically significant evidence for theefficacy of DG031, we will require the participation of a large number ofAfrican American patients willing to be tested for haplotype status and toparticipate in the clinical trial for at least 12 months. Many factors outsideour control may reduce the willingness of patients to be tested and participatein the clinical trial. If we fail to recruit a sufficient number of patients ina timely manner the trial may be delayed or we may fail to show the efficacy ofthe drug. This may delay or prevent the marketing approval of DG031, whichcould adversely impact our financial results and commercial prospects.

***We have onlyindirect evidence from biomarkers studies about the effectiveness of DG031 andthis data may not be validated in the Phase III clinical trial.***

The data collected duringthe Phase I and Phase II clinical trials for DG031, which is the basis for ourcontinuing development of this drug, does not provide evidence of whether DG031will prove to be an effective treatment to reduce the rate of acutecardiovascular events in the prospective treatment population. In order toprove or disprove the validity of our assumption about the efficacy of DG031,we will have to conduct the Phase III trial, which will be of at least 36months duration from the recruitment of the first patient, although the timemay vary due to unforeseen circumstances. Various factors which we do or do notcontrol may cause delays in the launch of the clinical trial or cause the trialto be lengthier or costlier than anticipated. Until data from the trial can becollected and analyzed we will not know whether DG031 is an effective treatmentand regulatory review by the FDA will ultimately determine whether the druggains marketing approval. The outcome of this process is uncertain and delaysor failure to gain market approval could adversely impact our financial resultsand commercial prospects.

***Our patent protection for DG031 may provide marketingexclusivity for only a limited term.***

The patents we licensedfrom Bayer for DG031 expire in 2009 and 2012. While we will seek to obtain oneor more use patents protecting our proprietary rights to specific uses of thiscompound for a longer period, we cannot be certain that we will obtain suchpatents or that they will adequately protect us. In addition, although we mayseek to extend the term of one of the patents we licensed from Bayer and toobtain marketing exclusivity under the Hatch-Waxman Act and equivalent foreignstatutes, we cannot be certain that we will be successful. Expiration of thepatent(s) prior to regulatory approval may affect our ability to gain thefull benefit of such possible term extension/marketing exclusivity. Further,even if regulatory approval is received before patent expiration, the U.S.Patent and Trademark Office and/or FDA may not rule on our application forterm extension in a timely manner. If we cannot obtain new patents or fullyextend the term of patent protection under one of the patents we licensed fromBayer, the amount of revenues that we will be able to derive from an approvedproduct based on these patents may be adversely affected.

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**Risks Related to Our Business**

***We may not successfully develop or derive revenuesfrom any products.***

We use ourtechnology and research capabilities to identify genes and gene variations thatcontribute to certain diseases and then develop small molecule drugs thattarget proteins produced by these genes. Although we have identified genes thatwe believe are likely to cause certain diseases, we may not be correct and maynot be successful in identifying any other similar genes or in developing drugsbased on these discoveries. Many experts believe that some of the diseases weare targeting are caused by both genetic and environmental factors. Even if weidentify specific genes that are partly responsible for causing diseases, anytherapeutic or diagnostic products we develop as a result of our genetic workmay not detect, prevent, treat or cure a particular disease. Any pharmaceuticalor diagnostic products that we or our collaborators are able to develop willfail to produce revenues unless we:

·       establishthat they are safe and effective;

·       successfullycompete with other technologies and products;

·       ensurethat they do not infringe on the proprietary rights of others;

·       establishthat they can be manufactured in sufficient quantities at reasonable costs;

·       obtainand maintain regulatory approvals for them; and

·       canmarket them successfully.

We may not be able to meetthese conditions. We expect that it will be years, if ever, before we willrecognize significant revenue from the development of therapeutic or diagnosticproducts.

***If we continue toincur operating losses longer than anticipated, or in amounts greater thananticipated, we may be unable to continue our operations.***

We incurred a net loss of $62.8 million, 57.3million and $35.1 million for the years ended December 31, 2005, 2004 and2003, respectively, and had an accumulated deficit of $450.2 million at December 31,2005. We have never generated a profit and we have not generated revenuesexcept for payments received in connection with our research and developmentcollaborations with Roche, Merck and others, from contract services, EmeraldBioSystems products and instruments, and under grants. Our research anddevelopment expenditures and general and administrative costs have exceeded ourrevenue to date, and we expect to spend significant additional amounts to fundresearch and development in order to enhance our core technologies andundertake product development (including drug development and related clinicaltrials). We do not expect to receive royalties or other revenues fromcommercial sales of products developed using our technology in the near term. Itmay be several years before product revenues materialize, if they do at all. Asa result, we expect to incur net losses for several years. If the time requiredto generate product revenues and achieve profitability is longer than wecurrently anticipate or the level of losses is greater than we currentlyanticipate, we may not be able to continue our operations.

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***If our assumption about the role of genes in diseaseis wrong, we may not be able to develop useful products.***

The products we hope todevelop involve new and unproven approaches. They are based on the assumptionthat information about genes may help scientists to better understand complexdisease processes. Scientists generally have a limited understanding of therole of genes in diseases, and few products based on gene discoveries have beendeveloped. Of the products that exist, all are diagnostic products. To date, weknow of no therapeutic products based on disease-gene discoveries. If ourassumption about the role of genes in the disease process is wrong, our genediscovery programs may not result in products.

***In order to conductclinical trials and to market our drugs we will have to develop methods toproduce these drugs using clinically approved methods and at commerciallyviable rates***

In order to conductclinical trials we may need to contract with third parties in order to obtainsufficient amounts of our drugs. These contractors need to implement thenecessary technology and obtain the necessary ingredients in order to producethe drugs to exacting standards set by us and the regulatory bodies. This is anuncertain and time consuming process and any disruption in it may delay or harmour ability to continue clinical development. For drugs which have reached thelast stage of clinical trials we will have to develop methods to scale up theproduction of the drug at commercially viable rates, securing both a contractoror partner with the ability to implement this process and obtain a secure andeconomical supply of the necessary ingredients. If we are not able to scale theprocess in a timely manner or do not have the ability to produce the drugeconomically, we may not have the ability to enter the market with a viableproduct. This would harm our financial and commercial prospects.

***Clinical trialsrequired for our product candidates or the products of our customers andpartners are expensive and time-consuming, their outcome is uncertain and wemay not achieve our projected development goals in the timeframes we haveannounced and expect.***

Before obtainingregulatory approvals for the commercial sale of any of our products underdevelopment, we must demonstrate through pre-clinical studies and clinicaltrials that the product is safe and effective for use in each target indication.Pre-clinical testing and clinical development are long, expensive and uncertainprocesses. It may take several years to complete testing for a product andfailure can occur at any stage of testing. The length of time necessary tocomplete clinical trials varies significantly and may be difficult to predict. Factorsthat can cause delay or termination of our clinical trials include:

·       slowerthan expected patient enrollment due to the nature of the protocol, theproximity of patients to clinical sites, the eligibility criteria for thestudy, competition with clinical trials for other drug candidates or otherfactors;

·       lowerthan expected retention rates of patients in a clinical trial;

·       delayedapproval of study protocol and pharmacogenomic components of studies byregulatory agencies in different countries, some of which are still developingpolicies with respect to  pharmacogenomictesting;

·       inadequatelytrained or insufficient personnel at the study site to assist in overseeing andmonitoring  clinical trials;

·       delaysin approvals or failure to obtain approval from the pertinent review boards orregulatory  authorities;

·       longertreatment time required to demonstrate effectiveness or determine theappropriate product dose;

·       lackof sufficient supply of the product candidate;

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·       adversemedical events or side effects in treated patients;

·       lackof effectiveness of the product candidate being tested; and

·       regulatorychanges.

Even if we obtain positiveresults from pre-clinical or clinical trials for a particular product, we maynot achieve the same success in future trials of that product. In addition,some or all of the clinical trials we undertake may not demonstrate sufficientsafety and efficacy to obtain the requisite regulatory approvals, which couldprevent the creation of marketable products. Our product development costs willincrease if we have delays in testing or approvals, if we need to perform moreor larger clinical trials than planned or if our trials are not successful. Delaysin our clinical trials may harm our financial results and the commercialprospects for our products. Delays or termination of clinical trials that weconduct for our partners or customers may also harm our financial results aspayments under these contracts may be delayed, reduced or curtailed.

***Co-development oftherapeutic and diagnostic products may be required, and delays in thedevelopment and approval of a commercially available diagnostic may delay drugapproval or impede market acceptance of the therapeutic product.***

The use of some of ourtherapeutic products may be dependent upon the selection of patients using bothclinical and genetic markers. This may require co-development and clinicaltesting of the therapeutic drug and a related diagnostic product. In the UnitedStates, drug approval could be delayed until we successfully obtain FDAapproval of the related diagnostic product. In addition, if the diagnostic testcannot be performed on a commercially viable basis, it may impede marketacceptance of our approved therapeutic products. To successfully co-develop andmarket a drug and diagnostic we may also need to establish and maintain successfulpartnerships with manufacturing and marketing partners for diagnostic products.If necessary partnerships can not be established or maintained, the developmentof our therapeutics and/or diagnostics may be delayed or may fail.

***If we are not ableto obtain sufficient additional funding to meet our capital requirements, wemay be forced to reduce or terminate our research and product developmentprograms.***

We have spentsubstantial amounts of cash to fund our research and development activities andexpect to continue to spend substantial amounts for these activities over thenext several years. We expect to use cash to collect, generate and analyzegenotypic and disease data from volunteers in our disease-gene researchprograms; to conduct drug discovery and development activities (includingclinical trials); and to continue other research and development activities.Many factors will influence our future capital needs, including:

·       thenumber, breadth and progress of our discovery and research programs;

·       ourability to attract customers;

·       ourability to commercialize our discoveries and the resources we devote tocommercialization;

·       theamount we spend to enforce patent claims and other intellectual propertyrights; and

·       thecosts and timing of regulatory approvals.

We have relied on, and may continue to rely on,revenues generated by our corporate alliances and fee-paying customers forsignificant funding of our research efforts. Historically, a substantialportion of our revenue has been derived from contracts with a limited number ofsignificant customers. Our largest partner, Roche, accounted for approximately23%, 30% and 43% of our consolidated revenue in the years ended December 31,2005, 2004 and 2003, respectively. Revenue under our alliances with Merck 

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accounted forapproximately 15%, 22% and 18% of our consolidated revenue in the years ended, December 31,2005, 2004 and 2003, respectively. During the year ended December 31,2005, divisions of the NIH represented 13% of our consolidated revenue. Workunder the Merck obesity agreement and the Roche 2002 agreement has beensubstantially completed, and this may significantly lower our revenues andaffect the resources available to support our drug discovery programs, whichwill increase our need for additional funding.

In addition, we may seek additional funding throughpublic or private equity offerings and debt financings. We may not be able toobtain additional financing when we need it or the financing may not be onterms favorable to us or our stockholders. Stockholders’ ownership will bediluted if we raise additional capital by issuing equity securities.

If we raise additionalfunds through collaborations and licensing arrangements, we may have torelinquish rights to some of our technologies or product candidates, or grantlicenses on unfavorable terms. If adequate funds are not available, we wouldhave to scale back or terminate our discovery and research programs and productdevelopment.

***The commercialsuccess of any products that we may develop will depend upon the degree ofmarket acceptance among physicians, patients, healthcare payors and the medicalcommunity.***

Any products thatwe may develop may not gain market acceptance among physicians, patients,healthcare payors and the medical community. If these products do not achievean adequate level of acceptance, we may not generate material product revenuesand we may not become profitable. The degree of market acceptance of any of ourproduct candidates, if approved for commercial sale, will depend on a number offactors, including:

·       demonstrationof efficacy and safety in clinical trials;

·       theprevalence and severity of any side effects;

·       potentialor perceived advantages over alternative treatments;

·       thetiming of market entry relative to competitive treatments;

·       theability to offer our product candidates for sale at competitive prices;

·       relativeconvenience and ease of administration;

·       thestrength of marketing and distribution support;

·       sufficientthird party coverage or reimbursement; and

·       the product labeling orproduct insert required by the FDA or regulatory authorities in othercountries.

***If we cannotsuccessfully develop a marketing and sales force or maintain suitablearrangements with third parties to market and sell our products, our ability todeliver products may be impaired.***

We currently have noexperience in marketing or selling pharmaceutical products. In order to achievecommercial success for any approved product, we must either develop a marketingand sales force, which will require substantial additional funds and personnel,or, where appropriate or permissible, enter into arrangements with thirdparties to market and sell our products. We might not be successful indeveloping marketing and sales capabilities. Further, we may not be able toenter into marketing and sales agreements with others on acceptable terms, andany such arrangements, if entered into, may be terminated. If we develop ourown marketing and sales capability, it will compete with other companies thatcurrently have experienced, well-funded and larger marketing and salesoperations. To the extent that we enter into co-

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promotionor other sales and marketing arrangements with other companies, revenues willdepend on the efforts of others, which may not be successful.

***If we cannotsuccessfully form and maintain suitable arrangements with third parties for themanufacturing of the products we may develop, our ability to develop or deliverproducts may be impaired.***

We have no experience in manufacturing products forcommercial purposes and do not have manufacturing facilities that can producesufficient quantities of drugs for large scale clinical trials. Accordingly, wemust either develop such facilities, which will require substantial additionalfunds, or rely on contract manufacturers for the production of products fordevelopment and commercial purposes. In order to conduct our currently plannedPhase III clinical trial of DG031, we will have to contract with thirdparties to manufacture a sufficient supply of the drug for the trial and toproduce tablets containing DG031 in amounts sufficient for the clinical trial. Whilewe have signed contracts with suppliers for the production of DG031 materialand tablets for the planned launch of our Phase III clinical trial, wehave not received the finished drug tablets, and we may fail to securesufficient supply of the drug in a timely manner over the duration of thetrial.

The manufacture of ourproducts for clinical trials and commercial purposes is subject to GoodManufacturing Practices (cGMP) regulations promulgated by the FDA. Themanufacture of diagnostic products is subject to the FDA’s quality systemrequirements (QSR). In the event that we are unable to develop satisfactorymanufacturing facilities or obtain or retain third party manufacturing for ourproducts, we will not be able to commercialize such products as planned. We maynot be able to enter into agreements for the manufacture of future productswith manufacturers whose facilities and procedures comply with cGMP, QSR andother regulatory requirements. Our current dependence upon others for themanufacture of our products may adversely affect our ability to develop anddeliver such products on a timely and competitive basis and, in the longerterm, the profit margin, if any, on the sale of future products and our abilityto develop and deliver such products on a timely and competitive basis.

***Our reliance on the Icelandic population may limit theapplicability of our discoveries to certain populations.***

The genetic make-up andprevalence of disease generally varies across populations around the world. Commoncomplex diseases generally occur with a similar frequency in Iceland and otherEuropean populations. However, the populations of other nations may begenetically predisposed to certain diseases because of mutations not present inthe Icelandic population. As a result, we and our partners may be unable todevelop diagnostic and therapeutic products that are effective on all or aportion of people with such diseases. For our business to succeed, we must beable to apply discoveries that we make on the basis of the Icelandic populationto other markets.

***If a substantialportion of participants in our genetics research studies withdraw their informedconsent, our ongoing research may suffer.***

We depend on thewillingness of Icelandic volunteers to participate in our genetics researchstudies. All of the participants in our genetic studies have signed an informedconsent form, which gives deCODE permission to process data and blood samplesthat the participant has donated for research purposes. Participants may at anytime revoke this permission by withdrawing their consent. If, for any reason, asubstantial portion of participants in our studies were to withdraw theirconsent, we would not be able to continue population genetic research in someor all of the diseases that we are studying. This would diminish our ability todiscover new drug targets and to develop products based on these discoveries.If our ability to use population genetic data is impaired, we may also not beable to fulfill some contractual obligations with our partners.

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***If we fail to protect confidential data adequately, wecould incur a liability.***

Under laws and regulationsin force in Iceland, including applicable European laws, directives andregulations, all information on individuals that is used in our populationresearch is anonymized under the protocols and supervision of the DataProtection Authority of Iceland. If we fail to comply with these laws andregulations, we could lose public support for participation in our research andwe could be liable to legal action. Any failure to comply fully with allconfidentiality requirements could lead to liability for damages incurred byindividuals whose privacy is violated, the loss of our customers and reputationand the loss of the goodwill and participation of the Icelandic population,including healthcare professionals. These eventualities could materiallyadversely affect our work in Iceland.

***Some parts of ourproduct development services create a risk of liability from clinical trialparticipants and the parties with whom we contract.***

Through our whollyowned subsidiary Encode, we conduct clinical trials of products we are developingand contract with drug companies and clinical research organizations to performa wide range of services to assist them in bringing new drugs to market. Ourservices include:

·       supervisingclinical trials;

·       dataand laboratory analysis;

·       patientrecruitment; and

·       acting as investigators inconducting clinical trials.

**If, in the course of these trialsor activities,**

·       wedo not perform our services to contractual or regulatory standards;

·       wefail to obtain permission to conduct trials from the appropriate authorities inIceland;

·       patientsor volunteers suffer personal injury caused by or death from adverse reactionsto the test drugs or otherwise;

·       thereare deficiencies in the professional conduct of the investigators with whom wecontract;

·       ourlaboratories inaccurately report or fail to report lab results; or

·       ourinformatics products violate rights of third parties,

then we could be held liable for these eventualitiesby the regulatory agencies or the drug companies and clinical research organizationswith whom we contract or by study participants. We maintain product liabilityinsurance for claims arising from the use of products we are developing inclinical trials conducted by Encode and are covered by the product liabilityinsurance of the drug companies and clinical research organizations for whom weprovide clinical trial services for claims arising from the use of theirproducts in such trials. Such insurance may be inadequate and in any eventwould not cover the risk of a customer deciding not to do business with us as aresult of poor performance or claims for a customer’s financial loss as theresult of our failure to perform our contractual obligations properly.

***Use of therapeuticor diagnostic products developed as a result of our programs may result inproduct liability claims for which we have inadequate insurance.***

The users of anytherapeutic or diagnostic products developed by us or our collaborators as aresult of our discovery or research programs (including participants in ourclinical trials) may bring product liability claims against us. Except asdescribed above with respect to clinical trials conducted by Encode, wecurrently do not carry liability insurance to cover such claims (although weexpect to obtain such insurance 

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for ourPhase III trial of DG031). We are not certain that we or our collaboratorswill be able to obtain such insurance or, if obtained, that sufficient coveragecan be acquired at a reasonable cost. If we cannot protect against potentialliability claims, we or our collaborators may find it difficult or impossibleto commercialize products.

***Our fee-for-service work bears certain risks ofliability to our customers.***

Our subsidiaries, deCODE chemistry, Inc., deCODEbiostructures, Inc., and Emerald Biosystems, Inc., provide services,equipment and products (including software) for third party customers who payus on a fee-for-service or product basis. In this function, we often synthesizecompounds, manufacture Active Pharmaceutical Ingredient (API) material andprovide recommendations for research direction for our customers. We alsoprovide contract research services in X-ray crystallographic structuredetermination of protein-ligand complexes for customers, and often recommendtargets to customers based on these determinations. In addition, we sellinstruments and software to these customers.

We may be liable to our customers for damages if weperform such services negligently or with willful misconduct, or if we providecustomers with defective products, equipment or software. We also may be heldliable for failure to meet specifications or failure to comply with othercontractual conditions. While our agreements with customers limit our liabilityand while we carry general commercial liability insurance, such contractuallimitations may not be effective in the event of our material breach of theagreements, gross negligence, or willful misconduct and such insurance may notbe adequate. We also supply compounds for clinical trials conducted by ourcustomers. In doing so, we may provide materials requiring certification ofcompliance with cGMP regulations applicable to production of such materials. Ifwe are found not to have complied with such requirements, we may incurliabilities related to such failures. If participants in these trials sufferpersonal injury or death from adverse reactions to the test drugs, we could beheld liable to our customers or the participants. We maintain product liabilityinsurance for claims arising from the use of products we supply. However, suchinsurance may be inadequate. Failure to perform to customer expectation alsomay limit future business from our existing customers, or could result in theholdback of certain payments due to us. We integrate software and productspurchased or licensed from third parties suppliers into certain of ourproducts, equipment and software sold to our customers. While we evaluate suchitems for defects and possible intellectual property infringement issues, andattempt to obtain contractual protections from suppliers, in the event any suchitems purchased or licensed from suppliers are defective or violateintellectual property rights of third parties, we may not be able to fullyrecover any of our damages or our customers’ damages from suppliers of suchitems.

Our facilities where work for customers is conductedare subject to audits by the FDA and by customers. In the event we are found innon-compliance by the FDA, there is a risk that such facility may be subject tocorrective measures up to and including the closure of the facility. Suchclosure would have impact on our ability to meet customer obligations as wellas obligations relating to our internal programs. Customer audits may lead todisputes regarding compliance with contractual terms, which could lead topotential disputes and/or liabilities as described above.

In addition, we typicallyhave the obligation to maintain the confidentiality of proprietary informationof our customers. While we have systems in place to ensure that such confidentialityis protected, we do conduct work on our internal projects at the samefacilities where we work for our customers; therefore, there is an increasedrisk that customers may claim that we have violated our confidentialityobligations or used their proprietary information in our proprietary projects.

***Increased leverage as a result of our convertible debtmay harm our financial condition and results of operations.***

On December 31,2005, we had $158.6 million of outstanding debt as reflected in our balancesheet. We may incur additional indebtedness in the future and our outstanding3.5% Senior Convertible Notes 

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(the “Notes”)do not restrict our future issuance of indebtedness. Our level of indebtednesswill have several important effects on our future operations, including,without limitation:

·       aportion of our cash flow from operations will be dedicated to the payment ofany interest required with respect to outstanding indebtedness;

·       increasesin our outstanding indebtedness and leverage will increase our vulnerability toadverse changes in general economic and industry conditions, as well as tocompetitive pressure; and

·       dependingon the levels of our outstanding debt, our ability to obtain additionalfinancing for working capital, capital expenditures, general corporate andother purposes may be limited.

Our ability to makepayments of principal and interest on our indebtedness depends upon our futureperformance, which will be subject to the success of our development andcommercialization of new pharmaceutical products, general economic conditions,industry cycles and financial, business and other factors affecting ouroperations, many of which are beyond our control. If we are not able togenerate sufficient cash flow from operations in the future to service ourdebt, we may be required, among other things:

·       toseek additional financing in the debt or equity markets;

·       torefinance or restructure all or a portion of our indebtedness, including theNotes;

·       tosell selected assets; or

·       toreduce or delay expenditures on planned activities, including but not limitedto clinical trials, and development and commercialization activities.

Such measures might not besufficient to enable us to service our debt. In addition, any such financing,refinancing or sale of assets might not be available on economically favorableterms.

***We may be unable to hire and retain the key personnelupon whom our success depends.***

We depend on the principalmembers of our management and scientific staff, including Dr. KariStefansson, Chairman, President and Chief Executive Officer. We have notentered into agreements with any of these people that bind them to a specificperiod of employment. If any of these people leave, our ability to conduct ouroperations may be negatively affected. Our future success also will depend inpart on our ability to attract, hire and retain additional personnel. There isintense competition for such qualified personnel and we cannot be certain thatwe will be able to continue to attract and retain such personnel. Failure toattract and retain key personnel could have a material adverse effect on us.

***Currency fluctuations may negatively affect ourfinancial condition.***

We primarily expend orgenerate cash in U.S. dollars, our functional currency. We also publish ourconsolidated financial statements in U.S. dollars. Currency fluctuations canaffect our financial results because a portion of our cash reserves, our debtand our operating costs are in Icelandic kronas. A fluctuation of the exchangerates of the Icelandic krona against the U.S. dollar can thus adversely affectthe “buying power” of our cash reserves and revenues. Most of our long-termliabilities are U.S. dollar denominated. However, we may enter into hedgingtransactions if we have substantial foreign currency exposure in the future. Wemay have increased exposure as a result of investments or payments fromcollaborative partners.

***Our contracts may terminate upon short notice.***

Many of our contracts forresearch services are terminable on short notice. This means that our contractscould be terminated for numerous reasons, any of which may be beyond ourcontrol such as a 

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reductionor reallocation of a customer’s research and development budget or a change ina customer’s overall financial condition. The loss of a large contract ormultiple smaller contracts, or a significant decrease in revenue derived from acontract, could significantly reduce our profitability and require us toreallocate under-utilized physical and professional resources.

**RisksRelated to Our Collaborative Relationships**

***If we are unable toform and maintain the collaborative relationships that our business strategyrequires, our programs will suffer and we may not be able to develop products.***

Our strategy for developing products and derivingrevenues from them is dependent, in part, upon our ability to enter intocollaborative arrangements with research collaborators, corporate partners andothers. We may rely on these arrangements both to provide funding necessary toour product development and to obtain goods and services that we require forour product development. We do not have the capacity to conduct large scalePhase III clinical trials and will rely on partnerships or third partycontractors to conduct our Phase III trials, including our currentlyplanned Phase III trial of DG031. We will rely on these third parties toprovide us with clinical material for the trial and various services necessaryto organize and conduct a multi-center, multinational study, as well as othergoods and services. We have not entered into contracts for all goods andservices required for the Phase III trial of DG031 at this time. Ourarrangement for this and other Phase III trials will be subject to risksdescribed below, with respect to our collaborative relationships.

If our collaborations are not successful or if we arenot able to manage multiple collaborations successfully, our programs maysuffer. If we increase the number of collaborations, it will become moredifficult to manage the various collaborations successfully and the potentialfor conflicts among the collaborators as to rights to the technology andproducts generated under work conducted with us will increase.

***Dependence oncollaborative relationships may lead to delays in product development, productdefects and disputes over rights to technology.***

We have formed, and may in the future form additional,collaborative relationships (including relationships with clinical researchorganizations to conduct clinical trials on our behalf) that will, in somecases, make us dependent on collaborators for the pre-clinical studies and/orclinical trials and for regulatory approval of any products that we aredeveloping. Failure of such collaborators to perform under these agreementsproperly in a timely manner, or at all, may lead to delays in our productdevelopment. In addition, if participants in the trials conducted by ourcollaborators suffer personal injury or death as a result of actions of thecollaborators, we could be held liable. In some cases, our agreements withcollaborators typically allow them significant discretion in electing whetherand how to pursue such activities. We cannot control the amount and timing ofresources collaborators will devote to these programs or potential products.

Our collaborators may stopsupporting our products or providing services to us if they develop or obtainrights to competing products. Disputes may arise in the future over theownership of rights to any technology developed with collaborators. These andother possible disagreements between our collaborators and us could lead todelays in the collaborative research, development or commercialization ofproducts. Such disagreements could also result in litigation or requirearbitration to resolve.

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**RisksRelated to Our Industry**

***Concerns regarding the use of genetic testing resultsmay limit the commercial viability of any products we develop.***

Other companies havedeveloped genetic predisposition tests that have raised ethical concerns. It ispossible that employers or others could discriminate against people who have agenetic predisposition to certain diseases. Concern regarding possiblediscrimination may result in governmental authorities enacting restrictions orbans on the use of all, or certain types of, genetic testing. Similarly, suchconcerns may lead individuals to refuse to use genetic tests even ifpermissible. These factors may limit the market for, and therefore thecommercial viability of, products that our collaborators and/or we may develop.

***We may not be able to compete successfully with othercompanies and government agencies in the development and marketing of productsand services.***

A number of companies areattempting to rapidly identify and patent genes that cause diseases or an increasedsusceptibility to diseases. Competition in this field and our other areas ofbusiness, including drug discovery and development, is intense and is expectedto increase. We have numerous competitors, including major pharmaceutical anddiagnostic companies, specialized biotechnology firms, universities and otherresearch institutions, and other government-sponsored entities and companiesproviding healthcare information products. Our collaborators, including Rocheand Merck, may also compete with us. Many of our competitors, either alone orwith collaborators, have considerably greater capital resources, research anddevelopment staffs and facilities, and technical and other resources than wedo, which may allow them to discover important genes or develop drugs based onsuch discoveries before we do. We believe that a number of our competitors aredeveloping competing products and services that may be commercially successfuland that are further advanced in development than our potential products and services.To succeed, we, together with our collaborators, must discoverdisease-predisposing genes, characterize their functions, develop genetic testsor therapeutic products and related information services based on suchdiscoveries, obtain regulatory and other approvals, and launch such services orproducts before competitors. Even if we or our collaborators are successful indeveloping effective products or services, our products and services may notsuccessfully compete with those of our competitors, including cases where thecompeting drugs use the same mechanism of action as our products. Ourcompetitors may succeed in developing and marketing products and services thatare more effective than ours or that are marketed before ours.

Competitors have established,and in the future may establish, patent positions with respect to genesequences related to our research projects. Such patent positions or the publicavailability of gene sequences comprising substantial portions of the humangenome could decrease the potential value of our research projects and make itmore difficult for us to compete. We may also face competition from otherentities in gaining access to DNA samples used for research and developmentpurposes. Our competitors may also obtain patent protection or otherintellectual property rights that could limit our rights, or our customers’ability, to use our technologies or databases, or commercialize therapeutic ordiagnostics products. In addition, we face, and will continue to face, intensecompetition from other companies for collaborative arrangements withpharmaceutical and biotechnology companies, for establishing relationships withacademic and research institutions and for licenses to proprietary technology.

We expect competition tointensify as technical advances are made and become more widely known. Ourfuture success will depend in large part on maintaining a competitive positionin the genomic field. Rapid technological development may result in products ortechnologies becoming obsolete before we recover the expenses we incur indeveloping them.

Ourability to compete successfully will depend, in part, on our ability, and thatof our collaborators, to:

·       developproprietary products;

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·       developand maintain products that reach the market first, and are technologicallysuperior to, and  more cost effectivethan, other products on the market;

·       obtainpatent or other proprietary protection for our products and technologies;

·       attractand retain scientific and product development personnel;

·       obtainrequired regulatory approvals; and

·       manufacture, market andsell products that we develop.

***Changes in outsourcing trends and economic conditionsin the pharmaceutical and biotechnology industries could adversely affect ourgrowth.***

Economic factors andindustry trends that affect our primary customers, pharmaceutical andbiotechnology companies, also affect our business. For example, the practice ofmany companies in these industries has been to outsource to organizations likeus the conduct of genetic research, clinical research, sales and marketingprojects and chemistry and structural biology research and development projects.If these industries reduce their present tendency to outsource those projects,our operations, financial condition and growth rate could be materially andadversely affected. These alliances and arrangements are both time consumingand complex and we face substantial competition in establishing theserelationships. In addition, our ability to generate new business could beimpaired by general economic downturns in our customers’ industries. We haveexperienced increasing pressure on the part of our customers to reduceexpenses, including the use of our services as a result of negative economictrends generally and in the pharmaceutical industry. If pharmaceutical andbiotechnology companies discontinue or decrease their usage of our services,for example, as a result of an economic slowdown or increased competition fromoutsourcing companies in India and China, our revenues and earnings could belower than we expect, and our revenues may decrease or not grow at historicalrates.

***If regulatory approvals for products resulting fromour gene discovery programs are not obtained, we will not be able to deriverevenues from these products.***

Government agencies mustapprove new drugs and diagnostic products in the countries in which they are tobe marketed. We cannot be certain that we can obtain regulatory approval forany drugs or diagnostic products resulting from our gene discovery programs. Theregulatory process can take many years and require substantial resources. Becausesome of the products likely to result from our disease research programsinvolve the application of new technologies and may be based upon a newtherapeutic approach, various government regulatory authorities may subjectsuch products to substantial additional review. As a result, these authoritiesmay grant regulatory approvals for these products more slowly than for productsusing more conventional technologies. Furthermore, regulatory approval mayimpose limitations on the use of a drug or diagnostic product.

Even if a product isapproved for marketing, it and its manufacturer must undergo continuing review.Discovery of previously unknown problems with a product may require theperformance of additional clinical trials or the change of the labeling of theproduct and may have adverse effects on our business, financial condition andresults of operations, including withdrawal of the product from the market.

***Third partyreimbursement and health care reform policies may reduce market acceptance ofour products.***

Our success will depend inpart on the price and extent to which we will be paid for our products bygovernment and health administration authorities, private health insurers andother third party payers. Reimbursement for newly approved healthcare productsis uncertain. Third party payers, including Medicare in the United States, areincreasingly challenging the prices charged for medical products and services. Theyare increasingly attempting to contain healthcare costs by limiting bothcoverage and the level of reimbursement for new therapeutic products. We cannotbe certain that any third party insurance coverage will be available topatients for any products we discover or develop. If third party payers do not 

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provideadequate coverage and reimbursement levels for our products, the marketacceptance of these products may be materially reduced.

Numerous governments haveundertaken efforts to control growing healthcare costs through legislation,regulation and voluntary agreements with medical care providers andpharmaceutical companies. If cost containment efforts limit the profits thatcan be derived from new drugs, our customers may reduce their research anddevelopment spending which could reduce the business they outsource to us.

***Our corporate compliance program cannot guarantee thatwe are in compliance with all applicable federal and state regulations in theUnited States, Iceland, the European Union and elsewhere.***

The development,manufacturing, distribution, pricing, sales, marketing and reimbursement of ourproducts, together with our general operations are subject to extensive federaland state regulations in the United States and national or supra-national lawsand regulations in Europe and other parts of the world. While we have developedand instituted a corporate compliance program based on current best practices,we cannot assure you that we or our employees are or will be in compliance withall potentially applicable federal and state regulations and/or laws. If wefail to comply with any of these regulations and/or laws, a range of actionscould result, including, but not limited to, the termination of clinicaltrials, the failure to approve a product candidate, restrictions on ourproducts or manufacturing processes, including withdrawal of our products fromthe market, significant fines, exclusion from government healthcare programs orother sanctions or litigations.

***Our operations involve a risk of injury or damage fromhazardous materials, and if an accident were to occur, we could be subject tocostly and damaging liability claims.***

In the course of our work,we handle and produce hazardous materials and chemicals as well as compoundswhich may have known or unknown characteristics such as toxicity and reactivitywith other compounds. Although we have systems in place to manage suchcompounds and their characteristics, the risk of accidental contamination orinjury from these materials cannot be completely eliminated. Any suchcontamination or injury could result in negative effects to our personnel orfacilities, which could lead to liabilities as well as impacting our ability tomeet customer obligations and conduct our internal programs.

**RisksRelated to Our Intellectual Property**

***We may not be ableto protect the proprietary rights that are critical to our success.***

Our success will depend inpart on our ability to protect our products, our genealogy database andgenotypic data and any other proprietary databases that we develop and ourproprietary software and other proprietary methods and technologies. Despiteour efforts to protect our proprietary rights, unauthorized parties may be ableto obtain and use information that we regard as proprietary.

While we requireemployees, business partners, academic collaborators and consultants to enterinto confidentiality agreements, there can be no assurance that proprietaryinformation will not be disclosed, that others will not independently developsubstantially equivalent proprietary information and techniques, otherwise gainaccess to our trade secrets or disclose such technology, or that we canmeaningfully protect our trade secrets.

Ourcommercial success will depend in part on obtaining patent protection. Thepatent positions of pharmaceutical, biopharmaceutical and biotechnologycompanies, including deCODE, are generally uncertain and involve complex legaland factual considerations that are constantly evolving. We cannot be surethat:

·       anyof our pending patent applications will result in issued patents;

·       wewill develop additional proprietary technologies that are patentable;

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·       anypatents issued to us or our partners will provide a basis for commerciallyviable products, will  provide us withany competitive advantages or will not be challenged by third parties; or

·       thepatents of others will not have an adverse effect on our ability to dobusiness.

If we are unable to obtainpatent protection for our technology or discoveries, the value of ourproprietary resources may be adversely affected.

In addition, patent lawrelating to the scope of claims in the area of genetics and gene discovery isstill evolving and subject to uncertainty, including in areas important to ussuch as patenting of discoveries for the development of therapeutic methods,diagnostic methods and products that predict inherited susceptibility todiseases and diagnostic methods and products that predict drug response anddisease progression. Accordingly, the degree of future protection for ourproprietary rights is uncertain and, we cannot predict the breadth of claimsallowed in any patents issued to us or others. We could also incur substantialcosts in litigation if we are required to defend ourselves in patent suits broughtby third parties or if we initiate such suits to enforce our own patentsagainst potential infringers.

