**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**FORM 10-Q**

| **(Mark One)**                                                                           |
|------------------------------------------------------------------------------------------|
| ** **                                                                               |
| **x****QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES**   |
| **EXCHANGE  ACT OF 1934.**                                                               |
| ** **                                                                               |
| **FOR THE  QUARTERLY PERIOD ENDED MARCH 31, 2007**                                  |
| ** **                                                                               |
| **OR**                                                                                   |
| ** **                                                                               |
| **o****TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES** |
| **EXCHANGE  ACT**                                                                        |

 

**FORTHE TRANSITION PERIOD FROM           TO           **

**COMMISSION FILE NUMBER 000-30469**

**deCODEgenetics, Inc.**

(Exact Name ofRegistrant as Specified in Its Charter)

| **Delaware**                     |   | **04-3326704**                        |
|----------------------------------|--------|---------------------------------------|
| (State or Other  Jurisdiction of |   | (I.R.S. Employer  Identification No.) |
| Incorporation or  Organization)  |   |                                  |

 

**STURLUGATA 8, IS-101 REYKJAVIK, ICELAND**

(Address ofPrincipal Executive Offices)

**+354-570-1900**

(Registrant’sTelephone Number, Including Area Code)

Indicate by check whetherthe registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.    Yes  x    No  o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act. (CheckOne):
| Large accelerated  filer o | Accelerated  filer  x | Non-accelerated filer  o |
|---------------------------------|---------------------------------|------------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).    Yes  o    No  x

The aggregate number ofshares of the registrant’s common stock outstanding on April 30, 2007 was61,701,333 shares of common stock $.001 par value.

 

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**deCODEgenetics, Inc.**

**INDEX**
| PART I.       |   | FINANCIAL  INFORMATION                                                                                    |
|--------------------|--------|-----------------------------------------------------------------------------------------------------------|
|               |   |                                                                                                      |
| Item 1.            |   | Financial  Statements (Unaudited)                                                                         |
|               |   |                                                                                                      |
|               |   | Condensed  Consolidated Balance Sheets as of March 31, 2007 and December 31,  2006              |
|               |   |                                                                                                      |
|               |   | Condensed  Consolidated Statements of Operations for the three-months ended  March 31, 2007 and 2006 |
|               |   |                                                                                                      |
|               |   | Condensed  Consolidated Statements of Cash Flows for the three-months ended  March 31, 2007 and 2006 |
|               |   |                                                                                                      |
|               |   | Notes to  Condensed Consolidated Financial Statements                                                     |
|               |   |                                                                                                      |
| Item 2.            |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations               |
|               |   |                                                                                                      |
| Item 3.            |   | Quantitative  and Qualitative Disclosures about Market Risk                                               |
|               |   |                                                                                                      |
| Item 4.            |   | Controls and  Procedures                                                                                  |
|               |   |                                                                                                      |
| PART II.      |   | OTHER INFORMATION                                                                                         |
|               |   |                                                                                                      |
| Item 1.            |   | Legal proceedings                                                                                         |
|               |   |                                                                                                      |
| Item 6.            |   | Exhibits                                                                                                  |
|               |   |                                                                                                      |
|               |   | (a) Exhibits                                                                                         |
|               |   |                                                                                                      |
| Signatures         |
|               |   |                                                                                                      |
| Index to  Exhibits |
|                    |        |                                                                                                           |  |

 

1

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**PART I. FINANCIAL INFORMATION**

** ITEM 1. FINANCIAL STATEMENTS**

**deCODEgenetics, Inc.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

(Unaudited)
| ** **                                                                                                                                                                                                              | ** ** | **March 31,**                                       | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                              | ** ** | **2007**                                                 | ** ** | **2006**              | ** ** |
| ** **                                                                                                                                                                                                              | ** ** | **(In thousands, except  share amounts)** | ** ** |
| ASSETS                                                                                                                                                                                                                  |       |                                                     |       |                  |       |
| Current assets:                                                                                                                                                                                                         |       |                                                     |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                                              |       | $                                                        | 17,206     |                  | $          | 21,882 |   |
| Investments                                                                                                                                                                                                             |       | 117,902                                                  |       | 130,134               |       |
| Receivables                                                                                                                                                                                                             |       | 8,241                                                    |       | 8,464                 |       |
| Other current  assets                                                                                                                                                                                                   |       | 9,551                                                    |       | 9,231                 |       |
| Total current  assets                                                                                                                                                                                                   |       | 152,900                                                  |       | 169,711               |       |
| Property and equipment,  net                                                                                                                                                                                            |       | 23,159                                                   |       | 24,382                |       |
| Goodwill                                                                                                                                                                                                                |       | 10,055                                                   |       | 10,055                |       |
| Intangible assets, net                                                                                                                                                                                                  |       | 4,282                                                    |       | 4,576                 |       |
| Other long-term  assets                                                                                                                                                                                                 |       | 6,506                                                    |       | 6,885                 |       |
| Total assets                                                                                                                                                                                                            |       | $                                                        | 196,902    |                  | $          | 215,609 |   |
| LIABILITIES AND  STOCKHOLDERS’ DEFICIT                                                                                                                                                                             |       |                                                     |       |                  |       |
| Current liabilities:                                                                                                                                                                                                    |       |                                                     |       |                  |       |
| Accounts payable                                                                                                                                                                                                        |       | $                                                        | 4,250      |                  | $          | 2,877 |   |
| Accrued expenses  and other current liabilities                                                                                                                                                                         |       | 13,443                                                   |       | 14,360                |       |
| Current portion  of capital lease obligations                                                                                                                                                                           |       | 2,105                                                    |       | 2,100                 |       |
| Current portion  of long-term debt                                                                                                                                                                                      |       | 603                                                      |       | 604                   |       |
| Deferred revenue                                                                                                                                                                                                        |       | 5,395                                                    |       | 3,557                 |       |
| Total current  liabilities                                                                                                                                                                                              |       | 25,796                                                   |       | 23,498                |       |
| Capital lease  obligations, net of current portion                                                                                                                                                                      |       | 2,978                                                    |       | 3,493                 |       |
| Long-term debt,  net of current portion                                                                                                                                                                                 |       | 213,182                                                  |       | 212,062               |       |
| Deferred gain on  sale-leaseback                                                                                                                                                                                        |       | 25,231                                                   |       | 25,716                |       |
| Deferred revenue                                                                                                                                                                                                        |       | 6,219                                                    |       | 6,219                 |       |
| Commitments and  contingencies                                                                                                                                                                                          |       |                                                     |       |                  |       |
| Stockholders’ 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:  61,698,833 and 61,697,833, respectively, at March 31, 2007; and 61,556,985  and 61,555,985 respectively, at December 31, 2006 |       | 62                                                       |       | 62                    |       |
| Additional paid-in  capital                                                                                                                                                                                             |       | 484,532                                                  |       | 483,052               |       |
| Notes receivable                                                                                                                                                                                                        |       | (2,764                                                   | )          | (2,778                | )          |
| Accumulated  deficit                                                                                                                                                                                                    |       | (558,313                                                 | )          | (535,688              | )          |
| Accumulated  other comprehensive income                                                                                                                                                                                 |       | (16                                                      | )          | (22                   | )          |
| Treasury stock,  1,000 shares stated at cost at March 31, 2007 and December 31, 2006                                                                                                                                    |       | (5                                                       | )          | (5                    | )          |
| Total  stockholders’ deficit                                                                                                                                                                                       |       | (76,504                                                  | )          | (55,379               | )          |
| Total liabilities and  stockholders’ deficit                                                                                                                                                                       |       | $                                                        | 196,902    |                  | $          | 215,609 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

2

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**deCODEgenetics, Inc.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

(Unaudited)
| ** **                                                     | ** ** | **For the Three-Months Ended  March 31,**     | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | **2007**                                                          | ** ** | **2006** | ** ** |
| ** **                                                     | ** ** | **(In thousands, except  per share amounts)** | ** ** |
|                                                           |       |                                                              |       |   |   |
| Revenue                                                        |       | $                                                                 | 8,554      |   | $ | 10,133 |   |
| Operating expenses:                                            |       |                                                              |       |   |   |
| Cost of revenue.                                               |       | 10,918                                                            |       | 9,850 |   |
| Research and development                                       |       | 12,676                                                            |       | 15,517 |   |
| Selling, general and administrative                            |       | 6,176                                                             |       | 5,267 |   |
| Total operating expenses                                       |       | 29,770                                                            |       | 30,634 |   |
| Operating loss                                                 |       | (21,216                                                           | )          | (20,501 | ) |
| Interest income                                                |       | 1,991                                                             |       | 1,712 |   |
| Interest expense                                               |       | (3,666                                                            | )          | (1,716 | ) |
| Other non-operating  income, net                               |       | 266                                                               |       | 232 |   |
| Net loss                                                       |       | $                                                                 | (22,625    | ) | $ | (20,273 | ) |
|                                                           |       |                                                              |       |   |   |
| Basic and  diluted net loss per share                          |       | $                                                                 | (0.37      | ) | $ | (0.37 | ) |
| Shares used in  computing basic and diluted net loss per share |       | 60,949                                                            |       | 54,601 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

3

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**deCODEgenetics, Inc.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

