Table of Contents

 

 

 

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

**x****QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934.**

 

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008**

 

**OR**

 

**o****TRANSITION REPORTPURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT**

 

**FOR THE TRANSITION PERIOD FROM           TO**

 

**COMMISSION FILE NUMBER 000-30469**

 

**deCODEgenetics, Inc.**

(Exact Name of Registrant as Specified in Its Charter)

 

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

 

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

(Address of Principal Executive Offices)

 

**+354-570-1900**

(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check whetherthe registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. xYes   o No

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company. See definitions of “largeaccelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

 

| Large  accelerated filer o                     |   | Accelerated  filer x         |
|------------------------------------------------|--------|------------------------------|
|                                           |   |                         |
| Non-accelerated  filer o                       |   | Smaller  reporting company o |
| (Do  not check if a smaller reporting company) |   |                         |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).   o Yes     x No

 

The aggregate number ofshares of the registrant’s common stock outstanding on October 31, 2008was 61,848,584 shares of common stock $.001 par value.

 

 

 

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**deCODE genetics, Inc.**

 

**INDEX**

** **
| PART I.      | FINANCIAL  INFORMATION                                                                                                        |   |
|-------------------|-------------------------------------------------------------------------------------------------------------------------------|--------|
|              |                                                                                                                          |   |
| Item 1.           | Financial  Statements (Unaudited)                                                                                             |   |
|              |                                                                                                                          |   |
|              | Condensed  Consolidated Balance Sheets as of September 30, 2008 and  December 31, 2007                              |   |
|              |                                                                                                                          |   |
|              | Condensed  Consolidated Statements of Operations for the three and nine-month periods  ended September 30, 2008 and 2007 |   |
|              |                                                                                                                          |   |
|              | Condensed  Consolidated Statements of Cash Flows for the nine-month periods ended  September 30, 2008 and 2007           |   |
|              |                                                                                                                          |   |
|              | 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 1A.          | Risk factors                                                                                                                  |   |
|              |                                                                                                                          |   |
| Item 6.           | Exhibits                                                                                                                      |   |
|              |                                                                                                                          |   |
|              | (a) Exhibits                                                                                                             |   |
|              |                                                                                                                          |   |
| Signatures        |                                                                                                                          |
|              |                                                                                                                          |
| Index to Exhibits |                                                                                                                          |

 

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**PART I. FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**deCODE genetics, Inc.**

**CONDENSED CONSOLIDATED BALANCESHEETS**

(Unaudited)

 
| ** **                                                                                                                                                                                                                    | ** ** | **September 30,**                                   | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                    | ** ** | **2008**                                                 | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                                                                                                    | ** ** | **(In thousands, except  share amounts)** | ** ** |
| ASSETS                                                                                                                                                                                                                        |       |                                                     |       |                  |       |
| Current assets:                                                                                                                                                                                                               |       |                                                     |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                     |       | $                                                        | 11,778     |                  | $          | 54,172 |   |
| Investments                                                                                                                                                                                                                   |       | —                                                   |       | 10,003                |       |
| Receivables                                                                                                                                                                                                                   |       | 12,574                                                   |       | 9,689                 |       |
| Other current assets                                                                                                                                                                                                          |       | 11,506                                                   |       | 8,782                 |       |
| Total current assets                                                                                                                                                                                                          |       | 35,858                                                   |       | 82,646                |       |
| Investments, non-current                                                                                                                                                                                                      |       | 18,209                                                   |       | 24,833                |       |
| Restricted investments and cash equivalents                                                                                                                                                                                   |       | 5,500                                                    |       | 5,050                 |       |
| Property and equipment, net                                                                                                                                                                                                   |       | 21,609                                                   |       | 23,142                |       |
| Goodwill                                                                                                                                                                                                                      |       | 10,055                                                   |       | 10,055                |       |
| Intangible assets, net                                                                                                                                                                                                        |       | 3,736                                                    |       | 4,008                 |       |
| Other long-term assets                                                                                                                                                                                                        |       | 5,277                                                    |       | 6,474                 |       |
| Total assets                                                                                                                                                                                                                  |       | $                                                        | 100,244    |                  | $          | 156,208 |   |
| LIABILITIES AND STOCKHOLDERS’ DEFICIT                                                                                                                                                                                    |       |                                                     |       |                  |       |
| Current liabilities:                                                                                                                                                                                                          |       |                                                     |       |                  |       |
| Accounts payable                                                                                                                                                                                                              |       | $                                                        | 8,663      |                  | $          | 8,618 |   |
| Accrued expenses and other current  liabilities                                                                                                                                                                               |       | 13,017                                                   |       | 12,558                |       |
| Deferred revenue                                                                                                                                                                                                              |       | 11,485                                                   |       | 9,133                 |       |
| Current portion of capital lease  obligations                                                                                                                                                                                 |       | 3,012                                                    |       | 3,155                 |       |
| Current portion of finance obligation on  sale-leaseback                                                                                                                                                                      |       | 627                                                      |       | 569                   |       |
| Current portion of long-term debt                                                                                                                                                                                             |       | 242                                                      |       | 224                   |       |
| Total current liabilities                                                                                                                                                                                                     |       | 37,046                                                   |       | 34,257                |       |
| Deferred revenue                                                                                                                                                                                                              |       | 6,219                                                    |       | 6,219                 |       |
| Deferred gain on sale-leaseback                                                                                                                                                                                               |       | 22,325                                                   |       | 23,778                |       |
| Capital lease obligations, net of current  portion                                                                                                                                                                            |       | —                                                   |       | 2,202                 |       |
| Finance obligation on sale-leaseback, net  of current portion                                                                                                                                                                 |       | 23,668                                                   |       | 24,145                |       |
| Long-term debt, net of current portion                                                                                                                                                                                        |       | 214,775                                                  |       | 211,257               |       |
| 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:  150,000,000 shares; Issued and outstanding: 61,850,584 and 61,848,584,  respectively, at September 30, 2008; Issued and outstanding: 61,745,072,  at December 31, 2007 |       | 62                                                       |       | 62                    |       |
| Additional paid-in capital                                                                                                                                                                                                    |       | 492,601                                                  |       | 488,963               |       |
| Notes receivable                                                                                                                                                                                                              |       | (2,449                                                   | )          | (2,536                | )          |
| Accumulated deficit                                                                                                                                                                                                           |       | (694,133                                                 | )          | (631,214              | )          |
| Accumulated other comprehensive income  (loss)                                                                                                                                                                                |       | 142                                                      |       | (925                  | )          |
| Treasury stock, 2,000 and 0 shares stated  at cost at September 30, 2008 and December 31, 2007, respectively                                                                                                        |       | (12                                                      | )          | —                |       |
| Total stockholders’ deficit                                                                                                                                                                                              |       | (203,789                                                 | )          | (145,650              | )          |
| Total liabilities and stockholders’ deficit                                                                                                                                                                              |       | $                                                        | 100,244    |                  | $          | 156,208 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

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**deCODE genetics, Inc.**

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS**

(Unaudited)

 
| ** **                                                     | ** ** | **Three Months Ended  September 30,**                  | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                     | ** ** | **2008**                                                              | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                     | ** ** | **(In thousands, except per share amounts)** | ** ** |
|                                                           |       |                                                                  |       |                                                |       |   |   |   |   |
| Revenue                                                        |       | $                                                                     | 11,978     |                                                | $          | 10,892 |   | $ | 41,982 |   | $ | 27,060 |   |
| Operating expenses:                                            |       |                                                                  |       |                                                |       |   |   |   |   |
| Cost of revenue.                                               |       | 10,992                                                                |       | 11,976                                              |       | 39,138 |   | 32,050 |   |
| Research and development                                       |       | 5,652                                                                 |       | 14,069                                              |       | 26,269 |   | 41,273 |   |
| Selling, general and administrative                            |       | 6,661                                                                 |       | 7,070                                               |       | 21,018 |   | 19,395 |   |
| Total operating expenses                                       |       | 23,305                                                                |       | 33,115                                              |       | 86,425 |   | 92,718 |   |
| Operating loss                                                 |       | (11,327                                                               | )          | (22,223                                             | )          | (44,443 | ) | (65,658 | ) |
| Interest income                                                |       | 500                                                                   |       | 1,646                                               |       | 1,989 |   | 5,155 |   |
| Interest expense                                               |       | (4,187                                                                | )          | (4,019                                              | )          | (12,332 | ) | (11,488 | ) |
| Other non-operating income and (expense),  net                 |       | (2,886                                                                | )          | 348                                                 |       | (8,133 | ) | 8,890 |   |
| Net loss                                                       |       | $                                                                     | (17,900    | )                                                   | $          | (24,248 | ) | $ | (62,919 | ) | $ | (63,101 | ) |
| Basic and diluted net loss per share                           |       | $                                                                     | (0.29      | )                                                   | $          | (0.40 | ) | $ | (1.03 | ) | $ | (1.03 | ) |
| Shares used in computing basic and diluted  net loss per share |       | 61,418                                                                |       | 61,033                                              |       | 61,353 |   | 60,996 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

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**deCODE genetics, Inc.**

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS**

(Unaudited)

 
| ** **                                                                   | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| ** **                                                                   | ** ** | **(In thousands)**                             | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                        |       |                                                |       |   |   |
| Net loss                                                                     |       | $                                                   | (62,919    | ) | $ | (63,101 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                                                |       |   |   |
| Depreciation and amortization                                                |       | 4,562                                               |       | 4,345 |   |
| Amortization of deferred gain on  sale-leaseback of real estate              |       | (1,453                                              | )          | (1,453 | ) |
| Stock-based compensation                                                     |       | 2,877                                               |       | 4,346 |   |
| Loss on investments                                                          |       | 7,594                                               |       | — |   |
| Disposal of equipment, net                                                   |       | 75                                                  |       | 73 |   |
| Foreign currency translation                                                 |       | 99                                                  |       | (32 | ) |
| Amortization of debt discount                                                |       | 3,702                                               |       | 3,489 |   |
| Amortization of deferred financing costs                                     |       | 1,236                                               |       | 1,201 |   |
| Accretion on investments                                                     |       | —                                              |       | (182 | ) |
| Changes in operating assets and  liabilities:                                |       |                                                |       |   |   |
| Receivables and other assets                                                 |       | (5,646                                              | )          | (6,050 | ) |
| Accounts payable, accrued expenses and  other current liabilities            |       | (5                                                  | )          | 2,355 |   |
| Deferred revenue                                                             |       | 2,352                                               |       | 5,396 |   |
| Net cash used in operating activities                                        |       | (47,526                                             | )          | (49,613 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                        |       |                                                |       |   |   |
| Purchase of investments                                                      |       | (5,500                                              | )          | (147,859 | ) |
| Sale of investments                                                          |       | 15,500                                              |       | 210,225 |   |
| Purchase of property and equipment                                           |       | (1,734                                              | )          | (2,534 | ) |
| Change in restricted cash and investments                                    |       | (450                                                | )          | (5,051 | ) |
| Proceeds from sale of property and  equipment                                |       | —                                              |       | 238 |   |
| Net cash provided by investing activities                                    |       | 7,816                                               |       | 55,019 |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                        |       |                                                |       |   |   |
| Proceeds from issuance of common stock                                       |       | 172                                                 |       | 110 |   |
| Repayment of notes receivable for common  stock                              |       | 75                                                  |       | 24 |   |
| Proceeds from property and equipment  financing, net of transaction costs    |       | —                                              |       | 25,927 |   |
| Repayments of debt, capital lease and  finance obligations                   |       | (2,931                                              | )          | (7,510 | ) |
| Net cash (used in) provided by financing  activities                         |       | (2,684                                              | )          | 18,551 |   |
| Net (decrease) increase in cash and cash  equivalents                        |       | (42,394                                             | )          | 23,957 |   |
| Cash and cash equivalents at beginning of  period                            |       | 54,172                                              |       | 21,882 |   |
| Cash and cash equivalents at end of period                                   |       | $                                                   | 11,778     |   | $ | 45,839 |   |
| Supplemental cash flow information:                                          |       |                                                |       |   |   |
| Cash paid for interest                                                       |       | $                                                   | 5,350      |   | $ | 4,805 |   |
| Supplemental schedule of non-cash  transactions:                             |       |                                                |       |   |   |
| Cancellation of notes receivable and  forfeiture of common stock             |       | $                                                   | 12         |   | $ | 177 |   |
| Deferred gain on sale and leaseback of  equipment                            |       | —                                              |       | 305 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

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**deCODE genetics, Inc.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS (UNAUDITED)**

(tabular amounts in thousands, except share and per share amounts)

 

**1.****                       ****Organization and Business**

 

 

Referencesin these financial statements to deCODE refer to deCODE genetics, Inc., aDelaware company, and deCODE genetics, Inc.’s wholly-owned subsidiary,Islensk erfdagreining ehf., an Icelandic company registered in Reykjavik, andits subsidiaries, as well as deCODE genetics, Inc.’s wholly-ownedsubsidiary, MediChem Life Sciences, Inc., a Delaware corporation, and itssubsidiaries.