Others may have filed andin the future are likely to file patent applications covering products ortechnology that are similar or identical to our products and technology. Thefact that patent applications of others may not publish until they issue aspatents in the US, or are not published until 18 months after filing in the USand other jurisdictions may have adverse effect on our own patent filings andbusiness, particularly if they claim subject matter similar to that of ourclinical programs. In addition, others may develop competitive products outsidethe protection that may be afforded by the claims of our patents. We cannot becertain that our patent applications will have priority over any patentapplications of others. The mere issuance of a patent does not guarantee thatit is valid or enforceable; thus even if we are holding or are granted patents,we cannot be sure that they would be valid and enforceable against thirdparties. Further, a patent does not provide the patent holder with freedom tooperate in a way that infringes the patent rights of others. Any legal actionagainst us or our partners claiming damages and seeking to enjoin commercialactivities relating to the affected products and processes could, in additionto subjecting us to potential liability for damages, require us or our partnersto obtain a license in order to continue to manufacture or market the affectedproducts and processes. There can be no assurance that we or our partners wouldprevail in any action or that any license required under any patent would bemade available on commercially acceptable terms, if at all. If licenses are notavailable, we or our partners may be required to cease marketing our productsor practicing our methods.

If expressed sequencetags, SNPs, or other sequence information become publicly available before weapply for patent protection on a corresponding full-length or partial gene, ourability to obtain patent protection for those genes or gene sequences could beadversely affected. In addition, other parties are attempting to rapidlyidentify and characterize genes through the use of SNP genotyping, geneexpression analysis and other technologies. If any patents are issued to otherparties on these partial or full-length genes or gene products or uses for suchgenes or gene products, the risk increases that the sale of our or ourcollaborators’ potential products or processes may give rise to claims ofpatent infringement. The amount of supportive data required for issuance ofpatents for human therapeutics is highly uncertain. If more data than we haveavailable is required, our ability to obtain patent protection could be delayedor otherwise adversely affected. Even with supportive data, the ability toobtain patents is uncertain in view of evolving examination guidelines, such asthe utility and written description guidelines that the U.S. Patent andTrademark Office has adopted.

***Our patentapplications covering DG041, DG051 and DG061 have not issued yet as patents.***

The most importantcompounds that we have currently in pre-clinical and clinical development andwe have discovered ourselves are DG041, DG051 and DG061. We have filed compositionof matter-type patent applications covering the compounds in the US. However,these patent applications are in the early stages of patent prosecution beforethe United States Patent and Trademark Office (USPTO) and we have 

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nocertainty or indication from the USPTO that these patent applications willissue as patents. The USPTO is currently facing considerable backlog forexamining pending patent applications so considerable time may elapse before wewill have more certainty as to the patentability of the compounds. Should theUSPTO ultimately reject our patent applications covering DG041, DG051 or DG061,or should others have filed or obtained issued patent covering the same, thevalue and potential of these programs for our business would be adverselyaffected.

***Any patentprotection we obtain for our products may not prevent marketing of similarcompeting products.***

Patents on our productsmay not prevent our competitors from designing around and developing similarcompounds or compounds with similar modes of action that may competesuccessfully with our products. Such third party compounds may prove to besuperior to our products or gain wider market acceptance and thus adverselyaffect any revenue stream that we could otherwise expect from sales of ourproducts.

***Any patents weobtain may be challenged by producers of generic drugs.***

Patents coveringinnovative drugs, which are also commonly referred to as “branded drugs” or “pioneerdrugs,” face increased scrutiny and challenges in the courts from manufacturersof generic drugs who may receive benefits such as limited marketingco-exclusivity if the challenge is successful. Such patent challenges typicallyoccur when the generic manufacturer files an Abbreviated New Drug Applicationwith the FDA and asserts that the patent or patents covering the branded drugare invalid or unenforceable, forcing the owner or licensee of the branded drugto file suit for patent infringement. If any patents we obtain covering ourpharmaceutical products are subject to such successful patent challenges, ourmarketing exclusivity may be eliminated or reduced in time, which would thusadversely affect any revenue stream that we could otherwise expect from salesof our products.

**RisksRelated to Investing in Our Stock**

***Future sales ofcommon stock may dilute our stockholders.***

We may sell common stockin the future in one or more transactions at prices and in a manner wedetermine from time to time. If we sell common stock in more than onetransaction, existing stockholders who previously purchased stock may bematerially diluted by subsequent sales of common stock.

***The price of ourcommon stock is volatile and the market value of your investment may decrease.***

Themarket prices for common stock of biotechnology and pharmaceutical companies,including ours, have historically been highly volatile, and the market has fromtime to time experienced significant price and volume fluctuations that areunrelated to the actual performance of particular companies. In addition to thevarious risks described elsewhere in this Form 10-K, the followingfactors could have an adverse effect on the market price of our common stock:

·       fluctuationsin our operating results;

·       announcementof technological innovations or new therapeutic products by us or others;

·       clinicaltrial results;

·       developmentsconcerning agreements with collaborators;

·       actualor threatened litigation;

·       governmentalregulation and regulatory actions;

·       changesin patent laws;

·       developmentsconcerning patent or other proprietary rights;

·       publicconcern as to the safety of drugs developed by us or others;

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·       futuresales of substantial amounts of common stock by existing stockholders; and

·       general market conditionsand economic and other external factors, including disasters, wars and othercrises.

***We may issuepreferred stock with rights that could affect your rights and prevent atakeover of the business.***

Our board of directors hasthe authority, without further approval of our stockholders, to fix the rightsand preferences, and to issue up to 6,716,666 shares of preferred stock. Inaddition, Delaware corporate law imposes limitations on certain businesscombinations. These provisions could, under certain circumstances, delay orprevent a change in control of deCODE and, accordingly, could adversely affectthe price of our common stock.

***We currently do not intend to pay dividends on ourcommon stock and consequently, your only opportunity to achieve a return onyour investment is if the price of our common stock appreciates.***

We currently do not planto pay dividends on shares of our common stock in the near future. Consequently,your only opportunity to achieve a return on your investment in our companywill be if the market price of our common stock appreciates.

**Item 1B.****               *Unresolved Staff Comments***

None.

**Item 2.****                        *Properties***

Our headquarters are inIceland in an approximately 150,000 square-foot, three-story building,used both for our laboratories and offices. The building is leased under afifteen year operating lease expiring in 2020. We also lease a total of 31,000square feet in a building at Krokhals 5, Reykjavik, to house additionallaboratory facilities and storage, including Encode’s operation. The Krokhals 5lease is also leased under a fifteen year operating lease expiring in 2020.

Our principal executiveoffices and discovery laboratories in the United States are located inWoodridge, Illinois, and encompass approximately 103,000 square feet with thecapability to expand our offices and laboratories to 200,000 square feet.Additionally, we occupy approximately a 19,000 square foot leased office andlaboratory facility in Bainbridge Island, Washington.

We lease approximately5,100 square feet of office space in Brighton, Michigan which houses ourproduct development group.

Wealso lease approximately 6,500 square feet of office space in Waltham,Massachusetts, for finance and 1,600 square feet of office space in New York,New York for investor relations and corporate communications.

**Item 3.****                        *Legal Proceedings***

Other than claims andlegal proceedings that arise form time to time in the ordinary course ofbusiness that are not material, deCODE has no pending legal proceedings exceptas follows:

On or about April 20,2002, an amended class action complaint, captioned *In re deCODEgenetics, Inc. Initial Public Offering Securities Litigation*(01 Civ. 11219(SAS)), alleging violations of federal securities laws inconnection with deCODE’s initial public offering was filed in the United StatesDistrict Court for the Southern District of New York on behalf of certainpurchasers of deCODE common stock. The complaint names deCODE, two individualswho were executive officers of deCODE at the time of its initial publicoffering (the “Individual Defendants”), and the two lead underwriters (the “UnderwriterDefendants”) for our initial public offering in July 2000 (the “IPO”) asdefendants.

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deCODE is aware thatsimilar allegations have been made in hundreds of other lawsuits filed (many bysome of the same plaintiff law firms) against numerous underwriter defendantsand issuer companies (and certain of their current and former officers) inconnection with various public offerings conducted in recent years. All of thelawsuits that have been filed in the Southern District of New York have been consolidatedfor pretrial purposes before United States District Judge Shira Scheindlin.Pursuant to the underwriting agreement executed in connection with our IPO,deCODE has demanded indemnification from the Underwriter Defendants. TheUnderwriter Defendants have asserted that our request for indemnification ispremature.

Pursuant to an agreementthe Individual Defendants have been dismissed from the case without prejudice.

On July 31, 2003, ourBoard of Directors (other than our Chairman and Chief Executive Officer, whorecused himself because he was an Individual Defendant) approved a proposedpartial settlement with the plaintiffs in this matter, subject to a number ofconditions, including the participation of a substantial number of other issuerdefendants in the proposed settlement, the consent of deCODE’s insurers to thesettlement, and the completion of acceptable final settlement documentation.Any direct financial impact of the proposed settlement is expected to be borneby deCODE’s insurers.

In conjunction with theplaintiffs, the settling issuer defendants filed a motion seeking the court’spreliminary approval of the settlement. The court granted preliminary approvalof the settlement on February 15, 2005, subject to certain modifications.On August 31, 2005, the court issued a preliminary order further approvingthe modifications to the settlement and certifying the settlement classes. Thecourt also appointed the Notice Administrator for the settlement and orderedthat notice of the settlement be distributed to all settlement class membersbeginning on November 15, 2005. The settlement fairness hearing has beenset for April 24, 2006. Following the hearing, if the court determinesthat the settlement is fair to the class members, the settlement will beapproved. There can be no assurance that this proposed settlement will beapproved and implemented in its current form, if at all. If the settlement ofthe IPO litigation is not consummated, deCODE expects to contest theallegations in the action vigorously. Due to the inherent uncertainties oflitigation and because the settlement approval process is at a preliminarystage, we cannot predict the ultimate outcome of this matter.

Due to the inherentuncertainties of litigation, and the fact that the settlement of the litigationrelating to our IPO remains subject to court approval, the ultimate outcome ofthis matter cannot be predicted. If deCODE were required to pay significantmonetary damages in the event that the IPO settlement is unconsummated or as aresult of an adverse determination in the other actions described above (or anyother lawsuits alleging similar claims filed against deCODE and deCODE’sdirectors and officers in the future), deCODE’s business could be significantlyharmed. Even if such litigations conclude in deCODE’s favor, deCODE may berequired to expend significant funds to defend against the allegations. deCODEis unable to estimate the range of possible loss from the above litigations andno amounts have been provided for such matters in deCODE’s financialstatements.

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

None.

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**PART II**

**Item 5.**                        *Market for the Company’s Common Equity and Related Stockholder Matters*

TheCompany’s Common Stock is traded on the Nasdaq National Market under the symbol“DCGN”. The following table sets forth, for the calendar periods indicated, therange of high and low sale prices for the Common Stock of the Company on theNasdaq National Market:

| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **2004**       |       |     |       |    |       |
| First Quarter  |       | $        | 13.80      |    | $          | 8.15 |   |
| Second Quarter |       | $        | 11.41      |    | $          | 6.98 |   |
| Third Quarter  |       | $        | 8.70       |    | $          | 5.10 |   |
| Fourth Quarter |       | $        | 8.35       |    | $          | 6.07 |   |
| **2005**       |       |     |       |    |       |
| First Quarter  |       | $        | 8.04       |    | $          | 5.57 |   |
| Second Quarter |       | $        | 9.97       |    | $          | 5.09 |   |
| Third Quarter  |       | $        | 10.67      |    | $          | 7.83 |   |
| Fourth Quarter |       | $        | 9.94       |    | $          | 7.14 |   |

 

We have neither declared nor paid dividends on ourcommon stock since our inception and do not plan to pay dividends in theforeseeable future. Any earnings that we may realize will be retained tofinance our growth.

As of February 20, 2006, there were 4,522 holdersof record of the Common Stock.

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**Item6.**                        *Selected Financial Data*

Thefollowing selected consolidated financial data should be read in conjunctionwith our consolidated financial statements and the notes to those statementsand “Management’s Discussion and Analysis of Financial Condition and Results ofOperations” included elsewhere in this Annual Report. The following data withregard to the consolidated balance sheets at December 31, 2005 and 2004and the related statements of operations and cash flows for the years ended December 31,2005 and 2004 has been derived from consolidated financial statements auditedby Deloitte & Touche LLP, an independent registered public accountingfirm. The following data with regard to the consolidated balance sheets at December 31,2003, 2002 and 2001 and the related statements of operations and cash flows forthe three years ended December 31, 2003 has been derived from consolidatedfinancial statements audited by PricewaterhouseCoopers LLP, independentregistered public accounting firm. Consolidated balance sheets at December 31,2005 and 2004 and the related statements of operations and cash flows for eachof the three years in the period ended December 31, 2005 and the notesthereto appear elsewhere in this annual report.

| ** **                                                                                      | ** ** | **For the Year Ended December 31,**                                                    | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                      | ** ** | **2005**                                                                                                        | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                                      | ** ** | **(Tabular amounts in thousands,  except share and per share amounts)** | ** ** |
| Revenue                                                                                         |       | $                                                                                                               | 43,955     |   | $ | 42,127 |   | $ | 46,811 |   | $ | 41,065 |   | $ | 26,099 |   |
| Operating expenses                                                                              |       |                                                                                                            |       |   |   |   |   |   |   |   |   |
| Research and  development, including cost of revenue                                            |       | 81,011                                                                                                          |       | 68,349 |   | 63,466 |   | 89,612 |   | 70,954 |   |
| Selling, general  and administrative                                                            |       | 20,118                                                                                                          |       | 20,187 |   | 17,178 |   | 18,685 |   | 12,402 |   |
| Impairment,  employee termination and other charges (2)                                         |       | —                                                                                                          |       | — |   | 951 |   | 64,790 |   | — |   |
| Total operating  expenses                                                                       |       | 101,129                                                                                                         |       | 88,536 |   | 81,595 |   | 173,087 |   | 83,356 |   |
| Operating loss                                                                                  |       | (57,174                                                                                                         | )          | (46,409 | ) | (34,784 | ) | (132,022 | ) | (57,257 | ) |
| Interest income                                                                                 |       | 6,397                                                                                                           |       | 2,903 |   | 1,151 |   | 2,954 |   | 6,925 |   |
| Interest expense                                                                                |       | (7,484                                                                                                          | )          | (8,983 | ) | (3,478 | ) | (3,079 | ) | (440 | ) |
| Other non-operating  income and (expense), net                                                  |       | (4,489                                                                                                          | )          | (4,766 | ) | 1,988 |   | (72 | ) | (1,675 | ) |
| Loss before  cumulative effect of change in accounting principle                                |       | (62,750                                                                                                         | )          | (57,255 | ) | (35,123 | ) | (132,219 | ) | (52,447 | ) |
| Cumulative effect  of change in milestone revenue recognition method                            |       | —                                                                                                          |       | — |   | — |   | 333 |   | — |   |
| Net loss                                                                                        |       | $                                                                                                               | (62,750    | ) | $ | (57,255 | ) | $ | (35,123 | ) | $ | (131,886 | ) | $ | (52,447 | ) |
| Basic and diluted net  loss per share:                                                          |       |                                                                                                            |       |   |   |   |   |   |   |   |   |
| Loss before  cumulative effect of change in accounting principle                                |       | $                                                                                                               | (1.17      | ) | $ | (1.07 | ) | $ | (0.68 | ) | $ | (2.69 | ) | $ | (1.26 | ) |
| Cumulative effect  of change in milestone revenue recognition method                            |       | -                                                                                                               |       | - |   | - |   | 0.01 |   | - |   |
| Net loss                                                                                        |       | $                                                                                                               | (1.17      | ) | $ | (1.07 | ) | $ | (0.68 | ) | $ | (2.68 | ) | $ | (1.26 | ) |
| Shares used in  computing basic and diluted net loss per share                                  |       | 53,823,999                                                                                                      |       | 53,422,931 |   | 51,507,869 |   | 49,098,254 |   | 41,634,009 |   |
| Pro forma amounts  assuming new milestone revenue recognition method was applied retroactively: |       |                                                                                                            |       |   |   |   |   |   |   |   |   |
| Revenue                                                                                         |       |                                                                                                            |       |   |   |   |   |   |   | $ | 23,182 |   |
| Net Loss                                                                                        |       |                                                                                                            |       |   |   |   |   |   |   | (55,364 | ) |
| Basic and diluted net  loss per share                                                           |       |                                                                                                            |       |   |   |   |   |   |   | (1.33 | ) |

 

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| ** **                                     | ** ** | **As of December 31,** | ** ** |
|------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                     | ** ** | **2005**                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                     | ** ** | **(In thousands)**               | ** ** |
| Cash and cash  equivalents                     |       | $                                     | 65,943     |   | $ | 70,238 |   | $ | 68,669 |   | $ | 87,244 |   | $ | 153,061 |   |
| Total assets(1)                                |       | 206,758                               |       | 288,252 |   | 183,475 |   | 213,417 |   | 249,900 |   |
| Total long-term  liabilities                   |       | 190,572                               |       | 197,950 |   | 49,874 |   | 56,533 |   | 44,428 |   |
| Total stockholders’  equity (deficit) (1) |       | (9,337                                | )          | 52,396 |   | 93,407 |   | 125,246 |   | 170,733 |   |
|                                                |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          InMarch 2002, deCODE completed the acquisition of MediChem Life Sciences, Inc.(MediChem) in a stock-for-stock exchange accounted for as apurchase transaction. Total consideration for the acquisition was $85,845,000.deCODE’s Statements of Operations include the results of MediChem from March 18,2002, the date of acquisition.

(2)          InSeptember 2002, deCODE recorded impairment, employee termination benefitsand other charges in the total amount of $64,790,000.

**Item7.**                        *Management’s Discussion and Analysis of Financial Condition and Resultsof Operations*

This Management’sDiscussion and Analysis of Financial Condition and Results of Operations as of December 31,2005 and for each of the three years in the period then ended should be read inconjunction with the audited consolidated financial statements and notesthereto set forth elsewhere in this report.

This Annual Report on Form 10-Kcontains forward-looking statements, including our expectations of futureindustry conditions, strategic plans and forecasts of operational results.Various risks may cause our actual results to differ materially. A list anddescription of some of the risks and uncertainties is contained below and inthe summary of risk factors included in Item 1A.

**Overview**

deCODE is abiopharmaceutical company applying its discoveries in human genetics to developdrugs for common diseases. Our population approach and resources enable us toisolate genes and drug targets directly involved in the development of many ofthe biggest challenges to public health. We are turning these discoveries intoa growing pipeline of therapeutics aimed at combating the causes of disease,not just the signs and symptoms. As these diseases are common and currenttherapies are of limited effectiveness, we believe that our strategy representsa significant opportunity to create better medicine with major potential in theglobal marketplace.

We believe that deCODE’sadvantage derives from our population approach to human genetics and theability to apply this approach across the drug development process. In Iceland,we have comprehensive population resources that enable our scientists toefficiently conduct genome- and population-wide scans to identify keygenes and gene variations contributing to common diseases. The proteins encodedby these genes, and other proteins with which they interact in the diseasepathway, offer drug targets that we believe are directly involved in the onsetand progression of disease. Small-molecule drugs that target theseproteins may therefore represent a direct means of modulating the onset orprogression of the disease.

Through our medicinalchemistry and structural biology subsidiaries based in the United States, weare able to discover novel small-molecule therapeutic compounds, takecandidate compounds through pre-clinical testing, and manufacture sufficientquantities for early-stage clinical trials. Our product development groupdesigns and implements our clinical development programs. By leveraging thecapabilities of Encode, and our expertise in genetics and drug and diseasemodeling, we are able to make the drug development process a more efficient andsensitive means of testing and optimizing the therapeutic and commercialpotential of new drugs. In certain programs we have also taken advantage of thefact that drug targets we have identified through our genetics research havealready been targeted by other companies to develop compounds for other indications.By licensing these compounds or entering 

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intoco-development arrangements, we have been able to bypass over several years ofdrug discovery, entering directly into Phase II clinical trials.

Our goal is to bring tomarket new drugs for major indications, and in so doing make the companyprofitable and create value for our shareholders. To achieve this goal we mustensure that we have the capabilities and financial means to expand and advanceour pipeline through the long, risky and expensive process of drug developmentand on to the market. This requires us to constantly evaluate the optimalbalance between several factors, including the level of our investment inresearch and development, the preservation of cash resources and theirdeployment for product development, and the financing environment.

In order to support ourdrug development infrastructure, to focus the use of our cash resources on ourproprietary therapeutics programs, and to diversify risk in our overall drugdevelopment portfolio, we leverage our capabilities to form corporate alliancesand to provide services to fee-paying customers. We also receive contract andgrant funding from various governmental agencies. We have formed drug and otherproduct development alliances with Roche and Merck, among others. In additionto conducting work on our targets in our collaborative and internal programs,our medicinal chemistry subsidiary provides drug discovery services andcontract manufacturing of therapeutic compounds for human clinical trials forour fee-for-service customers. Our other service offerings include proteincrystallography products and instruments, as well as protein structure analysiscontract services through our structural biology subsidiary; clinical trialsservices through Encode; and DNA analysis services through our genotypinglaboratory in Reykjavik.

We derive revenuesprimarily from research funding and other fees from our service customers andcollaborative partners; milestone payments and upfront, exclusivity, technology-accessand technology-development fees under our collaboration agreements constitutemost of the rest of our revenues. While we are entitled to royalties orprofit-sharing under the terms of some of our agreements, due to the extendedtime period for the development and commercialization of a saleable product ortherapy, we have not yet received royalties or profit sharing under any of ourcontracts and do not expect to do so for several years, if at all. Our expensesconsist primarily of research and development expenses such as, salaries andrelated employee costs, materials and supplies, and contractor services.

We believe that ongoingwork in genetics and advancing our drug development programs, particularly theconduct of clinical trials on a growing number of our compounds, will requiresignificant and increasing expenditures. In 2005, we concluded the Phase IIclinical studies for DG031, our developmental compound for the prevention ofheart attack; initiated our Phase I clinical program for DG041, ourdevelopmental compound for peripheral artery disease (PAD); and initiated aPhase II trial in asthma. In the first half of 2006, we expect to finalize ourprotocol and begin enrollment for a Phase III trial for DG031; we haveconcluded our Phase I program for DG041and expect to begin Phase II; and weexpect to conclude our Phase II trial in asthma. We are also advancing ourpre-clinical work on our follow-on compound in heart attack, DG051, and onDG061 for pain, and expect these to be the next programs we bring into clinicaldevelopment. We anticipate incurring additional net losses at least through thenext several years, due to, in addition to the above-mentioned factors,depreciation and amortization, as well as stock-based compensation and othernon-cash charges. We expect that our revenues and losses will fluctuate fromquarter to quarter and that such fluctuations may be substantial, especiallybecause progress in our scientific work and milestone payments that are relatedto progress can fluctuate between quarters. We do not believe that comparisonsof our quarter-to-quarter performance are a good indication of futureperformance.

At December 31, 2005,we had $155.6 million in cash, cash equivalents and investments and as weadvance and broaden our drug development pipeline we will require significantadditional capital for product development and so we will continue toinvestigate additional avenues of financing. Our ability to obtain capital willbe affected by conditions in the global financial markets and in thepharmaceutical 

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industry.We expect that downturns in the market valuations of biotechnology companiesand of the equity markets more generally will restrict our ability to raiseadditional capital on attractive terms, while more favorable conditions inthose markets will present opportunities for us.

The difficulties facingthe pharmaceutical industry present for us both near-term challenges andsignificant longer-term opportunities. One of the main issues confronting bigpharmaceutical companies is their lack of promising new drugs to treat majorindications. As many leading brand-name drugs come off patent and face genericcompetition, developing successful new medicines will become critical forfilling the gap. In the short term, the financial pressures on pharmaceuticalcompanies may be reflected in their research and development spending, makingit more difficult for us to sign corporate alliances with significant up-frontfunding, or lengthening the time required to negotiate such deals. We believethat in the medium to longer term, however, companies such as ours may be wellpositioned to play an important role in filling the gap in the pipeline of newdrugs, either alone or as partners of pharmaceutical companies. Ourpartnerships demonstrate that the industry is already investing in thedevelopment of new therapeutics based on our approach.

**Researchand Development Programs**

Thefollowing is a summary of the development of our drug candidates in latepre-clinical or clinical development. Because of uncertainties involved in thedrug development process, the actual timing for the events described below maydiffer materially from that provided in this summary.

·       Ourmost advanced developmental compound is DG031 for the prevention of heart attack.In 2005, we concluded the Phase II clinical trials for DG031. We have submittedthe safety summary and results of the Phase II trials to the FDA and haveconducted an end of Phase II meeting with the FDA. We are working with the FDAunder a Special Protocol Assessment to finalize the protocol for a Phase IIIoutcome trial for DG031 which will focus on African Americans with the HapKvariant in the LTA4H gene. The initiation of the DG031 Phase III trial may beaffected by timelines for manufacturing, packaging, labeling and shipping ofclinical supplies, negotiating with CROs for clinical trial performance, andthe approval process for the study protocol by local Institutional ReviewBoards (IRB) and/or the FDA. We expect to begin enrolling patients for thePhase III trial in the first half of 2006.

·       DG041is our lead compound for the treatment of atherosclerosis of the extremities,or peripheral artery disease (PAD). DG041 is a first-in-class small moleculeinhibitor of the EP3 receptor for prostaglandin E2, a G-protein coupledreceptor (GPCR) encoded by a gene we have shown to be associated with increasedrisk of developing the disease. Our IND application for DG041 was accepted bythe FDA in February 2005 and on this basis we began the Phase I programfor this compound. In fall 2005, ourchemistry group developed a new formulation which increased bioavailability bynearly four fold, and we concluded the Phase I program in early 2006. Nearly200 healthy subjects were exposed to DG041 in these studies at doses up to1600mg/day for seven days. The results of the Phase I program showed DG041 tobe well-tolerated, without any drug-related significant adverse events noted,and that DG041 can effectively inhibit platelet aggregation in a dose-dependentmanner without increasing bleeding time. We expect to begin a Phase II clinicaltrial in the first half of 2006.

·       Inasthma, we are conducting a Phase II trial on behalf of another company. Thiscompound inhibits MAP3K9, a kinase encoded by a gene we have linked to risk ofasthma. We expect to conclude this study in the second quarter of 2006.

·       Asa follow-on to DG031, we are developing an inhibitor of LTA4H, a compound whichis likewise aimed at preventing heart attack by decreasing the production ofLTB4. Our pre-clinical compound, DG051, appears to provide potent inhibition ofLTB4 production, is orally bioavailable, and with minimal potential fordrug-drug interaction. We anticipate filing an IND on DG051 in 2006.

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·       Utilizingcompounds discovered in our program on peripheral artery disease, our drugdiscovery group is bringing forward a lead pre-clinical candidate, DG061, forthe treatment of pain. Pre-clinical studies of DG061 demonstrate that it isefficacious in a mouse model for pain. Moreover, by targeting the EP3 receptorfor prostaglandins E2, it may be possible to avert the risk of cardiovascularevents and gastric ulceration that accompany the long-term use of selective Cox-2inhibitors and other NSAIDs. deCODE expects to file an IND on DG061 in 2006.

·       Weare pursuing a PDE4 inhibitor program for vascular disease/stroke pursuant toour 2004 agreement with Roche and working on identifying and advancing a leadpre-clinical compound.

We use many of ouremployee and infrastructure resources across several programs, and many of ourresearch and development costs are indirectly attributable to an individuallynamed program or are directed broadly to applicable research programs. However,taking into account costs that are specifically attributable to individualprograms and allocations of our research and development program costs basedupon those direct costs, we have cumulatively invested $12.6 million, $10.6million and $4.0 million and $6.0 million in our Myocardial Infarction(MI), PAD, stroke and asthma programs, respectively, from the beginning of 2003to date. Inception to-date costs are not available as these costs were nothistorically tracked by program.

We have not applied for orreceived marketing approval from the applicable regulatory authorities in anycountry for any of our drug candidates. In order for us to achieve marketingapproval in the United States, the FDA must conclude that our clinical dataestablish the safety and efficacy of our drug candidate. Other countries havesimilar requirements. Historically, the results from pre-clinical testing andearly clinical trials (through Phase II) have often not been predictive ofsuccess in later clinical trials. Many new compounds have shown promisingresults in early clinical trials, but subsequently failed to establishsufficient safety and efficacy data to obtain necessary marketing approvals.Additional risks and uncertainties involved in the development andcommercialization of any products are described above under the caption “RiskFactors”. We expect that it will be several years, if ever, before we receiverevenues from the commercial sale of our therapeutic products.

Furthermore, our strategyincludes the option of entering into collaborative arrangements with thirdparties to participate in the development and commercialization of ourproducts. Entering into a collaboration with a partner at any point in thedevelopment or commercialization of a product is a business decision. Whenmaking this decision we do and will consider, among other matters, thecomplexity of the indication, the size, complexity and expense of necessarydevelopment and/or commercialization efforts, competition in the market andsize of the applicable market, an assessment of our own resources—financial andoperational, and an assessment of the resources of a potential partner. In theevent that we do collaborate on any of the above programs in the future, apartner will have a level of control, which may be significant, over thepre-clinical development or clinical trial process for a product. As a resultthe completion date of such a partnered program could largely be under controlof that third party rather than under our control. We cannot forecast with anydegree of certainty which proprietary drug candidate will be subject to futurecollaborative arrangements or how such arrangements would affect ourdevelopment plan or capital requirements.

As a result of theuncertainties discussed above, we are unable to determine the duration andcompletion costs of our research and development projects or when and to whatextent we will receive cash inflows from the commercialization and sale of aproduct.

**Acquisitionsand in-licensing**

As part of our businessstrategy, we continue to consider joint development programs and merger andacquisition opportunities that may provide us with products in late-stagedevelopment, intellectual property or financial resources, or with capabilitiesthat will help accelerate our downstream drug discovery efforts.

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In January 2006, weacquired all of the outstanding shares of Urdur Verdandi Skuld ehf. (“UVS”), aprivately-held cancer research firm, from Iceland Genomics Corporation, Inc.(“IGC”), both companies having their principal offices in Reykjavik, Iceland.As consideration for the purchase, we issued 635,006 shares of deCODE commonstock valued at $6,082,000 to IGC. This acquisition will allow us to broadenour cancer program by applying our gene discovery and drug development effortsto a larger population.

In certain programs wehave taken advantage of the fact that drug targets we have identified throughour genetics research have already been employed by other companies to makedevelopmental compounds for other indications. By licensing these compounds orentering into co-development arrangements we have been able to leapfrog overseveral years of drug discovery, entering directly into Phase II clinicaltrials. We are currently preparing a Phase III clinical trial for DG031, ourlead developmental compound for the prevention of heart attack, which welicensed from Bayer HealthCare AG. We are also conducting a Phase II trial inasthma on behalf of a third party. We continue to investigate additional suchpossibilities for the in-licensing or co-development of promising existingcompounds that may effectively act against targets we have identified throughour gene discovery work.

**CriticalAccounting Policies**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America (GAAP) requires us to make certainestimates and assumptions that affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities at the date ofthe financial statements, and the reported amounts of revenues and expensesduring the reported period. On an ongoing basis we evaluate our estimates,which include, among others, those related to revenue recognition, property andequipment, goodwill and intangible assets, materials and supplies, derivativefinancial instruments, income taxes, litigation and other contingencies. Webase our estimates on historical experience and on various other assumptionsthat we believe to be reasonable under the circumstances, the results of whichform our basis for making judgments about carrying values of assets andliabilities that are not readily apparent from other sources. The impact andany associated risks related to these and our other accounting policies on ourbusiness or operations is discussed throughout “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” where such policiesaffect our reported and expected financial results. For a detailed discussionon the application of these and other accounting policies, please refer to ournotes to the Consolidated Financial Statements. There can be no assurance thatactual results will not differ from the estimates referred to above.

We believe the followingpolicies to be the most critical to an understanding of our financial conditionand results of operations because they require us to make estimates,assumptions and judgments about matters that are inherently uncertain.

***Collaborations andRevenue***

Our collaborativearrangements and the recognition of revenue in such arrangements is theaccounting policy most critical to us. A substantial portion of our revenuesrelate to funded research collaborations. Our revenues from research anddevelopment collaboration agreements are recorded and recognized in accordancewith the applicable performance requirements and terms of the respectivecontracts, generally either (i) as contract research costs are incurred,usually ratably over the period of effort, (ii) according to the level ofefforts expended based on the ratio of contract research costs incurred to expectedtotal costs, or (iii) upon the achievement of substantive milestones. Ouraccounting recognition policies with respect to each significant element of ourrevenue is summarized as follows:

*Research funding and otherservice fees.*   Research funding is recognized asearned, typically ratably over the period of effort. Funding payments are notrefundable in the event that the related efforts are not successful. Otherservice revenues from negotiated rate contracts are recognized based upon theterms of the underlying contract generally either (i) on a per diem basisas services are rendered; (ii) on the basis of efforts expended, generallyupon the ratio of costs incurred to total expected costs of providing theservice; 

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or (iii) uponcompletion of the service rendered. Any losses on contracts are provided forwhen they are determinable. Included in revenue are billings to customers forthe cost of materials purchased by deCODE.

*Milestone payments.*   Inarrangements with multiple elements entered into before June 15, 2003where (i) the milestone event is substantive, (ii) there issubstantial effort involved in achieving the milestone, (iii) themilestone payment amount is commensurate with the magnitude of the relatedachievement, and (iv) the associated follow-on revenue streams bear areasonable relationship to one another, we recognize revenue using thesubstantive milestone method. Under the substantive milestone method, deCODErecords revenue when the milestone has been achieved and payment is due and payableunder the terms of the respective agreement and we recognize revenue whenacknowledgement of achievement of applicable performance requirements isreceived from the collaborator. Milestone payments without the abovecharacteristics are recognized on a retrospective basis over the contractualterm of the underlying agreement. In arrangements with multiple elementsentered into after June 15, 2003, if the milestone is substantive innature and there is uncertainty in the achievement of the milestone and thereis no further obligation on our part, we record revenue when the milestone hasbeen achieved and payment is due and payable under the terms of the respectiveagreement and we recognize revenue when acknowledgement of achievement ofapplicable performance requirements is received from the collaborator (“MilestonePayment Method”). If the milestone is earned and we have no further obligationunder the contract for performance, then we will record revenue when themilestone has been achieved and payment is due and payable under the terms ofthe respective agreement and we retroactively recognize revenue through thecurrent period based on the total contractual term and amortize the balanceover the remaining contractual term.

*Up-front, exclusivity,technology access, and technology development fees.*   Werecognize revenue from non-refundable fees not specifically tied to a separateearnings process ratably over the expected customer relationship period orestimated period of performance. Changes in estimates could impact revenue inthe period the estimate is changed. If our estimate of the period ofperformance shortens or lengthens, the amount of revenue we recognize from suchnon-refundable fees not specifically tied to a separate earnings process couldincrease or decrease in the period the change in estimate becomes known; futurerelated revenues would be adjusted accordingly.

Revenue estimates arereviewed and revised throughout the lives of our contracts and are made basedupon current facts and circumstances. If changes in these estimates or othermaterial adjustments to revenue are identified, the adjustments to profitsresulting from such revisions will be recorded on a cumulative basis in theperiod in which the revisions are made.

***Long-Lived Assets,Goodwill and Intangibles***

We periodically reviewproperty and equipment, goodwill and intangibles for potential impairments andto assess whether their service lives have been affected by continuedtechnological change and development. There were no events in 2005, 2004 and2003 that triggered an impairment review nor did our annual review indicate anyrecoverability issues. Should we determine that there has been an impairment ofour fixed assets, goodwill or other intangible assets in the future we wouldsuffer an increase to our net loss or a reduction of our net income in theperiod such a determination is made. In light of experience and the currenttechnological environment, in 2004 we changed certain of our salvage value anduseful life estimates for equipment and furniture and fixtures for purposes ofdepreciation. These changes in estimates had the effect of increasingdepreciation expense in 2004 by $2.2 million as compared to 2003. Shouldwe determine that the pace of technological change or other matters dictatethat we change the service lives or other estimates inherent in determining thecarrying-values of our long-lived assets, there will be an impact ondepreciation expense from the date of the change.

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***Materials andSupplies***

We value our materials andsupplies at the lower of cost or market, cost being determined on the first-in,first-out method. We apply judgment in determining necessary provisions forslow moving, excess and obsolete materials and supplies based on historicalexperience and anticipated usage, giving effect to general market conditions.Any rapid technological changes or future business developments could result inan increase in the amount of obsolete materials and supplies on hand.Furthermore, if our estimates of our needs for materials and supplies prove tobe inaccurate, additional provision may be required for incremental excess andobsolete items. We recorded charges for write-down of obsolete and excessmaterials and supplies of $0.1 million, $0.1 million and $0.8 millionfor the years ended December 31, 2005, 2004 and 2003, respectively. In2005, 2004 and 2003, we used materials and supplies for which we had madeprovisions for in prior years as slow-moving, excess and obsolete, benefitingotherwise reported operating expenses by $0.8 million, $1.4 million and $0.8 million,respectively.