(Unaudited)
| ** **                                                                          | ** ** | **For the Three-Months** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                          | ** ** | **Ended March 31,**      | ** ** |
| ** **                                                                          | ** ** | **2007**                           | ** ** | **2006** | ** ** |
| ** **                                                                          | ** ** | **(In thousands)**            | ** ** |
| **Cash  flows from operating activities:**                                          |       |                               |       |   |   |
| Net loss                                                                            |       | $                                  | (22,625    | ) | $ | (20,273 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:        |       |                               |       |   |   |
| Depreciation and amortization                                                       |       | 1,754                              |       | 1,874 |   |
| Amortization of deferred gain on sale-leaseback of  real estate                     |       | (485                               | )          | (485 | ) |
| Stock-based compensation                                                            |       | 1,462                              |       | 971 |   |
| Gain (loss) on disposal of equipment, net                                           |       | —                             |       | 48 |   |
| Foreign currency translation                                                        |       | (15                                | )          | (4 | ) |
| Amortization of debt discount                                                       |       | 1,266                              |       | — |   |
| Amortization of deferred financing costs                                            |       | 381                                |       | 212 |   |
| Other                                                                               |       | (2                                 | )          | 25 |   |
| Changes in  operating assets and liabilities:                                       |       |                               |       |   |   |
| Receivables and other assets                                                        |       | (335                               | )          | (785 | ) |
| Accounts payable, accrued expenses and other current  liabilities                   |       | 456                                |       | 1,059 |   |
| Deferred revenue                                                                    |       | 1,838                              |       | 1,386 |   |
| Net cash used in operating activities                                               |       | (16,305                            | )          | (15,972 | ) |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                              |       |                               |       |   |   |
| Purchase of investments                                                             |       | (25,334                            | )          | (88,095 | ) |
| Sale of investments                                                                 |       | 37,587                             |       | 49,825 |   |
| Purchase of property and equipment                                                  |       | (237                               | )          | (819 | ) |
| Proceeds from sale of property                                                      |       | 238                                |       | - |   |
| Acquisition of UVS, net of cash acquired                                            |       | —                             |       | 1,270 |   |
| Net cash provided by (used in) investing activities                                 |       | 12,254                             |       | (37,819 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                              |       |                               |       |   |   |
| Proceeds from issuance of common stock                                              |       | 18                                 |       | 709 |   |
| Repayment of notes receivable for common stock                                      |       | 14                                 |       | 52 |   |
| Proceeds from equipment financing                                                   |       | —                             |       | 288 |   |
| Repayments of debt and capital lease obligations                                    |       | (657                               | )          | (765 | ) |
| Net cash (used in) provided by financing activities                                 |       | (625                               | )          | 284 |   |
| Net decrease in  cash and cash equivalents                                          |       | (4,676                             | )          | (53,507 | ) |
| Cash and cash  equivalents at beginning of period                                   |       | 21,882                             |       | 65,943 |   |
| Cash and cash  equivalents at end of period                                         |       | $                                  | 17,206     |   | $ | 12,436 |   |
| Supplemental  cash flow information:                                                |       |                               |       |   |   |
| Cash paid for interest                                                              |       | $                                  | 224        |   | $ | 177 |   |
| Supplemental  schedule of non-cash transactions Common stock issued for acquisition |       | $                                  | —     |   | $ | 6,082 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

4

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**deCODEgenetics, Inc.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

(tabular amountsin thousands, except share and per share amounts)
| **1.** | **Organization and Business** |
|--------|-------------------------------|

 

References in these financial statements to deCODErefer to deCODE genetics, Inc., a Delaware company, and deCODEgenetics, Inc.’s wholly-owned subsidiary, Islensk erfdagreining ehf., anIcelandic company registered in Reykjavik, and its subsidiaries, as well asdeCODE genetics, Inc.’s wholly-owned subsidiary, MediChem LifeSciences, Inc., a Delaware corporation, and its subsidiaries.
| **2.** | **Basis of Presentation** |
|--------|---------------------------|

 

In the opinion ofdeCODE’s management, the accompanying unaudited condensed consolidatedfinancial statements contain all adjustments (consisting of items of a normaland recurring nature) necessary to present fairly the financial position as ofMarch 31, 2007, the results of operations for the three-month periodsended March 31, 2007 and 2006 and cash flows for the three-month periodsended March 31, 2007 and 2006.  The results of operations for thethree-month period ended March 31, 2007 are not necessarily indicative ofthe results to be expected for the full year.  These financial statementsshould be read in conjunction with deCODE’s Annual Report on Form 10-K forthe year ended December 31, 2006, which includes consolidated financialstatements and notes thereto for the years ended December 31, 2006, 2005and 2004.

Certain priorperiod balances in cost of revenue and research and development have beenreclassified to conform to the current period presentation. Thereclassifications have no impact on reported revenue, net loss or loss pershare.
| **3.** | **Revenue** |
|--------|-------------|

 

Significantelements of deCODE’s revenue are summarized as follows:
| ** **                                                                 | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2007**                                                           | ** ** | **2006** | ** ** |
| ** **                                                                 | ** ** | **(In thousands)**                                            | ** ** |
| Research funding  and other service fees                                   |       | $                                                                  | 4,614      |   | $ | 5,468 |   |
| Milestone  payments                                                        |       | 342                                                                |       | 198 |   |
| Up-front,  exclusivity, technology access, and technology development fees |       | —                                                             |       | 500 |   |
| Government  research contracts and grant funding                           |       | 3,360                                                              |       | 2,987 |   |
| Other                                                                      |       | 238                                                                |       | 980 |   |
|                                                                       |       | $                                                                  | 8,554      |   | $ | 10,133 |   |

 

For the three months ended March 31, 2007 and2006, revenue from collaborations with F. Hoffmann-La Roche (Roche) constituted6% and 26%, respectively, of consolidated revenue, government research contractand grant revenues from divisions of the United States National Institutes ofHealth (NIH) constituted 26% and 25%, respectively, of consolidated revenue andgrant revenues from the Commission of the European Communities (EC) constituted13% and 4%, respectively, of consolidated revenue.

During the three-months ended March 31, 2007, deCODEperformed services totalling $121,000 for an employer of a member of deCODE’sboard of directors.
| **4.** | **Research and Development** |
|--------|------------------------------|

 

deCODE’s researchand development expense consist of the costs of its own proprietary programs,comprised of the following during the three-months ended March 31, 2007 and2006:
|                                                  | ** ** | **For the Three Months   Ended March 31,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **2007**                                                                 | ** ** | **2006** | ** ** |
| ** **                                       | ** ** | **(In thousands)**                                                  | ** ** |
|                                             |       |                                                                     |       |   |   |
| Salaries and  other personnel costs              |       | $                                                                        | 4,823      |   | $ | 5,336 |   |
| Materials and  supplies                          |       | 2,672                                                                    |       | 1,590 |   |
| Contractor  services and other third party costs |       | 2,699                                                                    |       | 5,827 |   |
| Overhead  expenses                               |       | 1,448                                                                    |       | 1,570 |   |
| Depreciation and  amortization                   |       | 722                                                                      |       | 872 |   |
| Stock-based  compensation                        |       | 312                                                                      |       | 322 |   |
|                                             |       | $                                                                        | 12,676     |   | $ | 15,517 |   |

 

5

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| **5.** | **Stock-Based Compensation** |
|--------|------------------------------|

 

Stock-basedcompensation to employees for the three-month periods ended March 31, 2007 and2006 is included in deCODE’s results of operations as follows: 

|                                                      | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                              | ** ** |
| Operating  Expenses:                                 |       |                                                 |       |   |   |
| Cost of revenue                                      |       | $                                                    | 252        |   | $ | 116 |   |
| Research and development – proprietary programs |       | 312                                                  |       | 322 |   |
| Selling, general and administrative                  |       | 845                                                  |       | 485 |   |
| Total                                                |       | $                                                    | 1,409      |   | $ | 923 |   |

 

As of March 31,2007 there was approximately $9,869,000 of total unrecognized compensationexpense related to nonvested stock options. This expense is expected to berecognized over a weighted-average period of approximately 2.5 years.

deCODE calculatedthe fair value of each option award on the date of grant using theBlack-Scholes option pricing model. The following weighted average assumptionswere used for the three-months ended March 31, 2007 and 2006:
|                           | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------|------------|------------------------------------------------------|------------|
| ** **                | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
|                      |       |                                                 |       |   |   |
| Dividend yield            |       | —                                               |       | — |   |
| Expected  volatility      |       | 64.8                                                 | %          | 68.2 | % |
| Expected term  (in years) |       | 5.4                                                  |       | 5.1 |   |
| Risk-free interest rate   |       | 4.5                                                  | %          | 4.6 | % |
|                           |            |                                                      |            |  |  |  |  |

 

deCODE estimatesthe expected term of the options based on historical patterns by employees withrespect to exercise and post vesting employment termination behaviors. deCODE’sexpected volatility is calculated using a weighted average of the volatilityover a period equal to the expected term of the award and the most recent oneyear volatility. deCODE bases the risk-free interest rate used on the impliedrate currently available on the U.S. Treasury zero-coupon issues with acomparable term. As deCODE does not pay dividends, the dividend variable rateis zero.

The followingtable summarizes stock option activity for the three-months ended March 31,2007:
|                                 | ** ** | **Number  of Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|---------------------------------|------------|----------------------------|------------|----------------------------------------|------------|
| Outstanding at  January 1, 2007 |       | 4,975,074                  |       | $                                      | 8.14       |   |
| Granted                         |       | 2,479,500                  |       | 3.45                                   |       |
| Exercised                       |       | (8,848                     | )          | 2.01                                   |       |
| Forfeited/cancelled             |       | (166,976                   | )          | 8.56                                   |       |
| Outstanding at  March 31, 2007  |       | 7,278,750                  |       | 6.54                                   |       |
| Exercisable at March  31, 2007  |       | 3,407,917                  |       | $                                      | 8.35       |   |

 

deCODE’s Equity Incentive Plans allow for the issuanceof restricted stock awards that may not be sold or otherwise transferred untilcertain restrictions have lapsed. The unearned stock-based compensation relatedto these awards is amortized to compensation expense over the period therestrictions lapse. The stock-based compensation expense for these awards isdetermined based on the market price of our stock at the date of the grantapplied to the total numbers of shares that are anticipated to fully vest andthen

6

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amortized over thevesting period. During the three-months ended March 31, 2007, deCODE recognizedexpense related to restricted stock grants of $53,000 and $48,000,respectively. At March 31, 2007, deCODE had 51,897 unvested restricted shareswith a weighted average grant date fair value of $9.33.
| **6.** | **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.