 

AtSeptember 30, 2008, deCODE had liquid funds available for operatingactivities (cash and cash equivalents together with current investments) of$11,778,000 as compared to $23,743,000 at June 30, 2008 and $64,175,000 atDecember 31, 2007. The net utilization of liquid funds in the three andnine-month periods ended September 30, 2008 was $11,965,000 and$52,397,000, respectively. At September 30, 2008, deCODE had $35,487,000of cash, cash equivalents and investments, comprised of $11,778,000 of cash andcash equivalents, as well as $5,500,000 in restricted investments in U.S.Treasury Bills and $18,209,000 in illiquid, non-current investments in auctionrate securities. At December 31, 2007, deCODE had $94,058,000 in cash,cash equivalents, restricted cash equivalents and investments.

 

In2008, deCODE’s focus remains within the same broad strategic continuity,emphasizing its core capabilities in human genetics as well as its integratedcapabilities in structural biology and chemistry. deCODE is leveraging thoseassets to build upon the commercial opportunities presented by both the drugdiscovery work and diagnostics work as well as deCODEme. Management of deCODEhas taken steps to slim down elements of deCODE’s broad capabilities to focusits remaining resources, and continues to seek efficiencies throughout theorganization. In order to bring to market products that can generate revenuesin the near term, in 2008, deCODE has focused its efforts on the developmentand marketing of its molecular diagnostic products and deCODEme, its personalgenome analysis service.

 

Atthe same time, deCODE aims to advance its therapeutics programs throughpartnerships and then advance its early preclinical programs both throughpartnerships and resources it may be able to generate through its contractservices and diagnostics programs. In its drug discovery programs deCODE isdeveloping compounds that address both known targets and new targets itdiscovered through its gene discovery program. deCODE’s experience in seekingpartners for the further development of its programs based on its genediscoveries has led deCODE to conclude that in the current environmentcompounds that address known, rather than newly identified, targets havegreater commercial potential in the near and medium term. Under thesecircumstances, deCODE expects that its drug development programs increasinglywill address targets that do not come out of its gene discovery programs andthat its gene discovery programs will be directed toward the development ofdiagnostic products.

 

deCODEmanagement continues investigating avenues of financing beyond collaborationsand licensing arrangements, namely further public or private equity offeringsand other forms of financing. Management has also carried-on analyzing non-coreelements of operations. Presently, deCODE is carrying out a review of itslong-term business strategy and has engaged professional advisors to assist inevaluating deCODE’s strategic alternatives and in executing swiftly on theresults of this review through the identification of buyers and partners fornon-core business units, programs and intellectual property. The goal of thisstrategic review is to optimize the value of these assets and sharpen the focusof deCODE’s business, selling assets, securing strategic partnerships, andutilizing the resources generated to underpin product development and marketingefforts in its core business. deCODE has utilized a 30-day grace period for thescheduled Otober 15 interest payment on its 3.5% Senior Convertible Notes due2011 and is reviewing methods for making this payment. Given its current liquid assets, and withoutpaying the interest on its Notes from its present funds, deCODE must obtainfurther financial resources through either the implementation of strategicalternatives, corporate partnerships, or the sale of or loans secured by itsauction rate securities in order to continue operations beyond the end of thisyear. deCODE is focusing on reducing expenses and speeding the evaluation ofits strategic options to achieve this goal.

 

In order to provide more time for the completionof this strategic review and the execution of alternatives including the saleof assets, deCODE elected to utilize a 30-day grace period for the scheduled October 15interest payment on its outstanding 3.5% Senior Convertible Notes due 2011.Failure to pay an installment payment on the interest within 30 days of the duedate would constitute an event of default. If an event of default occurs with respect tothe installment payment on the interest and is continuing, the trustee or theholders of at least 25% in aggregate principal amount of the notes thenoutstanding may declare the notes due and payable at their principal amounttogether with accrued interest.

 

**2.****                       ****Basis of Presentation**

 

Inthe opinion of deCODE’s management, the accompanying unaudited condensedconsolidated financial statements contain all adjustments (consisting of itemsof a normal and recurring nature) necessary to present fairly the financialposition as of September 30, 2008,

 

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the results of operationsfor the three and nine-month periods ended September 30, 2008 and 2007 andcash flows for the nine-month periods ended September 30, 2008 and2007. The results of operations for the three and nine-month periods endedSeptember 30, 2008 are not necessarily indicative of the results to beexpected for the full year. These financial statements should be read inconjunction with deCODE’s Annual Report on Form 10-K for the year ended December 31,2007, which includes consolidated financial statements and notes thereto forthe years ended December 31, 2007, 2006 and 2005.

 

**3.****                       ****Revenue**

 

Significantelements of deCODE’s revenue are summarized as follows:

 
| ** **                                       | ** ** | **Three Months Ended  September 30****,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                                 | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                       | ** ** | **(In thousands)**                                  | ** ** |
| Genomic services                                 |       | $                                                        | 4,034      |                                                | $          | 1,793 |   | $ | 14,030 |   | $ | 3,879 |   |
| Research funding and other service fees          |       | 3,703                                                    |       | 4,148                                               |       | 12,933 |   | 11,474 |   |
| Government research contracts and grant  funding |       | 3,717                                                    |       | 3,510                                               |       | 13,245 |   | 9,194 |   |
| Milestone payments and other                     |       | 524                                                      |       | 1,441                                               |       | 1,774 |   | 2,513 |   |
| Total revenue                                    |       | $                                                        | 11,978     |                                                | $          | 10,892 |   | $ | 41,982 |   | $ | 27,060 |   |

 

Duringthe three and nine-month periods ended September 30, 2008, deCODEperformed services totaling $34,000 and $163,000, respectively, for employersof members of deCODE’s Board of Directors. During the three and nine-monthperiod ended September 30, 2008, deCODE purchased services totaling$105,000 and $209,000, respectively, from employers of members of deCODE’sBoard of Directors. During the three and nine-month periods ended September 30,2007, deCODE performed services totaling $0 and $124,000 for employers ofmembers of deCODE’s Board of Directors.

 

**4.****                       ****Cost of Revenue**

 

deCODE’scost of revenue 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 withprograms that have been partnered and on which deCODE receives researchfunding; (ii) costs associated with other service fee revenues; and (iii) thetotal amount of those costs incurred in connection with discovery anddevelopment work performed under research contracts and grants.

 

Significantelements of deCODE’s revenue and cost of revenue are summarized as follows:

 
| ** **                                             | ** ** | **Three Months Ended September 30,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                                 | ** ** | **2007** | ** ** |
| ** **                                             | ** ** | **Revenue**                                              | ** ** | **Cost of  Revenue** | ** ** | **Net** | ** ** | **Revenue** | ** ** | **Cost of  Revenue** | ** ** | **Net** | ** ** |
| ** **                                             | ** ** | **(In thousands)**                                  | ** ** |
| Genomic services, research funding and  other services |       | $                                                        | 8,261      |   | $ | 6,385 |   | $ | 1,876 |   | $ | 7,382 |   | $ | 7,716 |   | $ | (334 | ) |
| Government research contracts and grant  funding       |       | 3,717                                                    |       | 4,607 |   | (890 | ) | 3,510 |   | 4,260 |   | (750 | ) |
| Total                                                  |       | $                                                        | 11,978     |   | $ | 10,992 |   | $ | 986 |   | $ | 10,892 |   | $ | 11,976 |   | $ | (1,084 | ) |

 
| ** **                                             | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| ** **                                             | ** ** | **Revenue**                                             | ** ** | **Cost of  Revenue** | ** ** | **Net** | ** ** | **Revenue** | ** ** | **Cost of  Revenue** | ** ** | **Net** | ** ** |
| ** **                                             | ** ** | **(In thousands)**                                 | ** ** |
| Genomic services, research funding and  other services |       | $                                                       | 28,737     |   | $ | 22,244 |   | $ | 6,493 |   | $ | 17,866 |   | $ | 18,856 |   | $ | (990 | ) |
| Government research contracts and grant  funding       |       | 13,245                                                  |       | 16,894 |   | (3,649 | ) | 9,194 |   | 13,194 |   | (4,000 | ) |
| Total                                                  |       | $                                                       | 41,982     |   | $ | 39,138 |   | $ | 2,844 |   | $ | 27,060 |   | $ | 32,050 |   | $ | (4,990 | ) |

 

**5.****                       ****Research and Development**

 

deCODE’sresearch and development expense consists of the costs of its own proprietaryprograms, comprised of the following:

 

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| ** **                                       | ** ** | **Three Months Ended  September 30****,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                                 | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                       | ** ** | **(In thousands)**                                  | ** ** |
| Salaries and other personnel costs               |       | $                                                        | 2,027      |                                                | $          | 4,576 |   | $ | 10,781 |   | $ | 14,379 |   |
| Materials and supplies                           |       | 858                                                      |       | 2,961                                               |       | 4,882 |   | 9,191 |   |
| Contractor services and other third party  costs |       | 1,293                                                    |       | 4,083                                               |       | 4,701 |   | 10,132 |   |
| Overhead expenses                                |       | 679                                                      |       | 1,420                                               |       | 3,025 |   | 4,247 |   |
| Depreciation and amortization                    |       | 560                                                      |       | 586                                                 |       | 1,963 |   | 1,934 |   |
| Stock-based compensation                         |       | 235                                                      |       | 443                                                 |       | 917 |   | 1,390 |   |
| Total                                            |       | $                                                        | 5,652      |                                                | $          | 14,069 |   | $ | 26,269 |   | $ | 41,273 |   |

 

**6.****                       ****Stock-Based Compensation**

 

InMay 2008, deCODE amended its 2006 Equity Incentive Plan to increase thenumber of shares of common stock that may be subject to awards thereunder to10,000,000 shares.

 

Stock-basedcompensation included in deCODE’s results of operations as follows:

 
| ** **                          | ** ** | **Three Months Ended  September 30****,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                          | ** ** | **2008**                                                 | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                          | ** ** | **(In thousands)**                                  | ** ** |
| Operating Expenses:                 |       |                                                     |       |                                                |       |   |   |   |   |
| Cost of revenue                     |       | $                                                        | 170        |                                                | $          | 156 |   | $ | 420 |   | $ | 408 |   |
| Research and development            |       | 235                                                      |       | 443                                                 |       | 917 |   | 1,390 |   |
| Selling, general and administrative |       | 443                                                      |       | 852                                                 |       | 1,540 |   | 2,548 |   |
| Total                               |       | $                                                        | 848        |                                                | $          | 1,451 |   | $ | 2,877 |   | $ | 4,346 |   |

 

Asof September 30, 2008 there was approximately $6,663,000 of totalunrecognized compensation expense related to nonvested stock options. Thisexpense is expected to be recognized over a weighted-average period ofapproximately 2.5 years.

 

deCODEcalculated the fair value of each option award on the date of grant using theBlack-Scholes option pricing model. The following weighted average assumptionswere used:

 

| ** **               | ** ** | **Nine-Months Ended  September 30,** | ** ** |
|--------------------------|------------|------------------------------------------------|------------|
| ** **               | ** ** | **2008**                                       | ** ** | **2007** | ** ** |
|                     |       |                                           |       |   |   |
| Dividend yield           |       | 0                                              | %          | 0 | % |
| Expected volatility      |       | 63.7                                           | %          | 64.4 | % |
| Expected term (in years) |       | 5.4                                            |       | 5.4 |   |
| Risk-free interest rate  |       | 2.8                                            | %          | 4.5 | % |

 

deCODEestimates the expected term of the options based on historical patterns byemployees with respect to exercise and post vesting employment terminationbehaviors. deCODE’s expected volatility is calculated using a weighted averageof the volatility over a period equal to the expected term of the award and themost recent one year volatility. deCODE bases the risk-free interest rate usedon the implied rate currently available on the U.S. Treasury zero-coupon issueswith a comparable term. As deCODE does not pay dividends, the dividend variablerate is zero.

 

Thefollowing table summarizes stock option activity for the nine-months ended September 30,2008:

 

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| ** **                                              | ** ** | **Number  of Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average**

**Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|---------------------------------------------------------|------------|----------------------------|------------|----------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                              | ** ** | ** **                 | ** ** | ** **                             | ** ** | **(In years)**                                     | ** ** | **(In thousands)**             | ** ** |
| Outstanding at January 1, 2008                     |       | 7,773,559                  |       | $                                      | 6.19       |                                                    |       |                                |       |   |
| Granted                                                 |       | 1,147,000                  |       | 2.73                                   |       |                                                    |       |                                |       |
| Exercised                                               |       | (2,500                     | )          | 2.11                                   |       |                                                    |       |                                |       |
| Forfeited/cancelled                                     |       | (312,471                   | )          | 6.13                                   |       |                                                    |       |                                |       |
| Outstanding at September 30, 2008                  |       | 8,605,588                  |       | $                                      | 5.74       |                                                    | 6.96       |                                | $          | 0 |   |
| Vested and expected to vest at  September 30, 2008 |       | 8,327,838                  |       | $                                      | 5.80       |                                                    | 6.90       |                                | $          | 0 |   |
| Exercisable at September 30, 2008                  |       | 5,519,622                  |       | $                                      | 6.88       |                                                    | 6.02       |                                | $          | 0 |   |

 

deCODE’sEquity Incentive Plans allow for the issuance of restricted stock awards thatmay not be sold or otherwise transferred until certain restrictions havelapsed. The unearned stock-based compensation related to these awards isamortized to compensation expense over the period the restrictions lapse. Thestock-based compensation expense for these awards is determined based on themarket price of our stock at the date of the grant applied to the total numbersof shares that are anticipated to fully vest and then amortized over thevesting period. During the three and nine-months ended September 30, 2008,deCODE recognized expense related to restricted stock grants of $23,000 and$123,000, respectively. During the three and nine-months ended September 30,2007, deCODE recognized expense related to restricted stock grants of $54,000and $159,000, respectively. At September 30, 2008, deCODE had 23,727unvested restricted shares with a weighted average grant date fair value of$1.18.