***Foreign ExchangeTransactions***

Our functional currency isthe U.S. dollar. However, in light of the significance of our operationsoutside the United States, an important element of our cost base is or will bedenominated in Icelandic krona, including much of our payroll and otheroperating expenses and some of our long-term borrowings. As a consequence ofthe nature our business and operations, our reported financial results and cashflows are exposed to the risks associated with fluctuations in the exchangerates of the U.S. dollar, the Icelandic krona and other world currencies. Tomanage our exposure to fluctuations in exchange rates, we have entered into,and will likely continue to enter into derivative instruments to hedge our exposureto such fluctuations. The net impact of foreign exchange on the translatedamount of our non-US dollar denominated liabilities, net together withtransaction gains and losses, amounted to losses of $0.1 million for theyear-ended December 31, 2005. Although the significant weakening of theU.S. dollar vis-à-vis the Icelandic krona during 2003 and 2004 somewhat abatedduring 2005, currency fluctuations may continue to adversely affect ourfinancial results.

***Income Taxes***

Significant estimates arerequired in determining our provision for income taxes, includinginterpretations of existing tax laws and regulations. Various internal andexternal factors may have favorable or unfavorable effects on our futureeffective tax rate. These factors include, but are not limited to, changes intax laws, regulations and/or rates, changing interpretations of existing taxlaws or regulations, future research and development spending and future levelsof capital expenditures. The preparation of financial statements requires us toevaluate the positive and negative evidence bearing upon the realizability ofour deferred tax assets resulting from deductible operating losses and otheritems. Due primarily to our history of operating losses and the expectationthat such losses will continue into the foreseeable future, we have concludedthat, insufficient positive evidence exists to justify the recognition of ournet deferred tax assets in our balance sheet. Although there can be no assurancethat losses generated to date will be used to offset future taxable income, anadjustment to the valuation of our current net deferred tax assets in thefuture would increase income in the period that we made a determination thatsuch an adjustment was appropriate. Income tax in Iceland is payable inIcelandic krona. Consequently, the US dollar value of our net operating losscarryforwards and other deferred tax assets and liabilities is subject tofluctuations in exchange rates. Such fluctuations over time may increase orreduce the reported US dollar balance of our deferred tax assets andliabilities, and there would be a corresponding gain or loss reported in ourincome statement.

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***Litigation and Other Contingencies***

We consider litigation andother claims and potential claims or contingencies in preparing our financialstatements under generally accepted accounting principles in the United Statesof America. We maintain accruals for litigation and other contingencies when webelieve a loss to be probable and reasonably estimated. In doing so, we assessthe likelihood of any adverse judgments or outcomes with respect to legal andother matters as well as potential of probable losses. We base our accruals oninformation available at the time of such determination. Changes ordevelopments in the relevant action or our strategy in such proceedings couldmaterially affect our results of operations for any particular quarterly orannual period. Since the recognition of a loss is dependent upon factors notcompletely in the control of management, timing of a charge, if any, isdifficult to predict with certainty.

***Recent Accounting Pronouncements***

In March 2005, the FASB issued FASB Interpretation(“FIN”) 47, “*Accounting for ConditionalAsset Retirement Obligations—an interpretation of FASB Statement No. 143”.*FIN 47 clarifies that conditional asset retirement obligations meet thedefinition of liabilities and should be recognized when incurred if their fairvalues can be reasonably estimated. We adopted the provisions of FIN 47effective December 31, 2005. The adoption of FIN 47 had no impact on ourresults of operations or financial position.

In May 2005, the FASBissued SFAS No. 154, “*AccountingChanges and Error**Correction*” (“SFASNo. 154”*)*, a replacement ofAPB Opinion No. 20 and Statement No. 3. SFAS No. 154 changes therequirements for the accounting and reporting of a change in accountingprinciples. SFAS No. 154 applies to all voluntary changes in accountingprinciples as well as to changes required by an accounting pronouncement thatdoes not include specific transition provisions. SFAS No. 154 is effectivefor accounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005.

**Resultsof Operations from the Years Ended December 31, 2005, 2004 and 2003**

Our results of operations have fluctuated from periodto period and may continue to fluctuate in the future based upon, among otherthings, the pace and progress of our proprietary research and clinicaldevelopment efforts, the timing and composition of funding under our variouscollaborative agreements, and the progress of our own research and developmentefforts. Results of operations for any period may be unrelated to results ofoperations for any other period. In addition, historical results should not beviewed as indicative of future operating results. We are subject to riskscommon to companies in our industry and at our stage of development, includingrisks inherent in our research and development efforts, reliance uponcollaborative partners, development by us or our competitors of newtechnological innovations, ability to market products or services, dependenceon key personnel, dependence on key suppliers, protection of proprietarytechnology, ability to obtain additional financing, ability to negotiatecollaborative arrangements, and compliance with governmental and otherregulations. In order for a product to be commercialized based on our research,we and our collaborators must conduct pre-clinical tests and clinical trials,demonstrate the efficacy and safety of our product candidates, obtainregulatory approvals or clearances and enter into manufacturing, distributionand marketing arrangements, as well as obtain market acceptance. We do notexpect to receive revenues or royalties based on therapeutic or diagnosticproducts for a period of years, if at all.

Financialhighlights as of and for the year ended December 31, 2005 include:

·       AtDecember 31, 2005, we had $155.6 million in cash, cash equivalents andinvestments compared to $198.3 million (including restricted cash) at December 31,2004. The net utilization of $42.7 million in 2005 reflects costs associatedwith the advancement of our drug development programs as reflected in the $54.0million cash used in operations, together with the net proceeds from the sale 

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and leaseback of ourSturlugata and Krokhals facilities in Reykjavik, Iceland ($22.0 million) andalso the refinancing of the mortgage on our Woodridge, IL facility.

·       Researchand development expense for proprietary programs was $43.7 million in 2005 ascompared to $24.9 million in 2004 and $17.6 million in 2003. The increase inour research and development expenses for proprietary programs is the resultprincipally of costs associated with the advancement of our lead drugdevelopment programs in clinical trials.

·       InMarch 2005, we entered into a financing for the sale and leaseback of ourheadquarters facility at Sturlugata 8, Reykjavik, Iceland. The sale price forthe property was 3.4 billion Icelandic kronas ($54.8 million after taking intoaccount a forward foreign exchange contract we entered into in connection withthe sale of the property). As a result of the sale, we have removed theremaining net book value of the property ($29.3 million) from our balancesheet, deferred the resulting gain and have begun recognizing the gain toearnings over the 15 year term of the leaseback. A portion of the proceeds fromthe sale of Sturlugata 8 went to prepay approximately $38.6 million of shortand long-term debt that was secured by mortgages on the property and, in thisconnection, we have recorded a loss on early extinguishment debt amounting to$3.1 million. We have leased the property back under a 15 year non-cancelablelease agreement at a rent of 21.4 million Icelandic kronas (approximately $0.3million as of December 31, 2005) per month, subject to changes based onthe Icelandic consumer price index. We are accounting for the leaseback as anoperating lease.

·       InJune 2005, we entered into a financing for the sale and leaseback of ourfacility at Krokhals 5D and 5E, Reykjavik, Iceland. The sale price for theproperty was 502 million Icelandic kronas (approximately $7.6 million aftertaking into account a sales commission). As a result of the sale, the remainingnet book value of the property ($4.0 million) has been removed from the balancesheet, and we have begun recognizing the deferred gain to earnings over the 15year term of the leaseback. A portion of the proceeds from the sale ofKrokhals were used to prepay approximately $1.8 million of long-term debt thatwas secured by a mortgage on the property. deCODE has leased the Krokhals 5Dand 5E property back under a 15 year non-cancelable lease agreement at a rentof 4.1 million Icelandic krona (approximately $0.06 million as of December 31,2005) per month, subject to changes based on the Icelandic consumer priceindex.

·       Our revenue in 2005 was$44.0 million as compared to $42.1million in 2004 and $46.8 million in 2003. Revenuefor the periods presented generally reflects our strategic focus on drugdiscovery and development. Specifically, the increase in revenue in 2005 ascompared to 2004 is mainly due to grant monies earned, service contract feesand the addition of the Roche alliance to co-develop inhibitors of PDE4, offsetby the completion of research funding under the 2002 agreement with Roche andthe Merck obesity research program.

***Revenue***

Our business strategy is focused on turning ourdiscoveries into new drugs for the treatment of common diseases. At the sametime, we leverage our capabilities to generate revenue through corporatealliances and through service contracts. In the majority of our programs we arepursuing drug development on our own. In certain others, we have formedalliances with pharmaceutical and biotechnology firms through which we can coversome of the cost of conducting basic research and spread the risk andinvestment involved in product development. We have entered into research,development, commercialization, and fee for service alliances and contractsacross our business. Depending on the nature of each prospective businessopportunity, the key components of the commercial terms of such arrangementstypically include one or more of the following: research funding; up-front,exclusivity, technology access, and technology development fees; fees forparticular services; milestone payments; license or commercialization fees; androyalties or profit sharing from the commercialization of products.

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Significantelements of our revenue is summarized as follows:

| ** **                                                                 | ** ** | **For the Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2005**                                                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                 | ** ** | **(In thousands)**                                      | ** ** |
| Research funding  and service fees                                         |       | $                                                            | 29,111     |   | $ | 31,723 |   | $ | 34,712 |   |
| Milestone  payments                                                        |       | 1,216                                                        |       | 1,835 |   | 5,794 |   |
| Up-front,  exclusivity, technology access, and technology development fees |       | 4,538                                                        |       | 4,116 |   | 4,000 |   |
| Grant funding                                                              |       | 7,287                                                        |       | 2,032 |   | 1,006 |   |
| Other                                                                      |       | 1,803                                                        |       | 2,421 |   | 1,299 |   |
|                                                                       |       | $                                                            | 43,955     |   | $ | 42,127 |   | $ | 46,811 |   |

 

Collaborations with ourmost significant partners include:

*F. Hoffmann-LaRoche (Roche)*

*Therapeutics.*   In2002, we entered into an agreement with Roche to collaborate on four diseasesthat had been the subject of an earlier collaboration with Roche. During 2004and through January 2005, we collaborated with Roche on two of thosediseases. Under this agreement we discovered genes linked to diabetes and Rochecontinues drug discovery based on one of these discoveries. Under the 2002agreement, which expired on February 1, 2005, we received $20.0 million inresearch funding and we are entitled to receive royalties on the sales of anydrugs that are developed coming out of work conducted under this agreement.

In November 2004, we signed a new three-yearagreement with Roche to co-develop inhibitors of PDE4 for the prevention andtreatment of vascular disease, including stroke. This agreement continues workadvanced under the 2002 agreement, and we will focus on optimizing leadcompounds identified under the previous agreement and beginning clinicaldevelopment. Under this agreement, as of the end of 2005, we received $2.0million of research funding. We will share drug discovery and clinical trialscosts under this new agreement, and we may receive an additional $4.0 millionof research funding over the remaining term of the agreement as well asmilestone payments and royalties based on drug sales.

*Diagnostics.**  *In June 2001, deCODE signed afive-year alliance with Roche’s diagnostics division to develop and marketDNA-based diagnostics for major diseases. More recently deCODE has addedresearch programs aimed at developing diagnostics to predict drug response formajor therapeutics used to treat those diseases, in order to help select themost effective treatment of those available. Under the agreement deCODEhas received $41.1 million in research funding, up-front fees and milestonepayments. deCODE may receive $3.1 million in additional research funding overthe remainder of the term of the agreement as well as milestone payments uponthe achievement of research and development milestones and royalties on the salesof diagnostic products developed.

Revenues from thesealliances with Roche amounted to $10.0 million, $12.6 million and $19.9 millionfor the years ended December 31, 2005, 2004 and 2003, respectively. Costsincurred with these collaborative programs with Roche amounted to $8.3 million,$19.5 million and $19.6 million for the years ended December 31, 2005,2004 and 2003, respectively.

*Merck & Co, Inc.(Merck)*

*Obesity.**  *In September 2002, we enteredinto a three year alliance with Merck aimed at developing new treatments forobesity. Under the alliance, we combined research efforts with Merck in thegenetics of obesity to identify, validate and prioritize a series of drugtargets to take into development. During the three-year research program, whichhas now expired, we have received research funding, technology access fees andmilestone payments in the aggregate amount of $25.3 million. In addition, wemay receive further 

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technology access fees inthe total aggregate amount of $2.0 million. Subject to Merck’s developingproducts based on collaboration discoveries, we may also receive developmentmilestones and royalties. We have discovered three genes linked to obesity underthis alliance, and Merck has generated a lead series of compounds against oneof the targets we validated through our genetics research.

Revenues from this alliance with Merck amounted $6.3million, $7.9 million and $8.5 million for the years ended December 31,2005, 2004 and 2003, respectively. Costs incurred in connection with thisalliance with Merck amounted to $2.9 million, $4.6 million and $5.2 million forthe years ended December 31, 2005, 2004 and 2003, respectively.

*Information-RichClinical Trials.**  *InFebruary 2004, we entered into an agreement with Merck which provides thatdeCODE will conduct information-rich clinical trials on a range of Merck’sdevelopmental compounds that Merck selects for inclusion in the program. Theterm of the alliance is seven years, subject to termination by Merck after fiveyears. The collaboration involved three agreements: (a) a License andResearch Collaboration Agreement; (b) a Stock and Warrant PurchaseAgreement; and (c) a Warrant Agreement. Under the terms of the License andResearch Collaboration Agreement, we will receive royalties on sales of drugsand diagnostics developed as part of the alliance, will receive milestonepayments as compounds or pharmacogenomic tests reach the market, will receiveresearch funding for the clinical development of compounds and pharmacogenomicanalysis, and received a one-time technology access fee of $10.0 million. Acontingency clause on the technology access fee provides that if deCODE rejectsthe first two non-exclusive development compounds that Merck presents to thecollaboration, then Merck has the right to request a refund of $2,500,000 ofthe technology access fee. The remaining amount of the technology access fee isnon-refundable. To date, Merck has not selected any compounds for developmentunder the agreement.

The warrant was valued at $6,300,000 using a BlackScholes model with the following assumptions: lives of one to five years, riskfree interest rates of 1.24% to 3.07%, volatility of 90% and no dividend yield.The one-time technology access fee of $10,000,000 and the $2,700,000 premiumreceived on the sale of common stock less the estimated fair value of thewarrant of $6,300,000, together netting to $6,400,000, has been recorded asdeferred revenue. This amount less the refundable amount of $2,500,000($3,900,000) is being recognized as revenue according to level of efforts overthe seven-year development term. The refundable $2,500,000 technology accessfee will be recognized as revenue according to level of efforts retrospectivelyover the seven-year development term commencing upon satisfaction of the. Todate, Merck has not selected any compounds for development under the agreementthat has advanced to patients.

Revenues from thisalliance with Merck amounted to $0.2 million and $0.8 million for the yearsended December 31, 2005 and 2004, respectively. Costs incurred inconnection with this alliance with Merck amounted to $0.1 million and $1.3million for the years ended December 31, 2005 and 2004, respectively.

*Grant Funding*

We have received various research grants fromdivisions of the United States National Institutes of Health (NIH), theCommission of the European Communities (EC) and private foundations. Researchgrants for multiple years are based on approved budgets with budgeted amountssubject to approval on an annual basis. NIH grants generally provide for 100%reimbursement of allowable expenditures while the grant under the EC generallyprovides for fifty percent reimbursement of allowable research and developmentrelated expenditures. Our significant research contracts include:

*NationalInstitute of Allergy and Infectious Diseases (NIAID).**  *In September 2004, deCODE wasawarded a five-year $23,900,000 contract by the NIAID, a division of NIH. Underthe contract, deCODE will apply its population approach and resources todiscover genetic factors associated with susceptibility to 

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certain infectiousdiseases and with responsiveness to vaccines targeting such diseases. deCODEmay receive $18.4 million in additional research funding over the remainingterm of the agreement.

For the years ended December 31, 2005, 2004 and2003, we recognized revenue of $7.3 million, $2.0 million and $1.0 million fromresearch grants. Costs incurred with research grants amounted to $7.7 million,$2.0 million and $1.0 million for the years ended December 31, 2005, 2004and 2003, respectively.

Revenuefor the years ended December 31, 2005, 2004 and 2003 are as follows:

| ** ** | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | **2005 as Compared  to 2004** | ** ** | **2004 as Compared  to 2003** | ** ** |
|------------|------------|---------------------------------------|------------|------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** ** | ** ** | **2005**                              | ** ** | **2004**   | ** ** | **2003**   | ** ** | **$ Change**                            | ** ** | **% Change**                            | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** ** | ** ** | **(In thousands, except%)** | ** ** |
| Revenue    |       | $                                     | 43,955     |       | $          | 42,127     |       | $                                            | 46,811     |                                         |       | $ | 1,828 |   |   |   | 4 | % |   |   | $ | (4,684 | ) |   |   | (10 | )% |   |
|            |            |                                       |            |            |            |            |            |                                              |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Revenue for the periodspresented generally reflects our strategic focus on drug discovery anddevelopment. Specifically the increase in revenue in 2005 as compared to 2004is mainly due to grant monies earned, service contract fees and the addition ofthe Roche alliance to co-develop inhibitors of PDE4, offset by the completionof research funding under the 2002 agreement with Roche and the Merck obesityresearch program. Revenue decrease as compared to the 2003 period is reflectiveof the transition of our business from the generation of near-term revenuethrough service partnerships and other means to a greater focus on thedevelopment of new drugs in major indications. At December 31, 2005 we had$12.3 million in deferred revenue, compared to $15.9 million at theclose of the 2004. We expect that our revenues will fluctuate from period toperiod and that such fluctuations may be substantial especially becauseprogress in our scientific work, including milestone payments that are relatedto progress, can fluctuate between periods.

***Cost of Revenue, including Collaborative Programs***

Costof revenue, including costs incurred in connection with collaborative programsfor the years ended December 31, 2005, 2004 and 2003 are as follows:

| ** **                                         | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | **2005 as Compared  to 2004** | ** ** | **2004 as Compared  to 2003** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                         | ** ** | **2005**                              | ** ** | **2004**   | ** ** | **2003**   | ** ** | **$ Change**                            | ** ** | **% Change**                            | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                         | ** ** | **(In thousands, except%)** | ** ** |
| Cost of Revenue,  Including Collaborative Programs |       | $                                     | 37,263     |       | $          | 43,407     |       | $                                            | 45,870     |                                         |       | $ | (6,144 | ) |   |   | (14 | )% |   |   | $ | (2,463 | ) |   |   | (5 | )% |   |
|                                                    |            |                                       |            |            |            |            |            |                                              |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Our cost of revenue consists of the costs of servicesprovided to customers, collaborators and under grants, including the entiretyof the costs incurred in connection with programs that have been partnered andon which we receive research funding. At times, we invested in addition tocosts covered by research funding received in such collaborative programs. Thedecrease in our cost of revenue, including costs incurred in connection withcollaborative programs over the periods presented, in general reflects arelative lessening of our investment in programs on which we receive researchfunding.

Our cost of revenue, including costs incurred inconnection with collaborative programs in 2005 as compared to 2004 includes (i) anoverall decrease in direct salary and employee related expenses ($0.9 million),(ii) less in chemicals and consumables ($1.3 million), which drives (iii) lowerallocation of overheads ($0.4 million) and depreciation and amortization ($4.4million) and also an increase in contractor services ($0.9 million). The lowerdepreciation and amortization is also due to the sale-leaseback of ourfacilities in Iceland during 2005 which reduced our depreciation expense.

Our cost of revenue, including costs incurred inconnection with collaborative programs in 2004 as compared to 2003 includes (i) anoverall decrease in direct salary and employee related expenses 

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($2.0 million) whichdrives a (ii) lower allocation of overheads, depreciation and amortization($1.7 million), together with (iii) a relative net benefit of$0.5 million resulting from chemicals and consumables we used for whichthere was relatively little or no attendant cost as a result of priorprovisions we had made as slow moving, excess or obsolete according to our accountingpolicy, (iv) increases in outside contractor services ($1.6 million),and (v) more in chemicals and consumables ($0.6 million).

Although the strengtheningof the Icelandic krona versus the U.S. dollar has somewhat abated during 2005,the relative strengthening of the Icelandic krona versus the U.S. dollar in2004 and 2003 has appreciably affected the U.S. dollar reported amounts of ourexpenses denominated in Icelandic krona (e.g., a portion of our salary andemployee related expenses included in cost of revenue) and may continue to doso.

***Research and Development—Proprietary Programs***

Researchand development for proprietary programs for the years ended December 31,2005, 2004 and 2003 is as follows:

| ** **                                          | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | **2005 as Compared  to 2004** | ** ** | **2004 as Compared  to 2003** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------|------------|------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                              | ** ** | **2004**   | ** ** | **2003**   | ** ** | **$ Change**                            | ** ** | **% Change**                            | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                          | ** ** | **(In thousands, except%)** | ** ** |
| Research and  Development—Proprietary Programs |       | $                                     | 43,748     |       | $          | 24,942     |       | $                                            | 17,596     |                                         | $          | 18,806 |   |   | 75 | % |   |   | $ | 7,346 |   |   |   | 42 | % |   |
|                                                     |            |                                       |            |            |            |            |            |                                              |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in our research and development expensesin proprietary programs results from our emphasis on and increasingexpenditures in product development, including pre-clinical and clinical workon our lead drug discovery and development programs. Importantly, in 2005 weconcluded a Phase II trial for DG031, our lead developmental compound for theprevention of heart attack and are currently preparing a Phase III clinical forthis compound. In 2005, we also funded and implemented a Phase I trials forDG041, our developmental compound in Peripheral Artery Disease and co-funded aPhase II trial in asthma for a compound developed by another company; a portionof the costs of this trial are included in our research and developmentexpenses for proprietary programs. Further, among other pre-clinical programswe are developing a compound to inhibit the LTA4 hydrolase, a protein encodedby a second gene within the same pathway targeted by DG031 that we have alsolinked to significantly increased risk of heart attack, and we have begun aPDE4 inhibitor program for vascular disease/stroke pursuant to our 2004agreement with Roche. In 2005, we also initiated a program to developinhibitors to the EP3 receptor for prostaglandins E2 for the management ofpain.

Ourresearch and development expenses for the years ended December 31, 2005,2004 and 2003 consist of the following:

| ** **                                       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Salaries and  other personnel costs              |       | $        | 18,072     |     | $          | 10,233   |       | $ | 8,375 |   |
| Materials and  supplies                          |       | 4,600    |       | 3,671    |       | 2,650    |       |
| Contractor  services and other third party costs |       | 13,285   |       | 3,938    |       | 3,669    |       |
| Overhead expenses                                |       | 4,630    |       | 1,603    |       | 1,773    |       |
| Depreciation and  amortization                   |       | 3,089    |       | 5,123    |       | 3,883    |       |
| Stock-based  compensation                        |       | 72       |       | 374      |       | 467      |       |
| Database license  fee reversal                   |       | —   |       | —   |       | (3,221   | )          |
|                                             |       | $        | 43,748     |     | $          | 24,942   |       | $ | 17,596 |   |

 

Increases in the research and development costs of ourproprietary programs (e.g., salaries and attendant costs, usage of chemicalsand consumables) will likely continue, particularly as we advance our 

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clinical development andproprietary drug development programs. Further, we have granted salaryincreases to our personnel and have added clinical development executives toour staff, which will contribute to future increases in our research anddevelopment costs for proprietary programs. The lower depreciation and amortizationis also due to the sale-leaseback of our facilities in Iceland during 2005which reduced our depreciation expense. Our rent increase will increase due tothe above transaction. This will be offset by the deferred gain on thesale-leaseback which is being amortized over the term of the lease.

Although the strengtheningof the Icelandic krona versus the U.S. dollar has somewhat abated during 2005,the relative strengthening of the Icelandic krona versus the U.S. dollar in2004 and 2003 has appreciably affected the U.S. dollar reported amounts of ourexpenses denominated in Icelandic krona (e.g., a portion of our salary andemployee related expenses included in cost of revenue) and may continue to doso.

***Selling, General and Administrative Expenses***

Selling,general and administrative expenses for the years ended December 31, 2005,2004 and 2003 are as follows:

| ** **                           | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | **2005 as Compared  to 2004** | ** ** | **2004 as Compared  to 2003** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                           | ** ** | **2005**                              | ** ** | **2004**   | ** ** | **2003**   | ** ** | **$ Change**                            | ** ** | **% Change**                            | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                           | ** ** | **(In thousands, except%)** | ** ** |
| Selling, General  and Administrative |       | $                                     | 20,118     |       | $          | 20,187     |       | $                                            | 17,178     |                                         |       | $ | (69 | ) |   |   | - | % |   |   | $ | 3,009 |   |   |   | 18 | % |   |
|                                      |            |                                       |            |            |            |            |            |                                              |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Our selling, general and administrative expenses for2005 compared to 2004 are essentially unchanged. Salaries and employee relatedcosts did increase ($0.9 million) and legal expenses increased with activityaround our intellectual property and patent applications ($0.2 million), butthen outside contractor service costs have decreased with efficiencies gainedin this second year of implementation of the provisions of the Sarbanes OxleyAct of 2002 ($0.3 million). There is also a relative decrease in our selling,general and administrative expenses for the year ended December 31, 2005as compared to the 2004 due to severance costs ($0.3 million) and an accrualfor probable losses related to grant monies received in pre-acquisition periodsof MediChem ($0.4 million) recorded in 2004.

Our selling, general and administrative expenses for2004 increased compared to 2003, notably including (i) increased salariesand employee related costs ($0.7 million), (ii) employee incentives($1.4 million), (iii) severance costs ($0.6 million), (iv) greatertravel and overhead expenses ($0.7 million), (v) recruiting fees relatedto the addition of new members to our Board of Directors and also our effortsto hire necessary clinical development and regulatory staff($0.4 million), (vi) an accrual for probable losses related to grantmonies received in pre-acquisition periods of MediChem ($0.4 million),offset by lower stock-based compensation ($1.1 million). We alsogrant annual salary increases to our personnel and are making efforts torecruit new members to our Board of Directors—which will increase our selling,general and administrative expenses.

Although the strengtheningof the Icelandic krona versus the U.S. dollar has somewhat abated during 2005,the relative strengthening of the Icelandic krona versus the U.S. dollar in2004 and 2003 has appreciably affected the U.S. dollar reported amounts of ourexpenses denominated in Icelandic krona (e.g., a portion of our salary andemployee related expenses included in cost of revenue) and may continue to doso.

***Stock-Based Compensation***

For purposes of our consolidated statements ofoperations, we have allocated stock-based compensation to expense categoriesbased on the nature of the service provided by the recipients of the 

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stock option andrestricted stock grants. We value the stock options we grant to non-employeesusing the Black-Scholes option-pricing model.

Stock-basedcompensation expense for the years ended December 31, 2005, 2004 and 2003is as follows:

| ** **                                         | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | **2005 as Compared  to 2004** | ** ** | **2004 as Compared  to 2003** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                         | ** ** | **2005**                              | ** ** | **2004**   | ** ** | **2003**   | ** ** | **$ Change**                            | ** ** | **% Change**                            | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                         | ** ** | **(In thousands, except%)** | ** ** |
| Cost of revenue,  including collaborative programs |       | $                                     | —     |       | $          | 362        |       | $                                            | 861        |                                         |       | $ | (362 | ) |   |   | (100 | )% |   |   | $ | (499 | ) |   |   | (58 | )% |   |
| Research and  development expense                  |       | 72                                    |       | 374        |       | 467        |       |                                         | (302       | )                                            |       |   | (81 | )% |   |   | (93 | ) |   |   | (20 | )% |   |
| Selling, general  and administrative expense  |       | 369                                   |       | 435        |       | 1,112      |       |                                         | (66        | )                                            |       |   | (15 | )% |   |   | (677 | ) |   |   | (61 | )% |   |
| Total stock based compensation                     |       | $                                     | 441        |       | $          | 1,171      |       | $                                            | 2,440      |                                         |       | $ | (730 | ) |   |   | (62 | )% |   |   | $ | (1,269 | ) |   |   | (52 | )% |   |

 

With little compensation expense being attributed toour more recent stock option grants, stock-based compensation expense hasbeen decreasing as grants made in earlier years become fully vested. Historicalstock-based compensation is not necessarily representative of the effectson reported income or loss for future years due to, among other things, thevesting period of the stock options, the value of stock options that have beengranted in recent times and the required change to the fair value method.

In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123(revised 2004), *“Share-Based Payment”* (“SFAS No. 123R”).This Statement replaces FASB Statement No. 123 and supersedes APB Opinion No. 25.SFAS No. 123R eliminates the ability to account for employee share-basedcompensation transactions using the intrinsic method used by deCODE. SFAS No. 123Rrequires such transactions be accounted for using a fair-value-based methodthat would result in expense being recognized in deCODE’s financial statements.In April 2005, the Securities and Exchange Commission (“SEC”) adopted a rule thatdefers the required effective date of SFAS No. 123R to fiscal yearsbeginning after June 15, 2005 (January 1, 2006 fordeCODE). Under SFAS No. 123R, companies must calculate andrecord in the income statement the cost of equity instruments, such as stockoptions or restricted stock, awarded to employees for services received; proforma disclosure is no longer permitted. The cost of the equity instruments isto be measured based on fair value of the instruments on the date they aregranted and is required to be recognized over the period during which theemployees are required to provide services in exchange for the equityinstruments.

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SFAS No. 123R provides two alternatives foradoption: (1) a “modified prospective” method in which compensation costis recognized for all awards granted subsequent to the effective date of thisstatement as well as for the unvested portion of awards outstanding as of theeffective date; or (2) a “modified retrospective” method which follows theapproach in the “modified prospective” method, but also permits entities torestate prior periods to record compensation cost calculated under SFAS No. 123for the pro forma disclosure. deCODE will adopt SFAS 123R using the modifiedprospective method. Prior to January 1, 2006, we accounted for stockoptions granted to employees and shares issued under our employee stockpurchase plan in accordance with the intrinsic value method permitted under APBOpinion No. 25 and therefore no compensation expense generally wasrecognized for these awards.

We expect to incur additional stock compensationexpense in our Consolidated Statement of Operations related to unvested stockoptions granted as of December 31, 2005 and future stock option grants aswe adopt the provisions of SFAS No. 123R effective January 1,2006. The impact of adopting SFAS No. 123R on periods after adoptioncannot be accurately estimated at this time, as it will depend on the marketvalue and the amount of share based awards granted in future periods. Becauseoptions vest over several years and because we expect to grant options infuture years, the pro forma results of applying the provisions of SFAS No. 123as presented in Note 2 to the Consolidated Financial Statements are notnecessarily representative of the pro forma results in future years.

At December 31, 2005,we had approximately $8.5 million of unamortized compensation expense, relatedto options granted prior to January 1, 2006, to be recognized through2009, based on the vesting terms of the option agreements and the date theoptions were granted. Of the $8.5 million of unamortized compensation expense,approximately $3.9 million of it will be recognized in the consolidatedstatements of operations in the year ended December 31, 2006. These amountdo not take into consideration any grants subsequent to December 31, 2005and also do not take into consideration any forfeiture rate discount as proscribedby SFAS No. 123R.

***Interest Income***

Interestincome for the years ended December 31, 2005, 2004 and 2003 is as follows:

| ** **      | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | **2005 as Compared  to 2004** | ** ** | **2004 as Compared  to 2003** | ** ** |
|-----------------|------------|---------------------------------------|------------|------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **      | ** ** | **2005**                              | ** ** | **2004**   | ** ** | **2003**   | ** ** | **$ Change**                            | ** ** | **% Change**                            | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **      | ** ** | **(In thousands, except%)** | ** ** |
| Interest Income |       | $                                     | 6,397      |       | $          | 2,903      |       | $                                            | 1,151      |                                         |       | $ | 3,494 |   |   |   | 120 | % |   |   | $ | 1,752 |   |   |   | 152 | % |   |
|                 |            |                                       |            |            |            |            |            |                                              |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Our interest income hasincreased with rising rates and increasing returns on a greater amount of cashand investments. We expect to use our cash and investments principally foradvancing our drug and clinical development programs. In the meantime, we willinvest the proceeds received in accordance with our policy, having theobjective of preserving principal while maximizing income we receive from ourinvestments without significantly increasing risk. We expect to maintain ourportfolio of cash equivalents and investments in a variety of securities,including auction rate securities, commercial paper, money market funds, mutualfund investments and government and non-government debt securities.

***Interest Expense***

Interestexpense for the years ended December 31, 2005, 2004 and 2003 is asfollows:

| ** **       | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | **2005 as Compared  to 2004** | ** ** | **2004 as Compared  to 2003** | ** ** |
|------------------|------------|---------------------------------------|------------|------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **       | ** ** | **2005**                              | ** ** | **2004**   | ** ** | **2003**   | ** ** | **$ Change**                            | ** ** | **% Change**                            | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **       | ** ** | **(In thousands, except%)** | ** ** |
| Interest Expense |       | $                                     | 7,484      |       | $          | 8,983      |       | $                                            | 3,478      |                                         |       | $ | (1,499 | ) |   |   | (17 | )% |   |   | $ | 5,505 |   |   |   | 158 | % |   |
|                  |            |                                       |            |            |            |            |            |                                              |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Our interest expense principally reflects interest onour 3.5% Senior Convertible Notes due 2011 that we issued in April 2004.

In March 2005, weprepaid $38.6 million of short and long-term debt that was secured by mortgageson Sturlugata 8. Also in March 2005, we refinanced the mortgage on ourWoodridge, IL facility, paying-down $4.0 million on the existing mortgage. Further,in June 2005, we prepaid $1.8 million of long-term debt that was securedby mortgages on Krokhals 5D and 5E. As a result of these prepayments andrefinancing, our future interest expense is expected to be approximately $5.6million on an annual basis.

***Other Non-Operating Income and Expense, Net***

Othernon-operating income and expense for the years ended December 31, 2005,2004 and 2003 is as follows:

| ** **                                   | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | **2005 as Compared  to 2004** | ** ** | **2004 as Compared  to 2003** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                              | ** ** | **2004**   | ** ** | **2003**   | ** ** | **$ Change**                            | ** ** | **% Change**                            | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                   | ** ** | **(In thousands, except%)** | ** ** |
| Other  Non-Operating Income And Expense, Net |       | $                                     | (4,489     | )          | $          | (4,766     | )          | $                                            | 1,988      |                                         |       | $ | 277 |   |   |   | 6 | % |   |   | $ | (6,754 | ) |   |   | (340 | )% |   |
|                                              |            |                                       |            |            |            |            |            |                                              |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Our other non-operating income and expense, netconsists principally of the net impact of foreign exchange, unrealized andrealized gains and losses on derivative financial instruments and, in 2005,loss on early extinguishment of debt and a realized loss on the sale ofinvestments.

As a consequence of the nature of our business andoperations, our reported financial results and cash flows are exposed to therisks associated with fluctuations in the exchange rates of the U.S. dollar,the Icelandic krona and other world currencies. The net impact of foreignexchange on the translated amount of our non-US dollar denominated liabilities,net together with transaction gains and losses, amounted to loss of $0.1million, $3.3 million and $0.1 million in 2005, 2004 and 2003, respectively.

Our losses on derivative financial instruments in 2005($0.2 million) resulted from three forward foreign currency exchange options weentered into as economic hedges against foreign exchange rate fluctuations onour ISK-denominated operating expenses but that did not qualify for hedgeaccounting.

Our losses on derivative financial instruments in 2004stem from the two cross-currency swaps we entered into as economic hedgesagainst foreign exchange rate fluctuations on our foreign currency debt butthat did not qualify for hedge accounting. In March 2004, we liquidatedour two cross-currency swaps receiving $9.7 million in proceeds. We realized aloss on this early termination that, together with unrealized losses on theswaps during the 2004, amounted to $1.5 million.

As a result of having prepaid the short and long-termdebts that were secured by mortgages on Sturlugata 8 we have recorded a loss onearly extinguishment debt during 2005 amounting to $3.1 million and consistingof (i) prepayment fees ($1.4 million), (ii) write-off of remainingunamortized finance costs ($1.4 million), and (iii) remaining unamortizeddiscount on the long-term debt ($0.3 million).

In December 2005, wesold investments and realized a loss on the sale of $1.0 million.