Diluted net lossper share is computed using the weighted-average number of common sharesoutstanding during the period, plus the dilutive effect of potential commonshares. Diluted net loss per share does not differ from basic net loss pershare in all periods presented as potential common shares are antidilutive forall such periods and are, therefore, excluded from the calculation. Potentialcommon shares excluded from the calculation of diluted net loss per share were:
| ** **                                                                                            | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                                                                            | ** ** | **2007**           | ** ** | **2006**           | ** ** |
| ** **                                                                                            | ** ** | **(Shares)**       | ** ** | **(Shares)**       | ** ** |
| Warrants to  purchase shares of common stock                                                          |       | 856,371            |       | 2,385,022          |       |
| Options to  purchase shares of common stock                                                           |       | 7,278,750          |       | 4,802,058          |       |
| Restricted  shares subject to vesting or with an associated outstanding non-recourse  promissory note |       | 705,497            |       | 762,800            |       |
| Convertible  shares issuable upon conversion of 3.5% senior convertible notes                         |       | 16,428,572         |       | 10,714,286         |       |
|                                                                                                  |       | 25,269,190         |       | 18,664,166         |       |

 
| **7.** | **Comprehensive Income** |
|--------|--------------------------|

 

Comprehensiveincome generally represents all changes in stockholders’ equity except thoseresulting from investments or contributions by stockholders. Amounts reportedin other comprehensive income include foreign currency translation adjustments,derivative financial instruments designated and effective as hedges ofunderlying foreign currency denominated transactions, and unrealized gains andlosses associated with investments.  The following table presents thecalculation of comprehensive income (loss):
|                                                     | ** ** | **For the Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2007**                                                               | ** ** | **2006** | ** ** |
| ** **                                          | ** ** | **(In thousands)**                                                | ** ** |
|                                                |       |                                                                   |       |   |   |
| Net loss                                            |       | $                                                                      | (22,625    | ) | $ | (20,273 | ) |
| Other  comprehensive income (loss):                 |       |                                                                   |       |   |   |
| Foreign currency  translation                       |       | (15                                                                    | )          | 8 |   |
| Unrealized gain  (loss) associated with investments |       | 21                                                                     |       | (21 | ) |
|                                                |       |                                                                   |       |   |   |
| Total comprehensive  loss                           |       | $                                                                      | (22,619    | ) | $ | (20,286 | ) |

 
| **8.** | **Investments** |
|--------|-----------------|

 

deCODE invests its excess cash with large U.S. basedfinancial institutions and considers its investment portfolio asavailable-for-sale. Investments are available for current operations and areclassified as current assets. Investments are carried at fair value with theunrealized holding gain or loss included in accumulated other comprehensiveincome. Fair value is generally determined with reference to quotations inactive markets. Premium and discounts associated with investments in bonds areamortized using the effective interest rate method.

Investments as of March 31, 2007 are summarizedas follows:
|                             | ** ** | **Amortized  Cost**     | ** ** | **Estimated  Fair Value** | ** ** |
|-----------------------------|------------|-------------------------|------------|--------------------------------|------------|
| ** **                  | ** ** | **(In thousands)** | ** ** |
| Auction rate  securities    |       | $                       | 91,425     |                           | $          | 91,425 |   |
| Municipal bonds             |       | 11,498                  |       | 11,497                         |       |
| Government debt  securities |       | 10,000                  |       | 9,980                          |       |
| Corporate bond              |       | 5,000                   |       | 5,000                          |       |
|                        |       | $                       | 117,923    |                           | $          | 117,902 |   |

 

7

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Gross unrealizedholding gains and gross unrealized holding losses at March 31, 2007 were $0 and$21,000, respectively, and at December 31, 2006 were $0 and $41,000,respectively, and are included in accumulated other comprehensive income.
| **9.** | **Sale-Leaseback Financing** |
|--------|------------------------------|

 

In February 2007, deCODE entered into an agreementregarding the sale and leaseback of its property (land and facility) in Woodridge,Illinois. Pursuant to the agreement and subject to the satisfaction ofcontingencies including, without limitation, negotiation of a satisfactorylease, deCODE will sell the Woodridge property for $25,000,000 in cash andlease the property back under a 17 year lease at an initial rent of $163,000per month, subject to annual rent increases of 2.5%. Under the leasecontemplated by the agreement, deCODE will have two 5-year renewal options withrent at the then prevailing market rate. The lease will be an absolute netlease and deCODE will continue to pay all expenses relating to the property,including taxes, utilities, insurance and maintenance. deCODE’sobligations under the lease are to be secured by a letter of credit in aninitial amount of $5,000,000 that may be reduced upon certain conditions. Theagreement regarding the sale and leaseback of the property is subject to thesatisfaction of various contingencies, including, without limitation, thenegotiation of a satisfactory lease, the buyer’s ability to obtain financingfor its purchase of the property and the buyer’s satisfaction with its duediligence review of the property. The transaction is expected to close inMay 2007 if such contingencies are satisfied, however, in light of the contingencies,there can be no assurance that the closing will occur.   
| **10.** | **Litigation** |
|---------|----------------|

Other than claims and legal proceedings that arisefrom time to time in the ordinary course of business which are not material,and matters described below, there has been no change in the matters reportedin our Annual Report on Form 10-K for the year ended December 31, 2006.

In the matter ofIn re deCODE genetics, Inc. Initial Public Offering , which is described indeCODE’s Annual Report on Form 10-K for the year ended December 31, 2006 (the “10-K”),the United States Court of Appeals for the Second Circuit, on April 6, 2007,denied plaintiffs’ petition for rehearing. In light of the Second Circuitopinion, deCODE’s counsel has informed the district court that the proposedsettlement described in the 10-K cannot be approved because the definedsettlement class, like the litigation class, cannot be certified. deCODE cannotpredict whether deCODE will be able to renegotiate a settlement that complies withthe Second Circuit’s mandate. Due to the inherent uncertainties of litigation,deCODE cannot accurately predict the ultimate outcome of the matter. 
| **11.** | **Recent Accounting Pronouncements** |
|---------|--------------------------------------|

 

On January 1,2007, deCODE adopted Financial Accounting Standards Board (“FASB”)Interpretation No. 48, *Accounting for Uncertainty in Income Taxes, aninterpretation of FASB Statement No. 109* (“FIN 48”). FIN 48clarifies the accounting for uncertainties in income taxes recognized in anenterprise’s financial statements. FIN 48 requires companies to determinewhether it is more likely than not that a tax position will be sustained uponexamination by the appropriate taxing authority. If a tax position meets the “morelikely than not” recognition criteria, FIN 48 requires the tax position bemeasured at the largest amount of benefit greater than 50 percent likely ofbeing realized upon ultimate settlement. This accounting standard is effectivefor fiscal years beginning after December 15, 2006. The cumulative effect, ifany, of applying FIN 48 is to be reported as an adjustment to the openingbalance of retained earnings in the year of adoption. The adoption onJanuary 1, 2007 did not have a material effect on deCODE’s financialstatements upon adoption or for the period ended March 31, 2007.

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**ITEM 2.****          MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

This Management’s Discussion and Analysis of FinancialCondition and Results of Operations as of March 31, 2007 and for thethree-month periods ended March 31, 2007 and 2006 should be read inconjunction with the unaudited condensed consolidated financial statements andnotes thereto set forth in Item 1 of this report.

 This quarterly report on Form 10-Q containsforward-looking statements, including our expectations of future industryconditions, strategic plans and forecasts of operational results. Various risksmay cause our actual results to differ materially. A list and description ofsome of the risks and uncertainties is contained below and in the summary of riskfactors that follow in Part II, Item 1A.

**Overview**

Headquartered inReykjavik, Iceland, deCODE is a biopharmaceutical company applying itsdiscoveries in human genetics to develop drugs and diagnostics for commondiseases. Our population approach and resources enable us to isolate genes anddrug targets directly involved in the development of many of the diseases whichpose the biggest challenges to public health. We are turning these discoveriesinto a growing pipeline of therapeutics and diagnostic tests taking aim at thecauses 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 with majorpotential in the global marketplace.

We believe thatdeCODE’s advantage derives from our population approach to human genetics andthe ability to apply this approach directly to drug and diagnostic development.In Iceland, we have comprehensive population resources that enable ourscientists to isolate key genes and gene variants contributing to commondiseases. The proteins encoded by these genes, and other proteins with whichthey interact in the disease pathway, offer drug targets that we believe are directlyinvolved in the onset and progression of disease. Our work indicates that thesegenes confer risk by increasing or decreasing the activity of common biologicalpathways, placing individuals on a spectrum of risk that encompasses thepopulation as a whole. Small-molecule drugs that can modulate theactivity of the pathway in question may therefore have broad potential utility,not only to those at highest risk but perhaps also to those at average risk,which in the common diseases may be unacceptably high. Moreover, these pathwaysoften provide biomarkers that can be used to assess the efficacy of a compoundfrom preclinical to mid-stage clinical testing.

We are alsoapplying our findings to create DNA-based diagnostics. Because such testsanalyze the same links between genetic variation and disease that we have usedto identify drug targets, they can be employed as an aid in developing moreeffective disease prevention strategies by helping individuals to betterunderstand their inherited risk of a given condition, as well as to identifypatients likely to respond well to a given drug. In April 2007 we beganoffering deCODE T2TM, our first reference laboratory DNA-based test for a genevariant we discovered to be associated with increased risk of type 2diabetes.  We have entered into anagreement with DNA Direct, Inc. pursuant to which it will market and sell thistest to consumers.  In addition, we aremarketing and selling the test directly to physicians and other health careprofessionals.

Through ourchemistry and structural biology units, based in the United States, we are ableto discover novel small-molecule therapeutic compounds, take candidatecompounds through pre-clinical testing, and manufacture sufficient quantitiesfor early-stage clinical trials. Our product development group, which hasexpertise in drug and disease modeling, designs and implements our clinicaltrials. We also actively explore in-licensing, co-development, and partnering opportunities, and in certain programshave brought directly into clinical trials compounds that address targets wehave identified through our genetics research but which were originallydeveloped by other companies for other indications.

deCODE hasdemonstrated its ability to discover novel therapeutic targets and compounds inmajor indications. The company has also shown that it can efficiently advancethese compounds into and through mid-stage clinical trials providing a clearand detailed association to the biology of disease.