 

**7.****                       ****Net Loss Per Share**

 

Basicnet loss per share is computed using net loss available to common stockholdersand the weighted-average number of common shares outstanding. Theweighted-average number of common shares outstanding during the period is thenumber of shares determined by relating the portion of time within a reportingperiod that common shares have been outstanding to the total time in thatperiod.

 

Dilutednet loss per share is computed using the weighted-average number of commonshares outstanding during the period, plus the dilutive effect of potentialcommon shares. Diluted net loss per share does not differ from basic net lossper share in all periods presented as potential common shares are antidilutivefor all such periods and are, therefore, excluded from the calculation.Potential common shares excluded from the calculation of diluted net loss pershare were:

 
| ** **                                                                                           | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                           | ** ** | **2008**               | ** ** | **2007**               | ** ** |
| ** **                                                                                           | ** ** | **(Shares)**           | ** ** | **(Shares)**           | ** ** |
| Warrants to purchase shares of common stock                                                          |       | 455,965                |       | 856,371                |       |
| Options to purchase shares of common stock                                                           |       | 8,605,588              |       | 7,536,187              |       |
| Restricted shares subject to vesting or  with an associated outstanding non-recourse promissory note |       | 408,227                |       | 672,238                |       |
| Convertible shares issuable upon conversion  of 3.5% senior convertible notes                        |       | 16,428,572             |       | 16,428,572             |       |
|                                                                                                 |       | 25,898,352             |       | 25,493,368             |       |

 

**8.****                       ****Other non-operating incomeand (expense), net**

 

During the three and ninemonth periods ended September 30, 2008, deCODE recognized another-than-temporary-loss on investments in auction rate securities (“ARS”)(see Note 10). Although the ARS continue to pay interest according to theirstated terms, based on valuation models and an analysis of other-than-temporaryimpairment factors, deCODE recorded an impairment charge of $2,430,000 and$6,624,000 for the three and nine-month periods ended September 30, 2008.The $6,624,000 charge for the nine-month period ended September 30, 2008includes $914,000 related to ARS which deCODE had previously recognized astemporary and had accounted for as an unrealized loss at December 31,2007.

 

In September 2007,deCODE entered into a legal settlement to end ongoing litigation regardingcertain proprietary and confidential information. Financial terms of the legalsettlement stipulated that deCODE would be paid $9,000,000, which was receivedby deCODE during the year ended December 31, 2007. deCODE recognized $0and $9,000,000 of the settlement amount during the three and nine-months ended September 30,2007, net of related expenses of $61,000 and $747,000, respectively.

 

**9.****                       ****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):

 

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| ** **                                                    | ** ** | **Three Months Ended  September 30****,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                    | ** ** | **2008**                                                 | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                    | ** ** | **(In thousands)**                                  | ** ** |
| Net loss                                                      |       | $                                                        | (17,900    | )                                                   | $          | (24,248 | ) | $ | (62,919 | ) | $ | (63,101 | ) |
| Other comprehensive income (loss):                            |       |                                                     |       |                                                |       |   |   |   |   |
| Foreign currency translation                                  |       | 40                                                       |       | (10                                                 | )          | 99 |   | (32 | ) |
| Unrealized gain (loss) associated with  marketable securities |       | 52                                                       |       | (225                                                | )          | 968 |   | (200 | ) |
| Total comprehensive loss                                      |       | $                                                        | (17,808    | )                                                   | $          | (24,483 | ) | $ | (61,852 | ) | $ | (63,333 | ) |

 

**10.****                ****Investments**

 

deCODE’smarketable securities are classified as available for sale and are as follows:

 
| **September 30, 2008**                   | ** ** | **Cost**                | ** ** | **Carrying  Value** | ** ** | **Unrealized  Gains (Losses)  In OCI** | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|---------------------|------------|--------------------------------------------------|------------|
| ** **                                         | ** ** | **(In thousands)** | ** ** |
| ** **                                         | ** ** | ** **              | ** ** | ** **          | ** ** | ** **                                       | ** ** |
| U.S. Treasury Bills (cash and cash  equivalents)   |       | $                       | 5,570      |                | $          | 5,627                                            |       | $ | 57 |   |
| U.S. Treasury Bills (restricted investments)       |       | 5,500                   |       | 5,500               |       | —                                           |       |
| Auction rate securities (non-current  investments) |       | 33,500                  |       | 18,209              |       | —                                           |       |
|                                                    |            |                         |            |                     |            |                                                  |            |  |  |  |

 

Grossunrealized holding gains and gross unrealized holding losses at September 30,2008 were $57,000 and $0, respectively, and at December 31, 2007 were $3,000and $914,000, respectively, and are included in accumulated other comprehensiveincome.

 

| ** **                                          | ** ** | **September 30,  2008** | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|
| ** **                                          | ** ** | **(In thousand)**       | ** ** |
| Contractual maturities of non-current  investments: |       |                         |       |
| Maturing after 10 years                             |       | $                            | 12,003     |   |
| No maturity date (perpetual)                        |       | 6,206                        |       |
|                                                |       | $                            | 18,209     |   |

 

AtSeptember 30, 2008, deCODE held investments in Auction Rate Securitieswith original purchase principal values totaling $33,500,000, all of which areclassified as non-current investments on the balance sheet. As of December 31,2007, deCODE had $38,500,000 invested in ARS, of which $33,500,000 wereclassified as non-current and $5,000,000 as current investments. Through theauction process deCODE reduced its ARS holdings during the nine-months ended September 30,2008 by selling, at par value, the $5,000,000 ARS security classified incurrent investments at December 31, 2007.

 

Thenon-current investments in ARS held by deCODE are private placement securitieswith long-term nominal maturities for which the interest rates are resetthrough a Dutch auction process at pre-determined calendar intervals, generallyeach month. This mechanism generally allows existing investors to rollovertheir holdings and continue to own their respective securities or liquidatetheir holdings by selling their securities at par value. deCODE generallyinvested in these securities for short periods of time as part of its cashmanagement program. However, the uncertainties in the credit markets during thepast year have prevented deCODE and other investors from liquidating holdingsof its remaining ARS in recent auctions because the amount of securitiessubmitted for sale has exceeded the amount of purchase orders resulting inmultiple failed auctions.

 

The estimated market valueof deCODE’s non current investments in ARS at September 30, 2008 was$18,209,000, which reflects a $15,291,000 ($6,624,000 during the nine-monthsended September 30, 2008 and $8,667,000 during the year ended December 31,2007) adjustment to the principal value of $33,500,000. Although the ARScontinue to pay interest according to their stated terms, based on valuationmodels and an analysis of other-than-temporary impairment factors, deCODE hasrecorded an impairment charge of $2,431,000 and $6,624,000 for the three andnine-month periods ended September 30, 2008, respectively, in Othernon-operating income (expense), net in the Statements of Operations, reflectingthe portion of ARS holdings that deCODE has concluded have another-than-temporary decline in value. The $6,624,000 charge for the nine-monthperiod ended September 30, 2008 includes $914,000 related to ARS whichdeCODE had previously recognized as temporary and had accounted for as anunrealized loss at December 31, 2007.

 

Thecredit and capital markets have continued to be volatile during 2008. Ifuncertainties in these credit and capital markets continue, these marketsdeteriorate further or deCODE experiences additional downgrades on itsinvestments, deCODE may incur additional impairments (unrealized, evenrealized) to its investment portfolio, which could negatively affect ourfinancial condition,

 

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cash flows and reportedearnings.

 

**11.****                ****Sale-Leaseback Financing**

 

InSeptember 2007, deCODE completed a sale and leaseback of its property(land and building) in Woodridge, Illinois. Pursuant to the agreement,deCODE sold the Woodridge property for $25,000,000 in cash and leased the propertyback under a 17 year lease at an initial rent of $163,000 per month, subject toannual rent increases of 2.5%. Under the lease, deCODE has two 5-year renewaloptions with rent at the then prevailing market rate. The lease is an absolutenet lease and deCODE will continue to pay all expenses relating to theproperty, including taxes, utilities, insurance and maintenance. deCODE’sobligations under the lease are collateralized by a letter of credit in aninitial amount of $5,000,000, that may be reduced upon certain conditions. Theletter of credit is collateralized by U.S. Treasury Bills held in a restrictedinvestment account ($5,500,000 at September 30, 2008).

 

Thesale and leaseback of the Woodridge property is being accounted for as afinancing, as such, the property remains on the balance sheet and continues tobe depreciated through the lease term. Proceeds on the sale have been recordedon the balance sheet as a finance obligation and a portion of the rentalpayments under the lease will be applied, using the effective interest method,to reduce the finance obligation over the term of the lease, with the remainderof the rental payments being recorded as interest expense. Transaction costsamounting to $1,170,000 have been deferred and included in other long termassets on the condensed consolidated balance sheets and will be amortized tointerest expense over the term of the lease, using the effective interestmethod.

 

Concurrentwith the sale and leaseback of Woodridge, deCODE paid the existing mortgageloan ($5,430,000) which had been collateralized by the Woodridge property.

 

**12.****                ****Litigation**

 

Otherthan claims and legal proceedings that arise from time to time in the ordinarycourse of business which are not material, and matters described below, therehas been no change in the matters reported in deCODE’s Annual Report on Form 10-Kfor the year ended December 31, 2007.

 

Inthe matter of In re deCODE genetics, Inc. Initial Public Offering, whichis described in deCODE’s Annual Report on Form 10-K for the year ended December 31,2007, on June 25, 2007, the United States District Court for the SouthernDistrict of New York entered an order formally denying the motion for finalapproval of the settlement agreement because the settlement class could not becertified. On August 14, 2007, the plaintiffs filed their secondconsolidated amended class action complaints against the “focus cases” and on September 27,2007, again moved for class certification, seeking certification of threeseparate classes. The focus cases are a small group of cases that were selectedas test cases due to the large number of nearly identical actions which wereconsolidated in the Initial Public Offering litigation. The court has indicatedthat the focus cases are intended to provide strong guidance for the othercases. The case involving deCODE is not a focus case. On November 12,2007, certain of the defendants in the focus cases moved to dismiss the secondconsolidated amended class action complaints. On March 26, 2008, the districtcourt denied the motions to dismiss except as to Section 11 claims raisedby those plaintiffs who sold their securities for a price in excess of theinitial public offering price and those who purchased outside the previouslycertified class period. Briefing on the class certification motion wascompleted in May 2008. That motion was withdrawn without prejudice on October 10,2008. On December 28, 2007, the underwriter defendants moved to strikeclass allegations in 26 cases in which the Plaintiffs failed to identifyproposed class representatives, and the issuer defendants joined in the motion.On May 13, 2008, the District Court granted the motion in part in eight ofthe 26 cases, striking the class allegations as to one of the three classesbecause the proposed class representatives were not a member of the proposedclasses. The case against deCODE is one of these eight cases. Due to theinherent uncertainties of litigation, deCODE cannot accurately predict theultimate outcome of the matter.

 

**13.****                ****Fair Value Measurement**

 

On September 6, 2006,Statement of Financial Standard No. 157 *FairValue Measurement*, (“SFAS 157”), was issued. This Standarddefines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles, or GAAP, and expands disclosuresabout fair value measurements. This standard is effective January 1, 2008for deCODE. In February 2008, the FASB issued FASB Statement of Position,(“FSP”) No. 157-2, *Partial Deferral ofthe Effective Date of Statement 157*, (“FSP No. 157-2”),which delays the effective date of SFAS No. 157 for all non-financialassets and non-financial liabilities, except those that are recognized ordisclosed at fair value in the financials statements on a recurring basis (atleast annually) to fiscal years beginning after November 15, 2008. deCODEadopted SFAS 157 as of January 1, 2008, with the exception of theapplication of the statement to nonfinancial assets and nonfinancialliabilities. The adoption of FAS 157 did not have a material impact on deCODE’sconsolidated financial statements. deCODE is evaluating the impact on thenon-financial assets and liabilities.