***Income Taxes***

As of December 31,2005, we had an accumulated deficit of $450.2 million and did not owe anyIcelandic or U.S. federal income taxes nor did we pay any in the years ended December 31,2005, 2004 or 2003. Realization of deferred tax assets is dependent on futureearnings, if any. As of December 31, 2005, we had net operating loss carryforwardsfor U.S. federal income tax purposes of approximately $45.7 million to offsetfuture taxable income in the United States that expire at various dates through2025. Also, 

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as of December 31,2005 our foreign subsidiaries had net operating loss carryforwards ofapproximately $239.7 million that expire in varying amounts beginning in 2006.

***Net Loss and Basic and Diluted Net Loss Per Share***

Netloss and basic and diluted net loss per share for the years ended December 31,2005, 2004 and 2003 are as follows:

| ** **                                 | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | **2005 as Compared  to 2004** | ** ** | **2004 as Compared  to 2003** | ** ** |
|--------------------------------------------|------------|---------------------------------------|------------|------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                              | ** ** | **2004**   | ** ** | **2003**   | ** ** | **$ Change**                            | ** ** | **% Change**                            | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                 | ** ** | **(In thousands, except%)** | ** ** |
| Net Loss                                   |       | $                                     | 62,750     |       | $          | 57,255     |       | $                                            | 35,123     |                                         |       | $ | 5,495 |   |   |   | 10 | % |   | $ | 22,132 |   |   | 63 | % |   |
| Basic and Diluted Net  Loss Per Share |       | $                                     | 1.17       |       | $          | 1.07       |       | $                                            | 0.68       |                                         |       | $ | 0.10 |   |   |   | 9 | % |   | $ | 0.39 |   |   | 57 | % |   |

 

Net loss and basic anddiluted net loss per share both increased in the years ended December 31,2005 and 2004, principally on account of higher research and developmentrelated to the advancement of our drug development programs, lower revenues,higher interest expense related to our convertible notes issued in April 2004and the impact, both realized and unrealized, of foreign exchange fluctuations.

**Liquidity and Capital Resources**

We have financed our operations primarily throughfunding from research and development collaborative agreements, and theissuance of equity securities and long-term financing instruments($828 million from the beginning of 1999 to-date). Future funding underterms of our existing agreements is approximately $50 million excludingmilestone payments, royalties and other payments that we may earn under suchcollaborations.

We make significant investments in proprietaryresearch and development and we incur the costs of such activities. In the nearterm, this requires us to devote resources to our in-house drug and clinicaldevelopment which we believe will better position us to capture the most valueto us in our discoveries. As we identify promising discoveries for furtherdevelopment, we may choose to continue the development ourselves into andthrough clinical trials, regulatory approvals, manufacturing, distribution andmarketing. In other cases we are or will be working to varying degrees withpartners. The decisions we make as to these matters will affect our cashrequirements.

Our cash requirements depend on numerous factors,including the level and timing of our research and development expenditures;our ability to access the capital markets; to obtain new research anddevelopment collaboration agreements; to obtain and maintain contract serviceagreements in our pharmaceuticals, biostructures, clinical research trials andgenotyping service groups; expenditures in connection with alliances, license agreementsand acquisitions of and investments in complementary technologies andbusinesses; competing technological and market developments; the cost offiling, prosecuting, defending and enforcing patent claims and otherintellectual property rights; the purchase of additional capital equipment; andcapital expenditures at our facilities. Changes in our research and developmentplans, notably the entry into clinical trials of drugs based on ourdiscoveries, or other changes affecting our operating expenses may result inchanges in the timing and amount of expenditures of our capital resources.

In December 2005, we filed a universal shelfregistration statement on Form S-3 with the Securities and ExchangeCommission (“SEC”) for the issuance and sale from time to time of debt andequity securities either individually or in units, in one or more offerings,with a total value of up to $100 million. As of December 31, 2005, we hadnot consummated any sales under this registration statement.

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At December 31, 2005, we had $155.6 million ofcash, cash equivalents and investments. As we advance and broaden our drugdevelopment pipeline we will require significant additional capital for productdevelopment and so we will continue to investigate additional avenues of financing,such as further public or private equity offerings, additional debt financing,other forms of financing or added collaborations and licensing arrangements.However, no assurance can be given that additional financing or collaborationsand licensing arrangements will be available when needed, or that if available,will be obtained on favorable terms. If adequate funds are not available whenneeded, we may have to curtail operations or attempt to raise funds onunattractive terms.

In January 2006,we acquired all of the outstanding shares of a Urdur Verdandi Skuld ehf. (“UVS”),a privately-held cancer research firm, from Iceland Genomics Corporation, Inc.(“IGC”), both companies having their principal offices in Reykjavik, Iceland.As consideration for the purchase, we issued 635,006 shares of deCODE commonstock valued at $6,082,000 to IGC. This acquisition will allow us to broadenour cancer program by applying our gene discovery and drug development effortsto a larger population. This acquisition will not have a material impact on ourcapital requirements in the future.

| ** **                                   | ** ** | **For the Year Ended December 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                   | ** ** | **(In thousands)**                                      | ** ** |
| **Cash provided by (used in):**              |       |                                                         |       |   |   |   |   |
| Operating  activities                        |       | $                                                            | (54,033    | ) | $ | (29,936 | ) | $ | (20,331 | ) |
| Investing activities                         |       | 95,832                                                       |       | (124,653 | ) | (792 | ) |
| Financing  activities                        |       | (46,094                                                      | )          | 156,158 |   | 2,548 |   |
| Cash and cash  equivalents, at end of period |       | 65,943                                                       |       | 70,238 |   | 68,669 |   |
|                                              |            |                                                              |            |  |  |  |  |  |  |  |

 

*Cashand Cash Equivalents.**  *AtDecember 31, 2005, we had $65.9 million in cash and cash equivalents.Together with our investments at December 31, 2005 ($89.6 million),this balance is approximately $42.7 million less than at December 31,2004. Significant cash flows during the year ended December 31, 2005include, the net proceeds from the sale and leaseback financing of ourSturlugata 8 headquarters facility ($54.8 million), the net proceeds from thesale and leaseback financing of our Krokhals facility ($7.7 million),prepayments of short and long-term debts secured by mortgages on Sturlugata 8($38.6 million), prepayments of short and long-term debts secured by mortgageson our Krokhals facility ($1.8 million), refinancing of the mortgage on ourWoodridge, IL facility ($4.0 million), other debt service ($3.0 million),capital expenditures ($4.0 million), and costs associated with the advancementof our drug development programs as reflected in the $54.0 million of cash weused in operating activities during the year ended December 31, 2005.

Available cash is invested in accordance with ourinvestment policy’s primary objectives of liquidity and safety of principalwhile maximizing the income we receive from our investments withoutsignificantly increasing risk. Our cash is deposited only with financialinstitutions in Iceland, the United Kingdom and the United States having a highcredit standing (A-/A3 or better). We expect to maintain our portfolio of cashequivalents and investments in a variety of securities, including auction ratesecurities commercial paper, money market funds, mutual fund investments andgovernment and non-government debt securities.

At December 31, 2005, our cash is largelyinvested in U.S. dollar denominated money market and checking accounts and alsoin Icelandic krona denominated accounts. At December 31, 2005, ourinvestments are comprised of auction rate securities and a corporate bond.

*OperatingActivities.*   Net cash used in operatingactivities increased to $54.0 million for the year ended December 31, 2005as compared to $29.9 million for the year ended December 31, 2004 and$20.3 million for the year ended December 31, 2003. As more fullydescribed above, the increase in use of cash in operating activities is mostimportantly attributable to the significant research and development 

55

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investments being made inadvancing our drug and clinical development programs. The balance of ourdeferred revenue has decreased during 2005 as we recognize revenue as workprogresses under collaborative contracts with significant up-front moniespaid. Also, during 2005, we have experienced lower average turnover of ourreceivables largely on account of monies due under grants.

*InvestingActivities.*   Our investing activities haveconsisted of short-term investments in marketable securities (consisting mainlyof auction rate securities, US government securities and in an intermediateterm bond mutual fund), capital expenditures and, in the year ended December 31,2005, the sale and leaseback of our headquarters facilities at Sturlugata, andKrokhals 5D and 5E in Reykjavik, Iceland.

We principally made replacement capital expendituresduring 2005, 2004 and 2003 and did invest in certain computer and laboratoryequipment. We have experienced the pace of necessary capital expendituresincrease somewhat of late and this trend may continue. Although we believe wewill continue to make largely replacement capital expenditures in thenear-term, net cash used in investing activities may in the future fluctuatesignificantly from period to period due to timing of our capital expendituresand other investments as well as changing business needs.

As more fully described below, in March 2005, weentered into a financing with an Icelandic real estate company for the sale andleaseback of our headquarters facility at Sturlugata 8, Reykjavik, Iceland. Thesale price for the property was 3.4 billion Icelandic kronas ($54.8 millionafter taking into account a standard forward foreign exchange contact weentered into in connection with the sale). In June 2005, we entered into afinancing with an Icelandic real estate company for the sale and leaseback ofour facility at Krokhals 5D and 5E, Reykjavik, Iceland. The sale price for theproperty was 502 million Icelandic kronas (approximately $7.7 million aftertaking into account the sales commission).

*FinancingActivities.*   Net cash of $46.1 million was usedin financing activities in the year ended December 31, 2005, as comparedto $156.2 million that was provided in the year ended December 31, 2004and $2.5 million that was provided in the year ended December 31, 2003. Financingactivities for the year ended December 31, 2005 largely consisted ofprepayments of short and long-term debts secured by mortgages on Sturlugata 8($38.6 million), prepayments of long-term debts secured by mortgages onKrokhals 5D and 5E ($1.8 million) refinancing of the mortgage on our Woodridge,IL facility ($4.0 million) which freed-up $6.0 million of previously restrictedcash (reflected above in investing activities), the sale-and-leaseback ofcertain equipment ($1.2 million) and other debt service ($3.0 million).Financing activities for the year-ended December 31, 2004 largelyconsisted of net proceeds from our convertible notes ($143.8 million), equityproceeds and the portion of the monies received by us in the information-richclinical trial alliance with Merck relating to the sale of common stock andwarrants ($13.6 million), proceeds in the liquidation of our two cross-currencyswaps ($9.7 million) and installment payments on debt and capital leaseobligations ($6.8 million).

A portion of the proceeds from the sale of ourheadquarters facility at Sturlugata 8 went to prepay approximately $34.1million of long-term debt that was secured by mortgages on the property, (ourTier A bonds, Tier B loan and March 2004 loan) and $4.5 million ofshort-term borrowings. We have leased the property back under a 15 yearnon-cancelable lease agreement at a rent of 21.4 million Icelandic kronas permonth (approximately $0.3 million as of December 31, 2005), subject tochanges based on the Icelandic consumer price index. Under the terms of thelease we will continue to pay property taxes and insurance and will beresponsible for the property’s maintenance. The monthly rent will be revised asof July 1, 2010 to reflect changes in capital markets as well as ourcredit quality. Under the terms of the lease, we have a right of first refusalon any sale of the property and a priority right to extend the term of thelease at its expiration. The lease provides us with the option to redenominatethe rent in currencies other than Icelandic kronas at a predetermined rate asof July 1, 2007.

In March 2005, we refinanced the mortgage on ourWoodridge, IL facility, paying-down $4.0 million of the then existing $10.2 millionmortgage and eliminating restricted cash collateral totaling $6.0 million. 

56

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The principal amount ofthe new mortgage ($6.2 million) is payable in monthly installments of $26,000for two years and three months with a final payment of $5.5 million due in June 2007.The new mortgage carries an interest rate of three-monthLIBOR + 2.25% (6.32% at December 31, 2005).

A portion of the proceeds from the sale of Krokhals 5Dand 5E were used to prepay approximately $1.8 million of long-term debt thatwas secured by a mortgage on the property. deCODE has leased the Krokhals 5Dand 5E property back under a 15 year non-cancelable lease agreement at a rentof 4.1 million Icelandic kronas (approximately $0.1million as of December 31,2005) per month, subject to changes based on the Icelandic consumer price index.The lease is a 15 year operating lease.

*Contractual Commitmentsand Off-Balance Sheet Arrangements.**  *The following summarizes ourcontractual obligations at December 31, 2005, and the effects suchobligations are expected to have on our liquidity and cash flows in futureperiods:

| ** **                                         | ** ** | **Payments Due by period** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                         | ** ** | **Total**                                 | ** ** | **Less Than  1 Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than  5 Years** | ** ** |
| ** **                                         | ** ** | **(In thousands)**                   | ** ** |
| 3.5% senior  convertible notes, including interest |       | $                                         | 178,875    |   |   | $ | 5,250 |   |   | $ | 10,500 |   | $ | 10,500 |   | $ | 152,625 |   |
| Operating leases                                   |       | 73,598                                    |       |   | 5,973 |   |   | 10,679 |   | 10,196 |   | 46,750 |   |
| Long-term  debt, including interest                |       | 6,745                                     |       |   | 923 |   |   | 5,822 |   | — |   | — |   |
| Capital lease  obligations, including interest     |       | 2,485                                     |       |   | 1,391 |   |   | 1,086 |   | 8 |   | — |   |
|                                               |       | $                                         | 261,703    |   |   | $ | 13,537 |   |   | $ | 28,087 |   | $ | 20,704 |   | $ | 199,375 |   |

 

Under the terms of certain technology licensingagreements, deCODE is obligated to make payments upon the achievement ofestablished milestones leading to the discovery of defined products. Thesepayments could total $6.0 million, of which deCODE believes $1.0 million may beincurred in 2006, with the timing of payments of the remainder not determinableat the current time. These potential payments are not included in the above table.

All material intercompanybalances and transactions have been eliminated. We do not have any othersignificant relationships with unconsolidated entities or financialpartnerships, such as entities often referred to as structured finance orspecial purpose entities, which would have been established for the purpose offacilitating off-balance sheet arrangements or other contractually narrow orlimited purposes. As such, we are not exposed to any financing, liquidity,market or credit risk that could arise if we had engaged in such relationships.Additionally, holders of our 3.5% senior convertible notes may elect to converttheir notes into shares of our common stock at any time at a price of $14.00per share.

**Item 7A.**                *Quantitative and Qualitative Disclosures About Market Risk*

The primary objectives of our investment activitiesare to preserve principal, maintain a high degree of liquidity to meetoperating needs, and obtain competitive returns subject to prevailing marketconditions. Investments are made primarily in high-grade corporate bonds, asset-backeddebt securities and U.S. government agency debt securities. These investmentsare subject to risk of default, changes in credit rating and changes in marketvalue. These investments are also subject to interest rate risk and willdecrease in value if market interest rates increase. A hypothetical 100 basispoint increase in interest rates would result in an approximate$0.3 million decrease in the fair value of our investments as of December 31,2005. Due to the nature of our investments and relatively short effectivematurities of debt instruments, interest rate risk is mitigated. Changes ininterest rates do not affect interest expense incurred on the Company’sConvertible Notes, because they bear interest at a fixed rate. The market valueof the Convertible Notes was $123.4 million on December 31, 2005.

57

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As a consequence of the nature our business andoperations our reported financial results and cash flows are exposed to the risksassociated with fluctuations in the exchange rates of the U.S. dollar, theIcelandic krona and other world currencies. We continue to monitor our exposureto currency risk. A hypothetical 10.0% decrease in value of the US dollaragainst the Icelandic krona would result in a loss of approximately$0.1 million on our Icelandic krona denominated non-U.S. dollar assets andliabilities. We have historically purchased instruments to hedge these generalrisks through the use of derivative financial instruments; however, we have noderivative instruments outstanding as of December 31, 2005.

As of December 31,2005 we did not have any financing arrangements that were not reflected in ourbalance sheet.

**Item8.**                        *Financial Statements and Supplementary Data*

|                                                                  | ** ** | **Page** | ** ** |
|------------------------------------------------------------------|------------|----------|------------|
| Reports of  Independent Registered Public Accounting Firms       |       | 59,60    |       |
| Consolidated  Balance Sheets                                     |       | 61       |       |
| Consolidated  Statements of Operations                           |       | 62       |       |
| Consolidated  Statements of Changes in Stockholders’ Equity |       | 63       |       |
| Consolidated  Statements of Cash Flows                           |       | 66       |       |
| Notes to Consolidated  Financial Statements                      |       | 67       |       |

 

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

To the Board of Directors and Stockholders ofdeCODE genetics Inc.:

We have audited the accompanying consolidated balancesheets of deCODE genetics Inc. and subsidiaries (the “Company”) as of December 31,2005 and 2004, and the related consolidated statements of operations,stockholders’ equity, and cash flows for the years then ended. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of the Companyas of December 31, 2005 and 2004, and the results of their operations andtheir cash flows for the years then ended, in conformity with accountingprinciples generally accepted in the United States of America.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2005, based on the criteriaestablished by the Committee of SponsoringOrganizations of the Treadway Commission (COSO) in *Internal Control-Integrated Framework* and ourreport dated March 14, 2006 expressed an unqualified opinion on management’sassessment of the effectiveness of the Company’s internal control overfinancial reporting and an unqualified opinion on the effectiveness of theCompany’s internal control over financial reporting.

/s/ Deloitte & Touche LLP

Boston, MassachusettsMarch 14, 2006

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

To the Board of Directors and Stockholders of deCODEgenetics, Inc.:

In our opinion, theaccompanying consolidated statements of operations, stockholders’ equity andcash flows present fairly, in all material respects, the results of operationsand cash flows of deCODE genetics, Inc. and its subsidiaries for the yearended December 31, 2003 in conformity with accounting principles generallyaccepted in the United States of America. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audit. We conducted ouraudit of these statements in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation. We believe that our audit provides a reasonable basisfor our opinion.

/s/ PricewaterhouseCoopers LLP

Boston, MassachusettsFebruary 27, 2004, except for the four paragraph of the section titled “MortgageLoans” in footnote 11 for which the date is March 15, 2004

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**deCODE genetics, Inc.**

**CONSOLIDATEDBALANCE SHEETS**

| ** **                                                                                                                                                                                                                           | ** ** | **December 31,**                                    | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                                                                                                                                                           | ** ** | **2005**                                                 | ** ** | **2004** | ** ** |
| ** **                                                                                                                                                                                                                           | ** ** | **(In thousands, except  share amounts)** | ** ** |
| ASSETS                                                                                                                                                                                                                               |       |                                                     |       |   |   |
| Current assets:                                                                                                                                                                                                                      |       |                                                     |       |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                           |       | $                                                        | 65,943     |   | $ | 70,238 |   |
| Investments                                                                                                                                                                                                                          |       | 89,611                                                   |       | 122,082 |   |
| Receivables                                                                                                                                                                                                                          |       | 7,856                                                    |       | 6,450 |   |
| Other current assets                                                                                                                                                                                                                 |       | 3,541                                                    |       | 4,307 |   |
| Total current assets                                                                                                                                                                                                                 |       | 166,951                                                  |       | 203,077 |   |
| Restricted cash                                                                                                                                                                                                                      |       | -                                                        |       | 6,000 |   |
| Property and equipment,  net                                                                                                                                                                                                         |       | 24,500                                                   |       | 60,447 |   |
| Goodwill                                                                                                                                                                                                                             |       | 8,863                                                    |       | 8,863 |   |
| Other long-term  assets and deferred charges                                                                                                                                                                                         |       | 6,444                                                    |       | 9,865 |   |
| Total assets                                                                                                                                                                                                                         |       | $                                                        | 206,758    |   | $ | 288,252 |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)                                                                                                                                                                                  |       |                                                     |       |   |   |
| Current liabilities:                                                                                                                                                                                                                 |       |                                                     |       |   |   |
| Accounts payable                                                                                                                                                                                                                     |       | $                                                        | 4,732      |   | $ | 5,829 |   |
| Accrued expenses and  other current liabilities                                                                                                                                                                                      |       | 12,823                                                   |       | 9,528 |   |
| Short-term  borrowings                                                                                                                                                                                                               |       | —                                                   |       | 5,069 |   |
| Current portion of  capital lease obligations                                                                                                                                                                                        |       | 1,313                                                    |       | 1,745 |   |
| Current portion of long-term  debt                                                                                                                                                                                                   |       | 550                                                      |       | 7,081 |   |
| Deferred revenue                                                                                                                                                                                                                     |       | 6,105                                                    |       | 8,654 |   |
| Total current  liabilities                                                                                                                                                                                                           |       | 25,523                                                   |       | 37,906 |   |
| Capital lease  obligations, net of current portion                                                                                                                                                                                   |       | 1,046                                                    |       | 1,194 |   |
| Long-term debt,  net of current portion                                                                                                                                                                                              |       | 155,653                                                  |       | 189,535 |   |
| Deferred gain on  sale-leaseback                                                                                                                                                                                                     |       | 27,654                                                   |       | - |   |
| Deferred revenue                                                                                                                                                                                                                     |       | 6,219                                                    |       | 7,221 |   |
| Commitments and contingencies                                                                                                                                                                                                        |       |                                                     |       |   |   |
| Stockholders’ equity (deficit):                                                                                                                                                                                                 |       |                                                     |       |   |   |
| Preferred stock, $0.001  par value; Authorized: 6,716,666 shares; Issued and outstanding: none                                                                                                                                       |       | —                                                   |       | — |   |
| Common stock, $0.001 par  value; Authorized: 100,000,000 shares; Issued and outstanding: 54,762,095 and  54,742,595, respectively, at December 31, 2005; and 54,539,069 and  54,522,069 respectively, at December 31, 2004 |       | 55                                                       |       | 55 |   |
| Additional paid-in  capital                                                                                                                                                                                                          |       | 444,401                                                  |       | 442,999 |   |
| Notes receivable                                                                                                                                                                                                                     |       | (2,898                                                   | )          | (3,111 | ) |
| Deferred compensation                                                                                                                                                                                                                |       | (418                                                     | )          | — |   |
| Accumulated deficit                                                                                                                                                                                                                  |       | (450,215                                                 | )          | (387,465 | ) |
| Accumulated other  comprehensive income                                                                                                                                                                                              |       | (139                                                     | )          | 38 |   |
| Treasury stock, 19,500  and 17,000 shares stated at cost at December 31, 2005 and 2004,  respectively                                                                                                                           |       | (123                                                     | )          | (120 | ) |
| Total stockholders’  (deficit) equity                                                                                                                                                                                           |       | (9,337                                                   | )          | 52,396 |   |
| Total liabilities and stockholders’ equity (deficit)                                                                                                                                                                            |       | $                                                        | 206,758    |   | $ | 288,252 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

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**deCODE genetics, Inc.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

| ** **                                                     | ** ** | **For the Years Ended December 31,**     | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | **2005**                                                          | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                     | ** ** | **(In thousands, except per  share amounts)** | ** ** |
| Revenue                                                        |       | $                                                                 | 43,955     |   | $ | 42,127 |   | $ | 46,811 |   |
| Operating expenses:                                            |       |                                                              |       |   |   |   |   |
| Cost of revenue, including collaborative programs.             |       | 37,263                                                            |       | 43,407 |   | 45,870 |   |
| Research and development—proprietary programs             |       | 43,748                                                            |       | 24,942 |   | 17,596 |   |
| Selling, general and administrative                            |       | 20,118                                                            |       | 20,187 |   | 17,178 |   |
| Impairment, employee termination benefits and other  charges   |       | —                                                            |       | — |   | 951 |   |
| Total operating expenses                                       |       | 101,129                                                           |       | 88,536 |   | 81,595 |   |
| Operating loss                                                 |       | (57,174                                                           | )          | (46,409 | ) | (34,784 | ) |
| Interest income                                                |       | 6,397                                                             |       | 2,903 |   | 1,151 |   |
| Interest expense                                               |       | (7,484                                                            | )          | (8,983 | ) | (3,478 | ) |
| Other non-operating  (expense) and income, net                 |       | (4,489                                                            | )          | (4,766 | ) | 1,988 |   |
| Net loss                                                       |       | $                                                                 | (62,750    | ) | $ | (57,255 | ) | $ | (35,123 | ) |
| Basic and diluted net loss per share                           |       | $                                                                 | (1.17      | ) | $ | (1.07 | ) | $ | (0.68 | ) |
| Shares used in computing  basic and diluted net loss per share |       | 53,824                                                            |       | 53,423 |   | 51,508 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

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**deCODE genetics, Inc.**

**CONSOLIDATEDSTATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)**

| **(In thousands, except share amounts)** |
|------------------------------------------|

** **

| ** **                                                                                | ** ** | ** **                                | ** ** | ** **     | ** ** | ** **           | ** ** | ** **            | ** ** | ** **                 | ** ** | ** **               | ** ** | **Accumulated**    | ** ** | ** **          | ** ** | ** **                                    | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|----------------|------------|----------------------|------------|-----------------------|------------|----------------------------|------------|--------------------------|------------|--------------------|------------|---------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                | ** ** | ** **                                | ** ** | ** **     | ** ** | ** **           | ** ** | ** **            | ** ** | ** **                 | ** ** | ** **               | ** ** | **Other**          | ** ** | ** **          | ** ** | ** **                                    | ** ** |
| ** **                                                                                | ** ** | **Shares**                                | ** ** | **Additional** | ** ** | ** **           | ** ** | ** **            | ** ** | ** **                 | ** ** | **Comprehensive**        | ** ** | ** **         | ** ** | **Total**           | ** ** |
| ** **                                                                                | ** ** | **Common  Stock**                         | ** ** | **Par  Value** | ** ** | **Paid-In  Capital** | ** ** | **Notes  Receivable** | ** ** | **Deferred  Compensation** | ** ** | **Accumulated  Deficit** | ** ** | **Income  (Loss)** | ** ** | **Treasury  Stock** | ** ** | **Stockholders’  Equity (Deficit)** | ** ** |
| ** **                                                                                | ** ** | **(In thousands, except share  amounts)** | ** ** |
| **Balance at January 1, 2002**                                                       |       | 53,545,234                                |       | $              | 54         |                 |       | $                     | 431,494    |                       |       |                     | $          | (7,607             | )          |                |       | $                                             | (2,642     | ) |   |   | $ | (295,087 | ) |   |   | $ | (1 | ) |   |   | $ | (965 | ) |   |   | $ | 125,246 |   |   |
| Issuance of common stock upon exercise of warrants                                        |       | 425,785                                   |       |           |       |                 | (1,799     | )                     |       |                       |       |                     |       |               |       |                |       |                                          |       |   |   |   |   |   |   |   | 1,799 |   |   |   |   |   |   |
| Issuance of common stock upon exercise of stock  options                                  |       | 135,801                                   |       |           |       |                 | 306        |                  |       |                       | (2         | )                        |       |               |       |                |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   | 304 |   |   |
| Deferred compensation arising from stock options                                          |       |                                      |       |           |       |                 | 373        |                  |       |                       |       |                     |       |               | (373       | )                   |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other issuances of common stock                                                           |       | 25,504                                    |       |           |       |                 | 158        |                  |       |                       |       |                     |       |               |       |                |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   | 158 |   |   |
| Forfeiture and cancellations of common stock issued  upon early exercise of stock options |       | (397,094                                  | )          |           |       |                 |       |                  |       |                       | 2,833      |                     |       |               | 118        |                |       |                                          |       |   |   |   |   |   |   |   | (2,951 | ) |   |   |   |   |   |
| Forfeiture of options                                                                     |       |                                      |       |           |       |                 | (43        | )                     |       |                       |       |                     |       |               | 43         |                |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Payment of notes                                                                          |       |                                      |       |           |       |                 |       |                  |       |                       | 536        |                     |       |               |       |                |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   | 536 |   |   |
| Amortization of deferred compensation                                                     |       |                                      |       |           |       |                 |       |                  |       |                       |       |                     |       |               | 2,282      |                |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   | 2,282 |   |   |
| Comprehensive  income (loss):                                                             |       |                                      |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss for the period                                                                   |       |                                      |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |                                          | (35,123    | ) |   |   |   |   |   |   |   |   |   |   | (35,123 | ) |   |
| Other comprehensive  income (loss):                                                       |       |                                      |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Foreign currency translation                                                              |       |                                      |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |                                          |       |   |   |   | 4 |   |   |   |   |   |   |   | 4 |   |   |
| Total  comprehensive income (loss):                                                       |       |                                      |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   | (35,119 | ) |   |
| **Balance  at December 31, 2003**                                                    |       | 53,735,230                                |       | $              | 54         |                 |       | $                     | 430,489    |                       |       |                     | $          | (4,240             | )          |                |       | $                                             | (572       | ) |   |   | $ | (330,210 | ) |   |   | $ | 3 |   |   |   | $ | (2,117 | ) |   |   | $ | 93,407 |   |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

63

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**deCODEgenetics, Inc.CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)**

| ** **                                                                                | ** ** | ** **                                                   | ** ** | ** **     | ** ** | ** **           | ** ** | ** **            | ** ** | ** **                 | ** ** | ** **               | ** ** | **Accumulated**    | ** ** | ** **          | ** ** | ** **                                    | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------|------------|----------------------|------------|-----------------------|------------|----------------------------|------------|--------------------------|------------|--------------------|------------|---------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                | ** ** | ** **                                                   | ** ** | ** **     | ** ** | ** **           | ** ** | ** **            | ** ** | ** **                 | ** ** | ** **               | ** ** | **Other**          | ** ** | ** **          | ** ** | ** **                                    | ** ** |
| ** **                                                                                | ** ** | **Shares**                                                   | ** ** | **Additional** | ** ** | ** **           | ** ** | ** **            | ** ** | ** **                 | ** ** | **Comprehensive**        | ** ** | ** **         | ** ** | **Total**           | ** ** |
| ** **                                                                                | ** ** | **Common  Stock**                                            | ** ** | **Par  Value** | ** ** | **Paid-In  Capital** | ** ** | **Notes  Receivable** | ** ** | **Deferred  Compensation** | ** ** | **Accumulated  Deficit** | ** ** | **Income  (Loss)** | ** ** | **Treasury  Stock** | ** ** | **Stockholders’  Equity (Deficit)** | ** ** |
| ** **                                                                                | ** ** | **(In thousands, except share amounts)** | ** ** |
| **Balance at December 31, 2003**                                                     |       | 53,735,230                                                   |       |           | $          | 54                   |       |                  |       | $                          | 430,489    |                     |       |               | $          | (4,240              | )          |                                          |       | $ | (572 | ) |   |   | $ | (330,210 | ) |   |   | $ | 3 |   |   |   | $ | (2,117 | ) |   |   | $ | 93,407 |   |   |
| Issuance of common stock and warrants                                                     |       | 689,703                                                      |       |           | 1          |                 |       |                  | 11,507     |                       |       |                     |       |               |       |                |       |                                          |       |   |   |   |   |   |   |   |   |   | 2,121 |   |   |   | 13,629 |   |   |
| Issuance of common stock upon exercise of stock  options                                  |       | 114,657                                                      | ** ** |           |       |                 |       |                  | 519        |                       |       |                     | 3          |               |       |                |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 522 |   |   |
| Compensation arising from stock options                                                   | ** ** | ** **                                                   | ** ** |           |       |                 |       |                  | 484        |                       |       |                     |       |               |       |                |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 484 |   |   |
| Forfeiture and cancellations of common stock issued  upon early exercise of stock options |       | (17,521                                                      | )          |           |       |                 |       |                  |       |                       |       |                     | 124        |               |       |                |       |                                          |       |   |   |   |   |   |   |   |   |   | (124 | ) |   |   | — |   |   |
| Payment of notes                                                                          | ** ** | ** **                                                   | ** ** |           |       |                 |       |                  |       |                       |       |                     | 1,002      |               |       |                |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 1,002 |   |   |
| Amortization of deferred compensation                                                     | ** ** | ** **                                                   | ** ** |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                | 572        |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 572 |   |   |
| Comprehensive income  (loss):                                                             |       |                                                         |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss for the period                                                                   | ** ** | ** **                                                   | ** ** |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |                                          |       |   | (57,255 | ) |   |   |   |   |   |   |   |   |   |   | (57,255 | ) |   |
| Other comprehensive  income (loss):                                                       |       |                                                         |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Foreign currency translation                                                              | ** ** | ** **                                                   | ** ** |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |                                          |       |   |   |   |   |   | 10 |   |   |   |   |   |   |   | 10 |   |   |
| Unrealized gain on marketable securities                                                  | ** ** | ** **                                                   | ** ** |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |                                          |       |   |   |   |   |   | 25 |   |   |   |   |   |   |   | 25 |   |   |
| Total  comprehensive income (loss):                                                       | ** ** | ** **                                                   | ** ** |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | (57,220 | ) |   |
| **Balance  at December 31, 2004**                                                    |       | 54,522,069                                                   |       |           | $          | 55                   |       |                  |       | $                          | 442,999    |                     |       |               | $          | (3,111              | )          |                                          |       | $ | — |   |   |   | $ | (387,465 | ) |   |   | $ | 38 |   |   |   | $ | (120 | ) |   |   | $ | 52,396 |   |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

64

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**deCODE genetics, Inc.**

**CONSOLIDATEDSTATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)**

| ** **                                                                                | ** ** | ** **                                                   | ** ** | ** **     | ** ** | ** **           | ** ** | ** **            | ** ** | ** **                 | ** ** | **Accumulated**          | ** ** | ** **         | ** ** | ** **          | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------|------------|----------------------|------------|-----------------------|------------|----------------------------|------------|--------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                                                                | ** ** | ** **                                                   | ** ** | ** **     | ** ** | ** **           | ** ** | ** **            | ** ** | ** **                 | ** ** | ** **               | ** ** | **Other**          | ** ** | ** **          | ** ** | ** ** | ** ** |
| ** **                                                                                | ** ** | **Shares**                                                   | ** ** | **Additional** | ** ** | ** **           | ** ** | ** **            | ** ** | ** **                 | ** ** | **Comprehensive**        | ** ** | ** **         | ** ** | **Total**           | ** ** |
| ** **                                                                                | ** ** | **Common  Stock**                                            | ** ** | **Par  Value** | ** ** | **Paid-In  Capital** | ** ** | **Notes  Receivable** | ** ** | **Deferred  Compensation** | ** ** | **Accumulated  Deficit** | ** ** | **Income  (Loss)** | ** ** | **Treasury  Stock** | ** ** | **Stockholders’  Equity (Deficit)** | ** ** |
| ** **                                                                                | ** ** | **(In thousands, except share amounts)** | ** ** |
| **Balance at December 31, 2004**                                                     |       | 54,522,069                                                   |       |           | $          | 55                   |       |                  |       | $                          | 442,999    |                     |       |               | $          | (3,111              | )          |   |   | $ | — |   |   |   | $ | (387,465 | ) |   |   | $ | 38 |   |   |   | $ | (120 | ) |   |   | $ | 52,396 |   |   |
| Issuance of common stock to consultant                                                    |       | 15,000                                                       |       |           |       |                 |       |                  | 104        |                       |       |                     |       |               |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 104 |   |   |
| Issuance of restricted common stock                                                  |       | 57,944                                                       |       |           |       |                 |       |                  | 526        |                       |       |                     |       |               |       |                | (526       | ) |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Issuance of common stock upon exercise of warrants                                        |       | 47,222                                                       |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Issuance of common stock upon exercise of stock  options                                  |       | 102,860                                                      |       |           | 439        |                 |       |                  |       |                       |       |                     |       |               |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 439 |   |   |
| Compensation arising from stock options                                                   |       | 333                                                          |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 333 |   |   |
| Forfeiture and cancellations of common stock issued  upon early exercise of stock options |       | (2,500                                                       | )          |           |       |                 |       |                  | 3          |                       |       |                     |       |               |       |                |       |   |   |   |   |   |   |   |   |   |   |   | (3 | ) |   |   |   |   |   |
| Payment of notes                                                                          |       |                                                         |       |           |       |                 |       |                  | 210        |                       |       |                     |       |               |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 210 |   |   |
| Amortization of restricted stock and deferred  compensation                               |       |                                                         |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                | 108        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 108 |   |   |
| Comprehensive income  (loss):                                                             |       |                                                         |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss for the period                                                                   |       |                                                         |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |   |   |   | (62,750 | ) |   |   |   |   |   |   |   |   |   |   | (62,750 | ) |   |
| Other comprehensive  income (loss):                                                       |       |                                                         |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Foreign currency translation                                                              |       |                                                         |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |   |   |   |   |   |   |   | (3 | ) |   |   |   |   |   |   | (3 | ) |   |
| Unrealized loss on marketable securities                                                  |       |                                                         |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |   |   |   |   |   |   |   | (174 | ) |   |   |   |   |   |   | (174 | ) |   |
| Total  comprehensive income (loss):                                                       |       |                                                         |       |           |       |                 |       |                  |       |                       |       |                     |       |               |       |                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (62,927 | ) |   |
| **Balance  at December 31, 2005**                                                    |       | 54,742,595                                                   |       |           | $          | 55                   |       |                  |       | $                          | 444,401    |                     |       |               | $          | (2,898              | )          |   |   | $ | (418 | ) |   |   | $ | (450,215 | ) |   |   | $ | (139 | ) |   |   | $ | (123 | ) |   |   | $ | (9,337 | ) |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