We are currentlyanalyzing the results of a Phase IIa clinical trial for DG041, ourdevelopmental anti-platelet compound for arterial thrombosis. Phase I studiesshowed DG041 to be well-tolerated and to effectively reduce plateletaggregation without increasing bleeding time. The Phase II study is examiningsafety, tolerability, dosing, and the effect of various dose levels onbiomarkers of platelet activation in patients with peripheral artery disease,and we expect to initiate a second Phase II study in patients with other vasculardisease by year end.

deCODE has twocompounds in clinical development targeting the leukotriene pathway for theprevention of heart attack. The results of the recently completed Phase Imultiple dose ranging study of our compound, DG051, showed it to be safe andwell-tolerated in the doses tested; to have a pharmacokinetic profile thatsupports its suitability for once-a-day dosing; and to lower, in adose-dependent manner, levels of leukotriene B4, the pro-inflammatory biomarkerthat deCODE believes confers the increased risk of heart attack through thispathway. deCODE expects to begin Phase II testing later this year. We arecurrently reformulating the tablets for DG031, our Phase III compound for theprevention of heart attack, and expect to be in a position to restart our PhaseIII testing by year end. deCODE is conducting drug discovery work in vasculardisease and stroke, the most advanced of

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its preclinical programs.

deCODE has apartnership with Roche focused on the discovery and development of PDE4inhibitors for vascular disease. deCODE and Illumina, Inc. are working togetherto develop DNA-based diagnostic kits utilizing deCODE’s gene discoveries inheart attack, type 2 diabetes and breast cancer and Illumina’s platform for SNPgenotyping. The company is also actively exploring drug developmentpartnerships in its most advanced therapeutic programs, in order to spread riskand cost, and to focus resources on the advancement of its drug discovery workand preclinical candidates.

The goal of our business strategy is to maximize thecreation of value from our human genetics, drug discovery and diagnostics workand to capture that value for the company and its stockholders. Our productdevelopment pipeline now includes drug development programs in heart attack andarterial thrombosis, and following on the launch of deCODE T2TM in type 2diabetes we are advancing our DNA-based risk predisposition testing programs inarterial fibrillation, heart attack and prostate and breast cancer. Executingon our strategy – advancing these programs swiftly while continuing ourdiscovery work in a broad range of common diseases – requires us to spread riskand manage cost. We are constantly evaluating the optimal balance betweenproprietary and partnered product development, the level of our investment inresearch and development, the deployment of cash resources for productdevelopment, and the financing environment.

As we invest in proprietary programs, we leverage ourcapabilities to form corporate alliances and to provide services to fee-payingcustomers. We also receive contract and grant funding from various governmentalagencies. We have formed drug and other product development alliances withRoche and Illumina, among others. Our chemistry subsidiary provides drugdiscovery and contract manufacturing services to fee-for-service customers, andour other service offerings include protein crystallography products andinstruments through our biosystems subsidiary, as well as protein structureanalysis contract services through our structural biology subsidiary; clinicaltrials services through our Encode CRO; and DNA analysis services through ourgenotyping laboratory in Reykjavik.

We derive revenuesprimarily from research funding and other fees from our service customers andcollaborative partners, as well as from research grants. Milestone payments andupfront, exclusivity, technology-access and technology-development fees underour collaboration agreements constitute another source of our revenues. Ourexpenses consist primarily of research and development expenses such as,salaries and related employee costs, materials and supplies, and contractorservices.

We believe thatour ongoing work in genetics, the advancement of our drug and diagnosticprograms, and in particular the conduct of clinical trials, will requiresignificant ongoing expenditure. In 2006, we completed our Phase Idose-ranging, pharmacokinetic and safety clinical program for DG041, ourdevelopmental anti-platelet compound for arterial thrombosis and concluded aPhase IIa trial; filed an IND and conducted a single-dose ranging Phase I studyfor DG051 for the prevention of heart attack; concluded our Phase II trial ofCephalon’s developmental compound CEP-1347 in asthma; and designed andinitiated a Phase III trial for DG031 for the prevention of heart attack, atrial that we voluntarily suspended in October in order to address aformulation problem with the tablets.  In the first quarter of 2007 we continued to advance our drugdevelopment programs, completing a successful Phase I multiple dose rangingstudy of DG051, and are working to advance this compound to the next phases ofclinical testing. We have established a Clinical Laboratory ImprovementAmendments (CLIA) certified reference laboratory for offering DNA-based tests,and expect to follow the launch of our deCODE T2TM test in type 2 diabetes withseveral other tests we now have in development. We anticipate incurringadditional net losses at least through the next several years, due to, inaddition to the above-mentioned factors, depreciation and amortization, as wellas stock-based compensation and other non-cash charges. We expect that ourrevenues and losses will fluctuate from quarter to quarter and that such fluctuationsmay be substantial, especially because progress in our scientific work andmilestone payments that are related to progress can fluctuate between quarters.We do not believe that comparisons of our quarter-to-quarter performance are agood indication of future performance.

At March 31, 2007,we had $135.1 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 in the future will be affected byconditions in the global financial markets and in the pharmaceutical industry.We expect that more favorable conditions in those markets will presentopportunities for us, while downturns in the market valuations of biotechnologycompanies and of the equity markets more generally will restrict our ability toraise additional capital on attractive terms.

One of the mainissues confronting big pharmaceutical companies is their lack of promising newdrugs to treat major indications. As many leading brand-name drugs come offpatent and face generic competition, developing successful new medicines willbecome critical for filling the gap. We believe that companies such as ours maybe well positioned to play an important role in filling the gap in the pipelineof new drugs, either alone or as partners of pharmaceutical companies. Recentannouncements demonstrate that the industry is already investing in thedevelopment of new therapeutics based on our approach.

**DrugDevelopment Programs**

The following is asummary of the development of our drug candidates in late pre-clinical orclinical development. Because of uncertainties involved in the drug developmentprocess, the actual timing for the events described below may differ materiallyfrom

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that provided in thissummary.

·       We have two compounds indevelopment for the prevention of heart attack. These programs come out of ourdiscovery of major risk variants in two genes encoding proteins in theleukotriene pathway. These variants – in the genes that code for 5-lipoxygenaseactivating protein (FLAP) and leukotriene A4 Hydrolase (LTA4H) – appear toconfer risk in the same way: by causing an upregulation in the production ofleukotriene B4, a potent pro-inflammatory molecule that is the end product ofone branch of the pathway.  Thetherapeutic goal of both compounds is to inhibit the activity of the pathway,lowering the production of LTB4 and thereby decreasing the inflammatoryactivity in atherosclerotic plaques and reducing the risk of heart attack.DG051, discovered by deCODE’s chemistry unit, is a small-molecule inhibitor ofLTA4H, which is directly involved in the synthesis of LTB4. The results of ourdevelopment work to date on DG051 indicates that it is well tolerated, providespotent inhibition of LTB4 production, is orally bioavailable, has potential foronce-daily dosing, and appears to have minimal potential for drug-interaction.We completed a single-dose ranging Phase I study for DG051 in December 2006,and a multiple dose ranging Phase I trial of DG051 in the first quarter of2007. The results from these studies demonstrated well-characterizedpharmacokinetic parameters and a reduction of LTB4 in a dose-dependent manner.

In May 2006 we began a Phase III clinical trial for DG031, an inhibitorof FLAP which we licensed from Bayer AG, but voluntarily suspended this trialin October 2006 due to an unexpected formulation problem with the tablets. Inroutine testing of clinical supplies we discovered that, over time, the drugtablets appeared to dissolve more slowly, potentially providing lesseningamounts of active drug the longer they were stored. This raised the possibilitythat as the trial progressed patients would be receiving too little drug,undermining the trial’s chances of success. We are currently reformulating thecompound to resolve this issue and expect to be ready to resume Phase IIItesting near the end of this year.

·       DG041 is being developed asa mechanism-specific anti-platelet compound for the prevention of arterialthrombosis. DG041 is a first-in-class small molecule inhibitor of the EP3receptor for prostaglandin E2, a G-protein coupled receptor (GPCR) encoded by agene we have shown to be associated with increased risk of arterial disease. Webelieve that PGE2 may have additive stimulatory effects on platelet aggregationbeyond those of other potent agonists such as ADP or thromboxane A2, targetedby clopidogrel and aspirin, respectively. In early 2006, we concluded the Phase I clinical program for DG041. Nearly200 healthy subjects were exposed to DG041 in these studies. The results of thePhase I program showed DG041 to be well-tolerated across the entire dose rangestudied, and that DG041 can effectively inhibit platelet aggregation in adose-dependent manner without increasing bleeding time. In the second quarterof 2006, we began a Phase IIa clinical trial that examined the effect of DG041on certain plasma biomarkers.  We concludedthis trial at the end of 2006 and expect to present the data during the secondquarter of 2007. Based on the results of our clinical trials thus far, webelieve that DG041 may offer a focused means of preventing the formation ofthrombi by specifically inhibiting platelet aggregation mediated by EP3.

·       In asthma, we completed aPhase IIa trial of Cephalon’s compound CEP-1347, originally developed fortreatment of Parkinson’s disease. This compound inhibits MAP3K9, a kinaseencoded by a gene we have linked to risk of asthma. In the Phase IIa trial wefound that the compound had a dose-related effect on both lung function andbiomarkers associated with lung inflammation and severity of disease inpatients with asthma who were already being treated with inhaledcorticosteroids and long-acting beta agonist (LABA). Cephalon is currentlyreviewing clinical development plans for this compound.

·       Among our most advancedpreclinical programs, we are pursuing a PDE4 inhibitor program for vasculardisease/stroke pursuant to our 2004 agreement with Roche and are working onidentifying and advancing a lead pre-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 $36.8 million, $16.7million, $9.3 million and $9.8 million in our heart attack (MyocardialInfarction, or MI), PAD, stroke and asthma programs, respectively, from thebeginning of 2003 to date (March 31, 2007). Inception to-date costs are notavailable as these costs were not historically tracked by program.

We have notapplied for or received marketing approval from the applicable regulatoryauthorities in any country for any of our drug candidates. In order for us toachieve marketing approval in the United States, the FDA must conclude that ourclinical data establish the safety and efficacy of our drug candidate. Othercountries have similar requirements. Historically, the results frompre-clinical testing and early clinical trials (through Phase II) haveoften not been predictive of success in later clinical trials. Many newcompounds have shown promising results in early clinical trials, butsubsequently failed to establish sufficient safety and efficacy data to obtainnecessary marketing approvals. Additional risks and uncertainties involved inthe development and commercialization of any products are described under Item1A in our reports on Forms 10-K and 10-Q. We expect that it will be severalyears, if ever, before we receive revenues from the commercial sale of ourtherapeutic products.

Furthermore, ourstrategy includes the option of entering into collaborative arrangements withthird parties 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, the

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complexity of theindication, the size, complexity and expense of necessary development and/orcommercialization efforts, competition in the market and size of the applicablemarket, an assessment of our own resources—financial and operational, and anassessment of the resources of a potential partner. In the event that we docollaborate on any of the above programs in the future, a partner will have alevel of control, which may be significant, over the pre-clinical developmentor clinical trial process for a product. As a result the completion date ofsuch a partnered program could largely be under control of that third partyrather than under our control. We cannot forecast with any degree of certaintywhich proprietary drug candidate will be subject to future collaborativearrangements or how such arrangements would affect our development plan orcapital 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.