 

**ValuationHierarchy.** SFAS 157establishes a valuation hierarchy for disclosure of the inputs to valuationused to measure fair value. This hierarchy prioritizes the inputs into threebroad levels as follows. Level 1 inputs are quoted prices (unadjusted) inactive

 

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markets for identical assetsor liabilities. Level 2 inputs are quoted prices for similar assets andliabilities in active markets or inputs that are observable for the asset orliability, either directly or indirectly through market corroboration, forsubstantially the full term of the financial instrument. Level 3 inputs areunobservable inputs based on assumptions used to measure assets and liabilitiesat fair value. A financial asset or liability’s classification within thehierarchy is determined based on the lowest level input that is significant tothe fair value measurement.

 

The following table providesthe assets and liabilities carried at fair value measured on a recurring basisas of September 30, 2008:

 
| ** **                                         | ** ** | ** **                                                   | ** ** | **Fair Value Measurements  at September 30, 2008 Using:** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| ** **                                         | ** ** | **Total  Carrying  Value at  September  30, 2008** | ** ** | **Quoted  prices in  active  markets  (Level 1)**                             | ** ** | **Significant  other  observable  inputs  (Level 2)** | ** ** | **Significant  unobservable  inputs  (Level 3)** | ** ** |
| ** **                                         | ** ** | **(In thousands)**                                      | ** ** |
| U.S. Treasury Bills (cash and cash  equivalents)   |       | $                                                            | 5,627      |                                                                                    | $          | 5,627 |   | $ | — |   | $ | — |   |
| U.S. Treasury Bills (restricted  investments)      |       | 5,500                                                        |       | 5,500                                                                                   |       | — |   | — |   |
| Auction rate securities (investments  non-current) |       | 18,209                                                       |       | —                                                                                  |       | — |   | 18,209 |   |
|                                                    |            |                                                              |            |                                                                                         |            |  |  |  |  |  |  |  |  |

 

The following table presentsdeCODE’s assets measured at fair value on a recurring basis using significantunobservable inputs (Level 3) at September 30, 2008:

 

| ** **                             | ** ** | **Auction Rate Securities**                  | ** ** |
|----------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                             | ** ** | **Three Months  Ended  September 30,  2008** | ** ** | **Nine Months  Ended  September 30,  2008** | ** ** |
| ** **                             | ** ** | **(In thousands)**                                | ** ** |
| Balance at beginning of period         |       | $                                                      | 20,640     |   | $ | 24,833 |   |
| Transfers to Level 3                   |       | —                                                 |       | — |   |
| Total gains (losses):                  |       |                                                   |       |   |   |
| Included in earnings                   |       | (2,431                                                 | )          | (7,538 | ) |
| Included in other comprehensive income |       | —                                                 |       | 914 |   |
| Purchase and settlements (net)         |       | —                                                 |       | — |   |
| Balance at September 30, 2008     |       | $                                                      | 18,209     |   | $ | 18,209 |   |

 

**ValuationTechniques.**deCODE’sinvestments in auction rate securities at September 30, 2008 did not havequoted market prices and are classified within Level 3 of the valuationhierarchy. The valuation models used to value the ARS include those that arebased on expected cash flow streams and collateral values, includingassessments of counterparty credit quality, default risk underlying thesecurity, discount rates and overall capital market liquidity. The valuation ofdeCODE’s investments in ARS is subject to uncertainties that are difficult topredict. Factors that may impact the valuation include changes in creditratings of the securities or their guarantors, underlying collateral value,discounts rates, counterparty risk and ongoing strength and quality of marketcredit and liquidity.

 

Effective January 1,2008, deCODE adopted, on a prospective basis, Statement of Financial AccountingStandards No. 159, *The Fair ValueOption for Financial Assets and Financial Liabilities*(“SFAS 159”).SFAS 159 permits entities to choose to measure many financial instruments andcertain other items at fair value. The objective of the guidance is to improvefinancial reporting by providing entities with the opportunity to mitigatevolatility in reported earnings caused by measuring related assets andliabilities differently without having to apply complex hedge accountingprovisions. deCODE has not elected the fair value option for any financialinstruments. The adoption of SFAS 159 did not have a material impact on deCODE’sconsolidated financial statements.

 

**14.****                ****Sale of Encode**

 

On July 1, 2008, deCODEsold its subsidiary Encode ehf (“Encode”) located in Iceland to a related party(an employee) for a nominal amount (100,000 ISK or $1,000 at September 30,2008), recognizing a loss on the sale of $102,000 during the three andnine-month periods ended September 30, 2008. The sale of Encode includedthe remainder of existing contracts at the date of the sale, immaterial assetsand all employees associated with Encode. For the six-month periods ended June 30,2008 and 2007, Encode had revenues of $717,000 and $639,000, respectively. Forthe year ended December 31, 2007, Encode had revenues of $795,000.

 

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**ITEM2.****  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

** **

ThisManagement’s Discussion and Analysis of Financial Condition and Results ofOperations as of September 30, 2008 and for the three and nine-monthperiods ended September 30, 2008 and 2007 should be read in conjunctionwith the unaudited condensed consolidated financial statements and notesthereto set forth in Item 1 of this report.

 

 Thisquarterly report on Form 10-Q contains forward-looking statements,including our expectations of future industry conditions, strategic plans andforecasts of operational results. Various risks may cause our actual results todiffer materially. A description of some of the risks and uncertainties iscontained below and in the risk factors referred to in Part II, Item 1A.

 

**Overview**

** **

Headquarteredin Reykjavik, Iceland, deCODE is a bio-pharmaceutical company developingproducts to improve the treatment, diagnosis and prevention of common diseases.deCODE applies its capabilities in chemistry and structural biology to thedevelopment of drugs and its discoveries in human genetics to bring to marketDNA-based reference laboratory tests and consumer genome analysis services toassess individual risk of common diseases. As these diseases are common andthere is significant unmet need for both more effective therapies and tools toempower prevention, we believe that our strategy represents a significantopportunity to create better medicine with major potential — both near- andlonger-term — in the global marketplace.

 

Webelieve that deCODE’s advantage derives from our integrated capabilities instructure-based drug design and medicinal chemistry, as well as our populationapproach to human genetics and the ability to apply this approach directly tothe development of DNA-based diagnostic tests for gauging individual risk ofcommon diseases. Through our structural biology and chemistry units based inthe United States, we can develop new and detailed understanding of thestructure and binding sites of drug targets. This makes it possible to discovercompounds that may have superior safety and tolerability profiles than existingdrugs. deCODE has fully integrated capabilities ranging from targeted *in vitro* and model organism biologythrough cGMP manufacturing for clinical trials. For the development ofdisease-risk diagnostics, we have in Iceland comprehensive population resourcesand one of the largest genotyping facilities in the world, enabling ourscientists to isolate key genes and gene variants contributing to commondiseases. Our work indicates that these genetic risk factors for commondiseases confer risk by increasing or decreasing the activity of commonbiological pathways, placing individuals on a spectrum of risk that encompassesthe population as a whole. Well-validated genetic variations conferring risk ofdisease can be directly applied as the basis for DNA-based tests gauging individualrisk of disease.

 

In2008, our focus remains within the same broad strategic continuity, emphasizingits core capabilities in human genetics as well as our integrated capabilitiesin structural biology and chemistry. We are leveraging those assets to buildupon the commercial opportunities presented by both our drug discovery work anddiagnostics work as well as deCODEme. Management of deCODE has taken steps toslim down elements of deCODE’s broad capabilities to focus its remainingresources, and continues to seek efficiencies throughout the organization. Inorder to bring to market products that can generate revenues in the near term,in 2008, we have focused our efforts on the development and marketing of ourmolecular diagnostic products and deCODEme, our personal genome analysisservice.

 

Atthe same time, deCODE aims to advance its therapeutics programs throughpartnerships and then advance its early preclinical programs both throughpartnerships and resources it may be able to generate through its contractservices and diagnostics programs. In our drug discovery programs we aredeveloping compounds that address both known targets and new targets wediscovered through our gene discovery program. Our experience in seekingpartners for the further development of our programs based on our genediscoveries has led us to conclude that in the current environment compoundsthat address known, rather than newly identified, targets have greatercommercial potential in the near and medium term. Under these circumstances, weexpect that our drug development programs increasingly will address targetsthat do not come out of our gene discovery programs and that our gene discoveryprograms will be directed toward the development of diagnostic products.

 

*Drug Development.*Through our chemistry and structural biology units, based in the UnitedStates, we are able to discover novel small-molecule therapeutic compounds thataddress both known and novel drug targets identified by us, 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 Phase 1 andPhase 2 clinical trials. We continue to actively explore out-licensing,co-development, and partnering opportunities, and in certain programs havebrought directly into clinical trials compounds that address targets we haveidentified through our genetics research but which were originally developed byother companies for other indications. Our capabilities in medicinal chemistryand protein crystallography have also enabled us to develop a detailedunderstanding of the sites at which candidate small-molecules bind to a target,and thus to discover compounds that bind to a site that may offer better safetyand tolerability profiles than existing compounds for certain indications.deCODE is actively exploring drug development partnerships in its most advancedtherapeutic programs, in order to spread risk and cost and to focus resourceson the advancement of its target discovery work and preclinical candidates.

 

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Ourlead drug development programs include:

* *

·      *DG041 for the prevention ofarterial thrombosis.*DG041is our novel, first-in-class antagonist of the EP3 receptor for prostaglandinsE2, which we are developing as a next-generation oral anti-platelet therapyaimed at preventing arterial thrombosis without increasing bleeding time. In aPhase II clinical trial and additional clinical pharmacology studies completedin 2007, DG041 was shown to dramatically inhibit platelet aggregation as wellas platelet activation mediated specifically through vasodilator-stimulatedphosphoprotein (VASP), a biomarker useful for measuring platelet activity.These effects were concentration-dependent and were seen irrespective ofwhether patients were receiving concomitant therapy with aspirin. In mid-2008,we completed a second clinical pharmacology study examining the impact of DG041on top of aspirin and Plavix TM, the results of which show thatDG041 blocks platelet aggregation and does not increase bleeding time whengiven alone, in combination with Plavix TM, or in combination withPlavixTM and aspirin. We are concurrently working on a controlled releaseformulation for DG041 and also continue to engage in partnering discussions.

 

·      *DG051 and DG031 for theprevention of heart attack.*Wehave completed Phase I and Phase IIa clinical studies for DG051, ourleukotriene A4 hydrolase inhibitor being developed for the prevention of heartattack. The Phase IIa study examined safety, tolerability and DG051’s impact onthe production of leukotriene B4 (LTB4), the pro-inflammatory molecule producedby the branch of the leukotriene pathway that deCODE’s gene discovery work haslinked to increased risk of heart attack. The results of our Phase I and PhaseIIa trials demonstrated that the compound is well-tolerated at all dose levelstested; has a pharmacokinetic profile suitable for once-a-day dosing; anddelivers dose-dependent reductions in LTB4 production in healthy subjects andheart patients alike. We have also successfully completed our reformulation ofDG031, our Phase III FLAP inhibitor also being developed for the prevention ofheart attack. Given the size and costs associated with pursuing a largecardiovascular indication, we are actively seeking a partner with whom to takethe next step in late stage clinical development of our leukotriene program.

 

·      *DG071 for Alzheimer’s andother cognitive disorders*.In October 2008 we filed an investigational new drug (IND) application forDG071, a novel small-molecule modulator of phosphodiesterase 4 (PDE4), beingdeveloped for Alzheimer’s and other cognitive disorders. The compound is beingdeveloped as a new and potentially safer means of targeting PDE4 to combatmemory loss and cognitive deficits associated with Alzheimer’s disease andother disorders in which neural signaling is reduced or impaired. In animalmodels, DG071 has been shown to significantly improve learning and long- andshort-term memory at doses that offer a wide margin for safety andtolerability. The compound has the potential to eliminate the nausea thatlimits the utility of previous PDE4 inhibitors. We are seeking a strategicpartner with whom to advance the clinical development of DG071.

 

*Diagnostics*. We are applying our discoveries and unique expertise in human geneticsand genotyping to the development of DNA-based tests for assessing individualrisk of a growing range of common diseases. Since April 2007 we havelaunched six reference laboratory DNA-based diagnostic tests to detectsingle-letter variations in the human genome (called SNPs) that we have linkedto increased risk of several common diseases:

 

·      *deCODE T2*TM - which detects SNPs we discovered to be associated with increasedrisk of type 2 diabetes.

·      *deCODE AFTM* - which detects SNPSs we discovered to beassociated with increased risk of atrial fibrillation and stroke

·      *deCODE MITM* - which detects SNPs we discovered to beassociated with early-onset heart attack, (myocardial infarction, or MI)

·      *deCODE ProstateCancerTM* - which detects SNPs we have linked toincreased risk of prostate cancer

·      *deCODE GlaucomaTM* -**whichdetects SNPs we have linked to increased risk of exfoliation glaucoma

·      *deCODE BreastCancerTM*-**whichdetects SNPs we and others have linked to risk of the most common forms ofbreast cancer

 

Such tests can be employedas an aid in developing more effective disease prevention strategies by helpingindividuals to better understand their inherited risk of a given condition, aswell as to identify patients likely to respond well to a given drug. Beginningin 2008, deCODE initiated billing to insurance companies on behalf ofphysicians ordering these tests and has received reimbursement from severalhealth insurance companies. All of our diagnostic tests are offered by deCODEvia direct sales efforts to physicians through our sales force in the United States;through marketing collaborations with other organizations in the U.S. and othercountries; as well as through our dedicated diagnostics website,www.decodediagnostics.com. deCODE also has an alliance with Illumina, Inc.to develop DNA-based diagnostic kits utilizing deCODE’s gene discoveries incertain diseases and Illumina’s platform for SNP genotyping.