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**deCODE genetics, Inc.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

| ** **                                                                   | ** ** | **For the Years Ended  December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                   | ** ** | **(In thousands)**                                   | ** ** |
| **Cash flows from operating activities:**                                    |       |                                                      |       |   |   |   |   |
| Net loss                                                                     |       | $                                                         | (62,750    | ) | $ | (57,255 | ) | $ | (35,123 | ) |
| Adjustments to reconcile net loss to net cash used in  operating activities: |       |                                                      |       |   |   |   |   |
| Depreciation and  amortization                                               |       | 7,611                                                     |       | 14,135 |   | 13,913 |   |
| Amortization of deferred  gain on sale-leaseback                             |       | (1,394                                                    | )          | — |   | — |   |
| Charges for debt  extinguishment                                             |       | 1,741                                                     |       | — |   | — |   |
| Loss on investments                                                          |       | 1,044                                                     |       | — |   | — |   |
| Gain on sale of  investment in common stock of eMR                           |       | —                                                    |       | — |   | (254 | ) |
| Stock-based  compensation                                                    |       | 441                                                       |       | 1,171 |   | 2,440 |   |
| Loss on disposal of  equipment, net                                          |       | 32                                                        |       | 883 |   | 224 |   |
| Charges for write-down  of obsolete and excess materials and supplies        |       | 63                                                        |       | 117 |   | 802 |   |
| Loss (gain) on derivative  financial instruments                             |       | —                                                    |       | 1,465 |   | (4,824 | ) |
| Foreign currency exchange  loss on Icelandic krona denominated debt          |       | 262                                                       |       | 2,936 |   | 3,947 |   |
| Amortization of deferred  financing costs                                    |       | 949                                                       |       | 872 |   | — |   |
| Other                                                                        |       | (31                                                       | )          | (177 | ) | (423 | ) |
| Changes in operating assets and liabilities:                                 |       |                                                      |       |   |   |   |   |
| Receivables                                                                  |       | (1,456                                                    | )          | 47 |   | (1,205 | ) |
| Other current assets                                                         |       | 703                                                       |       | 1,174 |   | 3,206 |   |
| Accounts payable                                                             |       | (1,097                                                    | )          | 476 |   | 488 |   |
| Accrued expenses                                                             |       | 3,399                                                     |       | 2,224 |   | (3,377 | ) |
| Deferred revenue                                                             |       | (3,550                                                    | )          | 1,857 |   | (145 | ) |
| Other                                                                        |       | —                                                    |       | 139 |   | — |   |
| Net cash used in  operating activities                                       |       | (54,033                                                   | )          | (29,936 | ) | (20,331 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                        |       |                                                      |       |   |   |   |   |
| Purchase of property and  equipment                                          |       | (3,968                                                    | )          | (2,695 | ) | (882 | ) |
| Purchase of investments                                                      |       | (230,678                                                  | )          | (248,040 | ) | — |   |
| Redemptions of  investments                                                  |       | 261,920                                                   |       | 125,950 |   | — |   |
| Proceeds from sale of  property and equipment                                |       | 62,452                                                    |       | 39 |   | 90 |   |
| Change in restricted cash                                                    |       | 6,000                                                     |       | — |   | — |   |
| Other                                                                        |       | 106                                                       |       | 93 |   | — |   |
| Net cash provided by  (used in) investing activities                         |       | 95,832                                                    |       | (124,653 | ) | (792 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                        |       |                                                      |       |   |   |   |   |
| Issuance of common stock  and warrants                                       |       | 439                                                       |       | 14,153 |   | 256 |   |
| Repayment of notes  receivable for common stock                              |       | 210                                                       |       | 1,002 |   | 536 |   |
| Proceeds from convertible  debt offering, net of financing costs             |       | —                                                    |       | 143,805 |   | — |   |
| Proceeds (payments) on  line of credit                                       |       | (4,500                                                    | )          | (2,000 | ) | 6,500 |   |
| Proceeds from short-term  borrowings                                         |       | —                                                    |       | 1,119 |   | 0 |   |
| Repayments of short-term  borrowings                                         |       | (569                                                      | )          | (550 | ) | 0 |   |
| Proceeds from equipment  sale-leaseback financing                            |       | 1,200                                                     |       | 436 |   | 4,750 |   |
| Proceeds from facility  financings                                           |       | —                                                    |       | — |   | 154 |   |
| Proceeds from swap  termination                                              |       | —                                                    |       | 9,720 |   | — |   |
| Debt refinancing cost                                                        |       | (59                                                       | )          | (478 | ) | — |   |
| Repayments of debt and  capital lease obligations                            |       | (42,815                                                   | )          | (11,049 | ) | (9,648 | ) |
| Net cash (used in)  provided by financing activities                         |       | (46,094                                                   | )          | 156,158 |   | 2,548 |   |
| Net (decrease) increase  in cash and cash equivalents                        |       | (4,295                                                    | )          | 1,569 |   | (18,575 | ) |
| Cash and cash equivalents  at beginning of period                            |       | 70,238                                                    |       | 68,669 |   | 87,244 |   |
| Cash and cash equivalents  at end of period                                  |       | $                                                         | 65,943     |   | $ | 70,238 |   | $ | 68,669 |   |
| Supplemental cash flow information:                                          |       |                                                      |       |   |   |   |   |
| Cash paid for interest                                                       |       | $                                                         | 6,608      |   | $ | 6,250 |   | $ | 2,479 |   |
| Deferred gain on sale of property and equipment                              |       | 29,270                                                    |       | — |   | — |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

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**deCODE genetics, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(tabular amounts in thousands, except share and per share amounts)**

**1.**   Organizationand Business

References in these financial statements to deCODErefer to deCODE genetics, Inc., a Delaware company, and its wholly ownedsubsidiaries, Islensk erfdagreining ehf., an Icelandic company registered inReykjavik, and its subsidiaries, MediChem Life Sciences, Inc., a Delawarecorporation, and its subsidiaries.

With its headquarters in Reykjavik, Iceland, deCODE isa biopharmaceutical company developing drugs and DNA-based diagnostics basedupon its discoveries in the inherited causes of common diseases. deCODE’spopulation approach and resources have enabled it to isolate genes and targetsdirectly involved in the development of many of the biggest challenges topublic health. deCODE is focused on turning these findings into a pipeline ofproducts which it believes will be able to combat the cause of disease, notjust the signs and symptoms. deCODE’s customers include major pharmaceuticalcompanies, biotechnology firms, pharmacogenomics companies, universities andother research institutions. deCODE’s business is global, with its principalmarkets in the United States and in Europe.

deCODE’s focus is on the discovery andcommercialization of novel therapeutics based on genetic information identifiedin deCODE’s population-based gene discovery work. deCODE has integratedcapabilities for applying genetic findings to the development of drugs, boththrough its proprietary programs and in alliance with corporate partners.deCODE is also applying the links it has identified between genetic factors anddisease to create DNA based tests which can also be used to identify patientswith increased risk of developing a disease or to predict which patients willrespond well to a given drug therapy. deCODE believes that such tests willbecome a standard part of healthcare within the coming decade, making itpossible to gauge individual predisposition to a particular illness and todesign effective preventive strategies; to complement traditional clinicaldiagnoses; and to identify patients who are likely to respond or not respond toparticular drugs.

In addition to conductingwork on targets in deCODE’s collaborative and internal programs, the chemistrygroup provides drug discovery work for fee-for-service customers. deCODE’sother service offerings include protein crystallization products and proteinstructure analysis contract services through its Seattle-based biostructuresgroup; pharmacogenomics and clinical trials services through its Encodesubsidiary; and DNA analysis services through its genotyping laboratory inReykjavik.

**2.**   SignificantAccounting Policies

***Basis of Presentation***

These financial statementsare reported in United States dollars, deCODE’s functional currency, andprepared in accordance with accounting principles generally accepted in theUnited States of America. Tabular amounts are stated in thousands, except pershare amounts.

***Reclassifications***

Beginning in 2004,deCODE began presenting cost of revenue in its statements of operations. To beconsistent with year-end 2004 operating expense classifications, deCODEreclassified previously reported research and development expenses for theyear-ended December 31, 2003. The reclassifications between research anddevelopment expenses and cost of revenue had no effect on reported amounts oftotal operating expenses or operating loss.

67

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**deCODE genetics, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (tabular amounts in thousands, except share and per share amounts)**

***Principles of Consolidation***

The consolidated financialstatements include the accounts and operations of deCODE genetics, Inc.and its subsidiaries, all of which are wholly-owned. All significantintercompany accounts and transactions have been eliminated.

***Use of Estimates and Assumptions***

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make certainestimates and assumptions that affect the reported amounts of assets andliabilities and the disclosure of contingent assets and liabilities at thedates of the financial statements and the reported amounts of revenues andexpenses during the reporting period. On an ongoing basis deCODE evaluates itsestimates, which include, among others, those related to collaborativearrangements, property and equipment, income taxes, litigation and othercontingencies, materials and supplies valuation, derivatives, goodwill andintangible assets, and bad debts. deCODE bases its estimates on historicalexperience and on various other assumptions that management  believes to be reasonable under thecircumstances, the results of which form its basis for making judgments aboutcarrying values of assets and liabilities that are not readily apparent fromother sources. Actual results could differ from those estimates.

***Uncertainties***

deCODE is subject to riskscommon to companies in the biotechnology industry including, but not limitedto, development by deCODE or its competitors of new technological innovations,ability to market products or services, dependence on key personnel, dependenceon key suppliers and many of deCODE’s materials and supplies, protection ofproprietary technology, ability to obtain additional financing, ability tonegotiate collaborative arrangements, and compliance with governmental andother regulations.

***Concentration of Risk***

At December 31, 2005, deCODE has no significantoff-balance sheet concentrations of credit risk such as foreign exchangecontracts, option contracts or other foreign hedging arrangements. Financialinstruments that potentially subject deCODE to concentrations of credit riskconsist principally of investments made primarily in high-grade commercialpaper, auction rate securities, money market funds, mutual fund investments,government and non-government debt securities and receivables. Theseinstruments are subject to risk of default, changes in credit rating andchanges in market value. Investments are also subject to interest rate risk andwill decrease in value if market interest rates increase.

deCODE’s cash and cash equivalents are deposited withfinancial institutions in Iceland, United Kingdom and the United States havinga high credit rating (A-/A3 or better). Deposits with banks may exceed theamount of insurance provided on such deposits. Generally, these deposits may beredeemed upon demand and, therefore, bear minimal risk.

At December 31, 2005and 2004, 20% and 24%, respectively, of consolidated receivables were due fromRoche. At December 31, 2005 and 2004, 0% and 3%, respectively, ofconsolidated receivables were due from Merck. At December 31, 2005, 18% ofconsolidated receivables were due from NIH.

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**deCODE genetics, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (tabular amounts in thousands, except share and per share amounts)**

***Fair Value of Financial Instruments***

The fair value of short-term financial instruments,including cash and cash equivalents, restricted cash, receivables, certainother current assets, trade accounts payable, certain accrued liabilities, andother current liabilities approximates their carrying amount in the financialstatements due mainly to the short maturity of such instruments. Based onborrowing rates currently available to deCODE for mortgage loans and capitallease obligations with similar terms, the carrying value of such of its debtobligations approximates fair value.

The fair values ofmortgage bonds and equipment notes at December 31, 2005 were approximately$0 and $281,000, respectively and at December 31, 2004 were approximately$15,531,000 and $529,000, respectively, as estimated based on quoted marketrates for instruments with similar terms and remaining maturities. The fairvalue of the 3.5% convertible notes at December 31, 2005 and 2004 wasapproximately $123,375,000 and $136,900,000, respectively. In October 2004,deCODE registered the convertible notes with the Securities and ExchangeCommission allowing the notes to be traded on the open market. The fair valueof the convertible notes was based on the quoted market prices at December 31,2005 and 2004.

***Cash and Cash Equivalents***

Highly liquid investmentswith a maturity of ninety days or less at the date of purchase are consideredcash equivalents.

***Investments***

deCODE invests its excesscash balances in marketable securities. deCODE classifies all of itsinvestments as available-for-sale. Available-for-sale investments are reportedat fair value as of each balance sheet date and any unrealized gains and lossesare reported in stockholders’ equity in accumulated other comprehensive income.Fair value is generally determined with reference to quotations in activemarkets. Premiums and discounts associated with investments in bonds are amortizedusing the effective interest rate method. If any adjustment to fair valuereflects a decline in the value of the investment, is determined to be “otherthan temporary”, the investment is marked to market through a charge to theconsolidated statement of operations.

***Materials and Supplies***

Materials and supplies, included in deCODE’s othercurrent assets, are valued at the lower of cost (first-in, first-out method) ormarket. deCODE evaluates materials and supplies levels and expected usage on aperiodic basis and records write-downs of value for obsolescence as required.At December 31, 2005 and 2004, materials and supplies were valued at$1,158,000 and $1,296,000, respectively.

deCODE recorded chargesfor write-down of obsolete and excess materials and supplies of $63,000,$117,000 and $802,000 for the years ended December 31, 2005, 2004 and2003, respectively. In 2005, 2004 and 2003, deCODE used materials and suppliesfor which it had made provisions for in prior years as slow-moving, excess andobsolete, benefiting otherwise reported research and development expenses by$816,000, $1,411,000 and $780,000, respectively.

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**deCODE genetics, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (tabular amounts in thousands, except share and per share amounts)**

***Property and Equipment***

Property and equipment arerecorded at cost. Depreciation is computed using the straight-line method overthe estimated useful lives of the related assets of generally fifty years forbuildings, three to four years for laboratory equipment, five years forfurniture and fixtures, and three to five years for other equipment.Maintenance and repairs are expensed as incurred, while major betterments arecapitalized. When assets are retired or otherwise disposed of, the assets andrelated accumulated depreciation or amortization are eliminated from theaccounts and any resulting gain or loss is reflected in the statement of operations.

***Capital Leases***

Assets held under capitallease agreements are initially recorded at the lower of the fair market valueof the related asset or the present value of the future minimum rental paymentsusing interest rates appropriate at the inception of the lease. Property andequipment subject to capital lease agreements are amortized over the shorter ofthe life of the lease or the estimated useful life of the asset unless thelease transfers ownership or contains a bargain purchase option, in which casethe leased asset is amortized over the estimated useful life of such asset.

***Impairment of Long-Lived Assets and Goodwill***

deCODE reviews long-lived assets for potentialimpairment annually and whenever events or changes in circumstances indicate thatthe carrying amount of an asset may not be recoverable. Recoverability ofassets held for use is measured by comparing the carrying amount of an asset tothe undiscounted estimated future cash flows expected to be generated by theasset. In estimating expected future cash flows for determining whether anasset is impaired, assets are grouped at the lowest level for which there areidentifiable cash flows that are largely independent of the cash flows of othergroups of assets. If any such assets are considered to be impaired, theimpairment to be recognized is the amount by which the carrying amount of theassets exceeds its fair value.

For purposes of thegoodwill impairment tests, deCODE identifies its reporting units, identifiesthe assets and liabilities of the reporting units and performs impairment testson the goodwill associated with them. Goodwill impairment is deemed to exist ifthe net book value of a reporting unit exceeds its estimated fair value. Toidentify potential impairments deCODE compares fair value of a reporting unitwith its carrying amount, including goodwill. For this purpose, deCODEestimates fair value of a reporting unit using analyses of comparable companiesand recent comparable transactions.

***Finance Costs Related to Long-Term Debt***

Costs associated withobtaining long-term debt are deferred and amortized as interest expense overthe term of the debt. Remaining unamortized deferred financing costs includedin long-term assets were $4,783,000 and $7,067,000 at December 31, 2005 and2004, respectively.

***Revenue Recognition***

deCODE records revenue provided that there ispersuasive evidence that an arrangement exists, the price is fixed anddeterminable, services were rendered and collectibility is reasonably assured.deCODE 

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**deCODE genetics, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (tabular amounts in thousands, except share and per share amounts)**

has entered into research,development and commercialization alliances and collaborations with majorpharmaceutical and biotechnology companies. The key components of thecommercial terms of such alliance arrangements typically include one or more ofthe following: research funding; up-front, exclusivity, technology access, andtechnology development fees; milestone payments; license or commercializationfees; and royalties or profit sharing from the commercialization of products.

deCODE’s revenues from research and developmentcollaboration agreements are recorded and recognized in accordance with theapplicable performance requirements and terms of the respective contracts,generally either (i) as contract research costs are incurred, usuallyratably over the period of effort, (ii) according to the level of effortsexpended based on the ratio of contract research costs incurred to expectedtotal costs, or (iii) upon the achievement of substantive milestones.deCODE’s accounting recognition policies with respect to each significantelement of deCODE’s revenue is summarized as follows:

*Researchfunding and other service fees.**  *Research funding is recognized asearned, typically ratably over the period of effort. Funding payments are notrefundable in the event that the related efforts are not successful. Otherservice revenues from negotiated rate contracts are recognized based upon theterms of the underlying contract generally either (i) on a per diem basisas services are rendered; (ii) on the basis of efforts expended, generallyupon the ratio of costs incurred to total expected costs of providing theservice; or (iii) upon completion of the service rendered. Any losses oncontracts are provided for when they are determinable. Included in revenue arebillings to customers for the cost of materials purchased by deCODE.

*Milestonepayments.**  *EffectiveJanuary 1, 2002 and prior to June 15, 2003, deCODE recognized revenuefrom milestone payments under the substantive milestone method where (i) themilestone event is substantive, (ii) there is substantial effort involvedin achieving the milestone, (iii) the milestone payment amount iscommensurate with the magnitude of the related achievement, and (iv) theassociated follow-on revenue streams bear a reasonable relationship to oneanother. Under the substantive milestone method deCODE records revenue when themilestone has been achieved and payment is due and payable under the terms ofthe respective agreement and deCODE recognizes revenue when acknowledgement ofachievement of applicable performance requirements is received from thecollaborator. Milestone payments without the above characteristics arerecognized on a retrospective basis over the contractual term of the underlyingagreement.

In arrangements with multiple elements entered intoafter June 15, 2003, if the milestone is substantive in nature and thereis uncertainty in the achievement of the milestone and there is no furtherobligation on the part of deCODE, deCODE records revenue when the milestone hasbeen achieved and payment is due and payable under the terms of the respectiveagreement and deCODE recognizes revenue when acknowledgement of achievement ofapplicable performance requirements is received from the collaborator (“MilestonePayment Method”). If the milestone is earned and there is further obligationunder the contract for performance by deCODE, then deCODE will record revenuewhen the milestone has been achieved and payment is due and payable under theterms of the respective agreement and deCODE retroactively recognizes revenuethrough the current period based on the total contractual term and amortizesthe balance over the remaining contractual term.

*Up-front,exclusivity, technology access, and technology development fees.**  *deCODE recognizes revenue fromnon-refundable fees not specifically tied to a separate earnings processratably over the expected 

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**deCODE genetics, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (tabular amounts in thousands, except share and per share amounts)**

customer relationshipperiod or estimated period of performance. Changes in estimates could impactrevenue in the period the estimate is changed. If deCODE’s estimate of theperiod of performance shortens or lengthens, the amount of revenue we recognizefrom such non-refundable fees not specifically tied to a separate earningsprocess could increase or decrease in the period the change in estimate becomesknown; future related revenues would be adjusted accordingly.

*GrantRevenue.*   Researchgrants and contracts that provide for payments to deCODE for work performed arerecognized as revenue when the related expense is incurred and deCODE hasobtained necessary governmental approval to use the grant funds for theseexpenses. Revenues under these contracts will be recognized as deCODE incurscosts related to the contracts.

*Deferred Revenue.*   Ingeneral, prerequisites for billings are established by contractual termsincluding predetermined payment schedules, the achievement of contractmilestones, or submission of appropriate billing detail. Deferred revenuerepresents amounts billed in accordance with contract terms but not yetrecognized according to deCODE’s accounting policy. Unbilled costs and feesarise when revenue has been recognized but customers have not been billed.

***Cost of Revenue, including Collaborative Programs***

deCODE’s cost of revenueis comprised of costs of services provided to customers and collaborators,including the entirety of costs incurred in connection with programs that havebeen partnered and on which deCODE receives research funding. At times, deCODEmay dedicate additional resources and incur costs in addition to costs coveredby research funding received in such collaborative programs. Major components ofdeCODE’s cost of revenue include personnel costs, namely salaries, benefits andstock-based compensation; materials and supplies; services contracted forresearch activities; other third party fees and costs; depreciation of propertyand equipment; amortization of patents and other intangible assets; and itemsof overhead, including allocations of various administrative and facilitiesrelated costs.

***Research and Development Expenses***

All costs associated withinternal research and development and research and development services,including pre-clinical and clinical trial studies, which deCODE has externallycontracted are expensed as incurred.

***Patent Costs***

Patent application costsare charged to legal expense as incurred and classified in selling, general andadministrative expense.

***Stock-Based Compensation***

deCODE follows SFAS No. 123, “*Accounting for Stock-Based Compensation”*(“SFAS No. 123”).The provisions of SFAS No. 123 allow companies to either expense theestimated fair value of stock options granted to employees or to follow theintrinsic value method set forth in Accounting Principles Board Opinion No. 25(“APB No. 25”), “*Accounting for StockIssued to Employees”*, and disclose the pro forma effects on net lossand net loss per share had the estimated fair value of the options granted toemployees been expensed. SFAS No. 123 requires companies to expense theestimated fair value of stock options 

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**deCODE genetics, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (tabular amounts in thousands, except share and per share amounts)**

granted to non-employees.deCODE has elected to follow the intrinsic value method in accounting for itsemployee stock options and follows the fair value method in accounting for itsnon-employee stock options.

Hadcompensation cost for all stock options been determined based on the fair valueat the grant date for awards consistent with the provisions of SFAS No. 123,as amended by SFAS No. 148, *“Accounting forStock-Based Compensation—Transition and Disclosure—an amendment ofFASB Statement No. 123”*(“SFAS No. 148”), deCODE’snet loss and basic and diluted net loss per share would have been changed tothe pro forma amounts indicated below:

| ** **                                                                                                  | ** ** | **For the Years Ended December 31,**         | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2005**                                                              | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                  | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Net loss  attributable to common stockholders—as reported                                              |       | $                                                                     | (62,750    | ) | $ | (57,255 | ) | $ | (35,123 | ) |
| Add: Stock-based  employee compensation expense included in reported net loss                               |       | 441                                                                   |       | 964 |   | 2,440 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value  method for all awards |       | (5,347                                                                | )          | (5,932 | ) | (6,964 | ) |
| Net loss  attributable to common stockholders—proforma                                                 |       | $                                                                     | (67,656    | ) | $ | (62,223 | ) | $ | (39,647 | ) |
| Basic and diluted  net loss per share as reported—as reported                                          |       | $                                                                     | (1.17      | ) | $ | (1.07 | ) | $ | (0.68 | ) |
| Basic and diluted net  loss per share—proforma                                                         |       | (1.26                                                                 | )          | (1.16 | ) | (0.77 | ) |

 

Thefair values of the options granted are estimated on the date of grant using theBlack-Scholes option-pricing model with the following weighted-averageassumptions:

| ** **                | ** ** | **For the Years Ended  December 31,** | ** ** |
|---------------------------|------------|-----------------------------------------------------------|------------|
| ** **                | ** ** | **2005**                                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| Dividends                 |       | -                                                         |       | - |   | - |   |
| Expected  volatility      |       | 80%                                                       |       | 92% |   | 100% |   |
| Expected term (in  years) |       | 5                                                         |       | 5 |   | 5 |   |
| Risk-free interest rates  |       | 4.05%                                                     |       | 3.65% |   | 3.11% |   |

 

In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial AccountingStandards  No. 123 (revised 2004), *“Share-Based Payment”* (“SFAS No. 123R”). This Statementreplaces FASB Statement No. 123 and supersedes APB Opinion No. 25.SFAS No. 123R eliminates the ability to account for employee share-basedcompensation transactions using the intrinsic method used by deCODE. SFAS No. 123Rrequires such transactions be accounted for using a fair-value-based methodthat would result in expense being recognized in deCODE’s financial statements.In April 2005, the Securities and Exchange Commission (“SEC”) adopted a rule thatdefers the required effective date of SFAS No. 123R to fiscal yearsbeginning after June 15, 2005 (January 1, 2006 fordeCODE). Under SFAS No. 123R, companies must calculate andrecord in the income statement the cost of equity instruments, such as stockoptions or restricted stock, awarded to employees for services received; proforma disclosure is no longer permitted. The cost of the equity instruments isto be measured based on fair value of the instruments on the date they aregranted and is required to be recognized over the period during which theemployees are required to provide services in exchange for the equityinstruments.

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**deCODE genetics, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (tabular amounts in thousands, except share and per share amounts)**

deCODE will adopt SFAS No. 123R using the modifiedprospective method. Under the modified prospective method, compensation cost isrecognized for all awards granted subsequent to the effective date of thisstatement as well as for the unvested portion of awards outstanding as of theeffective date. Prior to January 1, 2006, deCODE accounted for stockoptions granted to employees and shares issued under its employee stockpurchase plan in accordance with the intrinsic value method permitted under APBOpinion No. 25 and therefore no compensation expense generally wasrecognized for these awards.

deCODE expects to incur additional stock compensationexpense in its Consolidated Statement of Operations related to stock optionsgranted as of December 31, 2005 and future stock option grants under theprovisions of SFAS No. 123R. The impact of adoptingSFAS No. 123R on periods after adoption cannot be accuratelyestimated at this time, as it will depend on the market value and the amount ofshare based awards granted in future periods. At December 31, 2005, deCODEhad approximately $8.5 million of unamortized compensation expense, related tooptions granted prior to January 1, 2006, to be recognized through 2009,based on the vesting terms of the option agreements and the date the optionswere granted. Of the $8.5 million of unamortized compensation expense,approximately $3.9 million of it will be recognized in the consolidatedstatements of operations in the year ended December 31, 2006. Theseamounts do not take into consideration any grants subsequent toDecember 31, 2005 and also do not take into consideration any forfeiturerate discount as proscribed by SFAS No. 123R.

***Foreign Currency Translation***

deCODE’s functional currency is the U.S. dollar. Oneof its subsidiaries uses the local currency, the Icelandic krona, as thefunctional currency. For this entity, the assets and liabilities are translatedinto U.S. dollars at exchange rates in effect at the balance sheet date. Incomeand expense items are translated at the average exchange rates prevailingduring the period. Gains and losses from translation are included inaccumulated other comprehensive income.

Foreign currencytransaction gains and losses are reported according to the exchange ratesprevailing on the transaction date and are included in the consolidatedstatements of operations classified as other non-operating income and expense.Net transaction and translation losses recorded were $124,000, $3,294,000 and,$29,000 in 2005, 2004 and 2003, respectively.

***Income Taxes***

deCODE accounts for incometaxes using the liability method, which requires the recognition of deferredtax assets or liabilities for the temporary differences between the financialreporting and tax bases of deCODE’s assets and liabilities and for tax losscarryforwards at enacted statutory tax rates in effect for the years in whichthe differences are expected to reverse. A valuation allowance is appliedagainst any deferred tax asset if, based on the weighted available evidence, itis more likely than not that some or all of the deferred tax assets will not berealized.

***Computation of Net Loss per Share***

Basic net loss per share is computed using net lossavailable to common stockholders and the weighted-average number of commonshares outstanding. The weighted-average number of common shares outstandingduring the period is the number of shares determined by relating the portion oftime within a reporting period that common shares have been outstanding to thetotal time in that period.

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**deCODE genetics, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (tabular amounts in thousands, except share and per share amounts)**

Diluted net loss per shareis computed using the weighted-average number of common shares outstandingduring the period, plus the dilutive effect of potential common shares. Dilutednet loss per share does not differ from basic net loss per share in all periodspresented as potential common shares are antidilutive for all such periods andare, therefore, excluded from the calculation.

***Recent Accounting Pronouncements***

In March 2005, the FASB issued FASBInterpretation (“FIN”) 47, “*Accounting forConditional Asset Retirement Obligations—an interpretation of FASB Statement No. 143”.*FIN 47 clarifies that conditional asset retirement obligations meet thedefinition of liabilities and should be recognized when incurred if their fairvalues can be reasonably estimated. deCODE adopted the provisions of FIN 47effective December 31, 2005. The adoption of FIN 47 had no impact ondeCODE’s financial position or results of operations.

In May 2005, the FASBissued SFAS No. 154, “*AccountingChanges and Error**Correction”* (“SFAS No. 154”*)*, a replacement of APB Opinion No. 20 and Statement No. 3.SFAS No. 154 changes the requirements for the accounting and reporting ofa change in accounting principles. SFAS No. 154 applies to all voluntarychanges in accounting principles as well as to changes required by anaccounting pronouncement that does not include specific transition provisions.SFAS No. 154 is effective for accounting changes and corrections of errorsmade in fiscal years beginning after December 15, 2005.

**3.  Revenue**

Significantelements of deCODE’s revenue are summarized as follows:

| ** **                                                                 | ** ** | **For the Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2005**                                                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                 | ** ** | **(In thousands)**                                      | ** ** |
| Research funding  and other service fees                                   |       | $                                                            | 29,111     |   | $ | 31,723 |   | $ | 34,712 |   |
| Milestone  payments                                                        |       | 1,216                                                        |       | 1,835 |   | 5,794 |   |
| Up-front,  exclusivity, technology access, and technology development fees |       | 4,538                                                        |       | 4,116 |   | 4,000 |   |
| Grant funding                                                              |       | 7,287                                                        |       | 2,032 |   | 1,006 |   |
| Other                                                                      |       | 1,803                                                        |       | 2,421 |   | 1,299 |   |
|                                                                       |       | $                                                            | 43,955     |   | $ | 42,127 |   | $ | 46,811 |   |

 

Thefollowing table represents revenue derived by geographic area:

| ** **    | ** ** | **For the Years Ended December 31,**      | ** ** |
|---------------|------------|--------------------------------------------------------------------|------------|
| ** **    | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **    | ** ** | **(In thousands, except per share data)** | ** ** |
| United States |       | $                                                                  | 15,486     |   | $ | 13,680 |   | $ | 13,744 |   |
| Iceland       |       | 28,469                                                             |       | 28,447 |   | 33,067 |   |
|          |       | $                                                                  | 43,955     |   | $ | 42,127 |   | $ | 46,811 |   |

 

Significant collaborativeagreements, contracts and grants are as follows:

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**deCODE genetics, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (tabular amounts in thousands, except share and per share amounts)**

***F. Hoffmann-La Roche (Roche)***

*Therapeutics.*   In2002, deCODE entered into an agreement with Roche to collaborate on fourdiseases that had been the subject of an earlier collaboration with Roche.During 2004 and through January 2005, deCODE collaborated with Roche ontwo of those diseases. Under this agreement deCODE discovered genes linked todiabetes and Roche continues drug discovery based on one of these discoveries.Under the 2002 agreement, which expired on February 1, 2005, deCODEreceived $20,000,000 in research funding and also is entitled to receiveroyalties on the sales of any drugs that are developed coming out of workconducted under this agreement.

In November 2004, deCODE signed a new three-yearagreement with Roche to co-develop inhibitors of PDE4 for the prevention andtreatment of vascular disease, including stroke. This agreement continues workadvanced under the 2002 agreement, and deCODE will focus on optimizing leadcompounds identified in deCODE’s previous work and begin clinical development.Under this agreement, as of the end of 2005, we received $2.0 million ofresearch funding. We will share drug discovery and clinical trials costs underthis new agreement, and we may receive an additional $4.0 million of researchfunding over the remaining term of the agreement as well as milestone paymentsand royalties based on drug sales.

*Diagnostics.**  *In June 2001, deCODE signed afive-year alliance with Roche’s diagnostics division to develop and marketDNA-based diagnostics for major diseases. More recently deCODE has addedresearch programs aimed at developing diagnostics to predict drug response formajor therapeutics used to treat those diseases, in order to help select themost effective treatment of those available.   Under the agreementdeCODE has received $41,125,000 in research funding, up-front fees andmilestone payments. deCODE may receive $3,125,000 in additional researchfunding over the remainder of the term of the agreement as well as milestonepayments upon the achievement of research and development milestones and royaltieson the sales of diagnostic products developed.

Revenues from these alliances with Roche amounted to$9,995,000, $12,613,000 and $19,899,000 for the years ended December 31,2005, 2004 and 2003, respectively. Costs incurred with these collaborativeprograms with Roche amounted to $8,257,000, $19,475,000, and $19,629,000 forthe years ended December 31, 2005, 2004 and 2003, respectively.

For the years ended December 31,2005, 2004 and 2003, Roche represented 23%, 30% and 43%, respectively, ofconsolidated revenue.

***Merck & Co, Inc. (Merck)***

*Obesity.**  *In September 2002, deCODEentered into a three year alliance with Merck aimed at developing newtreatments for obesity. Under the alliance, deCODE combined research effortswith Merck in the genetics of obesity to identify, validate and prioritize aseries of drug targets to take into development. During the three-year researchprogram, which has now expired, deCODE has received research funding,technology access fees and milestone payments in the aggregate amount of $25.3million. In addition, deCODE may receive further technology access fees in thetotal aggregate amount of $2.0 million. Subject to Merck’s developing productsbased on collaboration discoveries, deCODE may also receive developmentmilestones and royalties. deCODE has discovered three genes linked to obesityunder this alliance, and Merck has generated a lead series of compounds againstone of the targets deCODE validated through deCODE’s genetics research.

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**deCODE genetics, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (tabular amounts in thousands, except share and per share amounts)**

Revenues from this alliance with Merck amounted$6,325,000, $7,850,000 and $8,500,000 for the years ended December 31,2005, 2004 and 2003, respectively. Costs incurred in connection with thisalliance with Merck amounted to $2,933,000, $4,630,000 and $5,230,000 for theyears ended December 31, 2005, 2004 and 2003, respectively.

*Information-RichClinical Trials.**  *InFebruary 2004, deCODE entered into an agreement with Merck which providesthat deCODE will conduct information-rich clinical trials on a range of Merck’sdevelopmental compounds that Merck selects for inclusion in the program. Theterm of the alliance is seven years, subject to termination by Merck after fiveyears. The collaboration involved three agreements: (a) a License andResearch Collaboration Agreement; (b) a Stock and Warrant PurchaseAgreement; and (c) a Warrant Agreement. Under the terms of the License andResearch Collaboration Agreement, deCODE will receive royalties on sales ofdrugs and diagnostics developed as part of the alliance, will receive milestonepayments as compounds or pharmacogenomic tests reach the market, will receiveresearch funding for the clinical development of compounds and pharmacogenomicanalysis, and received a one-time technology access fee of $10,000,000. Acontingency clause on the technology access fee provides that if deCODE rejectsthe first two non-exclusive development compounds that Merck presents to thecollaboration, then Merck has the right to request a refund of $2,500,000 ofthe technology access fee. The remaining amount of the technology access fee isnon-refundable. To date, Merck has not selected any compounds for developmentunder the agreement.

Under the terms of the Stock and Warrant PurchaseAgreement, Merck purchased 689,703 shares of deCODE’s common stock at a priceof $14.50 per share or $10,000,000, which represents a premium of $2,700,000 tothe fair market value of the stock on the effective date of the agreement($10.60 per share). Accordingly, of the $10,000,000 cash received, deCODEascribed $7,300,000 to the common stock and $2,700,000 to deferred revenue.Under the terms of the Warrant Agreement, deCODE has issued Merck a warrant topurchase up to 1,724,257 of additional shares of deCODE’s common stock at anexercise price of $29.00 per share over the five year term of the warrant. Thewarrant is exercisable at Merck’s option as to 344,851 shares for a period of30 days commencing on the first, second, third, fourth and fifthanniversaries of the Warrant Agreement with the final portion of warrantsexpiring in March 2009. Any portion of this warrant that is not exercisedduring an applicable exercise period shall expire and be of no further force oreffect. The warrant was valued at $6,300,000 using a Black Scholes model withthe following assumptions: lives of one to five years, risk free interest ratesof 1.24% to 3.07%, volatility of 90% and no dividend yield. The one-timetechnology access fee of $10,000,000 and the $2,700,000 premium received on thesale of common stock less the estimated fair value of the warrant of$6,300,000, together netting to $6,400,000, has been recorded as deferredrevenue. This amount less the refundable amount of $2,500,000 ($3,900,000) isbeing recognized as revenue according to level of efforts over the seven-yeardevelopment term. The refundable $2,500,000 technology access fee will berecognized as revenue according to level of efforts retrospectively over theseven-year development term commencing upon satisfaction of the contingency.