**Acquisitions,Joint Development Programs and In-licensing**

As part of ourbusiness strategy, we continue to consider joint development programs andmerger and acquisition opportunities that may provide us with products inlate-stage development, intellectual property or financial resources or withcapabilities that will help accelerate our downstream drug discovery efforts.

*UVS*.  In January 2006, we acquired all of theoutstanding shares of Urdur Verdandi Skuld ehf. (“UVS”), a privately-heldcancer research firm, from Iceland Genomics Corporation, Inc. (“IGC”).This acquisition has enabled us to broaden our cancer program by applying ourgene discovery and drug development efforts to a larger set of populationresources.

*Illumina*.  In May 2006, we entered into a strategicalliance with Illumina, Inc. (“Illumina”) to develop and commercializemolecular diagnostic products. Under the terms of the agreement, deCODE andIllumina will share development costs equally and split operating profits fromthe sales of diagnostic products. Our initial focus will be developingdiagnostics for heart attack, breast cancer and type 2 diabetes. Also as partof the agreement, we have installed Illumina’s SNP genotyping platform tocarry-out high-density, whole-genome studies utilizing our comprehensivepopulation genetics resources in Iceland, thereby, enabling us to expand ourcontract genotyping business to offer Illumina’s platform and assaytechnologies together with our proprietary analytical services for customers.

In certain programs we have taken advantage of the fact that drugtargets we have identified through our genetics research have already beenemployed by other companies to make developmental compounds for otherindications. By licensing these compounds or entering into co-developmentarrangements we have been able to leapfrog over several steps of drugdiscovery, entering directly into Phase II clinical trials. DG031, our mostadvanced compound for the prevention of heart attack, was licensed from BayerHealthCare AG, which was initially developing it for asthma. We also recentlyconcluded a Phase II trial in asthma, working with Cephalon on their compoundCEP-1347, originally developed for Parkinson’s disease. We continue to investigateadditional such possibilities for co-development of promising existingcompounds that may effectively act against targets we have identified throughour gene discovery work.

 **Results of Operations forthe Three-Month Periods Ended March 31, 2007 and 2006**

Our results ofoperations have fluctuated from period to period and may continue to fluctuatein the future based upon, among other things, the pace and progress of ourproprietary research and clinical development efforts, the timing andcomposition of funding under our various collaborative agreements, and theprogress of our own research and development efforts. Results of operations forany period may be unrelated to results of operations for any other period. Inaddition, historical results should not be viewed as indicative of futureoperating results. We are subject to risks common to companies in our industryand at our stage of development, including risks inherent in our research anddevelopment efforts, reliance upon collaborative partners, development by us orour competitors of new technological innovations, ability to market products orservices, dependence on key personnel, dependence on key suppliers, protectionof proprietary technology, ability to obtain additional financing, ability tonegotiate collaborative arrangements, and compliance with governmental andother regulations. In order for a product to be commercialized based on ourresearch, we and our collaborators must conduct pre-clinical tests and clinicaltrials, 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 three-month period ended March 31, 2007include:

·  AtMarch 31, 2007, we had $135.1 million in cash, cash equivalents andinvestments compared to $152.0 million at December 31, 2006. The netutilization of our cash  in these firstthree months reflects principally the costs associated with the advancement ofour drug and diagnostic product development programs as reflected in the $16.3million cash we used in operations.

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·  Ourresearch and development expense was $12.7 million for the three-month periodended March 31, 2007 as compared to $15.5 million for the three-monthperiod ended March 31, 2006. Our research and development expense for thequarter is principally associated with the advancing clinical development ofDG041 and DG051, as well DG031 reformulation work.  The decrease for the first quarter of 2007versus the comparable quarter of 2006 is largely on account of the clinicaldevelopment of DG031, in which we voluntarily suspended our Phase III triallate last year.

·  Ourrevenue for the three-month period ended March 31, 2007 was $8.6 millionas compared to $10.1 million for the three-month period ended March 31,2006, and declined principally due to lower alliance revenues.

***Revenue***

Revenuefor the three-month periods ended March 31, 2007 and 2006 is as follows:
|            | ** ** | ** **                                  | ** ** | ** ** | ** ** | **2007 as Compared to 2006** | ** ** |
|------------|------------|---------------------------------------------|------------|------------|------------|--------------------------------------------------|------------|
| ** ** | ** ** | **2007**                                    | ** ** | **2006**   | ** ** | **$ Change**                                | ** ** | **% Change** | ** ** |
| ** ** | ** ** | **(In thousands, except %)** | ** ** |
| Revenue    |       | $                                           | 8,554      |       | $          | 10,133                                           |       | $ | (1,579 | ) | (16 | )% |
|            |            |                                             |            |            |            |                                                  |            |  |  |  |  |  |

 

Our businessstrategy is focused on turning our discoveries into new drugs and diagnosticsfor the treatment of common diseases. At the same time, we leverage ourcapabilities to generate revenue through corporate alliances, through servicecontracts and increasingly through research grants. In the majority of ourprograms we are pursuing drug development on our own. In certain others, wehave formed alliances with pharmaceutical and biotechnology firms through whichwe can cover some of the cost of conducting basic research and spread the riskand investment involved in product development. Increasingly, we have alsosought and received research grant funding. 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.

Collaborationswith our most significant partners include:

*F. Hoffmann-La Roche (Roche)*

*Therapeutics*.    In November 2004, we signed a three-yearagreement with Roche to co-develop inhibitors of PDE4 for the prevention andtreatment of vascular disease, including stroke. This agreement continues workadvanced under a completed 2002 agreement (completed in 2005), and we willfocus on optimizing lead compounds identified under the previous agreement andbeginning clinical development. Under this agreement, as of the end of March2007, we have received $6.0 million of research funding, of which $2.0 millionwas received in the three-months ended March 31, 2007. We will share drugdiscovery and clinical trials costs under this agreement, and we may alsoreceive milestone payments and royalties based on drug sales.

*Diagnostics*.    InJune 2001, we signed a five-year alliance with Roche’s diagnosticsdivision and through June 2006 we collaborated to develop and market DNA-baseddiagnostics for major diseases.  Duringthe term of this alliance, which expired in 2006, we received $44.3 million inresearch funding, up-front fees and milestone payments under the agreement andwe may receive additional milestone payments upon the achievement of researchand development milestones by Roche and royalties on the sales of diagnosticproducts developed by Roche.

Revenues from these alliances with Roche amounted to$0.5 million and $2.6 million for the three-month periods ended March 31, 2007and 2006, respectively. Costs incurred with these collaborative programs withRoche amounted to $1.4 million and $2.2 million for the three-month periodsended March 31, 2007 and 2006, respectively.

*GovernmentResearch Contracts and 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 other government agencies andprivate foundations. Research grants for multiple years are based on approvedbudgets with budgeted amounts subject to approval on an annual basis.  NIH grants generally provide for 100%reimbursement of allowable expenditures while grants under the EC generallyprovides for fifty percent reimbursement of allowable research and development related expenditures. Our significantresearch contracts include:

*NationalInstitutes of Allergy and Infectious Diseases (NIAID).*InSeptember 2004, deCODE was awarded a five-year $23.9 million contract bythe NIAID, a division of NIH. Under the contract, deCODE will apply its populationapproach and resources to discover genetic factors associated withsusceptibility to certain infectious diseases and with responsiveness tovaccines targeting such diseases.

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deCODE may receive $11.7million in additional research funding over the remaining term of theagreement.

For thethree-month periods ended March 31, 2007 and 2006, we recognized revenue of$3.4 million and $3.0 million from research grants. Costs incurred withresearch grants amounted to $5.0 million and $3.6 million for the three-monthperiods ended March 31, 2007 and 2006, respectively.

Significantelements of our revenue are summarized as follows:
|                                                                            | ** ** | **For the Three  Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2007**                                                       | ** ** | **2006** | ** ** |
| ** **                                                                 | ** ** | **(In thousands)**                                        | ** ** |
|                                                                       |       |                                                           |       |   |   |
| Research funding  and service fees                                         |       | $                                                              | 4,614      |   | $ | 5,468 |   |
| Milestone  payments                                                        |       | 342                                                            |       | 198 |   |
| Up-front,  exclusivity, technology access, and technology development fees |       | —                                                         |       | 500 |   |
| Government  research contracts and grant funding                           |       | 3,360                                                          |       | 2,987 |   |
| Other                                                                      |       | 238                                                            |       | 980 |   |
|                                                                       |       | $                                                              | 8,554      |   | $ | 10,133 |   |

 

Our revenue for the periods presented generallyreflects our strategic focus on proprietary drug discovery and development andalso a shift away from corporate funded research broadly. The decline inrevenue in the three months ended March 31, 2007 compared to the same period in2006 is due principally to lower alliance revenues, and specifically on accountof the completion of research funding under the 2002 agreement with Roche(completed June 2006). We expect thatour revenues will fluctuate from period to period and that such fluctuationsmay be substantial especially because progress in our scientific work,including milestone payments that are related to progress, can fluctuatebetween periods. 

***Cost of Revenue***

Cost of revenue,including costs incurred in connection with collaborative programs for thethree-month periods ended March 31, 2007 and 2006 is as follows:
|                 | ** ** | ** **                            | ** ** | ** ** | ** ** | **2007 as Compared to 2006** | ** ** |
|-----------------|------------|---------------------------------------|------------|------------|------------|--------------------------------------------------|------------|
| ** **      | ** ** | **2007**                              | ** ** | **2006**   | ** ** | **$ Change**                                | ** ** | **% Change** | ** ** |
| ** **      | ** ** | **(In thousands, except%)** | ** ** |
| Cost of revenue |       | $                                     | 10,918     |       | $          | 9,850                                            |       | $ | 1,068 |   | 11 | % |
|                 |            |                                       |            |            |            |                                                  |            |  |  |  |  |  |

 

Our cost ofrevenue consists of the costs of services provided to customers andcollaborators and the costs of programs under research contracts and grants,including: (i) the entirety of the costs incurred in connection with programsthat have been partnered and on which we receive research funding; (ii) costsassociated with other service fee revenues; and (iii) the total amount of thosecosts incurred in connection with discovery and development work performedunder research contracts and grants. At times, we invest in addition to costscovered by research funding received in such collaborative programs and inaddition to monies received under research contracts and grants.