 

*deCODEmeTM.* In November 2007, we launched the firstconsumer genetic analysis service: deCODEmeTM. This service takes advantage ofdeCODE’s leadership in human genetics and the capabilities of itshigh-throughput genotyping laboratory, which is CLIA registered for analyticaland clinical validation. Through deCODEmeTM, subscribers can put themselves inthe context of the latest discoveries in genetics, learning what their own DNAsays about their ancestry, certain physical traits, as well as whether they havegenetic variants that have been associated with higher or lower than averagerisk of a range of common diseases. This information is

 

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continually updated as newdiscoveries are made, and is presented in subscribers’ secure individual webpages. deCODEmeTM is offered through a dedicated website, www.decodeme.com.

 

Thegoal of our business strategy is to maximize the creation of value from ourdrug discovery and development programs, our human genetics and diagnostics capabilitiesand test portfolio, and to capture that value for deCODE and its stockholders.Executing on our strategy – advancing and capturing the value of our productswhile continuing our discovery and product development work in a broad range ofcommon diseases – requires us to spread risk and manage cost. We are constantlyevaluating the optimal balance between proprietary and partnered productdevelopment, the level of our investment in research and development, thedeployment of cash resources for product development, and the financingenvironment.

 

Aswe invest in proprietary programs, we leverage our capabilities to provideservices to fee-paying customers. We also receive contract and grant fundingfrom various governmental agencies. We have formed drug and other productdevelopment alliances. Our chemistry subsidiary provides drug discovery andcontract manufacturing services to fee-for-service customers, and our otherservice offerings include protein crystallography products and instruments throughour biosystems subsidiary, as well as protein structure analysis contractservices through our structural biology subsidiary; and DNA analysis servicesthrough our genotyping laboratory in Reykjavik.

 

Oneof the main issues confronting big pharmaceutical companies is their lack ofpromising new drugs to treat major indications. As many leading brand-namedrugs come off patent and face generic competition, developing successful newmedicines will become critical for filling the gap. We believe that companiessuch as ours may be well positioned to play an important role in filling thegap in the pipeline of new drugs, either alone or as partners of pharmaceuticalcompanies.

 

Wehave derived revenues primarily from genomic services, research funding andother fees from our service customers, as well as from research grants.Milestone payments and upfront, exclusivity, technology-access andtechnology-development fees under our collaboration agreements constituteanother source of our revenues. Our expenses consist primarily of research anddevelopment expenses such as salaries and related employee costs, materials andsupplies, and contractor services.

 

Webelieve that our ongoing work in genetics, the advancement and marketing of ourdiagnostic programs, and the conduct of clinical trials in our therapeuticsprograms will require significant ongoing expenditure. We anticipate incurringadditional net losses at least through the next several years as we work todevelop and bring our products to market. We expect that our revenues andlosses will fluctuate from quarter to quarter and that such fluctuations may besubstantial, especially because progress in our scientific work and milestonepayments that are related to progress can fluctuate between quarters. We do notbelieve that comparisons of our quarter-to-quarter performance are a goodindication of future performance.

 

InOctober 2008 we announced that we were carrying out a review of ourlong-term business strategy. deCODE has over the past few years utilized itscapabilities in medicinal chemistry, structural biology and human genetics todevelop growing product and intellectual property portfolios in boththerapeutics and DNA-based diagnostics. The goal of this strategic review is tooptimize the value of these assets for our shareholders by sharpening the focusof our business, selling non-core assets, securing strategic partnerships, andutilizing the resources generated to underpin product development and marketingefforts in our core business. We have engaged the Stanford Group Company toassist in evaluating strategic alternatives and in executing swiftly on theresults of this review through the identification of buyers and partners fornon-core business units, programs and intellectual property.

 

AtSeptember 30, 2008, we had liquid funds available for operating activities(cash and cash equivalents together with current investments) of $11.8 millionas compared to $23.7 million at June 30, 2008 and $64.2 million at December 31,2007. The net utilization of liquid funds in the three and nine-month periodsended September 30, 2008 was $12.0 million and $52.4 million,respectively. At September 30, 2008, we had $35.5 million of cash, cashequivalents and investments, comprised of $11.8 million of cash and cashequivalents, as well as $5.5 million in restricted investments in U.S. TreasuryBills and $18.2 million in illiquid, non-current investments in auction ratesecurities. At December 31, 2007, we had $94.1 million in cash, cashequivalents, restricted cash equivalents and investments.

 

In2008, our focus remains within the same broad strategic continuity, emphasizingour core capabilities in human genetics and leveraging those assets to buildupon the commercial opportunities presented by our diagnostics work as well asdeCODEme. We have taken steps to slim down elements of deCODE’s broadcapabilities to focus our remaining resources, and we continue to seekefficiencies throughout the organization. With near-term value creation inmind, our core focus in 2008 has been in building our genomic services business(which includes diagnostics, deCODEme and scientific services). At the sametime, we aim to advance our therapeutics programs through partnerships and thenadvance our early preclinical programs both through partnerships and resourceswe may be able to generate from our diagnostics business. We continue toinvestigate avenues of financing beyond collaborations and licensingarrangements, namely further public or private equity offerings, additional debtfinancing and other forms of financing. We have also carried-on analyzingnon-core elements of operations. Presently, we are carrying out a review of ourlong-term business strategy and have engaged professional advisors to assist inevaluating our strategic alternatives and in executing swiftly on the resultsof this review through the identification of buyers and partners for non-corebusiness units, programs and intellectual property. The goal of this strategicreview is to optimize the value of these assets and sharpening the focus ofdeCODE’s business, selling non-core

 

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assets,securing strategic partnerships, and utilizing the resources generated tounderpin product development and marketing efforts in our core business. Wehave utilized a 30-day grace period for the scheduled October 15 interestpayment on our 3.5% Senior Convertible Notes due 2011 and are reviewing methodsfor making this payment. Givenour current liquid assets, and without paying the interest on our Notes fromour present funds, we must obtain further financial resources through eitherthe implementation of strategic alternatives, corporate partnerships, or thesale of or loans secured by our auction rate securities in order to continueoperations beyond the end of this year. We are focused on reducing expenses andspeeding the evaluation of our strategic options to achieve this goal.

 

In orderto provide more time for the completion of this strategic review and theexecution of alternatives including the sale of assets, we elected to utilize a30-day grace period for the scheduled October 15 interest payment on ouroutstanding 3.5% Senior Convertible Notes due 2011. Failure to pay aninstallment payment on the interest within 30 days of the due date wouldconstitute an event of default. If an event of default shall occur with respect to the installmentpayment on the interest and be continuing, the trustee or the holders of atleast 25% in aggregate principal amount of the notes then outstanding maydeclare the notes due and payable at their principal amount together withaccrued interest.

 

**Our productportfolio and development pipeline**

 

***DNA-based risk-predictive diagnostic testsand consumer genome analysis***

*** ***

Wecurrently offer six DNA-based diagnostic tests for gauging individual risk ofseveral common diseases — all launched since the second quarter of 2007 — andhave several more such tests in development. We also offer a personal genomeanalysis service, deCODEmeTM. We are actively marketing these products andassist our customers in obtaining payor reimbursement for our diagnostic tests.These products and others we now have in development are listed in the tablebelow. The predicted launch dates for those tests still in development aregiven only as a guide according to our current expectations for each program.

 
| **Indication**                                                            | ** ** | **Product**                 | ** ** | **Launch date** | ** ** | **Utility / Highlights**                                                                                                                                                                                                                                                                                                      |
|---------------------------------------------------------------------------|------------|-----------------------------|------------|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Type  2 diabetes                                                          |       | deCODE T2TM             |       | April 2007      |       | ·      High-risk  pre-diabetics can receive earlier lifestyle and pharmacologic intervention

·      Validated in  more than 60 populations                                                                                                                                 |
| Atrial  fibrillation/stroke                                               |       | deCODE AFTM             |       | July 2007       |       | ·      Post-stroke/TIA  patients at risk of AF to obtain additional cardiac monitoring

·      Patients with  intermittent AF, family history and CHF to obtain additional cardiac  monitoring

·      Validated in  more than 10 populations |
| Early-onset  heart attack/abdominal aortic aneurysm/intracranial aneurysm |       | deCODE MITM             |       | October 2007    |       | ·      Risk of  early-onset MI to seek CVD assessment or prevention management

·      Validated in  more than 25 populations                                                                                                                                               |
| Personal  genome scan                                                     |       | deCODEmeTM              |       | November 2007   |       | ·      Launched with  variants in 18 conditions; currently 30 conditions                                                                                                                                                                                                                                  |
| Prostate  cancer                                                          |       | deCODE ProstateCancerTM |       | February 2008   |       | ·      Validated  common risk variants that are linked to more than 50% of all prostrate cancer  cases

·      Some variants  included identify risk of aggressive forms of prostrate cancer

·      Validated in  more than 15 populations   |
| Exfoliation  glaucoma                                                     |       | deCODE GlaucomaTM       |       | February 2008   |       | ·      Risk of  exfoliant glaucoma

·      Validated in  more than 10 populations                                                                                                                                                                                           |
| Breast  cancer                                                            |       | deCODE BreastCancerTM   |       | October 2008    |       | ·      Tests 7  genetic risk variants

·      Assesses risk  of the most common forms of breast cancer, which represents 95% of all breast  cancers.

·      Validated in  more than 10 populations                                           |

 

OtherDNA-based risk diagnostic tests currently in development include: melanoma,basal cell cancer, bladder cancer and lung cancer.

 

***Drug Development Programs***

 

Thefollowing is a summary of the development of our drug candidates. Because ofuncertainties involved in the drug development process as well as costs relatedto late-stage clinical development, the actual timing for the events describedbelow may differ

 

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materially from thatprovided in this summary.

 

*DG041*.DG041 is being developed as an anti-platelet compound for the prevention ofarterial thrombosis. DG041 is a first-in-class small molecule inhibitor of theEP3 receptor for prostaglandin E2, a G-protein coupled receptor (GPCR). It hasbeen demonstrated by in vitro studies that PGE2 may have additive stimulatory effectson platelet aggregation beyond those of other potent agonists such as ADP orthromboxane A2, targeted by clopidogrel and aspirin, respectively. The resultsof the Phase I program showed DG041 to be well-tolerated across the entire doserange studied. The compound can effectively inhibit platelet aggregation in adose-dependent manner without increasing bleeding time. We completed asuccessful Phase IIa trial of DG041 along with a highly informative clinicalpharmacology study conducted in the presence and absence of aspirin. We alsocompleted key drug-drug interaction studies with DG041that demonstrated a lackof any relevant interaction by DG-041 on two common routes of drug metabolism.Based on the results of our clinical studies thus far, DG041 appears to bewell-tolerated, showing little difference in bleeding events between dosingarms and placebo, and to potentially offer focused means of preventing theformation of thrombi by specifically inhibiting platelet aggregation mediatedby EP3. Earlier this year, we completed a second clinical pharmacology studyexamining the impact of DG041 on top of aspirin and Plavix TM, theresults of which show that DG041 blocks platelet aggregation and does notincrease bleeding time when given alone, with Plavix TM, or withPlavixTM and aspirin. We are concurrently on a controlled release formulationfor DG041 and also continue to engage in partnering discussions.

 

*DG051 and DG031.*We have two compounds in development for the prevention of heartattack, DG051 and DG031. These programs come out of our discovery of major riskvariants in two genes encoding proteins in the leukotriene pathway. Thesevariants – in the genes that code for leukotriene A4 Hydrolase (LTA4H) and5-lipoxygenase activating protein (FLAP) – appear to confer risk in the sameway: by causing an up regulation in the production of leukotriene B4, a potentpro-inflammatory molecule that is the end product of one branch of the pathway.The therapeutic goal of both compounds is to inhibit the activity of thepathway, lowering the production of LTB4 and thereby decreasing theinflammatory activity in atherosclerotic plaques and reducing the risk of heartattack. In addition to reducing the risk of heart attack, these drugs mayprovide benefit in other inflammatory diseases.

 

DG051, discovered internallyby deCODE’s chemistry unit, is a small-molecule inhibitor of LTA4H, which isdirectly involved in the synthesis of LTB4. In 2007, we completed our Phase Iprogram, the results of which demonstrated that DG051 was safe and welltolerated at all doses tested, has a pharmacokinetic profile suited forpotential once-a-day dosing, and significantly reduces LTB4 levels in aconcentration-dependent manner. We also concluded a Phase IIa study in late2007, which demonstrated safety and tolerability and a significant reduction inLTB4, even at lower doses than were originally considered. deCODE has alsoin-licensed a FLAP inhibitor from Bayer AG, now known as DG031. Our Phase IIclinical studies demonstrated that DG031 was well-tolerated and reducedproduction of LTB4 in a dose-dependent manner. This effect was seen on top ofthe effects of the current standard of care, which included statin therapy fora majority of patients in our trials. In 2006 we began a Phase III clinicaltrial for DG031, a trial which we voluntarily suspended because the drugtablets appeared to dissolve more slowly than anticipated, potentiallyproviding lessening amounts of active drug the longer they were stored. We havesuccessfully reformulated the compound and are currently seeking a partner withwhom to take the next step in development of our leukotriene program.