Revenues from this alliance with Merck amounted to $190,000and $825,000 for the years ended December 31, 2005 and 2004, respectively.Costs incurred in connection with this alliance with Merck amounted to $144,000and $1,313,000 for the years ended December 31, 2005 and 2004,respectively.

For the years ended December 31,2005, 2004 and 2003, revenues from Merck represented 15%, 22% and 18%,respectively, of consolidated revenue.

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**deCODE genetics, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (tabular amounts in thousands, except share and per share amounts)**

***Grant Funding***

deCODE has received various research grants fromdivisions of the United States National Institutes of Health (NIH), theCommission of the European Communities (EC) and private foundations. Researchgrants for multiple years are based on approved budgets with budgeted amountssubject to approval on an annual basis. NIH grants generally provide for 100%reimbursement of allowable expenditures while the grant under the EC generallyprovides for fifty percent reimbursement of allowable research and developmentrelated expenditures. deCODE’s significant research grants include:

*NationalInstitute of Allergy and Infectious Diseases (NIAID).**  *In September 2004, deCODE wasawarded a five-year $23,900,000 contract by the NIAID, a division of NIH. Underthe contract, deCODE will apply its population approach and resources todiscover genetic factors associated with susceptibility to certain infectiousdiseases and with responsiveness to vaccines targeting such diseases. Revenuesfrom this contract with NIAID amounted to $4,042,000 and $138,000 for the yearsended December 31, 2005 and 2004, respectively.

For the years ended December 31,2005, 2004 and 2003, deCODE recognized revenue of $7,287,000, $2,032,000 and$1,006,000 from research grants. Costs incurred with research grants amountedto $7,724,000, $2,032,000 and $1,006,000 for the years ended December 31,2005, 2004 and 2003, respectively. For the year ended December 31, 2005,NIH represented 13% of consolidated revenue.

**4.  Research and Development—Proprietary Programs**

deCODE’sresearch and development expenses consist of the costs of its own proprietaryprograms and consist of the following:

| ** **                                       | ** ** | **For the Year Ended December 31,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                       | ** ** | **2005**                                                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                       | ** ** | **(In thousands)**                                      | ** ** |
| Salaries and  other personnel costs              |       | $                                                            | 18,072     |   | $ | 10,233 |   | $ | 8,375 |   |
| Materials and  supplies                          |       | 4,600                                                        |       | 3,671 |   | 2,650 |   |
| Contractor  services and other third party costs |       | 13,285                                                       |       | 3,938 |   | 3,669 |   |
| Overhead expenses                                |       | 4,630                                                        |       | 1,603 |   | 1,773 |   |
| Depreciation and  amortization                   |       | 3,089                                                        |       | 5,123 |   | 3,883 |   |
| Stock-based  compensation                        |       | 72                                                           |       | 374 |   | 467 |   |
| Database license  fee reversal                   |       | —                                                       |       | — |   | (3,221 | ) |
|                                             |       | $                                                            | 43,748     |   | $ | 24,942 |   | $ | 17,596 |   |

 

On January 22, 2000, the Icelandic Ministry ofHealth and Social Security (the “Ministry”), granted deCODE an operatinglicense (the “License”) to create, operate and commercialize the IcelandicHealth Sector Database (the “IHD”), or the License. As required by the License,and concurrently with its issuance, deCODE entered into an agreement (the “Agreement”)with the Ministry whereby deCODE would be obligated to pay the Icelandicgovernment a fixed annual fee of 70 million Icelandic kronas per year andan additional annual fee of 6% of its net profit, up to a maximum of70 million Icelandic krona per year as a consideration for the rightsgranted to deCODE under the License. Through June 2003, $3,221,000 inrespect of these annual fees had been provided for and included in otheraccrued expenses. Under the terms of the Agreement, certain events needed totake place in order for the fixed annual fee to 

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**deCODE genetics, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (tabular amounts in thousands, except share and per share amounts)**

become due, including theconsummation of certain data transfer agreements with the National UniversityHospital (“NUH”). No such agreement with the NUH has been consummated, and theIHD has not been commercialized primarily because the Icelandic Data ProtectionAuthority has not issued the required security certification. In light of thedevelopment of deCODE’s business since the Agreement was entered into, the lackof the required agreement with the NUH and the fact that the Icelandic DataProtection Authority has not issued the required security certification, we donot expect to operate the IHD under the terms of the Agreement.   Becauseof this, management’s estimation after consultation with legal counsel is thatit is no longer probable that the accrued fixed annual fee will become due, andaccordingly, a reversal of the accrued fees has reduced recorded research anddevelopment expenses for the year-ended December 31, 2003.

In November 2003,deCODE acquired an exclusive worldwide license from Bayer HealthCare AG (Bayer)to develop and commercialize a small molecule compound that is active against akey target, located within an inflammatory pathway, made by a gene isolated atdeCODE that predisposes to myocardial infarction, or heart attack. A portion ofdeCODE’s payment to Bayer for this license was paid in the fourth quarter 2003and the remainder was paid in the second quarter of 2004 following completionof certain diligence matters. Since there was no alternative use of thetechnology, these payments were recorded as research and development expenseduring the fourth quarter of 2003. Further, deCODE is obligated to makedevelopment milestone payments to Bayer as the compound advances towards marketapproval and will make royalty payments to Bayer based upon sales of thecompound as a marketed drug.

**5.  Net Loss PerCommon Share**

Thefollowing potentially dilutive common share equivalents were excluded from thecalculations of diluted net loss per share because their effect wasantidilutive:

| ** **                                                                                            | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                            | ** ** | **2005**                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                            | ** ** | **(Shares)**                                                  | ** ** | **(Shares)** | ** ** | **(Shares)** | ** ** |
| Warrants to  purchase shares of common stock                                                          |       | 2,729,873                                                     |       | 3,124,733 |   | 1,400,467 |   |
| Options to  purchase shares of common stock                                                           |       | 4,702,702                                                     |       | 4,689,942 |   | 4,108,331 |   |
| Restricted shares  subject to vesting or with an associated outstanding non-recourse  promissory note |       | 774,787                                                       |       | 788,800 |   | 1,235,975 |   |
| Convertible  shares issuable upon conversion of 3.5% senior convertible notes                         |       | 10,714,286                                                    |       | 10,714,286 |   | — |   |
|                                                                                                  |       | 18,921,648                                                    |       | 19,317,761 |   | 6,744,773 |   |

 

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**deCODE genetics, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (tabular amounts in thousands, except share and per share amounts)**

**6.  Investments**

deCODE’smarketable securities are classified as available for sale. These investmentsare classified in current assets and are summarized as follows:

| ** **                                      | ** ** | **Amortized  Cost**     | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |   |
|-------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|-------------------------------|------------|--------------------------------|------------|--------|
| ** **                                      | ** ** | **(in thousands)** | ** ** |                         |
| **December 31,  2005**                     |       |                    |       |                         |       |                          |       |                           |       |   |   |   |   |
| Auction rate  securities                        |       | $                       | 69,760     |                         |       | $                             | —     |                           |       |   | $ | — |   |   | $ | 69,760 |   |
| Government debt  securities                     |       | 15,000                  |       |                         | —     |                          |       |                           | (149       | )      |   | 14,851 |   |
| Corporate bond                                  |       | 5,000                   |       |                         | —     |                          |       |                           | —     |   |   | 5,000 |   |
|                                            |       | $                       | 89,760     |                         |       | $                             | —     |                           |       |   | $ | (149 | ) |   | $ | 89,611 |   |
| **December 31,  2004**                     |       |                    |       |                         |       |                          |       |                           |       |   |   |   |   |
| Auction rate  securities                        |       | $                       | 85,050     |                         |       | $                             | —     |                           |       |   | $ | — |   |   | $ | 85,050 |   |
| Intermediate term  bond fund                    |       | 30,000                  |       |                         | 27         |                          |       |                           | —     |   |   | 30,027 |   |
| Certificate of  deposit (due January 2005) |       | 5,000                   |       |                         | —     |                          |       |                           | —     |   |   | 5,000 |   |
| Corporate bond  (due January 2005)         |       | 2,007                   |       |                         | —     |                          |       |                           | (2         | )      |   | 2,005 |   |
|                                            |       | $                       | 122,057    |                         |       | $                             | 27         |                           |       |   | $ | (2 | ) |   | $ | 122,082 |   |

 

**7.  Property andEquipment**

Propertyand equipment consist of the following:

| ** **                                       | ** ** | **December 31,**   | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                       | ** ** | **(In thousands)** | ** ** |
| Land                                             |       |                    | $          | 2,303 |   |   | $ | 2,303 |   |
| Buildings                                        |       |                    | 16,138     |   |   | 50,547 |   |
| Laboratory  equipment                            |       |                    | 21,513     |   |   | 18,151 |   |
| Furniture and  fixtures                          |       |                    | 3,877      |   |   | 5,687 |   |
| Other equipment                                  |       |                    | 4,354      |   |   | 3,955 |   |
|                                             |       |                    | 48,185     |   |   | 80,643 |   |
| Less: accumulated  depreciation and amortization |       |                    | (23,685    | ) |   | (20,196 | ) |
| Total                                            |       |                    | $          | 24,500 |   |   | $ | 60,447 |   |

 

The total depreciation and amortization expense ofproperty and equipment for the years ended December 31, 2005, 2004 and2003 was $7,003,000, $12,029,000 and $12,442,000, respectively.

Property and equipment also includes amounts forcertain fixed assets financed under other capital lease obligations. Total costand accumulated amortization relating to all of deCODE’s property and equipmentsubject to capital lease obligations was $1,428,000 and $570,000, respectively,as of December 31, 2005 and $7,328,000 and $3,547,000, respectively, as ofDecember 31, 2004. deCODE’s capital lease obligations are collateralizedby the assets to which the obligations relate.

In light of experience and the current technologicalenvironment, in 2004, deCODE changed certain of its salvage value and usefullife estimates for equipment and furniture and fixtures for purposes of 

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**deCODE genetics, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (tabular amounts in thousands, except share and per share amounts)**

depreciation. Thesechanges in estimates had the effect in increasing depreciation expense andbasic and diluted net loss per share by $2,171,000 and $0.04 per share,respectively, for the year end December 31, 2004.

In June 2003, deCODE sold certain laboratoryequipment for $4,750,000 net cash proceeds and leased the equipment back fromthe counter-party (an Icelandic leasing company) for an 18-month term. InJanuary 2004, the lease was extended for another 18-month term withthe final payment due June 2006. As ownership of the equipment will betransferred to deCODE at the end of the extended lease without any furthersignificant payment, the transaction has been recorded as a financing and thegain ($1,418,000) has been deferred and is being amortized over the remaining usefullife of the leased equipment.

Long-lived assets locatedin the United States and Iceland were $26,231,000 and $13,494,000, respectivelyat December 31, 2005 and $22,955,000 and $55,115,000, respectively at December 31,2004.

**8.  Goodwill andOther Intangibles**

All of deCODE’s goodwill resulted from the acquisitionof MediChem and is allocated to deCODE’s drug discovery reporting unit. Thegoodwill is tested for impairment annually on September 30 of each yearand whenever changes in the circumstances indicate goodwill could be impaired.No goodwill impairment losses were recorded in the years ended December 31,2005, 2004 and 2003.

Otherintangible assets included in other long-term assets and deferred charges onthe consolidated balance sheet as of December 31, 2005 and 2004 consist ofthe following:

| ** **                                | ** ** | **For the Year Ended December 31, 2005** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Gross**                                                              | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| ** **                                | ** ** | **(In thousands)**                                                | ** ** |
| Developed technology,  5 year life   |       | $                                                                      | 4,560      |   |   | $ | 3,458 |   |   | $ | 1,102 |   |
| Patents, 5-7 year  life              |       | 380                                                                    |       |   | 181 |   |   | 199 |   |
| Royalty-free licenses,  10 year life |       | 230                                                                    |       |   | 87 |   |   | 143 |   |
| Other, 5 year life                   |       | 320                                                                    |       |   | 243 |   |   | 77 |   |
| Total                                     |       | $                                                                      | 5,490      |   |   | $ | 3,969 |   |   | $ | 1,521 |   |

 

| ** **                                | ** ** | **For the Year Ended December 31, 2004** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Gross**                                                              | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| ** **                                | ** ** | **(In thousands)**                                                | ** ** |
| Developed technology,  5 year life   |       | $                                                                      | 4,560      |   |   | $ | 2,546 |   |   | $ | 2,014 |   |
| Patents, 5-7 year  life              |       | 380                                                                    |       |   | 133 |   |   | 247 |   |
| Royalty-free licenses,  10 year life |       | 230                                                                    |       |   | 64 |   |   | 166 |   |
| Other, 5 year life                   |       | 320                                                                    |       |   | 179 |   |   | 141 |   |
| Total                                     |       | $                                                                      | 5,490      |   |   | $ | 2,922 |   |   | $ | 2,568 |   |

 

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**deCODE genetics, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (tabular amounts in thousands, except share and per share amounts)**

Aggregate amortization expense was $1,047,000 for eachof the years ended December 31, 2005, 2004 and 2003, respectively. Theseamounts were included in research and development expenses for all periodspresented. Estimated amortization expense for the five succeeding years as of December 31,2005 is as follows:

| 2006       |   | $   | 1,047  |   |
|------------|--------|-----|--------|--------|
| 2007       |   | 274 |   |
| 2008       |   | 71  |   |
| 2009       |   | 45  |   |
| 2010       |   | 38  |   |
| Thereafter |   | 46  |   |
|       |   | $   | 1,521  |   |

 

**9.  Accrued Expenses and Other Current Liabilities**

Accruedexpenses and other current liabilities consist of the following:

| ** **                            | ** ** | **December 31,**   | ** ** |
|---------------------------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                            | ** ** | **(In thousands)** | ** ** |
| Salaries and other  employee benefits |       | $                       | 6,814      |   | $ | 5,578 |   |
| Accrued interest                      |       | 1,107                   |       | 1,395 |   |
| Other current  liabilities            |       | 4,902                   |       | 2,555 |   |
| Total                                 |       | $                       | 12,823     |   | $ | 9,528 |   |

 

In January, 2004 a then executive officer of deCODEacquired an ownership interest in Icelandair, the only regularly-scheduledcommercial airline serving Iceland. From January 2004 through June 2004(when the executive officer left the employ of the company) deCODE incurredcharges to Icelandair of $436,000 for business travel by deCODE’s officers andemployees. deCODE believes that the rates charged us by Icelandair are no lessfavorable than those it charges other customers.

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**10. Short-Term Borrowings**

Short-term borrowings asof December 31, 2004 consisted of $4,500,000 with an Icelandic financialinstitution that was due in two amounts of $2,500,000 and $2,000,000 on March 17,2005 and April 28, 2005 at an interest rate of three month LIBOR (3.46%and 3.52%, respectively), together with a short-term loan for $1,100,000entered into in August 2004 at an interest rate of 3.79% due in tenmonthly principal installments of $114,000. The balance of the short-term loanat December 31, 2004 was $569,000. In 2005 and in connection with thesale-leaseback financing of Sturlugata 8 discussed in Note 12, deCODE repaidthe short-term borrowings of $4,500,000 and the remaining balance on theshort-term loan. There were no short-term borrowings outstanding at December 31,2005.

**11.  Long-TermDebt**

Long-termdebt consists of the following:

| ** **                | ** ** | **December 31,**   | ** ** |
|---------------------------|------------|-------------------------|------------|
| ** **                | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                | ** ** | **(In thousands)** | ** ** |
| Senior  convertible notes |       | $                       | 150,000    |   | $ | 150,000 |   |
| Mortgage bonds            |       | —                  |       | 14,236 |   |
| Mortgage loans            |       | 5,921                   |       | 31,659 |   |
| Equipment notes           |       | 282                     |       | 721 |   |
| Total                     |       | 156,203                 |       | 196,616 |   |
| Less current  portion     |       | 550                     |       | 7,081 |   |
| Long-term portion         |       | $                       | 155,653    |   | $ | 189,535 |   |

 

As of December 31,2005 principal payments on long-term debt are as follows:

| 2006                 |   | $       | 550     | ** ** |
|----------------------|--------|---------|---------|------------|
| 2007                 |   | 5,652   |    |
| 2008                 |   | 1       |    |
| 2009                 |   | -       |    |
| 2010                 |   | -       |    |
| 2011 and  thereafter |   | 150,000 |    |
|                 |   | $       | 156,203 |       |

 

***Senior Convertible Notes***

In April 2004, deCODEcompleted an offering of 3.5% Senior Convertible Notes (the “Notes”) due 2011to qualified institutional buyers. The Notes are convertible into shares ofdeCODE common stock, at the option of the holder, at a price of $14.00 pershare (fair market value of $10.60 on date of issuance), which is equivalent toan initial conversion rate of approximately 71.43 shares per $1,000 principalamount of the Notes. deCODE may redeem the Notes beginning April 20, 2009.Interest is payable semi-annually on April 15 and October 15. Duringthe years ended December 31, 2005 and 2004, interest expense of $5,250,000and $3,768,000 was recorded to other non-operating expenses in the ConsolidatedStatements of Operations. From this offering, deCODE received net proceeds of$143,805,000. deCODE recorded deferred offering costs of $6,195,000 which arebeing amortized to interest expense over the seven-year life of the Notes.During the years ended December 31, 2005 and 2004, interest expense of$885,000 and $635,000 was recorded to other non-operating expenses in theConsolidated Statements of Operations related to the deferred offering costamortization. Deferred financing costs related to the Notes is included inother long-term assets and totals $4,783,000 and $5,560,000 at December 31,2005 and 2004.

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***Mortgage Bonds***

The mortgage bonds (at December 31,2004 consisting of Tier A bonds) were issued in 2002 in the amount of$13,500,000 to finance the construction of deCODE’s headquarters facility inIceland and are denominated in Icelandic krona and are linked to the IcelandicConsumer Price Index. The mortgage bonds bore annual interest of 8.5% that waspayable annually along with principal beginning in December 2002 and finalpayment in December 2008. The mortgage bonds were collateralized by deCODE’sheadquarters facility. The mortgage bonds were repaid in 2005 in conjunctionwith the sale-leaseback financing (see Note 12).

***Mortgage Loans***

In March 2005,deCODE entered into sale-leaseback financings (see Note 12) and in conjunctionwith those financings, certain mortgage loans were extinguished. The mortgageloans are collateralized by deCODE’s facilities to which the underlying loansrelate to. Prior to the sale-leaseback financing the mortgage loans that wereextinguished in 2005, consisted of the following:

·       InDecember 2001, deCODE established a $27,500,000 bridge loan with anIcelandic financial institution to finance the construction of its newheadquarters facility. The borrowings under the bridge loan were repaid in January andMarch 2002 with the proceeds from the Tier A bonds, Tier C $7,300,000offering of privately placed bonds and Tier D $6,600,000 bank loan. In December 2001,deCODE also entered into a $4,000,000 bank loan (Tier B) for theconstruction of its new headquarters facility. The Tier B bank loan wasdenominated in U.S. dollars and the principal amount was payable quarterlybeginning in March 2002. The Tier B bank loan bears annual interest ofthree-month LIBOR plus 3.0% (5.42% at December 31, 2004) that was payablequarterly beginning March 2002. The lender may demand prepayment of theTier B bank loan in certain circumstances. The Tier C bonds was denominated inIcelandic krona and was linked to the Icelandic Consumer Price Index. Theprincipal amount was payable in March 2007. The Tier C bonds bear annualinterest of 12.0%. The principal amount was payable in March 2007. TheTier D bank loan was denominated in U.S. dollars and bears annual interest ofthree-month LIBOR plus 6.0% (8.71% at December 31, 2004) that was payablequarterly. The principal amount was payable in March 2007. Tier C bondsmay be prepaid at each interest payment date and the Tier D bank loan may beprepaid on the anniversary date of the loan.

·       Inconnection with the Tier A and Tier C bonds deCODE entered into twocross-currency swaps as economic hedges against foreign exchange ratefluctuations. These outstanding contracts bear annual interest of three-monthLIBOR plus 2.85% and twelve-month LIBOR plus 6%, respectively. (See Note 14)

·       InMarch 2004, deCODE entered into a $17,500,000 mortgage loan with anIcelandic financial institution (the “Lender”) to refinance the Tier C and TierD. deCODE has accounted for this refinancing in accordance with EITF 96-19“Debtor’s Accounting for Modification or Exchange of Debt Instruments”.Accordingly, the remaining unamortized borrowing costs and discount associatedwith the refinanced debt, along with borrowing costs associated with the newterm loan will be amortized to interest expense over the remaining term of thenew loan. Deferred financing costs related to the mortgage loan is included inother long-term assets and total $1,400,000 at December 31, 2004.

·       InNovember 2002, deCODE established a $2,200,000 mortgage loan with anIcelandic financial institution. The bank loan was denominated in U.S. dollarsand bore interest at a rate of 6 month LIBOR plus 1.95%, payable insemi-annual installments of $73,000 beginning June 2003 with a finalpayment of $1,836,000 that was paid in 2005 in connection with thesale-leaseback transaction (See Note 12).

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In June 2002, deCODE executed a mortgage for$11,800,000 with a financial institution for its Woodridge, IL facility. Thedebt carried an interest rate of three-month LIBOR + 1.75%,withmonthly principal payments of $49,000 for five years and a final payment of$8,800,000 in 2007. In connection with a refinancing of the mortgage in March 2005,deCODE eliminated restricted cash collateral totaling $6,000,000 and enteredinto an agreement to refinance its $10,211,000 mortgage with the same financialinstitution by paying down $4,000,000 of the mortgage balance and refinancing$6,211,000. The new mortgage carries an interest rate of three-month LIBOR +2.25% (6.32% at December 31, 2005), payable in monthly installments of$26,000 for two years and three months with a final payment of $5,500,000 duein June 2007.

***Equipment Notes***

The equipment notesconsist of various loans for laboratory and other equipment and range inprincipal amount from $7,000 to $181,000 and are collateralized by the relatedequipment. The notes are generally payable over a term of 4 years atinterest rates ranging from 8.52% to 9.57%.

**12.  **Sale-LeasebackFinancing

***Sturlugata***

*In March 2005, deCODE enteredinto a financing for the sale and leaseback of its headquarters facility atSturlugata 8, Reykjavik, Iceland. The sale price for the property was 3.4billion Icelandic kronas ($54,767,000 after taking into account a forwardforeign exchange contact entered in connection with the sale of the property).As a result of the sale, the remaining net book value of the property($29,278,000) has been removed from the balance sheet as of December 31,2005 and the resulting gain has been deferred and is being recognized inearnings over the 15 year term of the leaseback.*

A portion of the proceeds from the sale of Sturlugata8 were used to prepay approximately $38,639,000 of short and long-term debtthat was secured by mortgages on the property (See Notes 10 and 11). deCODErecorded a loss on early extinguishment of debt during the year ended December 31,2005 amounting to $3,142,000 which consisted of (i) prepayment fees($1,400,000), (ii) write-off of remaining unamortized finance costs($1,394,000), and (iii) remaining unamortized discount on the prepaidlong-term debt ($347,000). The loss has been recorded in other non-operatingexpense in the accompanying Consolidated Statement of Operations.

deCODE has leased theSturlugata 8 property back under a 15 year non-cancelable lease agreement at arent of 21.4 million Icelandic kronas per month ($339,000 as of December 31,2005), subject to changes based on the Icelandic consumer price index. Thelease is an operating lease and, as a result, Icelandic krona denominated rentwill be included in operating expenses over the 15 year term of the leaseagreement.

***Krokhals***

In June 2005, deCODE entered into a financing forthe sale and leaseback of its facility at Krokhals 5D and 5E, Reykjavik,Iceland. The sale price for the property was 502 million Icelandic kronas ($7,672,000 after taking into account the sales commission of $117,000). As aresult of the sale, the remaining net book value of the property ($4,029,000)has been removed from the balance sheet as of December 31, 2005, and theresulting gain ($3,559,000) has been deferred and will be recognized toearnings over the 15 year term of the leaseback. A portion of the proceeds fromthe sale of Krokhals were used to prepay approximately $1,836,000 of long-termdebt that was secured by a mortgage on the property.

deCODE has leased theKrokhals 5D and 5E property back under a 15 year non-cancelable lease agreementat a rent of 4.1 million Icelandic krona per month ( $65,000 as of December 31,2005), subject 

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tochanges based on the Icelandic consumer price index. The lease is an operatinglease and, as a result, Icelandic krona denominated rent will be included inoperating expenses over the 15 year term of the lease agreement.

***Equipment***

In June 2003, deCODE sold certain laboratoryequipment for $4,750,000 net cash proceeds and leased the equipment back fromthe counter-party (an Icelandic leasing company) for an 18-month term. InJanuary 2004, the lease was extended for another 18-month term withthe final payment due June 2006. As ownership of the equipment will betransferred to deCODE at the end of the extended lease without any furthersignificant payment, the transaction has been recorded as a financing and thegain ($1,418,000) has been deferred and is being amortized over the remaininguseful life of the leased equipment.

In December 2005,deCODE entered into a financing for the sale and leaseback of equipment. Thesale price of the equipment was 71.6 million Iceland kronas ($1,200,000) andthe resulting gain of $222,000 has been deferred and is being recognized inearnings over the 37 month term of the leaseback.

**13.  Commitmentsand Contingencies**

***Lease Arrangements***

deCODEleases certain property, equipment and other assets under non-cancelable leasesthat expire at varying dates through 2020. At December 31, 2005, futureminimum lease payments under all non-cancelable leases are as follows:

| ** **                                      | ** ** | **Operating**           | ** ** | **Capital** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|-------------|------------|
| ** **                                      | ** ** | **(In thousands)** | ** ** |
| 2006                                            |       |                    | $          | 5,973       |       |   | $ | 1,391 |   |
| 2007                                            |       |                    | 5,429      |        |       | 615 |   |
| 2008                                            |       |                    | 5,250      |        |       | 471 |   |
| 2009                                            |       |                    | 5,157      |        |       | 8 |   |
| 2010                                            |       |                    | 5,039      |        |       | — |   |
| 2011 and  thereafter                            |       |                    | 46,750     |        |       | -— |   |
| Total minimum  lease payments                   |       |                    | $          | 73,598      |       |   | 2,485 |   |
| Less amount  representing interest              |       |                    |       |        |       | (126 | ) |
| Present value of  future minimum lease payments |       |                    |       |        |       | 2,359 |   |
| Less: current  portion                          |       |                    |       |        |       | 1,313 |   |
| Long-term portion                               |       |                    |       |        |       | $ | 1,046 |   |

 

Total rent expense foroperating leases was $2,888,000, $1,482,000 and $1,648,000 in the years ended December 31,2005, 2004 and 2003, respectively. For the year ended December 31, 2005the amount reflects the amortization of the deferred gain on sale-leaseback ofproperties of $1,583,000.

***Other Commitments***

Under the terms of certaintechnology licensing agreements, deCODE is obligated to make payments upon theachievement of established milestones leading to the discovery of definedproducts. These payments could total $6,000,000, of which deCODE believes$1,000,000 may be incurred in 2006, with the timing of payments of theremainder not determinable at the current time.

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***Guarantees***

When as part of anacquisition deCODE acquires all of the stock or all of the assets andliabilities of a company, it assumes the liability for certain events oroccurrences that took place prior to the date of acquisition. The maximumpotential amount of future payments it could be required to make for suchobligations is undeterminable at this time. deCODE has no liabilities recordedfor these liabilities as of December 31, 2005.

***Indemnification***

deCODE enters intoindemnification provisions under (i) its agreements with other companiesin its ordinary course of business, typically with business partners,contractors, clinical sites and customers and (ii) its agreements withinvestors. Under these provisions deCODE generally indemnifies and holdsharmless the indemnified party for losses suffered or incurred by theindemnified party as a result of deCODE’s activities or, in some cases, as aresult of the indemnified party’s activities under the agreement. Theseindemnification provisions generally survive termination of the underlyingagreement. In addition, in some cases, deCODE has agreed to reimburse employeesfor certain expenses and to provide salary continuation during short termdisability. The maximum potential amount of future payments deCODE could berequired to make under these indemnification provisions is unlimited. deCODEhas not incurred material costs to defend lawsuits or settle claims related tothese indemnification agreements. As a result, the estimated fair value ofthese agreements is minimal. Accordingly, deCODE has no liabilities recordedfor these agreements as of December 31, 2005.

***Litigation***

Other than claims and legal proceedings that ariseform time to time in the ordinary course of business which are not material,deCODE has no pending legal proceedings except as follows:

On or about April 20, 2002, an amended classaction complaint, captioned *In re deCODE genetics, Inc.Initial Public Offering Securities Litigation* (01 Civ. 11219(SAS)),alleging violations of federal securities laws in connection with deCODE’sinitial public offering was filed in the United States District Court for theSouthern District of New York on behalf of certain purchasers of deCODE commonstock. The complaint names deCODE, two individuals who were executive officersof deCODE at the time of its initial public offering (the “IndividualDefendants”), and the two lead underwriters (the “Underwriter Defendants”) forour initial public offering in July 2000 (the “IPO”) as defendants.

deCODE is aware that similar allegations have beenmade in hundreds of other lawsuits filed (many by some of the same plaintifflaw firms) against numerous underwriter defendants and issuer companies (andcertain of their current and former officers) in connection with various publicofferings conducted in recent years. All of the lawsuits that have been filedin the Southern District of New York have been consolidated for pretrial purposesbefore United States District Judge Shira Scheindlin. Pursuant to theunderwriting agreement executed in connection with our IPO, deCODE has demandedindemnification from the Underwriter Defendants. The Underwriter Defendantshave asserted that our request for indemnification is premature.

Pursuant to an agreement the Individual Defendantshave been dismissed from the case without prejudice.

On July 31, 2003, our Board of Directors (otherthan our Chairman and Chief Executive Officer, who recused himself because hewas an Individual Defendant) approved a proposed partial settlement with theplaintiffs in this matter, subject to a number of conditions, including theparticipation of a substantial number of other issuer defendants in theproposed settlement, the consent of deCODE’s insurers to the 

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settlement, and thecompletion of acceptable final settlement documentation. Any direct financialimpact of the proposed settlement is expected to be borne by deCODE’s insurers.

In conjunction with the plaintiffs, the settlingissuer defendants filed a motion seeking the court’s preliminary approval ofthe settlement. The court granted preliminary approval of the settlement on February 15,2005, subject to certain modifications. On August 31, 2005, the courtissued a preliminary order further approving the modifications to thesettlement and certifying the settlement classes. The court also appointed theNotice Administrator for the settlement and ordered that notice of thesettlement be distributed to all settlement class members beginning on November 15,2005. The settlement fairness hearing has been set for April 24, 2006.Following the hearing, if the court determines that the settlement is fair tothe class members, the settlement will be approved. There can be no assurancethat this proposed settlement will be approved and implemented in its currentform, if at all. If the settlement of the IPO litigation is not consummated,deCODE expects to contest the allegations in the action vigorously. Due to theinherent uncertainties of litigation and because the settlement approvalprocess is at a preliminary stage, we cannot predict the ultimate outcome ofthis matter.

Due to the inherentuncertainties of litigation, and the fact that the settlement of the litigationrelating to our IPO remains subject to court approval, the ultimate outcome ofthis matter cannot be predicted. If deCODE were required to pay significantmonetary damages in the event that the IPO settlement is unconsummated or as aresult of an adverse determination in the other actions described above (or anyother lawsuits alleging similar claims filed against deCODE and deCODE’sdirectors and officers in the future), deCODE’s business could be significantlyharmed. Even if such litigations conclude in deCODE’s favor, deCODE may berequired to expend significant funds to defend against the allegations. deCODEis unable to estimate the range of possible loss from the above litigations andno amounts have been provided for such matters in deCODE’s financialstatements.

**14.  Derivative Financial Instruments**

deCODE recognizes all derivatives as either assets orliabilities in the consolidated balance sheet and measures those instruments atfair value. The fair value of derivative instruments is sensitive to movementsin the underlying market rates and other variables. deCODE monitors the fairvalue of derivative instruments on a periodic basis. Fair values are estimatedfor each derivative using common market valuation methods with reference toavailable market data as of the balance sheet date.

deCODE seeks to maintain a desired level offloating-rate debt with respect to its overall debt portfolio denominated inU.S. dollars. To this end, deCODE had used interest rate and cross-currencyswaps to manage interest rate and foreign currency risk arising from long-termdebt obligations denominated in Icelandic krona. During 2003, these interestrate and cross-currency swaps with a combined notional amount of1,730 million Icelandic krona were designated as economic hedges of fixedrate foreign currency debt, but did not qualify for hedge accounting. For theyear ended December 31, 2003, the resulting change in the unrealized gainrelated to these instruments for the year-ended December 31, 2003 of$4,824,000 is included in other non-operating income and (expense), net in theConsolidated Statements of Operations.

In March 2004, deCODE refinanced its foreigncurrency debt, with the new instrument being a variable rate U.S dollardenominated debt. Following-on from this refinancing, deCODE reconsidered itstwo cross-currency swaps and decided to liquidate them realizing $9,720,000 inproceeds. deCODE realized a loss on this early termination that, together withunrealized losses on the swaps during the quarter ended March 31, 2004,amounted to $1,465,000. Unrealized and realized gains and losses on these twocross-currency swaps are included in other non-operating income and (expense),net in the Consolidated Statements of Operations.

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In March 2004, deCODE entered into five forwardforeign exchange contracts with an Icelandic financial institution for purposesof hedging a portion of its Icelandic krona-denominated salaries. On thematurity date of each contract, deCODE sold $1,600,000 and deCODE receivedIcelandic krona at the contracted forward rate. These forward foreign exchangecontracts were designated as economic hedges of the foreign currency salarycash flows and qualified for hedge accounting. The final contract matured in August 2004and no new contracts were entered into. During the year ended December 31,2004, a loss of $11,000 with regard to these forward exchange contracts wasrecorded to operating expenses in the Condensed Consolidated Statements ofOperations.

In March 2005, deCODEpurchased three forward foreign exchange option contracts for $214,000  from an Icelandic financial institution forpurposes of hedging a portion of its Icelandic krona-denominated salaries andother operating expenses. The forward foreign exchange option contractsprovided deCODE the right but not the obligation to sell stated amount of U.S.dollars and receive Icelandic krona at the contracted forward rates. Theforward foreign exchange option contracts to sell $10,000,000, $3,394,000 and$3,394,000, expired unexercised on June 10, June 30 and July 29,2005, respectively. During the year ended December 31, 2005, a loss of$214,000 with regard to these forward exchange contracts was recorded tooperating expenses in the Condensed Consolidated Statements of Operations.

**15.  PreferredStock**

At December 31,2005, deCODE had 6,716,666 shares of undesignated preferred stock authorizedand no shares issued or outstanding. In respect of the undesignated shares ofpreferred stock, deCODE’s Board of Directors is authorized, except as otherwiselimited by Delaware law, without further action by the stockholders to:

·       issueshares of preferred stock in one or more series;

·       fixor alter the dividend rights, dividend rates, conversion rights, voting rights,terms of redemption (including sinking fund provisions), redemption price orprices, and liquidation preferences of any wholly unissued series of preferredstock;

·       designatethe number of shares constituting, and the designation of, any series ofpreferred stock; and

·       increase or decrease thenumber of shares of a series subsequent to the issue of shares of that series,but not below the number of shares of that series then outstanding.

**16.  CommonStock**

The total authorized shares of common stock, par value$0.001, of deCODE is 100,000,000 shares. Holders of shares of common stock areentitled to one vote at all meetings of stockholders for each share held bythem. The common stock has no preemptive rights or other rights to subscribefor additional shares, no conversion right and no right of redemption. Subjectto the rights and preferences of the holders of any preferred stock, theholders of the common stock are entitled to receive such dividends as, when andif declared by the Board of Directors out of funds legally available for thatpurpose.

At December 31, 2005 and 2004, forfeited unvestedshares of common stock, which had been issued upon early exercise of stockoptions totaling 19,500 and 17,000 shares, respectively, were held in treasury.

Notes receivable provided in connection with thepurchase of common stock are collateralized only by the shares to which theyrelate, are payable after a fixed period of generally four years and bear afixed interest rate of generally six percent per annum. Several of the notesthat have become due have been 

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extended a further sixyears without additional interest. The loan becomes payable upon termination ofemployment and/or when the shares are sold.