Increases in ourcost of revenue for the three-months ended March 31, 2007 as compared to thesame period in 2006 are largely on account of (i) the shift away from corporatefunded research broadly, but specifically the completion of research fundingunder the 2002 agreement with Roche, and also (ii) an increased amount ofdiscovery and development work performed under ongoing contracts and grantswith the NIH and EC. Increased costs of discovery and development workperformed under contracts and grants with the NIH and EC is partially due toour high-density, whole-genome studies utilizing the Illumina SNP genotypingplatform and our comprehensive population genetics resources inIceland. Further, we continue significant efforts in our PDE4 inhibitorprogram for vascular disease/stroke pursuant to our 2004 agreement with Roche.

Our cost ofrevenue, including costs incurred in connection with collaborative programs inthe three-month period ended March 31, 2007 as compared to the three-monthperiod ended March 31, 2006 increased chiefly with regard to our usage ofchemicals and consumables ($0.9 million). Other and much less significant increases were experienced for personnelcosts. 

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***Research and Development***

Research and developmentexpense for the three-month periods ended March 31, 2007 and 2006 is asfollows:
|                           | ** ** | ** **                                  | ** ** | ** ** | ** ** | **2007 as Compared to 2006** | ** ** |
|---------------------------|------------|---------------------------------------------|------------|------------|------------|--------------------------------------------------|------------|
| ** **                | ** ** | **2007**                                    | ** ** | **2006**   | ** ** | **$ Change**                                | ** ** | **% Change** | ** ** |
| ** **                | ** ** | **(In thousands, except %)** | ** ** |
| Research and  development |       | $                                           | 12,676     |       | $          | 15,517                                           |       | $ | (2,841 | ) | (18 | )% |
|                           |            |                                             |            |            |            |                                                  |            |  |  |  |  |  |

 

Our research anddevelopment expense for the three-months ended March 31, 2007 is principallyassociated with the advancing clinical development of DG041 and DG051, as wellDG031 reformulation work.  Decrease forthe first quarter of 2007 versus the comparable quarter of 2006 is largely onaccount of the clinical development of DG031, in which we voluntarily suspendedour Phase III trial late last year. Based upon the range of our current research and development activitiesbut excluding any significant new collaborations, we believe that our overallinvestment in research and development for the fiscal year 2007 may be in therange of $55 to $60 million.

Our research and development expense for thethree-month periods ended March 31, 2007 and 2006 consist of the following:
|                                                  | ** ** | **For the Three Months   Ended March 31,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **2007**                                                                 | ** ** | **2006** | ** ** |
| ** **                                       | ** ** | **(In thousands)**                                                  | ** ** |
|                                             |       |                                                                     |       |   |   |
| Salaries and  other personnel costs              |       | $                                                                        | 4,823      |   | $ | 5,336 |   |
| Materials and  supplies                          |       | 2,672                                                                    |       | 1,590 |   |
| Contractor  services and other third party costs |       | 2,699                                                                    |       | 5,827 |   |
| Overhead  expenses                               |       | 1,448                                                                    |       | 1,570 |   |
| Depreciation and  amortization                   |       | 722                                                                      |       | 872 |   |
| Stock-based  compensation                        |       | 312                                                                      |       | 322 |   |
|                                             |       | $                                                                        | 12,676     |   | $ | 15,517 |   |

 

During the year ended December 31, 2006, weexperienced increasing research and development costs and we expect thatfurther increases may continue, particularly as we advance our clinicaldevelopment and proprietary drug development programs. However, we havevoluntarily suspended our Phase III clinical trial for DG031 and are conductingre-formulation work.  This suspension hasand may continue to serve to reduce the rate of acceleration of the increasesin our research and development costs, and even reduce the overall cost of ourresearch and development expenses in 2007. Additionally, in the second half of2006 we began our high-density, whole-genome studies utilizing the Illumina SNPgenotyping platform and that effort continues in 2007.

***Selling, General and Administrative Expense***

Selling, generaland administrative expense for the three-month periods ended March 31,2007 and 2006 is as follows:
|                                               | ** ** | ** **                                  | ** ** | ** ** | ** ** | **2007 as Compared to 2006** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------|------------|------------|------------|--------------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                                    | ** ** | **2006**   | ** ** | **$ Change**                                | ** ** | **% Change** | ** ** |
| ** **                                    | ** ** | **(In thousands, except %)** | ** ** |
| Selling,  general, and administrative expense |       | $                                           | 6,176      |       | $          | 5,267                                            |       | $ | 909 |   | 17 | % |
|                                               |            |                                             |            |            |            |                                                  |            |  |  |  |  |  |

 

The increase inour selling, general and administrative expense for the three-month periodended March 31, 2007 compared to the three-month period ended March 31, 2006 isattributable to legal fees incurred in relation to our lawsuit to protect ourintellectual property ($0.4 million), increased salary expense ($0.2 million)and increased stock-based compensation ($0.4 million).

***Interest Income***

Interest incomefor the three-month periods ended March 31, 2007 and 2006 is as follows:
|                 | ** ** | ** **                                  | ** ** | ** ** | ** ** | **2007 as Compared to 2006** | ** ** |
|-----------------|------------|---------------------------------------------|------------|------------|------------|--------------------------------------------------|------------|
| ** **      | ** ** | **2007**                                    | ** ** | **2006**   | ** ** | **$ Change**                                | ** ** | **% Change** | ** ** |
| ** **      | ** ** | **(In thousands, except %)** | ** ** |
| Interest income |       | $                                           | 1,991      |       | $          | 1,712                                            |       | $ | 279 |   | 16 | % |
|                 |            |                                             |            |            |            |                                                  |            |  |  |  |  |  |

 

Our interestincome has increased in 2007 as compared to 2006. Our interest income is afunction of both the balance of our cash and investments (which generally havebeen declining as resources are deployed in operations) and the rate of returnwe are able to

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garner under ourinvestment policy (which average rate of return has been increasing). We expectto use our cash and investments principally for advancing our discovery anddevelopment programs. In the meantime, we will invest the monies received inaccordance with our policy, having the objective of preserving principal andmaintaining a high degree of liquidity to meet operating needs and obtainingcompetitive returns subject to prevailing market conditions. We expect tomaintain our portfolio of cash equivalents and investments in a variety ofsecurities, including auction rate securities, commercial paper, money marketfunds, mutual fund investments and government and non-government debtsecurities.

***Interest Expense***

Interest expensefor the three-month periods ended March 31, 2007 and 2006 is as follows:
|                  | ** ** | ** **                                  | ** ** | ** ** | ** ** | **2007 as Compared to 2006** | ** ** |
|------------------|------------|---------------------------------------------|------------|------------|------------|--------------------------------------------------|------------|
| ** **       | ** ** | **2007**                                    | ** ** | **2006**   | ** ** | **$ Change**                                | ** ** | **% Change** | ** ** |
| ** **       | ** ** | **(In thousands, except %)** | ** ** |
| Interest expense |       | $                                           | 3,666      |       | $          | 1,716                                            |       | $ | 1,950 |   | 114 | % |
|                  |            |                                             |            |            |            |                                                  |            |  |  |  |  |  |

 

Our interest expense has increased in the three-monthperiod ended March 31, 2007 as compared to the three-month period ended March31, 2006. Our interest expense is primarily attributable to interest on our3.5% Senior Convertible Notes due in 2011 that we issued in April 2004($150 million of principal at a full par price) and then again in November 2006(a further $80 million of principal at a price of 70% of par). With the additional$80 million of notes added in 2006, our future cash interest payments will beapproximately $8.1 million on an annual basis for the Senior Convertible Notes.Taking into account also the accretion of the discount of the notes and theamortization of offering costs, our total interest expense related to theSenior Convertible Notes is expected to be approximately $14.0 million for theyear ending December 31, 2007.

**Liquidityand Capital Resources**

We have financedour operations primarily through funding from research and developmentcollaborative agreements, and the issuance of equity securities and long-termfinancing instruments ($960.9 million from the beginning of 1999 to-date).At March 31, 2007, future funding under terms of our existing agreements is approximately$40.1 million excluding milestone payments, royalties and other payments thatwe may earn under such collaborations. Of the $40.1 million, approximately$21.2 million is expected to be received during the year ended December 31,2007, with the remaining amount due through 2010.

We makesignificant investments in proprietary research and development and we incurthe costs of such activities. In the near term, this requires us to devoteresources to our in-house drug and clinical development which we believe willbetter position us to capture the most value to us in our discoveries. As weidentify promising discoveries for further development, we may choose tocontinue the development ourselves into and through clinical trials, regulatoryapprovals, manufacturing, distribution and marketing. In other cases we are orwill be working to varying degrees with partners. The decisions we make as tothese matters will affect our cash requirements.

Our cashrequirements depend on numerous factors, including the level and timing of ourresearch and development expenditures; our ability: to access the capitalmarkets; to obtain new research and development collaboration agreements; toobtain and maintain contract service agreements in our pharmaceuticals, biostructures,clinical research trials and genotyping service groups; expenditures inconnection with alliances, license agreements and acquisitions of andinvestments in complementary technologies and businesses; competingtechnological and market developments; the cost of filing, prosecuting,defending and enforcing patent claims and other intellectual property rights;the purchase of additional capital equipment; and capital expenditures at ourfacilities. Changes in our research and development plans, notably the entryinto clinical trials of drugs based on our discoveries, or other changesaffecting our operating expenses may result in changes in the timing and amountof expenditures of our capital resources.