 

*DG071*.DG071 is a novel, potent and selective PDE4D modulator discovered by deCODE’schemistry group. First and second generation PDE4 inhibitors such as rolipram,cilomilast, and roflumilast caused significant side effects, including nauseaand vomiting, at therapeutic doses in human clinical trials. Such side effectsseverely limit the utility of these earlier compounds. Data generated at deCODEsuggest that the observed side effects were closely correlated with the bindingof these molecules in the PDE4 enzymatic active site competitively with cAMP.As cAMP is of critical importance to neuronal signaling, the goal of deCODE’sprogram has been to discover compounds that would modulate PDE4 activity via anallosteric mechanism to improve safety and tolerability. Towards this goal, thedeCODE biostructures team solved multiple novel co-crystal structures of PDE4D &PDE4B containing regulatory domains with bound ligands. Those structuresallowed the deCODE chemistry team to identify a novel binding site forallosteric modulators in the PDE4 regulatory domain. Binding of an allostericmodulator at that site is non-competitive with cAMP. DG071 has been shown inanimal models to improve cognitive function with benefit similar to that ofcholinesterase inhibitors such as donepezil that currently are a mainstay oftherapy for memory loss in early Alzheimer’s disease, yet also benefiting longterm memory function in animal tests where the cholinesterase inhibitors areineffective. Additionally, we have developed a broad proprietary platform forPDE4 modulators that we are applying to discover compounds with potentialutility for the treatment of over-active bladder, inflammatory and respiratorydiseases.

 

TheDG071compound is being developed as a new and potentially safer means oftargeting PDE4 to combat memory loss and cognitive deficits associated withAlzheimer’s disease and other disorders in which neural signaling is reduced orimpaired. In animal models, DG071 has been shown to significantly improvelearning and long- and short-term memory at doses that offer a wide margin forsafety and tolerability. The compound has the potential to eliminate the nauseathat limits the utility of previous PDE4 inhibitors. In October 2008 wefiled an IND application for DG071, which we plan to advance the clinicaldevelopment of DG071 with a strategic partner.

 

Forour most significant research and development programs we have cumulativelyinvested $47.1 million, $24.4 million and $15.8 million in our heart attack(myocardial infarction, or MI), arterial thrombosis and stroke programs,respectively, from the

 

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beginning of 2003 to date (September 30,2008). Inception to-date costs are not available as these costs were nothistorically tracked by program.

 

Wehave not applied for or received marketing approval from the applicableregulatory authorities in any country for any of our drug candidates. In orderfor us to achieve marketing approval in the United States, the FDA mustconclude that our clinical data establish the safety and efficacy of our drugcandidate. Other countries have similar requirements. Historically, the resultsfrom pre-clinical testing and early clinical trials (through PhaseII) have often not been predictive of success in later clinical trials.Many new compounds 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,our strategy includes the option of entering into collaborative arrangementswith third parties to participate in the development and commercialization ofour products. Entering into collaboration with a partner at any point in thedevelopment or commercialization of a product is a business decision. Whenmaking this decision we do and will consider, among other matters, thecomplexity of the indication, the size, complexity and expense of necessarydevelopment and/or commercialization efforts, competition in the market andsize of the applicable market, an assessment of our own resources—financial andoperational, and an assessment of the resources of a potential partner. In theevent that we do collaborate on any of the above programs in the future, apartner will have a level of control, which may be significant, over thepre-clinical development or clinical trial process for a product. As a resultthe completion date of such a partnered program could largely be under controlof that third party rather than under our control. We cannot forecast with anydegree of certainty which proprietary drug candidate will be subject to futurecollaborative arrangements or how such arrangements would affect ourdevelopment plan or capital requirements.

 

Dueto the uncertainties discussed above, we are unable to determine the durationand completion costs of our research and development projects or when and towhat extent we will receive cash inflows from the commercialization and sale ofa product.

 

**Results ofOperations for the Three and Nine-Month Periods Ended September 30, 2008and 2007**

** **

In2008, our focus remains within the same broad strategic continuity, emphasizingits core capabilities in human genetics and leveraging those assets to buildupon the commercial opportunities presented by our diagnostics work anddeCODEme. We have taken steps to slim down elements of deCODE’s broadcapabilities to focus our remaining resources, and we continue to seekefficiencies throughout the organization. With near-term value creation in mind,our core focus in 2008 has been in building our genomic services business(which includes diagnostics, deCODEme and scientific services). At the sametime, we aim to advance our therapeutics programs through partnerships and thenadvance our early preclinical programs both through partnerships and resourceswe may be able to generate from our diagnostics business. We continue toinvestigate avenues of financing beyond collaborations and licensingarrangements, namely further public or private equity offerings, additionaldebt financing and other forms of financing. We have also carried-on analyzingnon-core elements of operations. Presently, we are carrying out a review of ourlong-term business strategy and have engaged professional advisors to assist inevaluating our strategic alternatives and in executing swiftly on the resultsof this review through the identification of buyers and partners for non-corebusiness units, programs and intellectual property. The goal of this strategicreview is to optimize the value of these assets and sharpening the focus ofdeCODE’s business, selling non-core assets, securing strategic partnerships,and utilizing the resources generated to underpin product development andmarketing efforts in its core business. We have utilized a 30-day grace periodfor the scheduled October 15 interest payment on our 3.5% SeniorConvertible Notes due 2011 and are reviewing methods for making this payment. Given our current liquid assets, and withoutpaying the interest on our Notes from our present funds, we must obtain furtherfinancial resources through either the implementation of strategicalternatives, corporate partnerships, or the sale of or loans secured by ourauction rate securities in order to continue operations beyond the end of thisyear. We are focused on reducing expenses and speeding the evaluation of ourstrategic options to achieve this goal.

 

Financialhighlights as of and for the three and nine-month periods ended September 30,2008 include:

 

· At September 30, 2008, we had liquidfunds available for operating activities (cash and cash equivalents togetherwith current investments) of $11.8 million as compared to $23.7 million at June 30,2008 and $64.2 million at December 31, 2007. The net utilization of liquidfunds in the three and nine-month periods ended September 30, 2008 was$12.0 million and $52.4 million, respectively. At September 30, 2008, wehad $35.5 million of cash, cash equivalents and investments, comprised of $11.8million of cash and cash equivalents, as well as $5.5 million in restrictedinvestments in U.S. Treasury Bills and $18.2 million in illiquid, non-currentinvestments in auction rate securities. At December 31, 2007, we had $94.1million in cash, cash equivalents, restricted cash equivalents and investments.

 

· Our revenue was $12.0 million and $42.0million for the three and nine-month periods ended September 30, 2008,respectively, as compared to $10.9 million and $27.1 million for the three andnine-month periods ended September 30, 2007, respectively. As of September 30,2008, we had $17.7 million in deferred revenue that will be recognized overfuture reporting periods. The period-on-period increase in revenue for thethird quarter and the first nine months of 2008 was driven principally bygrowth in our genomic services business, which includes our diagnostics, deCODEmeTMpersonal genome analysis, and contract genotyping business. Importantly, our genomic services revenueswere 4.0 million and $14.0 million during the three and nine-month periodsended

 

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September 30, 2008,respectively, as compared to $1.8 million and $3.9 million during the three andnine-month periods ended September 30, 2007, respectively.

 

· Our research and development expense was$5.7 million and $26.3 million for the three and nine-month periods ended September 30,2008, respectively, as compared to $14.1 million and $41.3 million for thethree and nine-month periods ended September 30, 2007, respectively. Ourresearch and development expense in the three and nine-month periods ended September 30,2008 reflect the conclusion of clinical pharmacological studies in our mostadvanced drug development programs, the launch of our prostate cancer, breast cancerand glaucoma diagnostic tests, and the advancement of gene and target discoverywork in a range of major disease areas. We also continue to pursue our PDE4 modulatorprogram across several indications and filed an IND application for DG071 for Alzheimer’s and other cognitivedisorders in October 2008.

 

· Our selling, general and administrativeexpense for the three and nine-month periods ended September 30, 2008 was$6.7 million and $21.0 million, respectively, as compared to $7.1 million and$19.4 million for the three and nine-month periods ended September 30,2007, respectively. The changes in selling, general and administrative expenseperiod-on-period reflect principally the build-up of our sales efforts for ourdiagnostics and deCODEmeTM businesses offset chiefly by lower salary and stock-based compensation expense.

 

· With continuing developments in the globalcredit and capital markets into 2008, we recognized an other-than-temporaryloss on investments in auction rate securities (“ARS”), classified asnon-current investments on our balance sheet. The estimated market value of ourARS holdings at September 30, 2008 was $18.2 million. Although the ARScontinue to pay interest according to their stated terms, based on thevaluation models and an analysis of other-than-temporary impairment factors, wehave recorded an impairment charge of $2.4 million and $6.6 million during thethree and nine-month periods ended September 30, 2008.

 

·  In order toprovide more time for the completion of this strategic review and the executionof alternatives including the sale of assets, deCODE elected to utilize a30-day grace period for the scheduled October 15 interest payment on itsoutstanding 3.5% Senior Convertible Notes due 2011. Failure to pay aninstallment payment on the interest within 30 days of the due date wouldconstitute an event of default. Ifan event of default occurs with respect to the installment payment on theinterest and is continuing, the trustee or the holders of at least 25% inaggregate principal amount of the notes then outstanding may declare the notesdue and payable at their principal amount together with accrued interest.

 

***Revenue***

 
| ** ** | ** ** | **Three Months**                 | ** ** | **Nine Months**              | ** ** | **2008 as Compared to 2007** | ** ** |
|------------|------------|---------------------------------------|------------|-----------------------------------|------------|--------------------------------------------------|------------|
| ** ** | ** ** | **Ended September 30,**     | ** ** | **Ended September 30,** | ** ** | **Three Months**                            | ** ** | **Nine Months** | ** ** |
| ** ** | ** ** | **2008**                              | ** ** | **2007**                          | ** ** | **2008**                                         | ** ** | **2007** | ** ** | **$ Change** | ** ** | **% Change** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** ** | ** ** | **(In thousands, except%)** | ** ** |
| Revenue    |       | $                                     | 11,978     |                              | $          | 10,892                                           |       | $ | 41,982 |   | $ | 27,060 |   | $ | 1,086 |   | 10 | % | $ | 14,922 |   | 55 | % |
|            |            |                                       |            |                                   |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

In2008, our business strategy is focused on emphasizing our core capabilities inhuman genetics and leveraging those strengths to build on opportunities togenerate near-term revenue from products that we already have available; namelyour genomic services comprising diagnostics, our consumer genetics servicedeCODEme and genotyping and other scientific services. At the same time, weplan to advance our early and late stage drug programs through corporatepartnerships, and will generate revenue from contract and other service fees.Further, we will continue to leverage our capabilities to continue with andpursue funding in the form of research grants. In the majority of our programswe are pursuing diagnostic and early-stage drug development on our own.Depending on the nature of each prospective business opportunity, the keycomponents of the commercial terms of such arrangements typically include oneor more of the following: research funding; up-front, exclusivity, technologyaccess, and technology development fees; fees for particular services;milestone payments; license or commercialization fees; and royalties or profitsharing from the commercialization of products.

 

Significantelements of our revenue are summarized as follows:

 
| ** **                                       | ** ** | **Three Months Ended  September 30****,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                                 | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                       | ** ** | **(In thousands)**                                  | ** ** |
| Genomic services                                 |       | $                                                        | 4,034      |                                                | $          | 1,793 |   | $ | 14,030 |   | $ | 3,879 |   |
| Research funding and other service fees          |       | 3,703                                                    |       | 4,148                                               |       | 12,933 |   | 11,474 |   |
| Government research contracts and grant  funding |       | 3,717                                                    |       | 3,510                                               |       | 13,245 |   | 9,194 |   |
| Milestone payments and other                     |       | 524                                                      |       | 1,441                                               |       | 1,774 |   | 2,513 |   |
| Total revenue                                    |       | $                                                        | 11,978     |                                                | $          | 10,892 |   | $ | 41,982 |   | $ | 27,060 |   |

 

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Increasesin our revenue for the three and nine-month periods ended September 30,2008 as compared to the same periods in 2007 are largely on account of thegrowth of our genomics business, principally our genotyping and otherscientific services and also an increased amount of discovery and developmentwork performed under ongoing contracts and grants with the NIH and EC includingnew grants.

 

Wehad $17.7 million in deferred revenue at September 30, 2008, compared to$15.4 million at December 31, 2007. Of this deferred revenue, $6.2million relates to our agreement with Merck to conduct information-richclinical trials in Iceland and, to date, Merck has not selected any compoundsfor development under the agreement. We expect that our revenues will fluctuatefrom period to period and that such fluctuations may be substantial especiallybecause progress in our scientific work, including milestone payments that arerelated to progress, can fluctuate between periods.