On November 1, 2003, principal and accruedinterest in the amount of $1,846,000 under a promissory note from a thenexecutive officer of the Company became due. On November 3, 2003, and inaccordance with the terms of the note, the Company applied 240,096 of the total260,000 shares of the pledged stock (valued at $1,846,000 based on the openingprice on the Nasdaq Stock Market on November 3, 2003) to payment ofprincipal and interest due on the note.

In December 2005,deCODE filed a universal shelf registration statement on Form S-3with the Securities and Exchange Commission (“SEC”) for the issuance and salefrom time to time of debt and equity securities either individually or inunits, in one or more offerings, with a total value of up to $100 million. Asof December 31, 2005, deCODE had not consummated any sales under thisregistration statement.

**17.  Warrants**

Upon the closing of deCODE’s public offering in July 2000,warrants to purchase 1,075,833 shares of Series A preferred stock andwarrants and options to purchase 416,667 shares of Series C preferredstock automatically converted into warrants and options to purchase the samenumber of shares of common stock. Of these warrants, 47,222, 0 and 450,833 wereexercised in the years ended December 31, 2005, 2004 and 2003,respectively.

In May 2002, deCODE issued warrants to purchase933,800 shares of common stock at an exercise price of $15.00 per share inconjunction with the issuance of debt.

In February 2004, deCODE issued a warrant topurchase 1,724,257 shares of common stock at $29.00 per share over five yearsto Merck in connection with a Stock and Warrant Purchase Agreement. The warrantis exercisable at Merck’s option as to 344,851 shares for a period of30 days commencing on the first, second, third, fourth and fifthanniversaries of the Warrant Agreement. Any portion of this warrant that is notexercised during an applicable exercise period shall expire and be of nofurther force or effect (see Note 3).

Warrantactivity is summarized as follows:

| ** **                        | ** ** | **For the Years Ended December 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                        | ** ** | **2005**                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Outstanding at  beginning of year |       | 3,124,724                                                     |       | 1,400,467 |   | 1,851,300 |   |
| Issued                            |       | —                                                        |       | 1,724,257 |   | — |   |
| Exercised                         |       | (47,222                                                       | )          | — |   | (450,833 | ) |
| Cancelled                         |       | (347,629                                                      | )          | — |   | — |   |
| Outstanding at end of  year       |       | 2,729,873                                                     |       | 3,124,724 |   | 1,400,467 |   |

 

Asummary of the exercisable deCODE warrants as of December 31, 2005, is asfollows:

| **Common Shares  Issuable for** | ** ** | **Exercise Price  Per Share** | ** ** | **Warrant Expiration  Date** | ** ** |
|-------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------|------------|
| 250,000                                   |       |                                    | $          | 2.00                              |       |   | February 2,  2007 |   |
| 55,555                                    |       |                                    | 3.00       |                              |       | February 5,  2008 |   |
| 55,556                                    |       |                                    | 3.00       |                              |       | May 20,  2009 |   |
| 55,556                                    |       |                                    | 4.00       |                              |       | February 10,  2010 |   |
| 933,800                                   |       |                                    | 15.00      |                              |       | March 1,  2007 |   |
| 1,350,467                                 |       |                                    |       |                              |       |   |   |

 

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**18.  EquityIncentive Plans**

deCODE maintains the deCODE genetics, Inc. 1996and 2002 Equity Incentive Plans (the “Plans”). A total of 10,000,000 optionsare reserved for grants under the terms of the Plans. The Plans provide forgrants of stock options to employees, members of the Board of Directors,consultants and other advisors who are not employees.

The equity incentive plans are administered by theCompensation Committee of the Board of Directors. The Compensation Committeedetermines the type and term of each award, the award exercise or purchaseprice, if applicable, the number of shares underlying each award granted andthe rate at which each award becomes vested or exercisable. Incentive stockoptions may be granted only to employees of deCODE at an exercise price pershare of not less than the fair market value per share of common stock asdetermined by the Compensation Committee on the day before the grant and with aterm not to exceed ten years from date of grant. Nonqualified stock options maybe granted to any officer, employee, director, consultant or advisor at a pershare exercise price in such amount as the Compensation Committee maydetermine. Generally each employee option grant vests twenty-five percent onthe first anniversary date of an employee’s commencement of employment and1/48th of the original grant each month thereafter for the following threeyears.

The Compensation Committee may also grant restrictedstock and other stock-based awards on such terms and conditions as it maydetermine subject to the deCODE’s right to repurchase the underlying stock ifthe award terms and conditions are not satisfied.

Options granted to date generally vest over a periodof four years, generally have a maximum term of 10 years, and may containearly-exercise provisions allowing for company-provided financing of theexercise price. As of December 31, 2005, 657,211 shares were available forgrant under the 1996 and 2002 Plans.

Thefollowing table summarizes information about stock options outstanding underthe Plans at December 31, 2005:

| ** **                             | ** ** | **Exercise Price  Greater Than Grant  Date  Stock Fair Value** | ** ** | **Exercise Price  Equals Grant Date  Stock Fair Value** | ** ** | **Exercise Price  Less Than Grant  Date  Stock Fair Value** | ** ** | **Total**                              | ** ** |
|----------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                             | ** ** | **Number  of Shares**                                                              | ** ** | **Weighted  Average  Exercise  Price**                                           | ** ** | **Number  of Shares**                                                           | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  of Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  of Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding at  December 31, 2002 |       |                                                                                    | 105,000    |                                                                             |       |                                                                                 | $          | 7.92                                   |       |   | 1,873,007 |   |   | $ | 9.33 |   |   | 292,500 |   |   | $ | 10.42 |   |   | 2,270,507 |   |   | $ | 9.40 |   |   |
| Granted                                |       |                                                                                    | —     |                                                                             |       |                                                                                 | —     |                                   |       | 2,492,150 |   |   | 6.93 |   |   | 260,000 |   |   | 5.63 |   |   | 2,752,150 |   |   | 6.81 |   |   |
| Exercised                              |       |                                                                                    | —     |                                                                             |       |                                                                                 | —     |                                   |       | (77,031 | ) |   | 2.59 |   |   | (60,000 | ) |   | 1.00 |   |   | (137,031 | ) |   | 1.89 |   |   |
| Cancelled                              |       |                                                                                    | (5,000     | )                                                                                |       |                                                                                 | 18.00      |                                   |       | (771,295 | ) |   | 9.53 |   |   | (1,000 | ) |   | 18.00 |   |   | (777,295 | ) |   | 9.60 |   |   |
| Outstanding at  December 31, 2003 |       |                                                                                    | 100,000    |                                                                             |       |                                                                                 | 7.42       |                                   |       | 3,516,831 |   |   | 7.73 |   |   | 491,500 |   |   | 9.02 |   |   | 4,108,331 |   |   | 7.88 |   |   |
| Granted                                |       |                                                                                    | 30,000     |                                                                             |       |                                                                                 | 8.39       |                                   |       | 832,734 |   |   | 8.35 |   |   | — |   |   | — |   |   | 862,734 |   |   | 8.35 |   |   |
| Exercised                              |       |                                                                                    | —     |                                                                             |       |                                                                                 | —     |                                   |       | (113,427 | ) |   | 4.57 |   |   | — |   |   | — |   |   | (113,427 | ) |   | 4.57 |   |   |
| Cancelled                              |       |                                                                                    | —     |                                                                             |       |                                                                                 | —     |                                   |       | (164,154 | ) |   | 7.68 |   |   | (3,542 | ) |   | 10.00 |   |   | (167,696 | ) |   | 7.73 |   |   |
| Outstanding at  December 31, 2004 |       |                                                                                    | 130,000    |                                                                             |       |                                                                                 | 7.64       |                                   |       | 4,071,984 |   |   | 7.95 |   |   | 487,958 |   |   | 9.02 |   |   | 4,689,942 |   |   | 8.05 |   |   |
| Granted                                |       |                                                                                    | —     |                                                                             |       |                                                                                 | —     |                                   |       | 592,333 |   |   | 8.85 |   |   | — |   |   | — |   |   | 592,333 |   |   | 8.85 |   |   |
| Exercised                              |       |                                                                                    | (20,000    | )                                                                                |       |                                                                                 | 7.42       |                                   |       | (82,860 | ) |   | 3.51 |   |   | — |   |   | — |   |   | (102,860 | ) |   | 4.27 |   |   |
| Cancelled                              |       |                                                                                    | (30,000    | )                                                                                |       |                                                                                 | 8.39       |                                   |       | (186,713 | ) |   | 7.77 |   |   | (260,000 | ) |   | 5.63 |   |   | (476,713 | ) |   | 6.64 |   |   |
| Outstanding at  December 31, 2005 |       |                                                                                    | 80,000     |                                                                             |       |                                                                                 | $          | 7.42                                   |       |   | 4,394,744 |   |   | $ | 8.16 |   |   | 227,958 |   |   | $ | 12.88 |   |   | 4,702,702 |   |   | $ | 8.38 |   |   |

 

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Theweighted-average grant date fair values using the Black-Scholes option pricingmodel were:

| ** **                                            | ** ** | **For the Years Ended  December 31,** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                            | ** ** | **2005**                                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| Exercise price  equals grant date stock fair value    |       | $                                                         | 5.87       |   | $ | 6.05 |   | $ | 4.97 |   |
| Exercise price less than  grant date stock fair value |       | —                                                    |       | — |   | 5.54 |   |
|                                                       |            |                                                           |            |  |  |  |  |  |  |  |

 

Thefollowing table summarizes information about stock options outstanding andexercisable at December 31, 2005:

| ** **              | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|-------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Exercise Price** | ** ** | ** **                   | ** ** | **Number of  Shares**   | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life  (In Years)** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $1.52 to $7.62          |       | 983,196                      |       |                         | $          | 4.56 |   |   |   | 7.25 |   |   | 698,891 |   |   | $ | 4.05 |   |   |
| $8.00 to $8.65          |       | 1,321,242                    |       |                         | 8.17       |   |   |   | 7.31 |   |   | 854,910 |   |   | 8.16 |   |   |
| $8.96 to $8.96          |       | 1,477,500                    |       |                         | 8.96       |   |   |   | 7.88 |   |   | 937,823 |   |   | 8.96 |   |   |
| $9.40 to $10.00         |       | 590,245                      |       |                         | 9.71       |   |   |   | 8.18 |   |   | 299,151 |   |   | 9.85 |   |   |
| $10.56 to $24.56        |       | 330,519                      |       |                         | 15.60      |   |   |   | 4.96 |   |   | 330,519 |   |   | 15.60 |   |   |
| $1.52 to $24.56         |       | 4,702,702                    |       |                         | $          | 8.38 |   |   |   | 7.42 |   |   | 3,121,294 |   |   | $ | 8.43 |   |   |
|                         |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Stock-basedcompensation included in the statements of operations in the followingcaptions:

| ** **                                         | ** ** | **For the Years Ended  December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                         | ** ** | **2005**                                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                         | ** ** | **(In thousands)**                                   | ** ** |
| Cost of revenue,  including collaborative programs |       | $                                                         | —     |   | $ | 362 |   | $ | 861 |   |
| Research and  development expense                  |       | 72                                                        |       | 374 |   | 467 |   |
| General and  administrative expense                |       | 369                                                       |       | 435 |   | 1,112 |   |
| Total                                              |       | $                                                         | 441        |   | $ | 1,171 |   | $ | 2,440 |   |

 

In 2005, deCODE granted 7,944 and 50,000 shares,respectively, to its Audit Committee members and an executive officer.   These grants remain subject to the right ofdeCODE to repurchase the shares in certain circumstances until March 2006and July 2008, respectively. deCODE recognized expense of $36,000 and $72,000in 2005, respectively, related to these grants, based on the fair market valueof common stock on the date of grant amortized over the period of performance.

In 2004, deCODE granted a stock award to a consultantfor 15,000 shares. deCODE recognized expense of $104,000 in 2004 related to this grant based on the fair market value ofcommon stock on the date of grant. These shares were issued in January 2005.

In 2004, deCODE grantedoptions to purchase 31,500 shares of common stock to consultants under the 2002Equity Incentive Plan. These options were valued at $103,000 using a BlackScholes model, with 90% volatility, and a 10 year life assumption.Compensation for these options is subject to remeasurement and is beingamortized over the performance period.

**19.  DefinedContribution Benefits**

deCODE contributes to relevant pension organizationsfor personnel in Iceland in accordance with Icelandic law and employmentpractices. Certain other discretionary contributions may be made. 

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Contributions are based onemployee salaries paid and deCODE has no further liability in connection withthese plans. Total contributions were $2,120,000, $1,648,000 and $1,745,000 forthe years ended December 31, 2005, 2004 and 2003, respectively.

deCODEmaintains 401(k) pension plans available to eligible full-time employeesin the United States. deCODE made contributions of $273,000, $248,000 and$188,000 in the years ended December 31, 2005, 2004 and 2003 to theseplans.

**20. Income Taxes**

Deferred income taxes include the net effects oftemporary differences between the carrying amounts for assets and liabilitiesfor financial reporting purposes and the amounts used for income tax purposes.

deCODE’sdeferred tax assets (liabilities) are comprised of the following:

| ** **                                  | ** ** | **December 31,**   | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| ** **                                  | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                  | ** ** | **(In thousands)** | ** ** |
| Loss  carryforwards                         |       | $                       | 61,039     |   | $ | 55,648 |   |
| Capitalized  research and development costs |       | 15,640                  |       | 13,688 |   |
| Deferred revenue                            |       | 2,200                   |       | 2,141 |   |
| Fixed asset  depreciation                   |       | 107                     |       | (556 | ) |
| Intangible  assets/patents                  |       | (597                    | )          | (1,009 | ) |
| Other deferred  tax assets                  |       | 637                     |       | 85 |   |
| Total deferred  tax asset, net              |       | 79,026                  |       | 69,997 |   |
| Valuation  allowance                        |       | (79,026                 | )          | (69,997 | ) |
|                                        |       | $                       | —     |   | $ | — |   |

 

Thetable below reconciles the expected U.S. federal income tax rate to therecorded income tax rate:

| ** **                                  | ** ** | **For the Years Ended  December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| Income taxes at  federal statutory rates    |       | (34.0                                                     | )%         | (34.0 | )% | (34.0 | )% |
| State income  taxes, net of federal benefit |       | (0.2                                                      | )          | (1.6 | ) | (1.4 | ) |
| Non-deductible  equity compensation         |       | 0.3                                                       |       | 3.9 |   | 1.3 |   |
| Foreign rate  differential                  |       | 14.8                                                      |       | 12.2 |   | 11.1 |   |
| Foreign currency  adjustment                |       | 2.6                                                       |       | (12.4 | ) | (9.2 | ) |
| Other                                       |       | 2.1                                                       |       | (0.8 | ) | 1.9 |   |
| Net change in  valuation allowance          |       | 14.4                                                      |       | 32.7 |   | 30.3 |   |
|                                        |       | 0.0                                                       | %          | 0.0 | % | 0.0 | % |

 

Pre-tax U.S. losses were $7,986,000, $13,587,000 and$10,813,000 and pre-tax Icelandic losses were $54,764,000, $43,668,000 and$24,310,000 in 2005, 2004 and 2003, respectively. As of December 31, 2005,deCODE had U.S. federal net operating loss (“NOL”) carryforwards ofapproximately $45,675,000 that may be available to offset future U.S. federalincome tax liabilities and expire at various dates through 2025. As of December 31,2005, deCODE’s Icelandic subsidiaries had NOL carryforwards of approximately$239,678,000 that begin to expire in 2006. Management has evaluated thepositive and negative evidence bearing upon the realizability of its deferredtax assets and has established a full valuation allowance for such assets,which are comprised principally of net operating loss carryforwards andcapitalized research and experimentation costs.

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Approximately $538,000 of the net operating losscarryforwards relate to the exercise of non-qualified stock options anddisqualifying dispositions of incentive stock options, the tax benefit fromwhich, if realized, will be credited to additional paid in capital.

Ownership changes, as defined in the Internal RevenueCode, may have limited the amount of net operating loss carryforwards that canbe utilized annually to offset future taxable income. Subsequent ownershipchanges could further affect the limitation in future years.

In the years ended December 31,2004 and 2003 there was a foreign currency adjustment caused by strengtheningof the Icelandic krona against the U.S. dollar, resulting in an increase indeferred tax assets and liabilities that was offset by an increase in the taxvaluation allowance of $32,502,000 and $18,000,000, respectively. In 2005, thisstrengthening began to reverse resulting in a decrease in deferred tax assetsand liabilities that was offset by a decrease in the tax valuation allowance of$11,096,000.

**21.  SubsequentEvent**

In January 2006,deCODE acquired all of the outstanding shares of Urdur Verdandi Skuld ehf. (“UVS”),a privately-held cancer research firm, from Iceland Genomics Corporation, Inc.(“IGC”), both companies having their principal offices in Reykjavik, Iceland.As consideration for the purchase, deCODE issued 635,006 shares of deCODEcommon stock valued at $6,082,000 to IGC. None of the results of operationsrelated to UVS are included in deCODE’s statements of operations for the yearended December 31, 2005.

**22.  Selected Quarterly Data (Unaudited)**

| ** **                            | ** ** | ** **                                                            | ** ** | **For the Three Months Ended** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                            | ** ** | **March 31,**                                                    | ** ** | **June 30,**                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                            | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **2005**                              |       |                                                                  |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Revenue                               |       |                                                                  | $          | 9,523                                              |       |   | $ | 11,437 |   |   | $ | 13,197 |   |   |   | $ | 9,798 |   |   |
| Operating loss                        |       |                                                                  | 12,050     |                                               |       | 12,855 |   |   | 11,781 |   |   |   | 20,488 |   |   |
| Net loss                              |       |                                                                  | 16,936     |                                               |       | 13,332 |   |   | 11,370 |   |   |   | 21,112 |   |   |
| Basic and diluted  net loss per share |       |                                                                  | (0.32      | )                                                  |       | (0.25 | ) |   | (0.21 | ) |   |   | (0.39 | ) |   |
| **2004**                              |       |                                                                  |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Revenue                               |       |                                                                  | $          | 10,282                                             |       |   | $ | 9,635 |   |   | $ | 11,022 |   |   |   | $ | 11,188 |   |   |
| Operating loss                        |       |                                                                  | 9,414      |                                               |       | 11,677 |   |   | 10,275 |   |   |   | 15,043 |   |   |
| Net loss                              |       |                                                                  | 12,036     |                                               |       | 13,279 |   |   | 12,502 |   |   |   | 19,438 |   |   |
| Basic and diluted net  loss per share |       |                                                                  | (0.23      | )                                                  |       | (0.25 | ) |   | (0.23 | ) |   |   | (0.36 | ) |   |

 

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**Item9.**                        *Changes in and Disagreements with Accountants on Accounting andFinancial Disclosure*

Not applicable.

**Item9A.**                *Controls and Procedures*

(a)*  Evaluation of disclosure controls andprocedures.* Our Chief Executive Officer and our Chief FinancialOfficer evaluated the effectiveness of deCODE’s disclosure controls andprocedures (as defined in Rule 13a-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”)) as of the end of thefiscal year covered by this Annual Report on Form 10-K. Based uponthat evaluation, the Chief Executive Officer and the Chief Financial Officerhave concluded that as of the end of such fiscal year deCODE’s disclosurecontrols and procedures are adequate and effective to ensure that informationrequired to be disclosed in the reports deCODE files under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms.

In designing andevaluating our disclosure controls and procedures, our management recognizesthat any controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance that the desired objectives of the controlsystem will be met. In addition, the design of any control system is based inpart upon certain assumptions about the likelihood of future events and theapplication of judgment in evaluating the cost-benefit relationship of possiblecontrols and procedures. Because of these and other inherent limitations of controlsystems, there is only reasonable assurance that our controls will succeed inachieving their goals under all potential future conditions.

(b)*Changes inInternal Controls.* We are continuously seeking to improve theefficiency and effectiveness of our internal controls. This results in periodicrefinements to internal control processes throughout the Company. However,there was no significant change in our internal control over financialreporting (as defined in Rule 13a-15(f) under the Exchange Act)during the last fiscal quarter of the year ended December 31, 2005 thathas materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

**Management’sReport on Internal Control Over Financial Reporting**

The management of theCompany is responsible for establishing and maintaining adequate internalcontrol over financial reporting as defined in Rule 13a-15(f) underthe Securities Exchange Act of 1934, as amended. The Company’s internal controlsystem was designed to provide reasonable assurance to the Company’s managementand board of directors regarding the preparation and fair presentation ofpublished financial statements for external reporting purposes in accordancewith accounting principles generally accepted in the United States of America.

All internal controlsystems, no matter how well designed, have inherent limitations. Therefore,even those systems determined to be effective can provide only reasonableassurance with respect to financial statement preparation and presentation.

The Company’s managementassessed the effectiveness of the Company’s internal control over financialreporting as of December 31, 2005. In making this assessment, it used thecriteria set forth by the Committee of Sponsoring Organizations of the TreadwayCommission (COSO) in *Internal Control-IntegratedFramework*. Based on its assessment management believes that, as of December 31,2005, the Company’s internal control over financial reporting is effectivebased on those criteria.

The Company’s independentregistered public accounting firm, Deloitte & Touche LLP, whichaudited the financial statements contained in this Annual Report on Form 10-K,has issued an attestation report on management’s assessment of the Company’sinternal control over financial reporting as of December 31, 2004. Thisreport, which expresses an unqualified opinion on management’s assessment andon the effectiveness of the Company’s internal control over financial reportingas of December 31, 2005, is included below under the heading “Report ofIndependent Registered Public Accounting Firm.”

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Stockholders ofdeCODE genetics, Inc.:

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Control Over FinancialReporting, that deCODE genetics, Inc and subsidiaries (the “Company”)maintained effective internal control over financial reporting as of December 31,2005, based on criteria established by the Committee of SponsoringOrganizations of the Treadway Commission (COSO) in *InternalControl-Integrated Framework*. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express an opinion on management’sassessment and an opinion on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinions.

A company’s internal control over financial reportingis a process designed by, or under the supervision of, the company’s principalexecutive and principal financial officers, or persons performing similarfunctions, and effected by the company’s board of directors, management, andother personnel to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of the company;and (3) provide reasonable assurance regarding prevention or timelydetection of unauthorized acquisition, use, or disposition of the company’sassets that could have a material effect on the financial statements.

Because of the inherent limitations of internalcontrol over financial reporting, including the possibility of collusion orimproper management override of controls, material misstatements due to erroror fraud may not be prevented or detected on a timely basis. Also, projectionsof any evaluation of the effectiveness of the internal control over financialreporting to future periods are subject to the risk that the controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that theCompany maintained effective internal control over financial reporting as of December 31,2005, is fairly stated, in all material respects, based on the criteriaestablished by the Committee of Sponsoring Organizations of the TreadwayCommission (COSO) in *InternalControl-Integrated Framework*. Also in our opinion, the Companymaintained, in all material respects, effective internal control over financialreporting as of December 31, 2005, based on the criteria established bythe Committee of Sponsoring Organizations of the Treadway Commission (COSO) in *Internal Control-Integrated Framework*.

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated financialstatements as of and for the year ended December 31, 2005 of the Companyand our report dated March 14, 2006 expressed an unqualified opinion onthose financial statements.

/s/ Deloitte & Touche LLP

Boston, MassachusettsMarch 14, 2006

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**Item 9B.**               *Other Information*

Not applicable

**PART III**

**Item 10.**                 *Directors and Executive Officers of the Registrant*

**Directors**

Our certificate of incorporation requires that theBoard of Directors be divided into three classes. The members of each class ofdirectors serve for staggered three-year terms. Class I consists of LindaBuck, whose term will expire at the Annual Meeting of Stockholders in 2008.Class II consists of J. Neal Armstrong and James Beery, whose terms willexpire at the Annual Meeting of Stockholders in 2006. Class III consistsof Kari Stefansson and Terrance McGuire, whose terms will expire at the AnnualMeeting of Stockholders in 2007. The directors hold office until the expirationof their respective terms and until their respective successors are elected andqualify, or until death, resignation or removal.

Thename, age and position (if any) of each of our current directors are set forthbelow. Additional biographical information concerning each of the directorsfollows the table.

| **Name**            | ** ** | **Age** | ** ** | **Position(s)**                                                           |
|---------------------|------------|---------|------------|---------------------------------------------------------------------------|
| Kari Stefansson     |       | 56      |       | Director, Chairman of  the Board, Chief Executive 

Officer and President |
| Terrance G. McGuire |       | 49      |       | Director and  Vice-Chairman                                               |
| J. Neal Armstrong   |       | 67      |       | Director                                                                  |
| James Beery         |       | 64      |       | Director                                                                  |
| Linda Buck          |       | 59      |       | Director                                                                  |

 

*Kari Stefansson, M.D., Dr. Med.*has served as our President, Chief ExecutiveOfficer and a director since he co-founded deCODE in August 1996. Dr. Stefanssonwas appointed to serve as the Chairman of our Board of Directors in December 1999.He also served as our Secretary from August 1996 to March 2001. From1993 until April 1997, Dr. Stefansson was a professor of Neurology,Neuropathology and Neuroscience at Harvard University. In addition, from 1993through December 1996 he was Director of Neuropathology at Beth IsraelHospital in Boston, Massachusetts. From 1983 to 1993, he held faculty positionsin Neurology, Neuropathology and Neurosciences at the University of Chicago. Dr. Stefanssonreceived his M.D. and Dr. Med. from the University of Iceland in 1976 and1986, respectively.

*Terrance G. McGuire*has served as a director since August 1996and as Vice-Chairman of the Board of Directors since April 2000. Hecurrently serves as Chairman of our Compensation Committee and as a member ofour Audit and Nominating and Corporate Governance Committees. He served as ourAssistant Secretary from January 1998 to October 2000. Since March 1996,he has been a Founding General Partner of Polaris Venture Partners. Since 1992,he has served as a general partner of Alta V Management Partners L.P., which isthe general partner of Alta V Limited Partnership. He is a director of severalprivate healthcare and information technology companies. Mr. McGuirereceived his B.S. in Physics and Economics from Hobart College, his M.S. in Engineeringfrom Dartmouth College and his M.B.A. from the Harvard Business School.

*J. Neal Armstrong*has served as a director since October 2003.He currently serves as Chairman of our Audit Committee and a member of ourCompensation and Nominating and Corporate Governance Committees. Mr. Armstrongserved as Vice President, Chief Financial Officer, Secretary and Treasurer ofAspect Medical Systems, Inc., a developer and manufacturer of ananesthesia monitoring system, from 1996 through 2005. From 1990 to 1996, Mr. Armstrongserved as Vice President of Finance, Chief Financial Officer and as a directorof Haemonetics, Inc., a manufacturer of blood processing systems. 

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*From1985 to 1990, he was the Vice President of Finance and Administration,Treasurer and Chief Financial Officer at BTU International, a manufacturer ofthermal processing systems. Prior to 1985, he served for 14 years insenior operating and financial positions at Texas Instruments, Inc., anelectronics company. Mr. Armstrong holds a bachelor’s degree in BusinessAdministration from the University of Texas and is a certified publicaccountant.*

*James R. Beery*has served as a director since April 2004.He currently serves as Chairman of our Nominating and Corporate GovernanceCommittee and a member of our Audit and Compensation Committees. Mr. Beeryhas served since March 2002 as Senior Of Counsel in the London office ofCovington & Burling, an international law firm based in Washington,D.C. Prior to his retirement in June 2001, Mr. Beery served as SeniorVice President and General Counsel of GlaxoSmithKline plc, a UK-based globalpharmaceutical company. From 1993 until the formation of the merged companyGlaxoSmithKline in December 2000, Mr. Beery served as Senior VicePresident, General Counsel and Corporate Secretary of SmithKline Beecham plc.Mr. Beery holds an A.B. from Harvard College and a J.D. from Stanford LawSchool. He is currently a director of Martek Biosciences Corporation and OrchidCellmark Inc.

*Linda Buck, Ph.D.*joined our Board of Directors in December 2005.Dr. Buck has served as Associate Director of the Basic Sciences Divisionat Fred Hutchinson Cancer Research Center in Seattle since 2002, and a HowardHughes Medical Institute investigator since 2001. She also has served as an affiliateprofessor of physiology and biophysics at the University of Washington since2003. Prior to her current positions, Dr. Buck was a professor ofneurobiology at Harvard Medical School from 2001 to 2002, and associateprofessor of neurobiology from 1996 to 2001. Dr. Buck holds B.S. degreesin psychology and microbiology from the University of Washington, and shereceived her Ph.D. in immunology from the University of Texas SouthwesternMedical Center at Dallas. Dr. Buck is the author of numerous scientificpublications and the recipient of many honors and awards for her research,including a Nobel Prize in physiology or medicine in 2004 for her discoverieson the workings of the olfactory system.

**Audit Committee**

The Board of Directors hasan Audit Committee, which oversees our accounting and financial reportingprocesses and the audits of the financial statements and is responsible for theappointment, compensation, retention and oversight of our independentregistered public accounting firm. The current members of the Audit Committeeare J. Neal Armstrong, James R. Beery and Terrance G. McGuire. The Board ofDirectors has determined that Mr. Armstrong is an audit committeefinancial expert. All members of our Audit Committee are “independent” asdefined by the listing standards of The Nasdaq Stock Market and within themeaning of applicable regulations of the Securities and Exchange Commission. Acopy of the charter for the Audit Committee is available on our website atwww.deCODE.com.

**Director Nomination Process**

There have been no changesto the procedures by which security holders may recommend nominees to our Boardof Directors.

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**Executive Officers**

Thename, age and position of each person who is currently serving as an executiveofficer (but not also as a director) is listed below, followed by summaries oftheir backgrounds and principal occupations. Executive officers are electedannually and serve at the discretion of the Board of Directors.

| **Name**         | ** ** | **Age** | ** ** | **Position(s)**                                        |
|------------------|------------|---------|------------|--------------------------------------------------------|
| Lance Thibault   |       | 39      |       | Chief Financial Officer  and Treasurer                 |
| Mark Gurney      |       | 57      |       | Senior Vice President,  Drug Discovery and Development |
| Daniel Hartman   |       | 44      |       | Senior Vice President,  Product Development            |
| Hakon Hakonarson |       | 45      |       | Vice President, Business Development                   |

 

*Lance Thibault*joined deCODE in February 2001 and was named Chief Financial Officer andTreasurer in June 2001. He was a Director with the Global Capital Marketspractice of PricewaterhouseCoopers in London, England prior to joining deCODE.Mr. Thibault received a B.S. in Accountancy from Bentley College in 1988and is a CPA.

*Mark Gurney, Ph.D.*has served as our Senior Vice President, Drug Discovery and Development since February 2005.From October 2003 to February 2005 he served as our Senior VicePresident, Drug Discovery. Dr. Gurney joined deCODE in August 2000and was elected our Vice President, Pharmaceutical Discovery in October 2000and our Vice President, Drug Development in August 2002. He was formerlyDirector, Genomics Research at Pharmacia Corporation. Prior to his positions atPharmacia, Dr. Gurney held academic appointments in the Department ofPharmacological and Physiological Sciences at the University of Chicago and inthe Department of Cell, Molecular and Structural Biology at the NorthwesternUniversity Medical School. He received his B.A. in Biology from the Universityof California at San Diego in 1975 and his Ph.D. from the California Instituteof Technology in 1980. In 1994, he completed his M.B.A. at NorthwesternUniversity’s Kellogg School of Management.

*Daniel Hartman, M.D*., joined deCODE in July 2005 as our Senior VicePresident, Product Development. Prior to joining deCODE, Dr. Hartmanserved since 2001 in senior clinical development positions at Pfizer, includingGlobal Clinical Leader, Allergy and Respiratory Diseases; Clinical ExploratoryHead, Cardiovascular and Metabolic Diseases; and Experimental Medicine TherapyArea Leader, Cardiovascular, Metabolism and Anaderm. From 2000 to 2001, Dr. Hartmanwas Vice President of Worldwide Clinical Development at Esperion Therapeutics. Priorto joining Esperion, he was Director, Clinical Cardiovascular and Therapy Head,thrombosis and Cardiopulmonary Disease at Pfizer. From 1995 to 1999, Dr. Hartmanserved in senior clinical research positions at Eli Lilly & Company.Dr. Hartman received his M.D. from Wayne State University, and heldpost-doctoral and faculty positions at the Indiana University School ofMedicine. He is board certified in internal medicine and is a member ofnumerous medical societies.

*HakonHakonarson, M.D., Ph.D.* joined deCODE in October 1998and has served as our Vice President, Clinical Sciences since May 2003. Hehas also served as our Director of Respiratory, Inflammatory andPharmacogenomics Research since 1998, as well as Chief Scientific Officer ofour subsidiary Encode since 2001. Dr. Hakonarson received his M.D. andPh.D. from the University of Iceland, School of Medicine. He completed hispediatric residency training at the University of Connecticut in 1992 andsubspecialty training in pulmonary medicine at the Children’s Hospital ofPhiladelphia, University of Pennsylvania School of Medicine in 1995. Dr. Hakonarsonwas an Assistant Professor of Pediatrics at the Children’s Hospital ofPhiladelphia and the University of Pennsylvania from 1995 until his relocationto Iceland in 1998.

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**Section 16(a) BeneficialOwnership Reporting Compliance**

Section 16(a) ofthe Securities Exchange Act of 1934, as amended, requires our executiveofficers and directors and persons who beneficially own more than ten percentof a registered class of our equity securities to file reports of ownership andchanges in ownership with the Securities and Exchange Commission and The NasdaqNational Market. Based solely upon our review of the copies of Forms 3, 4 and 5furnished to us, we believe that all of our directors, officers and greaterthan 10% stockholders have timely filed all required reports except that Dr. Buckinadvertently filed her initial Form 4 one day late.

**Code of Ethics**

We have adopted a Code of Business Conduct and Ethicsthat applies to all of our directors, officers and employees, including ourprincipal executive officer, principal financial officer and principalaccounting officer or controller. The Code of Business Conduct and Ethics canbe found on our website at www.decode.com.

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**Item 11.**                 *Executive Compensation*

Thefollowing table sets forth information concerning the annual and long-termcompensation for services to us for each of the fiscal years ended December 31,2005, 2004 and 2003 of those persons who served as (i) our chief executiveofficer during 2005, (ii) our other four most highly compensated executiveofficers who were serving as such on December 31, 2005, and (iii) oneadditional individual who would have been among our four most highlycompensated executive officers but for the fact that he was not serving as suchon December 31, 2005 (the “Named Executive Officers”). 

| ** **                                     | ** ** | **Annual Compensation** | ** ** | **Long-Term  Compensation** | ** ** | ** **    | ** ** |
|------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|---------------|------------|
| **Name and Principal Position** | ** ** | ** **                   | ** ** | **Year**                    | ** ** | **Salary(1)** | ** ** | **Bonus** | ** ** | **Other  Annual  Compensation(1)** | ** ** | **Restricted  Stock  Awards  ($)** | ** ** | **Stock  Option  Awards  (#)** | ** ** | **All  Other  Compensation(1)** | ** ** |
| Kari Stefansson                                |       | 2005                         |       | $                           | 614,548    |          | $          | 300,000 |   |   | $ | 88,296(2 | ) |   | — |   | — |   |   | $ | 27,675(3 | ) |   |
| Chairman, President                            |       | 2004                         |       | 601,770                     |       | —        |       |   | 52,017(2 | ) |   | — |   |  — |   |   | 23,416(3 | ) |   |
| and Chief Executive  Officer                   |       | 2003                         |       | 503,373                     |       |  —  |       |   |  44,116(2 | ) |   | — |   |  600,000 |   |   | 20,806(3 | ) |   |
| Lance Thibault                                 |       | 2005                         |       | $                           | 222,558    |          | $          | 70,000 |   |   | — |   |   | — |   | — |   |   | $ | 6,901(3 | ) |   |
| Chief Financial Officer                        |       | 2004                         |       | 185,558                     |       | 65,000        |       |   |  — |   |   | — |   | — |   |   | 5,585(3 | ) |   |
| and Treasurer                                  |       | 2003                         |       | 160,000                     |       | —        |       |   |  — |   |   | — |   | 50,000 |   |   |  4,846(3 | ) |   |
| Mark Gurney                                    |       | 2005                         |       | $                           | 311,337    |          | $          | 100,000 |   |   | — |   |   | — |   | — |   |   | $ | 7,838(3 | ) |   |
| Senior Vice President,                         |       | 2004                         |       | 256,731                     |       | 84,000        |       |   | — |   |   | — |   | 30,000 |   |   | 7,142(3 | ) |   |
| Drug Discovery and  Development                |       | 2003                         |       | 212,423                     |       | —        |       |   |   — |   |   | — |   |  120,000 |   |   | 5,573(3 | ) |   |
| Daniel Hartman(4)                              |       | 2005                         |       | $                           | 167,538    |          | $          | 100,000(5) |   |   | — |   |   | $ | 470,000(6 | ) | 200,000 |   |   | — |   |   |
| Senior Vice President,                         |       |                         |       |                        |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Product Development                            |       |                         |       |                        |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Hakon Hakonarson                               |       | 2005                         |       | $                           | 278,848    |          | $          | 70,000 |   |   | $ | 17,079(7 | ) |   | — |   | — |   |   | — |   |   |
| Vice President,                                |       | 2004                         |       | 256,590                     |       | 50,000        |       |   | 7,943(7 | ) |   | — |   | — |   |   | — |   |   |
| Business Development                           |       | 2003                         |       | 202,361                     |       | —        |       |   | — |   |   |  — |   | 154,000 |   |   |  — |   |   |
| Michael Young                                  |       | 2005                         |       | $                           | 250,693    |          | $          | 94,000 |   |   | — |   |   | — |   | — |   |   | $ | 267,323(8 | ) |   |
| Former Senior Vice                             |       | 2004                         |       | 247,981                     |       | —        |       |   | — |   |   |  — |   | — |   |   | 6,980(3 | ) |   |
| President, Business Development                |       |   2003                  |       | 235,000                     |       | —        |       |   | — |   |   |  — |   | — |   |   | 5,980(3 | ) |   |
|                                                |            |                              |            |                             |            |               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Represents, with respectto Drs. Stefansson and Hakonarson, compensation paid in Icelandic kronas.Figures reflect exchange rates of 63.13, 61.19 and 71.16 Icelandic kronas to$1.00, the exchange rates determined by the Central Bank of Iceland on December 31,2005, 2004 and 2003, respectively.