At March 31, 2007,we had $135.1 million of cash, cash equivalents and investments.  Excluding any significant new alliances orfinancing activities, we believe that our overall use of cash resources in 2007may be in the range of $75 to $85 million. 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 offinancing, such as further public or private equity offerings, additional debtfinancing, other forms of financing or added collaborations and licensingarrangements. However, no assurance can be given that additional financing orcollaborations and licensing arrangements will be available when needed, orthat if available, will be obtained on favorable terms. If adequate funds arenot available when needed, we may have to curtail operations or attempt toraise funds on unattractive terms.
| ** **                                   | ** ** | **For the Three Month Periods  Ended March 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **2007**                                                                       | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | **(In thousands)**                                                        | ** ** |
| **Cash  provided by (used in):**             |       |                                                                           |       |   |   |
| Operating  activities                        |       | $                                                                              | (16,305    | ) | $ | (15,972 | ) |
| Investing  activities                        |       | 12,254                                                                         |       | (37,819 | ) |
| Financing  activities                        |       | (625                                                                           | )          | 284 |   |
| Cash and cash  equivalents, at end of period |       | 17,206                                                                         |       | 12,436 |   |
|                                              |            |                                                                                |            |  |  |  |  |

 

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*Cashand Cash Equivalents.*  AtMarch 31, 2007, we had $17.2 million in cash and cash equivalents.Together with our investments at March 31, 2007 ($117.9 million),this balance ($135.1 million) is $16.9 million less than at December 31,2006. Significant cash outflows during the three months ended March 31,2007 include costs associated with the advancement of our drug developmentprograms as reflected in the $16.3 million of cash we used in operations.

Available cash isinvested in accordance with our investment policy having primary objectives ofliquidity and safety of principal while maximizing the income we receive fromour investments without significantly increasing risk. Our cash is depositedonly with financial institutions in Iceland, the United Kingdom and the UnitedStates having a high credit standing (A-/A3 or better). We expect to maintainour portfolio 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.

At March 31, 2007,our cash is largely invested in U.S. dollar denominated money market andchecking accounts and also in Icelandic krona denominated accounts.  At March 31, 2007, our investments are inauction rate securities, a municipal bond, US government securities and a corporatebond.

*Operating Activities.*Net cash used in operating activities was $16.3 million for the three-monthperiod ended March 31, 2007 as compared to $16.0 million having been usedin the same period in 2006.  Cash in ouroperations is most importantly attributable to the significant research anddevelopment investments being made in advancing our drug and clinicaldevelopment programs, as more fully described above.

*Investing Activities.*Ourinvesting activities have consisted of short-term investments in marketablesecurities (mainly investments in auction rate securities, US governmentsecurities and in an intermediate term bond mutual fund) and capitalexpenditures. In the three-months ended March 31, 2006, during our purchase ofUVS we acquired $1.3 million of cash used to fund the acquired liabilities ofUVS.

We principally made replacement capital expendituresduring the three-month periods ended March 31, 2007 and 2006.  We have experienced the pace of necessarycapital expenditures increase somewhat of late and this trend maycontinue.  Although we expect we will continue to make principallyreplacement capital expenditures in the near-term, net cash used in investingactivities may in the future fluctuate significantly from period to period dueto the timing of our capital expenditures and other investments as well aschanging business needs.

*Financing Activities.*Net cash of $0.6 million was used in financing activities in the three-monthperiod ended March 31, 2007, as compared to $0.3million that was providedin the three-month period ended March 31, 2006.  Financing activitiesfor the three-month period ended March 31, 2007 were primarily installmentspayments on debt and capital lease obligations ($0.7 million). Financingactivities for the three-month period ended March 31, 2006 largelyconsisted of equity proceeds on the exercise of common stock options ($0.7million), financing of certain equipment ($0.3 million) and installmentpayments on debt and capital lease obligations ($0.8 million).

In February 2007,we entered into an agreement regarding the sale and leaseback of our property(land and facility) in Woodridge, Illinois.  Pursuant to the agreement and subject to thesatisfaction of contingencies including, without limitation, negotiation of asatisfactory lease, we will sell the Woodridge property for $25.0 millionin cash and lease the property back under a 17 year lease at an initial rent of$163,000 per month, subject to annual rent increases of 2.5%. Under thelease contemplated by the agreement, we will have two 5 year renewal optionswith rent at the then prevailing market rate. The lease will be an absolute netlease and we will continue to pay all expenses relating to the property,including taxes, utilities, insurance and maintenance. Our obligationsunder the lease are to be secured by a letter of credit in an initial amount of$5.0 million that may be reduced upon certain conditions.. The agreementregarding the sale and leaseback of the property is subject to the satisfactionof various contingencies, including, without limitation, the negotiation of asatisfactory lease, the buyer’s ability to obtain financing for its purchase ofthe property and the buyer’s satisfaction with its due diligence review of theproperty. The transaction is expected to close in May 2007 if suchcontingencies are satisfied, however, in light of the contingencies, there canbe no assurance that the closing will occur.

*Contractual Commitments andOff-Balance Sheet Arrangements.  * The followingsummarizes our contractual obligations at March 31, 2007, 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 – 2 Years** | ** ** | **2 – 3 Years** | ** ** | **3 – 4 Years** | ** ** | **4 – 5 Years** | ** ** | **More Than  5 Years** | ** ** |
| ** **                                         | ** ** | **(In thousands)** | ** ** |
| 3.5% Senior  convertible notes, including interest |       | $                       | 266,225    |                                      | $          | 8,050 |   | $ | 8,050 |   | $ | 8,050 |   | $ | 8,050 |   | $ | 234,025 |   | $ | — |   |
| Long-term debt,  including interest (1)            |       | 7,079                   |       | 1,084                                     |       | 5,714 |   | 250 |   | 31 |   | — |   | — |   |
| Capital lease  obligations, including interest     |       | 5,498                   |       | 2,385                                     |       | 2,181 |   | 933 |   | — |   | — |   | — |   |
| Operating leases  (2)                              |       | 67,746                  |       | 5,555                                     |       | 5,402 |   | 5,279 |   | 5,147 |   | 5,136 |   | 41,226 |   |
| Total                                              |       | $                       | 346,548    |                                      | $          | 17,074 |   | $ | 21,347 |   | $ | 14,512 |   | $ | 13,228 |   | $ | 239,161 |   | $ | 41,226 |   |

 

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(1)             Balanceincludes a $6.2 million mortgage loan at March 31, 2007, which has avariable interest rate of LIBOR + 2.25% (7.75% at March 31, 2007). Ahypothetical 100 basis point increase or decrease in the interest rate wouldresult in an increase or decrease of our interest payments related to thisamount of approximately $0.06 million per year.

(2)             Balanceincludes $66.9 million of Icelandic krona (ISK) denominated leaseobligations which are variable based on the exchange rate of the ISK versus theU.S. dollar and also this amount is subject to periodic adjustments based onthe Icelandic Consumer Price Index (ICPI). A hypothetical 10% increase ordecrease in the ISK and U.S. dollar exchange rate would result in an increaseor decrease of our annual lease payments of $0.5 million. A hypothetical 100basis point increase of the ICPI would result in an increase or decrease of ourannual lease payments of $0.05 million.

Under the terms ofcertain technology licensing agreements, deCODE is obligated to make paymentsupon the achievement of established milestones leading to the discovery ofdefined products. These payments could total $5.0 million, with the timing ofpayments not determinable at the current time. These potential payments are notincluded in the above table.

All materialintercompany balances and transactions have been eliminated. We do not have anyother significant 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, marketor 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.

**CriticalAccounting Policies**

The preparation offinancial statements in conformity with generally accepted accountingprinciples requires us to make certain estimates and assumptions that affectthe reported amounts of assets and liabilities, the disclosure of contingentassets and liabilities at the date of the financial statements, and thereported amounts of revenues and expenses during the reported period. On anongoing basis we evaluate our estimates, which include, among others, thoserelated to collaborative arrangements, long-lived assets, and litigation andother commitments and contingencies. We base our estimates on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances, the results of which form our basis for makingjudgments about carrying values of assets and liabilities that are not readilyapparent from other sources. The impact and any associated risks related tothese and our other accounting policies on our business or operations isdiscussed throughout Management’s Discussion and Analysis of FinancialCondition and Results of Operations where such policies affect our reported andexpected financial results. For a detailed discussion on the application ofthese and other accounting policies, please refer to our notes to the CondensedConsolidated Financial Statements in this quarterly report on Form 10-Qand the Consolidated Financial Statements in the Annual Report onForm 10-K. There can be no assurance that actual results may not differfrom the estimates referred to above.

**FORWARD-LOOKING STATEMENTS AND CAUTIONARY FACTORS**

**THAT MAY AFFECT FUTURE RESULTS**

This Quarterly Report onForm 10-Q contains forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended, and Section 21E ofthe Securities Exchange Act of 1934. These statements relate to future events or our future financialperformance. In some cases, forward-looking statements can be identified byterminology such as “may,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,”“estimate,” “predict,” “intend,” “potential” or “continue” or the negative ofsuch terms or other comparable terminology. These statements are onlyexpectations.  We cannot assure you thatour expectations and assumptions will prove to be correct. We do not intend toupdate or revise any forward-looking statements, whether as a result of futureevents, new information or otherwise, except to the extent that the reports weare required to file under the Securities Exchange Act of 1934, as amended,(the “Exchange Act”) contain such updates or revisions. Actual events orresults may differ materially from the forward-looking statements due to anumber of factors, including. but not limited to, those set forth inItem 1A of our Annual Report on Form 10-K for the year endedDecember 31, 2006 as updated by Item A of this Quarterly Report on Form10-Q and elsewhere in this Quarterly Report on Form 10-Q and in the reports wefile under the Exchange Act.

**ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

The primary objectives ofour investment activities are to preserve principal, maintain a high degree ofliquidity to meet operating needs, and obtain competitive returns subject toprevailing market conditions. Investments are made primarily in high-gradecorporate bonds, asset-backed debt securities and U.S. government agency debtsecurities. These investments are subject to risk of default, changes in creditrating and changes in market value. These investments are also subject tointerest rate risk and will decrease in value if market interest ratesincrease. A hypothetical 100 basis point increase in interest rates wouldresult in an approximate $0.2 million

18

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decrease in the fairvalue of our investments as of March 31, 2007. Due to the conservativenature of our investments and relatively short effective maturities of debtinstruments, interest rate risk is mitigated. Changes in interest rates do notaffect interest expense incurred on the Company’s Convertible Notes, becausethey bear interest at a fixed rate. Using the price in the latest trade inMarch 2007, the market value of the Convertible Notes was approximately$159.4 million on March 31, 2007.

As a consequence of thenature 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. Wecontinue to monitor our exposure to currency risk. A hypothetical 10.0%decrease in value of the US dollar against the Icelandic krona would result ina loss of approximately $0.1 million on our Icelandic krona denominatednon U.S. dollar assets and liabilities. We have historically purchasedinstruments to hedge these general risks through the use of derivativefinancial instruments.