* *

*Government Research 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. NIHgrants generally provide for 100% reimbursement of allowable expenditures whilegrants under the EC generally provides for fifty percent reimbursement ofallowable research and development related expenditures. Our most significantresearch contract is with the National Institutes of Allergy and InfectiousDiseases (NIAID) dating to September 2004, where we were awarded afive-year $23.9 million contract by the NIAID. Under the contract, we areapplying our population approach and resources to discover genetic factorsassociated with susceptibility to certain infectious diseases and withresponsiveness to vaccines targeting such diseases. We may receive $5.7 millionin additional research funding over the remaining term of the agreement.

 

***Cost of Revenue***

 
| ** **      | ** ** | **Three Months**                       | ** ** | **Nine Months**              | ** ** | **2008 as Compared to 2007** | ** ** |
|-----------------|------------|---------------------------------------------|------------|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **      | ** ** | **Ended September 30,**           | ** ** | **Ended September 30,** | ** ** | **Three Months**                            | ** ** | **Nine Months** | ** ** |
| ** **      | ** ** | **2008**                                    | ** ** | **2007**                          | ** ** | **2008**                                         | ** ** | **2007** | ** ** | **$ Change** | ** ** | **% Change** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **      | ** ** | **(In thousands, except %)** | ** ** |
| Cost of revenue |       | $                                           | 10,992     |                              | $          | 11,976                                           |       | $ | 39,138 |   | $ | 32,050 |   | $ | (984 | ) | (8 | )% | $ | 7,088 |   | 22 | % |
|                 |            |                                             |            |                                   |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Ourcost of revenue 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 withprograms that have been partnered and on which we receive research funding; (ii) costsassociated with other service fee revenues; and (iii) the total amount ofthose costs incurred in connection with discovery and development workperformed under research contracts and grants. At times, we invest in additionto costs covered by research funding received in such collaborative programsand in addition to monies received under research contracts and grants.

 

Significantelements of our revenue and cost of revenue are summarized as follows:

 
| ** **                                             | ** ** | **Three Months Ended September 30,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                                 | ** ** | **2007** | ** ** |
| ** **                                             | ** ** | **Revenue**                                              | ** ** | **Cost of  Revenue** | ** ** | **Net** | ** ** | **Revenue** | ** ** | **Cost of  Revenue** | ** ** | **Net** | ** ** |
| ** **                                             | ** ** | **(In thousands)**                                  | ** ** |
| Genomic services, research funding and  other services |       | $                                                        | 8,261      |   | $ | 6,385 |   | $ | 1,876 |   | $ | 7,382 |   | $ | 7,716 |   | $ | (334 | ) |
| Government research contracts and grant  funding       |       | 3,717                                                    |       | 4,607 |   | (890 | ) | 3,510 |   | 4,260 |   | (750 | ) |
| Total                                                  |       | $                                                        | 11,978     |   | $ | 10,992 |   | $ | 986 |   | $ | 10,892 |   | $ | 11,976 |   | $ | (1,084 | ) |

 
| ** **                                             | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| ** **                                             | ** ** | **Revenue**                                             | ** ** | **Cost of  Revenue** | ** ** | **Net** | ** ** | **Revenue** | ** ** | **Cost of  Revenue** | ** ** | **Net** | ** ** |
| ** **                                             | ** ** | **(In thousands)**                                 | ** ** |
| Genomic services, research funding and  other services |       | $                                                       | 28,737     |   | $ | 22,244 |   | $ | 6,493 |   | $ | 17,866 |   | $ | 18,856 |   | $ | (990 | ) |
| Government research contracts and grant  funding       |       | 13,245                                                  |       | 16,894 |   | (3,649 | ) | 9,194 |   | 13,194 |   | (4,000 | ) |
| Total                                                  |       | $                                                       | 41,982     |   | $ | 39,138 |   | $ | 2,844 |   | $ | 27,060 |   | $ | 32,050 |   | $ | (4,990 | ) |

 

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Generallyour costs of revenue have been increasing due to (i) the growth of ourgenomics business, principally the growth of scientific services, (ii) servicesprovided by our chemistry and structural biology units, and also (iii) anincreased amount of discovery and development work performed under ongoingcontracts and grants with the NIH and EC including new grants. The decrease inour cost of revenue for the three-month period ended September 30, 2008 ascompared to the same period in 2007 is largely on account of the completion ofour work under a collaboration agreement with F. Hoffmann-La Roche (Roche) in2007 that did not occur in 2008. Our cost of revenue in the three-month periodended September 30, 2008 as compared to the same period in 2007 decreasedchiefly with regard to an increase of our usage of chemicals and consumables($1.2 million) offset by decreased salaries and employee compensation ($1.8 million)and contractor services and other overhead costs ($0.4 million). Our cost ofrevenue in the nine-month period ended September 30, 2008 as compared tothe same period in 2007 increased chiefly with regard to an increase of ourusage of chemicals and consumables ($8.6 million) and contractor and otheroverhead costs ($0.3 million), offset by decreased salaries and employeecompensation ($1.8 million). During the three and nine-month periods ended September 30,2007 we performed work ($1.0 million and $3.9 million, respectively) under acollaboration agreement with F. Hoffmann-La Roche (Roche) and recognized revenue of $0.5 million and$1.5 million, respectively under that agreement.

 

***Research and Development***

 
| ** **               | ** ** | **Three Months**                       | ** ** | **Nine Months**              | ** ** | **2008 as Compared to 2007** | ** ** |
|--------------------------|------------|---------------------------------------------|------------|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **               | ** ** | **Ended September 30,**           | ** ** | **Ended September 30,** | ** ** | **Three Months**                            | ** ** | **Nine Months** | ** ** |
| ** **               | ** ** | **2008**                                    | ** ** | **2007**                          | ** ** | **2008**                                         | ** ** | **2007** | ** ** | **$ Change** | ** ** | **% Change** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **(In thousands, except %)** | ** ** |
| Research and development |       | $                                           | 5,652      |                              | $          | 14,069                                           |       | $ | 26,269 |   | $ | 41,273 |   | $ | (8,417 | ) | (60 | )% | $ | (15,004 | ) | (36 | )% |
|                          |            |                                             |            |                                   |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Ourresearch and development expense consist of the following:

 
| ** **                                       | ** ** | **Three Months Ended  September 30****,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                                 | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                       | ** ** | **(In thousands)**                                  | ** ** |
| Salaries and other personnel costs               |       | $                                                        | 2,027      |                                                | $          | 4,576 |   | $ | 10,781 |   | $ | 14,379 |   |
| Materials and supplies                           |       | 858                                                      |       | 2,961                                               |       | 4,882 |   | 9,191 |   |
| Contractor services and other third party  costs |       | 1,293                                                    |       | 4,083                                               |       | 4,701 |   | 10,132 |   |
| Overhead expenses                                |       | 679                                                      |       | 1,420                                               |       | 3,025 |   | 4,247 |   |
| Depreciation and amortization                    |       | 560                                                      |       | 586                                                 |       | 1,963 |   | 1,934 |   |
| Stock-based compensation                         |       | 235                                                      |       | 443                                                 |       | 917 |   | 1,390 |   |
| Total                                            |       | $                                                        | 5,652      |                                                | $          | 14,069 |   | $ | 26,269 |   | $ | 41,273 |   |

 

Ourresearch and development expense for the third quarter of 2008 and year to datereflects the advancement of our drug and diagnostic programs, including costsrelated to the development and launch of our latest DNA-based diagnostic testsfor gauging individual risk of a growing number of common diseases and ongoinggene discovery work that is feeding our diagnostic pipeline and deCODEmeservice. We also continue to pursue our PDE4 modulator program across severalindications and filed an IND for DG071 in October 2008. With near-termvalue creation in mind, our core focus in 2008 has been towards building ourdiagnostics and deCODEme businesses and our genomic services broadly. At thesame time, we aim to advance our therapeutics programs through partnerships.With this focus, we believe that our overall investment in research anddevelopment for the fiscal year 2008 may be in the range of $30 to $35 million.

 

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

 
| ** **                          | ** ** | **Three Months**                       | ** ** | **Nine Months**              | ** ** | **2008 as Compared to 2007** | ** ** |
|-------------------------------------|------------|---------------------------------------------|------------|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **                          | ** ** | **Ended September 30,**           | ** ** | **Ended September 30,** | ** ** | **Three Months**                            | ** ** | **Nine Months** | ** ** |
| ** **                          | ** ** | **2008**                                    | ** ** | **2007**                          | ** ** | **2008**                                         | ** ** | **2007** | ** ** | **$** | ** Change** | ** ** | **% Change** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                          | ** ** | **(In thousands, except %)** | ** ** |
| Selling, general and administrative |       | $                                           | 6,661      |                              | $          | 7,070                                            |       | $ | 21,018 |   | $ | 19,395 |   | $ | (409 | ) | (6 | )% | $ | 1,623 |   | 8 | % |
|                                     |            |                                             |            |                                   |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thedecrease in our selling, general and administrative expenses for thethree-months ended September 30, 2008 compared to the same period ended September 30,2007 is primarily attributable to increased selling expenses and othercontractor services related to our diagnostic and deCODEme offerings ($0.9million) offset chiefly by lower salary and stock-based compensation expense($1.0 million) and decreased legal and other contractor services ($0.3million). The increase for the nine-month period ended September 30, 2008

 

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compared to the same periodin 2007 is primarily attributable to increased selling expenses and othercontractor services related to our diagnostic and deCODEme offerings ($3.7million) offset chiefly by lower salary and stock-based compensation expense($2.2 million).

 

***Interest Income***

 
| ** **      | ** ** | **Three Months**                       | ** ** | **Nine Months**              | ** ** | **2008 as Compared to 2007** | ** ** |
|-----------------|------------|---------------------------------------------|------------|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **      | ** ** | **Ended September 30,**           | ** ** | **Ended September 30,** | ** ** | **Three Months**                            | ** ** | **Nine Months** | ** ** |
| ** **      | ** ** | **2008**                                    | ** ** | **2007**                          | ** ** | **2008**                                         | ** ** | **2007** | ** ** | **$ Change** | ** ** | **% Change** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **      | ** ** | **(In thousands, except %)** | ** ** |
| Interest income |       | $                                           | 500        |                              | $          | 1,646                                            |       | $ | 1,989 |   | $ | 5,155 |   | $ | (1,146 | ) | (70 | )% | $ | (3,166 | ) | (61 | )% |
|                 |            |                                             |            |                                   |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Ourinterest income is a function of both the balance of our cash and investments(which have been declining as resources are deployed in operations) and therate of return we are able to garner under our investment policy (which averagerate of return has also been declining of late with prevailing marketconditions). We expect to use our cash and investments principally foradvancing our molecular diagnostic business and discovery and developmentprograms. In the meantime, we will invest the monies received in accordancewith our investment policy, having the objective of preserving principal and maintaininga high degree of liquidity to meet operating needs and obtaining competitivereturns subject to prevailing market conditions.

 

***Interest Expense***

 
| ** **       | ** ** | **Three Months**                       | ** ** | **Nine Months**              | ** ** | **2008 as Compared to 2007** | ** ** |
|------------------|------------|---------------------------------------------|------------|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **       | ** ** | **Ended September 30,**           | ** ** | **Ended September 30,** | ** ** | **Three Months**                            | ** ** | **Nine Months** | ** ** |
| ** **       | ** ** | **2008**                                    | ** ** | **2007**                          | ** ** | **2008**                                         | ** ** | **2007** | ** ** | **$ Change** | ** ** | **% Change** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **       | ** ** | **(In thousands, except %)** | ** ** |
| Interest expense |       | $                                           | 4,187      |                              | $          | 4,019                                            |       | $ | 12,332 |   | $ | 11,488 |   | $ | 168 |   | 4 | % | $ | 844 |   | 7 | % |
|                  |            |                                             |            |                                   |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Ourinterest expense is primarily attributable to interest on our 3.5% SeniorConvertible Notes due in 2011 for which our cash interest payments areapproximately $8.1 million on an annual basis. Taking into account also theaccretion of the discount of the notes and the amortization of offering costs, ourtotal interest expense related to the Senior Convertible Notes is expected tobe approximately $14.6 million for the year ending December 31, 2008. The September 2007sale and leaseback of our Woodridge property is being accounted for as afinancing and, as such, a portion of our rent payments are charged to interestexpense ($0.4 million and $1.1. million during the three and nine months ended September 30,2008, respectively) and is primarily responsible for the increase in ourinterest expense for the three and nine-month periods ended September 30,2008 versus the same periods in 2007.

 

In order to provide more time for the completionof our strategic business review and the execution of alternatives includingthe sale of assets, we elected to utilize a 30-day grace period for thescheduled October 15 interest payment ($4.0 million) on our outstanding3.5% Senior Convertible Notes due 2011. Failure to pay an installment paymenton the interest within 30 days of the due date would constitute an event ofdefault. If an event ofdefault occurs with respect to the installment payment on the interest and iscontinuing, the trustee or the holders of at least 25% in aggregate principalamount of the Notes then outstanding may declare the Notes due and payable attheir principal amount together with accrued interest.