(2)          Represents the value ofhousing and an automobile provided by us for the benefit of the Named ExecutiveOfficer.

(3)          Represents, with respectto Mr. Thibault and Dr. Gurney, matching 401(k) contributionsmade on behalf of the Named Executive Officer; and, with respect to DrStefansson, discretionary contributions made to Icelandic  pension organizations on his behalf. Does notinclude mandatory contributions made to pension organizations on behalf of Drs. Stefanssonand Hakonarson in accordance with Icelandic law and employment practices. See, “DefinedContribution Plans.”

(4)          Dr. Hartman becamean executive officer of deCODE in July 2005.

(5)          Represents a one-timesign-on bonus paid to Dr. Hartman.

(6)          Represents the dollarvalue of 50,000 shares of restricted stock based on the closing price of deCODE’scommon stock on The Nasdaq Stock Market at July 15, 2005, the date ofissuance, of 

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$9.40. The dollar value ofthe shares as of December 31, 2005 was $413,000, based on the closingprice of deCODE’s common stock on The Nasdaq Stock Market at December 30,2005 of $8.26. Shares will vest on the third anniversary of the date of grant,subject to accelerated vesting upon a change of control or termination withoutcause. Dr. Hartman will not have any rights as a stockholder, including,without limitation, the right to vote and to receive dividends, with respect toany of the shares that have not vested.

(7)          Represents the value ofan automobile provided by us for the benefit of the Named Executive Officer.

(8)          Includes $7,323 inmatching 401(k) contributions made on behalf of the Mr. Young, and$260,000 paid to Mr. Young in accordance with the severance provisions ofhis employment agreement.

The following tables setforth information about options grants to, and option exercises by, the NamedExecutive Officers.

**OptionGrants in Last Fiscal Year**

| ** **       | ** ** | **Number of  Securities** | ** ** | **Percentage  of Total  Options  Granted to** | ** ** | **Exercise**                        | ** ** | ** **                                    | ** ** | **Potential Realizable Value at  Assumed Annual Rates of   Stock Price Appreciation  for Option Term(1)** | ** ** |
|------------------|------------|--------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Name**         | ** ** | ** **                     | ** ** | **Underlying  Options   Granted**                  | ** ** | **Employees  in Fiscal  2005** | ** ** | **or Base  Price Per  Share ** | ** ** | **Expiration   Date **                                                                                                                                 | ** ** | **5%** | ** ** | **10%** | ** ** |
| Kari Stefansson  |       | —                         |       |                                                    | —     |                                |       |                                          | —     |                                                                                                                                                             |       |   | — |   |   | — |   | — |   |
| Lance Thibault   |       | —                         |       |                                                    | —     |                                |       |                                          | —     |                                                                                                                                                             |       |   | — |   |   | — |   | — |   |
| Mark Gurney      |       | —                         |       |                                                    | —     |                                |       |                                          | —     |                                                                                                                                                             |       |   | — |   |   | — |   | — |   |
| Daniel Hartman   |       | 150,000(2                      | )          |                                                    | 60.4       | %                                   |       |                                          | $          | 9.40                                                                                                                                                             |       |   |   | 7/15/15 |   |   | $ | 866,568 |   | $ | 2,184,689 |   |
|             |       | 50,000                         |       |                                                    | 20.1       | %                                   |       |                                          | $          | 9.40                                                                                                                                                             |       |   |   | 7/15/15 |   |   | $ | 288,856 |   | $ | 728,230 |   |
| Hakon Hakonarson |       | —                         |       |                                                    | —     |                                |       |                                          | —     |                                                                                                                                                             |       |   | — |   |   | — |   | — |   |
| Michael Young    |       | —                         |       |                                                    | —     |                                |       |                                          | —     |                                                                                                                                                             |       |   | — |   |   | — |   | — |   |
|                  |            |                                |            |                                                         |            |                                     |            |                                               |            |                                                                                                                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          The dollar amounts underthese columns are the result of calculations assuming that the price of commonstock on the date of the grant of the option increases at the hypothetical 5%and 10% rates set by the Securities and Exchange Commission and therefore arenot intended to forecast possible future appreciation, if any, of our stockprice over the option term of 10 years.

(2)          Suchoptions will vest as to 37,500 shares on July 15, 2006 and as to 1/48 ofthe shares on the last day of each month thereafter

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**AggregatedOption Exercises in Last Fiscal Yearand Fiscal Year-End Option Values**

| ** **       | ** ** | **Shares  Acquired  on** | ** ** | ** **        | ** ** | **Number of  Securities Underlying  Unexercised Options at  December 31, 2005 ** | ** ** | **Value of  Unexercised  in-the-Money  Options at  December 31,  2005(1) ** | ** ** |
|------------------|------------|--------------------------|------------|-------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|
| **Name**         | ** ** | ** **               | ** ** | **Exercise  (#)** | ** ** | **Value  Realized **                                                                                           | ** ** | **Exercisable/  Unexercisable**                                                                 | ** ** | **Exercisable/  Unexercisable ** | ** ** |
| Kari Stefansson  |       |                     | —     |              |       |                                                                                                                | —     |                                                                                            |       | 462,502 |   | 137,498 |   | — |   | — |   |
| Lance Thibault   |       |                     | —     |              |       |                                                                                                                | —     |                                                                                            |       | 127,083 |   | 22,917 |   | $ | 16,000 |   | — |   |
| Mark Gurney      |       |                     | —     |              |       |                                                                                                                | —     |                                                                                            |       | 200,000 |   | 70,000 |   | — |   | — |   |
| Daniel Hartman   |       |                     | —     |              |       |                                                                                                                | —     |                                                                                            |       | 50,000 |   | 150,000 |   | — |   | — |   |
| Hakon Hakonarson |       |                     | —     |              |       |                                                                                                                | —     |                                                                                            |       | 109,168 |   | 69,832 |   | $ | 21,315 |   | $ | 6,660 |   |
| Michael Young    |       |                     | —     |              |       |                                                                                                                | —     |                                                                                            |       | 80,000 |   | — |   | $ | 67,200 |   | — |   |
|                  |            |                          |            |                   |            |                                                                                                                     |            |                                                                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Basedon the closing price of deCODE’s common stock on The Nasdaq Stock Market at December 30,2005 of $8.26.

**Compensation Arrangements**

*DirectorCompensation*

The Board has adopted a policy for compensatingdirectors who are not also employees. Pursuant to this policy, we pay eachdirector (i) an annual retainer of $12,000 (or a pro rated portion of suchamount in case of a partial term), (ii) $2,000 for each board or committeemeeting that he or she attends, whether personally or by telephone, (iii) $2,000for each Nominating and Corporate Governance Committee and CompensationCommittee meeting that he or she attends (excluding meetings held inconjunction with a Board meeting), (iv) $500 for each standing telephonicNominating and Corporate Governance Committee and Compensation Committeemeeting that he or she attends, (v) $3,000 per fiscal quarter for his orher attendance at Audit Committee meetings****during thatquarter, and (vi) $2,000 per day and for each other day on which he or sheprovides services to deCODE at deCODE’s request. In addition, in accordancewith this policy we grant (i) to each director a non-qualified stockoption under our 2002 Equity Incentive Plan to purchase 60,000 shares (or a prorated portion of such amount in case of a partial term) of our common stock ata price equal to the closing price of the stock as reported on The NasdaqNational Market on the day prior to such director’s election or appointment tothe Board, with such option to vest in three equal annual installments over thecourse of the director’s term, (ii) annually to the chairman of the AuditCommittee a number of shares of restricted stock having a fair market value onthe date of grant (based on the closing price of our common stock as reportedon The Nasdaq National Market on the day prior to the annual meeting ofstockholders for that year) of $24,000 (or a pro rated portion of such amountsin case of a partial term), with one quarter of such restricted stock to vestimmediately and the remainder to vest in three equal installments on the lastday of each fiscal quarter following the grant, and (iii) annually to eachmember of the Audit Committee (other than the Chairman), a number of shares ofrestricted stock having a fair market value on the date of grant (based on theclosing price of our common stock as reported on The Nasdaq National Market onthe day prior to the annual meeting of stockholders for that year) of $16,000(or a pro rated portion of such amounts in case of a partial term), with onequarter of such restricted stock to vest immediately and the remainder to vestin three equal installments on the last day of each fiscal quarter followingthe grant.

At the time of adoption of this policy, we granted2,270 shares of restricted stock to Messrs. McGuire and Beery, and 3,404shares of restricted stock to Mr. Armstrong. Of the shares issued, onequarter vested 

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immediately and on each ofSeptember 30, 2005 and December 31, 2005, and the final quarter willvest on March 31, 2006, provided that the holder is then serving as amember of our Audit Committee.

In addition to thecompensation described above, we reimburse all directors for their expensesincurred in connection with attendance at Board and committee meetings,including $1,000 for each Board or committee meeting that he or she attends forwhich long-distance travel was required.

*EmploymentAgreements*

At the time of commencement of employment, ourexecutive officers generally receive offer letters specifying basic terms andconditions of their employment. Our executive officers have signed agreementswhich require them to maintain the confidentiality of our information and toassign inventions to us. These agreements also prohibit these officers fromcompeting with us during the terms of their employment and for a certain periodthereafter by engaging in any capacity in any business which is, or on the dateof termination of their employment was, competitive with our business.

In June 2001 we entered into an employmentagreement with Michael Young, our former Senior Vice President, BusinessDevelopment, which stipulated that if we terminated his employment other thanfor “cause” we were required to make a lump sum severance payment to him equalto one year of his base salary then in effect. Pursuant to the terms of thisagreement, Mr. Young received a one-time payment in the amount of$260,000.

In July 2005 weentered into an employment agreement with Daniel Hartman. Pursuant to hisemployment agreement, Dr. Hartman’s initial annual base salary is****$360,000 a year, which the Board may at any time adjustupwards as it may deem appropriate. In addition, Dr. Hartman is eligibleto receive cash and equity bonuses at the determination of the Board orCompensation Committee and to participate in all incentive, savings, stockoption, profit sharing retirement, welfare and other employee benefit plansapplicable generally to our employees based in the United States. Dr. Hartmanreceived a one-time lump sum cash sign-on bonus in the amount of $100,000, aportion of which must be returned to us in the event he terminates hisemployment or we terminate his employment for Cause (as defined in hisemployment agreement) at any time during the 24-month period commencingon the effective date of his employment agreement. In accordance with the termsof his employment agreement, Dr. Hartman received stock options and sharesof restricted stock. The shares of restricted stock will vest on the thirdanniversary of the effective date of his employment agreement and immediately upon a Change in Control (asdefined in his employment agreement). In the event that Dr. Hartman’semployment is terminated other than for Cause, a portion of the restricted stock will vest upon such termination. Ifwe terminate Dr. Hartman’s employment without Cause, we will continue topay him his annual base salary, as in effect on the date of termination, foreighteen (18) months. If following the occurrence of a Change in Control Dr. Hartmanterminates his employment as a result of an Adverse Change (as defined in hisemployment agreement) we will pay him, in addition to any compensation heearned prior to the date of termination, a lump sum cash payment in an amountequal to eighteen (18) months of his annual base salary at the time of histermination, plus one and one-half (11⁄2) times the average annual bonus paid to him during the last two (2) yearsof his employment.

*DefinedContribution Plans*

As required by Icelandic law, deCODE contributes topension organizations for personnel in Iceland. In accordance with the law andIcelandic employment practices, we contribute 6% of an employee’s salary, plusup to an additional 3% in matching contributions, to a pension organization ofthe employee’s choosing. deCODE has no additional obligation to makecontributions, but may make discretionary contributions. deCODE made totalcontributions of $2,119,530 for the year ended December 31, 2005.

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deCODE maintains a 401(k) planavailable to eligible full-time employees in the United States. Pursuant to the401(k) plan, employees may elect to reduce their current compensation byup to the statutorily prescribed annual limit ($14,000 in 2005) and have theamount of such reduction contributed to the 401(k) plan. The 401(k) planrequires that we make additional matching contributions on behalf ofparticipants at a rate of 50% of employee contributions up to a maximum of 6%of their base salary. Contributions by employees to the 401(k) plan andincome earned on such contributions are not taxable to employees untilwithdrawn from the 401(k) plan. In the year ended December 31, 2005,deCODE made contributions of $272,637 to the 401(k) plan.

**CompensationCommittee Interlocks and Insider Participation**

The members of our Compensation Committee during 2005were Mr. McGuire and Dr. Goran Ando (who resigned as a directoreffective January 31, 2006). Mr. McGuire served as deCODE’s assistantsecretary from January 1998 until October 2000. Otherwise, no memberof the Compensation Committee was at any time during 2005, or formerly, anofficer or employee, nor had any relationship with us requiring disclosureunder Item 404 of Regulation S-K under the Exchange Act of 1934, asamended. No executive officer has served as a director or member of thecompensation committee (or other committee serving an equivalent function) ofany other entity whose executive officers served as a director of deCODE or amember of our Compensation Committee.

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**Item 12. *Security Ownership ofCertain Beneficial Owners and Management and Related Stockholder Matters***

Thefollowing table sets forth certain information as of February 15, 2006,except as otherwise noted, regarding the beneficial ownership of our common stockby (i) each current director, (ii) each Named Executive Officer, (iii) allof our directors and executive officers as a group, and (iv) each personknown to us to be the beneficial owner of more than five percent of theoutstanding shares of our common stock.

| Name and Address of  Beneficial Owner        | ** ** | ** ** | ** ** | **Amount and  Nature of  Beneficial Ownership(1)** | ** ** | **Percent of  Outstanding  Commonstock(2)** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|-------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| T. Rowe Price Associates, Inc.(3)                           |       |       | 6,927,546  |                                                              |       |                                             | 12.6       | % |   |
| 100 E. Pratt Street                                              |       |       |       |                                                              |       |                                             |       |   |   |
| Baltimore, MD 21202                                              |       |       |       |                                                              |       |                                             |       |   |   |
| AXA Financial, Inc. and  affiliates(4)                      |       |       | 3,613,017  |                                                              |       |                                             | 6.6        | % |   |
| 1290 Avenue of the Americas                                      |       |       |       |                                                              |       |                                             |       |   |   |
| New York, NY 10104                                               |       |       |       |                                                              |       |                                             |       |   |   |
| SAPAC Corporation Ltd(5)                                         |       |       | 3,240,134  |                                                              |       |                                             | 5.9        | % |   |
| Cerrito 461 Piso 4                                               |       |       |       |                                                              |       |                                             |       |   |   |
| P.O. Box 531                                                |       |       |       |                                                              |       |                                             |       |   |   |
| Correo Central                                                   |       |       |       |                                                              |       |                                             |       |   |   |
| Montevideo, Uraguay  11000                                       |       |       |       |                                                              |       |                                             |       |   |   |
| Kari Stefansson(6)                                               |       |       | 3,106,544  |                                                              |       |                                             | 5.6        | % |   |
| c/o deCODE  genetics, Inc.                                  |       |       |       |                                                              |       |                                             |       |   |   |
| Sturlugata 8                                                     |       |       |       |                                                              |       |                                             |       |   |   |
| IS-101 Reykjavik,  Iceland                                       |       |       |       |                                                              |       |                                             |       |   |   |
| Lance Thibault(7)                                                |       |       | 136,067    |                                                              |       |                                             | *          |   |   |
| Mark Gurney(8)                                                   |       |       | 209,375    |                                                              |       |                                             | *          |   |   |
| Daniel Hartman(9)                                                |       |       | 50,000     |                                                              |       |                                             | *          |   |   |
| Hakon Hakonarson(10)                                             |       |       | 118,876    |                                                              |       |                                             | *          |   |   |
| J. Neal Armstrong(11)                                            |       |       | 42,550     |                                                              |       |                                             | *          |   |   |
| James Beery(12)                                                  |       |       | 28,369     |                                                              |       |                                             | *          |   |   |
| Linda Buck                                                       |       |       | 0          |                                                              |       |                                             | *          |   |   |
| Terrance G. McGuire(13)                                          |       |       | 138,938    |                                                              |       |                                             | *          |   |   |
| Michael Young                                                    |       |       | 0          |                                                              |       |                                             | *          |   |   |
| All directors and executive  officers as a group (9 persons)(14) |       |       | 3,830,719  |                                                              |       |                                             | 6.9        | % |   |

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*                    Comprises lessthan one percent of the outstanding common stock.

(1)          The number of sharesbeneficially owned by the individuals and entities listed in the table isdetermined in accordance with the rules of the Securities and ExchangeCommission, and may not be conclusive as to ownership of those securities forany other purpose. Under those rules, an individual (or entity) is deemed tobeneficially own shares of common stock as to which the individual currentlyhas certain sole or shared powers or as to which the individual can acquiresuch powers within 60 days by the exercise of any option, warrant or otherright. Accordingly, the table includes shares underlying options and warrants whichwill be exercisable within 60 days of February 15, 2006, but does notinclude shares underlying options and warrants that will become exercisablemore than 60 days after February 15, 2006. The footnotes to the table setforth the number of such shares included in the 

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table. We have beenadvised that each stockholder listed in the table has sole voting anddispositive power with respect to such shares unless otherwise noted in thefootnotes below.

(2)          Applicable percentage ofownership is based on 54,846,933 shares of common stock outstanding on February 15,2006.

(3)          As set forth inSchedule 13G/A, filed on February 14, 2006 by T. Rowe PriceAssociates, Inc. (Price Associates). These securities are owned by variousindividuals and institutional investors, which T. Rowe Price Associates, Inc.(Price Associates) serves as investment adviser with power to directinvestments and/or sole power to vote the securities. For purposes of thereporting requirements of the Securities Exchange Act of 1934, Price Associatesis deemed to be a beneficial owner of such securities; however Price Associatesexpressly disclaims beneficial ownership of such securities. Of the reportedshares,  Price Associates reported thatit has sole voting power of 1,752,200 shares, no shared voting power, soledispositive power of 6,927,546 shares and no shared dispositive power.

(4)          As set forth inSchedule 13G, filed on February 14, 2006 by AXA Financial, Inc.(“Financial”) on behalf of itself and affiliated entities. According to the Schedule,the shares are also beneficially owned by the following French affiliates ofFinancial: AXA Assurances I.A.R.D. Mutuelle; AXA Assurances Vie Mutuelle; AXACourtage Assurance Mutuelle; and AXA (collectively with Financial, the “AXAGroup”). Of the reported shares, the AXA Group reported that it has sole votingpower with respect to 2,785,817 shares, that it shares voting power withrespect to no shares, that is has sole dispositive power with respect to3,613,017, and that it shares dispositive power with respect to no shares. TheAXA Group disclaims beneficial ownership of the reported shares

(5)          As set forth in aSchedule 13G/A, dated February 7, 2006, filed by SAPAC Corporation Ltd. (“SAPAC”).Includes 416,667 shares of common stock issuable upon exercise of warrantsowned by SAPAC.

(6)          Includes 481,252 sharesof common stock issuable upon exercise of options held by Dr. Stefansson.

(7)          Includes 130,208 sharesof common stock issuable upon exercise of options held by Mr. Thibault.

(8)          Represents shares ofcommon stock issuable upon exercise of options held by Dr. Gurney.

(9)          Includes 50,000 sharesof common stock issuable upon exercise of options held by Dr. Hartman. Doesnot include 50,000 shares of restricted stock with respect to which Dr. Hartmanhas no dispositive or voting rights.

(10)   Represents 118,876 shares ofcommon stock issuable upon exercise of options held by Dr. Hakonarson.

(11)   Includes 40,000 shares ofcommon stock issuable upon exercise of options held by Mr. Armstrong. Doesnot include 851 shares of restricted stock with respect to which Mr. Armstronghas no dispositive power or voting rights.

(12)   Includes 26,667 shares ofcommon stock issuable upon exercise of options held by Mr. Beery. Does notinclude 568 shares of restricted stock with respect to which Mr. Beery hasno dispositive power or voting rights.

(13)   Includes (a) 97,236 sharesof common stock held by Terrance McGuire TTEE, Terrance McGuire Trust-1999and (b) 40,000 shares of common stock issuable upon exercise of optionsheld by Mr. McGuire. Does not include 568 shares of restricted stock withrespect to which Mr. McGuire has no dispositive power or voting rights.

(14)   Representsan aggregate of 2,734,341 shares of common stock and 1,096,378 shares of commonstock issuable upon exercise of options.

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**EquityCompensation Plan Information**

The following table sets forth information concerningthe number of outstanding options, the weighted average exercise price of thoseoptions and the number of securities remaining to be granted under existingequity plans, whether approved or not approved by security holders, as of December 31,2005.

| **Plan Category**                                      | ** ** | ** ** | ** ** | **Number of Securities  to be Issued Upon  Exercise of Outstanding  Options,  Warrants and Rights** | ** ** | **Weighted-Average  Exercise Price of  Outstanding Options,   Warrants and Rights** | ** ** | **Number of Securities  Remaining Available for  Future Issuance Under  Equity  Compensation Plans** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders     |       |       | 7,432,575  |                                                                                                                                             |       |                                                                                                              | $          | 12.71                                                                                                                                   |       |   |   | 657,211 |   |   |
| Equity  compensation plans not approved by security holders |       |       | N/A        |                                                                                                                                             |       |                                                                                                              | N/A        |                                                                                                                                    |       |   | N/A |   |   |
| Total                                                       |       |       | 7,432,575  |                                                                                                                                             |       |                                                                                                              | $          | 12.71                                                                                                                                   |       |   |   | 657,211 |   |   |

 

**Item 13.**              *Certain Relationships and Related Transactions*

Covington & Burling, a law firm of which Mr. Beeryserves as Senior Of Counsel, provided legal services to us during the fiscalyear ended December 31, 2005 (for which we paid approximately $5,000) andwe expect the firm to continue to provide legal services to us in 2006.

In 2005, deCODE employed: (i) AriKarason, Dr. Stefansson’s son, as a research scientist and paid him inkronas the equivalent of $78,263 for his services; and (ii) HelgaStefansdottir, Dr. Stefansson’s sister, as the office manager of Encodeehf. and paid her in kronas the equivalent of $73,462 for her services. Compensationindicated in the foregoing sentence represents the aggregate dollar value ofthe compensation paid to the individual based on the effective krona to dollarexchange rate on each day payment was made. deCODE continues to employ theseindividuals at the same or similar salaries (although the dollar value ofsalaries paid in kronas is subject to fluctuations in the krona to dollarexchange rate).

**Item 14.**                 *Principal Accountant Fees and Services*

The following table summarizes the fees billed orexpected to be billed by Deloitte & Touche LLP (“Deloitte”) forservices rendered for the fiscal years ended December 31, 2005 and  2004:

| **Type of Fees** | ** ** | ** ** | ** ** | **Fiscal Year Ended  December 31,  2005** | ** ** | **Fiscal Year Ended  December 31,  2004** | ** ** |
|----------------------------|------------|------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| Audit Fees                 |       |       | $          | 886,500                                                  |       |                                                     |       | $ | 972,296 |   |   |
| Audit-Related  Fees        |       |       | 0          |                                                     |       |                                                     | 5,000      |   |   |
| Tax Fees                   |       |       | 95,400     |                                                     |       |                                                     | 95,000     |   |   |
| All Other Fees             |       |       | 0          |                                                     |       |                                                     | 0          |   |   |
| Total Fees                 |       |       | $          | 881,900                                                  |       |                                                     |       | $ | 1,072,296 |   |   |

 

The caption “audit fees”includes fees for professional services for the audit of our financialstatements included in our Form 10-K, review of our financialstatements included in our Form 10-Qs, issuance of comfort lettersand/or consents in connection with registration statements filed with theSecurities and Exchange Commission, and the attestation of management’sassessment of internal control as required by Section 404 of theSarbanes-Oxley Act of 2002. “Audit-related fees” are fees for grant audits,statutory audits, mergers and acquisitions and consultations. “Tax fees” arefees for tax compliance, tax advice and tax planning.

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**AuditCommittee Pre-Approval of Audit and Permissible Non-Audit Services byIndependent Registered Public Accounting Firm**

The Audit Committee has adopted policies andprocedures relating to the approval of all audit and legally permissiblenon-audit services provided by our independent registered public accountingfirm. Pursuant to this policy, all services to be performed by our independentregistered public accounting firm must be approved by the Audit Committee inadvance. Pre-approval is generally provided for up to one year as to a detailedlist of services, subject to a budget. The Audit Committee may also pre-approveparticular services on a case-by-case basis. The Audit Committee has delegatedthe authority to each of its members to pre-approve services that exceed thebudgeted amounts or that were not previously pre-approved when time constraintsdo not permit pre-approval by the full Audit Committee. Any such pre-approvalsmust be reported to the Audit Committee as its next meeting.

The Audit Committeepre-approved all services performed by our independent registered publicaccounting firm during 2004 and 2005.

**PART IV**

**Item 15.**                 *Exhibits, Financial Statement Schedules, and Reports on Form 8-K*

(a)           Thefollowing documents are included as part of this Annual Report on Form 10-K:

1.           Financial Statements:

| ** **                                                       | ** ** | **PAGE** |
|------------------------------------------------------------------|------------|----------|
| Reports of Independent  Registered Public Accounting Firms       |       | 43,44    |
| Consolidated Balance  Sheets                                     |       | 45       |
| Consolidated Statements  of Operations                           |       | 46       |
| Consolidated Statements  of Changes in Stockholders’ Equity |       | 47       |
| Consolidated Statements  of Cash Flows                           |       | 50       |
| Notes to Consolidated Financial Statements                       |       | 51       |

 

2.           All schedules are omitted as theinformation required is inapplicable or the information is presented in theconsolidated financial statements or the related notes.

3.                 Exhibits

The exhibits required to be filed are listed on the “Exhibit Index”attached hereto, which is incorporated herein by reference.

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**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

|        |   |   | deCODE genetics, Inc. |
|--------|--------|--------|----------------------------|
|   |   |   | By:                        | /s/ Kari Stefansson |
|   |   |   |                       | Kari Stefansson,   Chairman, President and Chief Executive Officer |

 

**Dated: March 15, 2006**

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

| /s/ Kari Stefansson   |   | Chairman, President, Chief Executive Officer and    | March 15, 2006 |
|-----------------------|--------|-----------------------------------------------------|--------------------------|
| Kari Stefansson       |   | Director (principal executive officer)              |                     |
| /s/ Lance Thibault    |   | Chief Financial Officer and Treasurer (principal    | March 15, 2006      |
| Lance Thibault        |   | financial officer and principal accounting officer) |                     |
| /s/ J. Neal Armstrong |   | Director                                            | March 15, 2006      |
| J. Neal Armstrong     |   |                                                |                     |
| /s/ James Beery       |   | Director                                            | March 15, 2006      |
| James Beery           |   |                                                |                     |
| /s/ Terrance McGuire  |   | Director                                            | March 15, 2006      |
| Terrance McGuire      |   |                                                |                     |
| /s/ Linda Buck        |   | Director                                            | March 15, 2006      |
| Linda Buck            |   |                                                |                     |

 

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**EXHIBIT INDEX**

| **ExhibitNumber** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|-------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1               |       | Amended and Restated Certificate of Incorporation,  as further amended (Incorporated by reference to Exhibit 3.1 and  Exhibit 3.3 to the Company’s Registration Statement on Form S-1  (Registration No. 333-31984) which became effective on  July 17, 2000).                                                                                                                                                                          |
| 3.2               |       | Bylaws, as amended (Incorporated by reference to  Exhibit 3.2 to the Company’s Registration Statement on Form S-1  (Registration No. 333-31984) which became effective on  July 17, 2000).                                                                                                                                                                                                                                                   |
| 3.3               |       | Certificate of Amendment to Amended and Restated  Certificate of Incorporation dated August 30, 2002 (Incorporated by  reference to Exhibit 3.2 to the Company’s Quarterly Report on  Form 10-Q filed on November 14, 2002).                                                                                                                                                                                                                 |
| 4.1               |       | Specimen Common Stock Certificate (Incorporated by  reference to Exhibit 4.1 to the Company’s Registration Statement on  Form S-1 (Registration No. 333-31984) which became  effective on July 17, 2000).                                                                                                                                                                                                                                    |
| 4.2               |       | Form of Warrant to Purchase Series C  Preferred Stock (Incorporated by reference to Exhibit 4.3 to the  Company’s Registration Statement on Form S-1 (Registration  No. 333-31984) which became effective on July 17, 2000).                                                                                                                                                                                                       |
| 4.3               |       | Warrant Certificate, dated May 6, 2002 issued  to Islandsbanki-FBA hf. (Incorporated by reference to Exhibit 4.1  to the Company’s Quarterly Report on Form 10-Q filed on  May 15, 2002).                                                                                                                                                                                                                                                    |
| 4.4               |       | Warrant, dated February 25, 2004, issued to  Merck & Co., Inc. (Incorporated by reference to  Exhibit 4.7 to the Company’s Annual Report on Form 10-K filed  on March 15, 2004).                                                                                                                                                                                                                                               |
| 4.5               |       | Indenture dated as of April 14, 2004 between  deCODE genetics,Inc. and The Bank of New York (including form of 3.5% Senior  Convertible Note due 2011.)(Incorporated by reference to Exhibit 4.2 to  the Company’s Registration Statement on Form S-3(Registration  No. 333-116543) which was filed on June 16,2004).                                                                                                                   |
| 4.6               |       | Registration Rights Agreement dated as of  April 14, 2004 between deCODE genetics, Inc., J.P. Morgan  Securities Inc. and Lehman Brothers Inc., as representatives of the Initial  Purchasers (Incorporated by reference to Exhibit 4.9 to the Company’s  Quarterly Report on Form 10-Q filed on May 10, 2004).                                                                                                                    |
| 10.1              |       | Form of License from The Icelandic Data  Protection Commission (now, The Icelandic Data Protection Authority) to  Islensk erfdagreining ehf. and its Clinical Collaborators to Use and Access  Patient Records and Other Clinical Data Relating to Individuals (Incorporated  by reference to Exhibit 10.1 to the Company’s Registration Statement on  Form S-1 (Registration No. 333-31984) which became  effective on July 17, 2000). |
| 10.2*             |       | 1996 Equity Incentive Plan, as amended (Incorporated  by reference to Exhibit 10.1 to the Company’s Registration Statement on  Form S-8 (Registration No. 333-56996) filed on  March 14, 2001).                                                                                                                                                                                                                                              |
| 10.3*             |       | Form of Non-Statutory Stock Option  Agreement, as executed by employees and officers of deCODE  genetics, Inc. who received non-statutory stock options  (Incorporated by reference to Exhibit 10.3 to the Company’s Annual  Report on Form 10-K filed April 15, 2003).                                                                                                                                                                 |
| 10.4*             |       | Form of Employee Proprietary Information and Inventions  Agreement (Incorporated by reference to Exhibit 10.4 to the Company’s  Registration Statement on Form S-1 (Registration No. 333-31984)  which became effective on July 17, 2000).                                                                                                                                                                                              |
| 10.5              |       | Co-operation Agreement between Reykjavik  Hospital and Islensk erfdagreining ehf., dated November 4, 1998  (Incorporated by reference to Exhibit 10.22 to the Company’s  Registration Statement on Form S-1 (Registration No. 333-31984)  which became effective on July 17, 2000).                                                                                                                                                     |

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| 10.6   |   | Co-operation Agreement between the Iceland  State Hospital and Islensk erfdagreining ehf., dated December 15, 1998  (Incorporated by reference to Exhibit 10.24 to the Company’s  Registration Statement on Form S-1 (Registration No. 333-31984)  which became effective on July 17, 2000). |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.7*  |   | Form of Employee Confidentiality, Invention  Assignment and Non-Compete Agreement executed by certain officers  (Incorporated by reference to Exhibit 10.44 to the Company’s  Registration Statement on Form S-1 (Registration No. 333-31984)  which became effective on July 17, 2000).     |
| 10.8   |   | Collaboration and Cross-License Agreement Re.  Diagnostics between F.Hoffman-La Roche Ltd. AG and deCODE genetics, ehf.  dated as of June 29, 2001 (Incorporated by reference to  Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q  filed on August 14, 2001).                         |
| 10.9   |   | Purchase Agreement between Vetrargardurinn ehf. and  Festing ehf. dated March 29, 2005 (Incorporated by reference to  Exhibit 10.1 to the Company’s Report on From 10-Q filed on  May 10, 2005).                                                                                                       |
| 10.10  |   | Lease Agreement between Vetrargardurinn ehf. and  Festing ehf. dated March 29, 2005 (Incorporated by reference to  Exhibit 10.2 to the Company’s Report on From 10-Q filed on  May 10, 2005).                                                                                                          |
| 10.11* |   | Employment Agreement between deCODE  genetics, Inc. and Daniel L. Hartman, effective as of July 15, 2005.  (Incorporated by reference to Exhibit 10.1 to the Company’s Report on  From 10-Q filed on November 9, 2005).                                                                           |
| 10.12* |   | Form of Restricted Stock Agreement  (Incorporated by reference to Exhibit 99.1 to the Company’s Current  Report on Form 8-K filed August 1, 2005).                                                                                                                                                |
| 10.13* |   | 2002 Equity Incentive Plan. (Incorporated by  reference to Exhibit 10.40 to the Company’s Annual Report on  Form 10-K filed on April 15, 2003).                                                                                                                                                        |
| 10.14+ |   | License Agreement, dated as of October 17,  2003, between deCODE genetics, ehf. and Bayer AG (Incorporated by reference  to Exhibit 10.32 to the Company’s Annual Report on Form 10-K  filed on March 15, 2004).                                                                                  |
| 10.15+ |   | License and Research Collaboration Agreement, dated  February 25, 2004, between deCODE genetics, ehf. and Merck &  Co., Inc. (Incorporated by reference to Exhibit 10.33 to the  Company’s Annual Report on Form 10-K filed on March 15,  2004).                                    |
| 10.16* |   | Agreement between deCODE genetics, Inc. and J.  Neal Armstrong dated as of August 18, 2003 and effective as of  October 3, 2003. (Incorporated by reference to Exhibit 10.2 to the  Company’s Quarterly Report on From 10-Q filed on November 13,  2003).                                    |
| 21.1   |   | Subsidiaries of deCODE genetics, Inc.                                                                                                                                                                                                                                                                                 |
| 23.1   |   | Consent of Deloitte & Touche LLP,  independent registered public accounting firm.                                                                                                                                                                                                                                 |
| 23.2   |   | Consent of PricewaterhouseCoopers LLP, independent  registered public accounting firm.                                                                                                                                                                                                                                     |
| 31.1   |   | Certifications pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                            |
| 31.2   |   | Certifications pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                            |
| 32     |   | Certifications pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                            |

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+                Certain portionsof this exhibit have been granted confidential treatment by the Commission. Theomitted portions have been separately filed with the Commission.

*                    Constitutes amanagement contract or compensatory plan or arrangement.

#                 A request forconfidential treatment had been submitted with respect to this exhibit. Thecopy which was filed as an exhibit omits the information subject to the requestfor confidential treatment.

Note: Unless otherwise noted, the SEC File numberof each of the above referenced documents is 000-30469.

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