**ITEM4. CONTROLS AND PROCEDURES**

a)*Evaluation ofdisclosure controls and procedures.* Our Chief Executive Officer andour Chief Financial Officer evaluated the effectiveness of our disclosure controlsand procedures (as defined in Rule 13a-15(e) under the Securities ExchangeAct of 1934, as amended (the “Exchange Act”)) as of the end of the fiscalquarter covered by this Quarterly Report on Form 10-Q.  Based upon that evaluation, theChief Executive Officer and the Chief Financial Officer have concluded that asof the end of such fiscal quarter deCODE’s disclosure controls and proceduresare adequate and effective to ensure that information required to be disclosedin the reports deCODE files under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms. Disclosure controls and proceduresinclude without limitation, controls and procedures designed to ensure thatinformation required to be disclosed by an issuer in the reports that it filesor submits under the Act is accumulated and communicated to the issuer’smanagement including its principal executive and principal financial officersor persons performing similar functions as appropriate to allow timelydecisions regarding required disclosures.

In designing and evaluating our disclosure controls andprocedures, our management recognizes that any controls and procedures, nomatter how well designed and operated, can provide only reasonable assurancethat the desired objectives of the control system will be met. In addition, thedesign of any control system is based in part upon certain assumptions aboutthe likelihood of future events and the application of judgment in evaluatingthe cost-benefit relationship of possible controls and procedures. Because ofthese and other inherent limitations of control systems, there is onlyreasonable assurance that our controls will succeed in achieving their goalsunder all potential future conditions.

b) *Changes in InternalControls.* We are continuously seeking to improve the efficiency andeffectiveness of our internal controls. This results in periodic refinements tointernal control processes throughout the company. However, there was no changein our internal control over financial reporting (as defined inRule 13a-15(f) under the Exchange Act) during the fiscal quarter coveredby this Quarterly Report on Form 10-Q that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

**PART IIOTHER INFORMATION**

**ITEM1. LEGAL PROCEEDINGS**

Other than claims and legal proceedings that arisefrom time to time in the ordinary course of business which are not material,and matters described below, there has been no change in the matters reportedin our Annual Report on Form 10-K for the year ended December 31, 2006.

In the matter ofIn re deCODE genetics, Inc. Initial Public Offering , which is described in ourAnnual Report on Form 10-K for the year ended December 31, 2006 (the “10-K”),the United States Court of Appeals for the Second Circuit, on April 6, 2007,denied plaintiffs’ petition for rehearing. In light of the Second Circuitopinion, our counsel has informed the district court that the proposedsettlement described in the 10-K cannot be approved because the definedsettlement class, like the litigation class, cannot be certified. We cannotpredict whether we will be able to renegotiate a settlement that complies withthe Second Circuit’s mandate. Due to the inherent uncertainties of litigation,we cannot accurately predict the ultimate outcome of the matter.

**ITEM1A. RISK FACTORS**

Otherthan with respect to the risk factors set forth below, there have been no materialchanges from the risk factors disclosed in Item 1A of our Annual Report on Form10-K for the year ended December 31, 2006. The risk factors set forth below have been updated to provide data forand as of the quarter ended March 31, 2007.

***If we continue to incur operating losseslonger than anticipated, or in amounts greater than anticipated, we may beunable to continue our operations.***

Weincurred a net loss of $22.6 million and $20.3 million for the three monthsended March 31, 2007 and 2006, respectively, and $85.5 million for theyear ended December 31, 2006, and had an accumulated deficit of$558.3 million at March 31, 2007. We have

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nevergenerated a profit and we have not generated revenues except for paymentsreceived in connection with our research and development collaborations withRoche, Merck and others, from contract services, Emerald BioSystems productsand instruments, and under grants. Our research and development expendituresand general and administrative costs have exceeded our revenue to date, and weexpect to spend significant additional amounts to fund research and developmentin order to enhance our core technologies and undertake product development(including drug development and related clinical trials). We do not expect to receiveroyalties or other revenues from commercial sales of products developed usingour technology in the near term. It may be several years before productrevenues materialize, if they do at all. As a result, we expect to incur netlosses for several years. If the time required to generate product revenues andachieve profitability is longer than we currently anticipate or the level oflosses is greater than we currently anticipate, we may not be able tocontinue our operations.

***If we are not able to obtain sufficientadditional funding to meet our capital requirements, we may be forced toreduce or terminate our research and product development programs.***

We havespent substantial amounts of cash to fund our research and developmentactivities and expect to continue to spend substantial amounts for theseactivities over the next several years. We expect to use cash to collect,generate and analyze genotypic and disease data from volunteers in ourdisease-gene research programs; to conduct drug discovery and developmentactivities (including clinical trials); and to continue other research anddevelopment activities. Many factors will influence our future capital needs,including:

·                                       the number, breadth and progress of ourdiscovery and research programs;

·                                       our ability to attract customers;

·                                       our ability to commercialize ourdiscoveries and the resources we devote to commercialization;

·                                       the amount we spend to enforce patentclaims and other intellectual property rights; and

·                                       the costs and timing of regulatoryapprovals.

We haverelied on, and may continue to rely on, revenues generated by ourcorporate alliances and fee-paying customers for significant funding of ourresearch efforts. Historically, a substantial portion of our revenue has beenderived from contracts with a limited number of significant customers. Roche,accounted for approximately 6% and 26% of our consolidated revenue in thethree-months ended March 31, 2007 and 2006, respectively. Divisions of the NIHrepresented 26% and 25% of our consolidated revenue in the three-months endedMarch 31, 2007 and 2006, respectively. The EC represented 13% and 4% of our consolidatedrevenue in the three-months ended March 31, 2007 and 2006, respectively.

Inaddition, we may seek additional funding through public or private equityofferings and debt financings. We may not be able to obtain additionalfinancing when we need it or the financing may not be on terms favorableto us or our stockholders. Stockholders’ ownership will be diluted if we raiseadditional capital by issuing equity securities.

If weraise additional funds through collaborations and licensing arrangements, wemay have to relinquish rights to some of our technologies or productcandidates, or grant licenses on unfavorable terms. If adequate funds are notavailable, we would have to scale back or terminate our discovery and researchprograms and product development.

**ITEM6. EXHIBITS AND REPORTS ON FORM 8-K**

(a) EXHIBITS

The following is alist of exhibits filed as part of this Quarterly Report on Form 10-Q.
| EXHIBIT    | ** ** | ** **                                                                                                                                                                                                                                                                        |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **NUMBER** | ** ** | **DESCRIPTION OF EXHIBIT**                                                                                                                                                                                                                                                        |
|       |       |                                                                                                                                                                                                                                                                              |
| 3.1        |       | Amended and Restated Certificate of Incorporation,  as further amended (Incorporated by reference to Exhibit 3.1 and Exhibit  3.3 to the Company’s Registration Statement on Form S-1 (Registration  No. 333-31984) which became effective on July 17, 2000). |
|       |       |                                                                                                                                                                                                                                                                              |
| 3.2        |       | Certificate of Amendment to Amended and Restated  Certificate of Incorporation dated August 30, 2002 (Incorporated by  reference to Exhibit 3.2 to the Company’s Quarterly Report on  Form 10-Q filed on November 14, 2002).                             |
|       |       |                                                                                                                                                                                                                                                                              |
| 3.3        |       | 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).                                                                     |
|       |       |                                                                                                                                                                                                                                                                              |
| 10.1       |       | Agreement of Purchase and Sale between deCODE  Chemistry, Inc. and Woodridge Holdings LLC, dated as of February 5, 2007  (Incorporated by reference to Exhibit 10.21 to the Company’s Annual Report on  Form 10-K filed on March 15, 2007).                                  |

 

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| 31.1   |   | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|--------|--------|--------------------------------------------------------------------------------|
|   |   |                                                                           |
| 31.2   |   | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|   |   |                                                                           |
| 32.1   |   | Certification pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

Note: Unlessotherwise noted, the SEC File number of each of the above referenced documentsis 000-30469.

**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

Dated: May 9, 2007
|                                            | deCODE  genetics, Inc. |   |
|--------------------------------------------|-----------------------------|--------|
|                                       |                        |   |
|                                       |                        |
|                                       | /s/ Kari  Stefansson        |   |
| Kari Stefansson                            |                        |
| Chairman,  President,                      |                        |
| and Chief  Executive Officer               |                        |
|                                       |                        |
|                                       |                        |
|                                       | /s/ Lance  Thibault         |   |
| Lance Thibault                             |                        |
| Chief Financial  Officer and               |                        |
| Treasurer  (principal financial            |                        |
| officer and  principal accounting officer) |                        |
|                                       |                        |
|                                            |                             |        |  |

 

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| EXHIBIT    | ** ** | ** **                                                                                                                                                                                                                                                                        |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **NUMBER** | ** ** | **DESCRIPTION OF EXHIBIT**                                                                                                                                                                                                                                                        |
|       |       |                                                                                                                                                                                                                                                                              |
| 3.1        |       | Amended and Restated Certificate of Incorporation,  as further amended (Incorporated by reference to Exhibit 3.1 and Exhibit  3.3 to the Company’s Registration Statement on Form S-1 (Registration  No. 333-31984) which became effective on July 17, 2000). |
|       |       |                                                                                                                                                                                                                                                                              |
| 3.2        |       | Certificate of Amendment to Amended and Restated Certificate  of Incorporation dated August 30, 2002 (Incorporated by reference to  Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q filed on  November 14, 2002).                             |
|       |       |                                                                                                                                                                                                                                                                              |
| 3.3        |       | 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).                                                                     |
|       |       |                                                                                                                                                                                                                                                                              |
| 10.1       |       | Agreement of Purchase and Sale between deCODE  Chemistry, Inc. and Woodridge Holdings LLC, dated as of February 5, 2007  (Incorporated by reference to Exhibit 10.21 to the Company’s Annual Report on  Form 10-K filed on March 15, 2007).                                  |
|       |       |                                                                                                                                                                                                                                                                              |
| 31.1       |       | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                    |
|       |       |                                                                                                                                                                                                                                                                              |
| 31.2       |       | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                    |
|       |       |                                                                                                                                                                                                                                                                              |
| 32.1       |       | Certification pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                    |

 

Note: Unlessotherwise noted, the SEC File number of each of the above referenced documentsis 000-30469.

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