 

**Othernon-operating income and (expense), net**

 
| ** **                                     | ** ** | **Three Months**                       | ** ** | **Nine Months**              | ** ** | **2008 as Compared to 2007** | ** ** |
|------------------------------------------------|------------|---------------------------------------------|------------|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **                                     | ** ** | **Ended September 30,**           | ** ** | **Ended September 30,** | ** ** | **Three Months**                            | ** ** | **Nine Months** | ** ** |
| ** **                                     | ** ** | **2008**                                    | ** ** | **2007**                          | ** ** | **2008**                                         | ** ** | **2007** | ** ** | **$** | ** Change** | ** ** | **% Change** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                     | ** ** | **(In thousands, except %)** | ** ** |
| Other non-operating income and (expense),  net |       | $                                           | (2,886     | )                                 | $          | 348                                              |       | $ | (8,133 | ) | $ | 8,890 |   | $ | (3,234 | ) | (929 | )% | $ | (17,023 | ) | (191 | )% |
|                                                |            |                                             |            |                                   |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Ourother non-operating income and expense, net, during the three and nine-monthperiods ended September 30, 2008 is principally comprised ofother-than-temporary losses on investments in auction rate securities andduring the nine-month period of 2007 is principally comprised of a legalsettlement.

 

Withcontinuing developments in the global credit and capital markets into 2008, werecognized an other-than-temporary loss on investments in auction ratesecurities (“ARS”), classified as non-current investments on our balance sheetat September 30, 2008. The estimated market value of our ARS at September 30,2008 was $18.2 million. Although the ARS continue to pay interest according totheir stated terms, based on the valuation models and an analysis ofother-than-temporary impairment factors, we have recorded an

 

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impairmentcharge of $2.4 million and $6.6 million during the three and nine-months ended September 30,2008, respectively. The credit and capital markets have continued todeteriorate in 2008. If uncertainties in these credit and capital marketscontinue, these markets deteriorate further or we experience additionaldowngrades on our investments, we may incur additional impairments to ourinvestment portfolio, which could negatively affect our financial condition,cash flows and reported earnings.

 

Weentered into a legal settlement in June 2007 to end ongoing litigationregarding certain proprietary and confidential information. Financial terms ofthe legal settlement stipulated that we would be paid $9.0 million which werecognized during the nine-months ended September 30, 2007, net oflitigation expenses incurred of $0.1 million and $0.8 million during the threeand nine-months ended September 30, 2007, respectively.

 

**Liquidityand Capital Resources**

 

AtSeptember 30, 2008, we had liquid funds available for operating activities(cash and cash equivalents together with current investments) of $11.8 millionas compared to $23.8 million at June 30, 2008 and $64.2 million at December 31,2007. The net utilization of liquid funds in the three and nine-month periodsended September 30, 2008 was $12.0 million and $52.4 million,respectively. At September 30, 2008, we had $35.5 million of cash, cashequivalents and investments, comprised of $11.8 million of cash and cashequivalents, as well as $5.5 million in restricted investments in U.S. TreasuryBills and $18.2 million in illiquid, non-current investments in auction ratesecurities. At December 31, 2007, we had $94.1 million in cash, cashequivalents, restricted cash equivalents and investments.

 

 *FinancialCondition*.  In 2008 our focusremains within the same broad strategic continuity, emphasizing our corecapabilities in human genetics as well as our integrated capabilities instructural biology and chemistry. We are leveraging those assets to build uponthe commercial opportunities presented by both our drug discovery work anddiagnostics work as well as deCODEme. We have taken steps to slim down elementsof our broad capabilities to focus our remaining resources, and continue toseek efficiencies throughout the organization. In order to bring to marketproducts that can generate revenues in the near term, in 2008, we have focusedour efforts on the development and marketing of our molecular diagnosticproducts and deCODEme, our personal genome analysis service.

 

Atthe same time, we aim to advance our therapeutics programs through partnershipsand then advance our early preclinical programs both through partnerships andresources we may be able to generate through our contract services anddiagnostics programs. In our drug discovery programs we are developingcompounds that address both known targets and new targets we discovered throughour gene discovery program. Our experience in seeking partners for the furtherdevelopment of our programs based on our gene discoveries has led us toconclude that in the current environment compounds that address known, ratherthan newly identified, targets have greater commercial potential in the nearand medium term. Under these circumstances, we expect that our drug developmentprograms increasingly will address targets that do not come out of our genediscovery programs and that our gene discovery programs will be directed towardthe development of diagnostic products.

 

Wecontinue investigating avenues of financing beyond collaborations and licensingarrangements, namely further public or private equity offerings and other formsof financing. We have also carried-on analyzing non-core elements ofoperations. Presently, we are carrying out a review of our long-termbusiness strategy and have engaged professional advisors to assist inevaluating our strategic alternatives and in executing swiftly on the resultsof this review through the identification of buyers and partners for non-corebusiness units, programs and intellectual property. The goal of this strategicreview is to optimize the value of these assets and sharpen the focus of ourbusiness, selling assets, securing strategic partnerships, and utilizing theresources generated to underpin product development and marketing efforts inour core business. We have utilized a 30-day grace period for the scheduled October 15interest payment on our 3.5% Senior Convertible Notes due 2011 and arereviewing methods for making this payment. Given our current liquid assets, and without paying the interest on ourNotes from our present funds, we must obtain further financial resources througheither the implementation of strategic alternatives, corporate partnerships, orthe sale of or loans secured by our auction rate securities in order tocontinue operations beyond the end of this year. We are focused on reducingexpenses and speeding the evaluation of our strategic options to achieve thisgoal.

 

Wehave financed our operations primarily through funding from research anddevelopment collaborative agreements, and the issuance of equity securities andlong-term financing instruments ($1,061 million from the beginning of 1999to-date). At September 30, 2008, future funding under terms of ourexisting agreements is approximately $39.5 million excluding milestonepayments, royalties and other payments that we may earn under suchcollaborations. Of the $39.5 million, approximately $13.6 million is expectedto be received during the year ended December 31, 2008, with the remainingamount due through 2012.

 

Wemake significant investments in proprietary research and development and weincur the costs of such activities. In the near term, this requires us todevote resources to our in-house drug and diagnostic development which webelieve will better position us to capture the most value to us in ourdiscoveries. As we identify promising discoveries for further development, wemay choose to continue the development ourselves into and through clinicaltrials, regulatory approvals, manufacturing, distribution and marketing. Inother cases we are or will be working to varying degrees with partners. The decisionswe make as to these matters will affect our cash requirements.

 

*Icelandic Economic Situation.* deCODE has significant operations in Icelandand pays a large proportion of its fixed costs in

 

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Icelandic Krona (ISK), whileits sales are generally denominated in U.S. dollars and its reporting currencyis the U.S. dollar. Beginning in the third quarter of 2008 and particularly inthe first weeks of the fourth quarter, the effects of the global credit andfinancial crisis hit the Icelandic economy particularly hard. The ISK fell from80.7 ISK to the U.S. dollar on June 30, 2008 to 98.4 ISK to the U.S.dollar on September 30, 2008. In mid-October 2008, the Icelandicparliament passed emergency legislation to minimize the impact of the financialcrisis, resulting in the government takeover of the three largest Icelandicbanks. By the end of October, with significant foreign exchange controls inplace, the official exchange rate was 120.6 ISK to the U.S. dollar. The turmoilin the Icelandic financial sector and economy as a whole have not had asignificant impact on deCODE and have had no material adverse impact on our dayto day operations, except to decrease the dollar value of our ISK-denominatedcosts. deCODE has ISK denominated capital lease obligations ($3.1 million at September 30,2008) and operating lease obligations ($56.4 million at September 30,2008). At September 30, 2008, we had cash and cash equivalents denominatedin ISK of $2.2 million. Our most significant operating expenses denominated inISK include salaries and rental payments on our leased facilities and capitalequipment leases and we expect that in as far as the ISK decreases in valueversus the U.S. dollar our ISK-denominated operating expenses will generallydecrease. Given that the decline in the value of the ISK has been most rapid inthe latter half of 2008, the impact of the decrease in value of the ISK will bemost apparent in year-on-year comparisons of expense for our Icelandicoperations and for our operating costs in general.

 

*Fair Value.*As of September 30, 2008, we have certain assets recorded at fairvalue. In accordance with Statement of Financial Accounting Standards No. 157,*Fair Value Measurement*, or SFAS No. 157,we have classified our financial assets as Level 1, 2 or 3 within the fairvalue hierarchy. Fair values determined by Level 1 inputs utilize quoted prices(unadjusted) in active markets for identical assets or liabilities. Fair valuesdetermined by Level 2 inputs utilize quoted prices for similar assets andliabilities in active markets or inputs that are observable for the asset orliability, either directly or indirectly through market corroboration, forsubstantially the full term of the financial instrument. Fair values determinedby Level 3 inputs utilize unobservable inputs based on assumptions used tomeasure assets and liabilities at fair value. A financial asset or liability’sclassification within the hierarchy is determined based on the lowest levelinput that is significant to the fair value measurement.

 

Asnoted in Note 13, Fair Value Measurement, a majority of our financial assetsconsist of auction rate securities (ARS) and have been classified as Level 3 inthe fair value hierarchy. The non-current investments in ARS held by us areprivate placement securities with long-term nominal maturities for which theinterest rates are reset through a Dutch auction process at pre-determinedcalendar intervals, generally each month. This mechanism generally allowedexisting investors to rollover their holdings and continue to own theirrespective securities or liquidate their holdings by selling their securitiesat par value. We generally invested in these securities for short periods oftime as part of our cash management program. However, the ongoing uncertaintiesin the credit markets have prevented us and other investors from liquidatingholdings of our remaining ARS in recent auctions for these securities becausethe amount of securities submitted for sale has exceeded the amount of purchaseorders and this has resulted in multiple failed auctions. Our non currentinvestments in ARS represent interests in debt obligations, namely lifeinsurance wrapped issues, of companies offering credit derivatives, and ofentities on which monoline insurers retain capital put rights. The remainingARS investments are generally collateralized by pools of commercial paper,investment-grade corporate debt, asset and mortgage-backed securities,government and money-market issues and other ARS. Consistent with ourinvestment policy guidelines, all of the ARS investments were rated asinvestment grade (at least A or better) at the time of purchase and subsequentto year end remain rated as investment grade.

 

OurLevel 3 investments in ARS have a present lack of observable market quotes. Thevaluation models used to value the securities include those that are based onexpected cash flow streams and collateral values, including assessments ofcounterparty credit quality, default risk underlying the security, discountrates and overall capital market liquidity. The valuation of our investments inARS is subject to uncertainties that are difficult to predict. Factors that mayimpact the valuation include changes in credit ratings of the securities ortheir guarantors, underlying collateral value, discounts rates, counterpartyrisk and ongoing strength and quality of market credit and liquidity. Wevalidate the prices provided by our third party pricing service byunderstanding the models used and challenging pricing data in certaininstances.

 

The estimated market valueof our non current investments in ARS at September 30, 2008 was $18.2million. Although the ARS continue to pay interest according to their statedterms, based on the valuation models and an analysis of other-than-temporaryimpairment factors, we have recorded an impairment charge of $6.6 millionduring the nine-months ended September 20, 2008, reflecting the portion ofARS holdings that we have concluded have an other-than-temporary decline invalue and this charge is included in Other non-operating income and (expense),net in our Statements of Operations. This $6.6 million impairment chargedincludes $0.9 million related to ARS for which deCODE had previously determinedto be temporary and accounted for as an unrealized loss at December 31,2007.

 

The credit and capitalmarkets have continued to be volatile in 2008. If uncertainties in these creditand capital markets continue, these markets deteriorate further or weexperience additional downgrades on our investments, we may incur additionalimpairments (unrealized and/or realized) to our investment portfolio, whichcould negatively affect our financial condition, cash flows and reportedearnings. While the current lack of liquidity in the credit and capital marketsis impacting our financial flexibility, we do not believe the conditions willhave a material impact on our cash flows or our ability to fund our operationsduring the fiscal year 2008.

 

Our cash was provided by andused as follows:

 

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| ** **                                  | ** ** | **Nine-Month Periods Ended  September 30,** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                  | ** ** | **2008**                                              | ** ** | **2007** | ** ** |
| ** **                                  | ** ** | **(In thousands)**                               | ** ** |
| **Cash provided by (used in):**             |       |                                                  |       |   |   |
| Operating activities                        |       | $                                                     | (47,526    | ) | $ | (49,613 | ) |
| Investing activities                        |       | 7,816                                                 |       | 55,019 |   |
| Financing activities                        |       | (2,684                                                | )          | 18,551 |   |
| Cash and cash equivalents, at end of period |       | 11,778                                                |       | 45,839 |   |
|                                             |            |                                                       |            |  |  |  |  |

 

*Cash and Cash Equivalents.* At September 30, 2008, we hadliquid funds available for operating activities (cash and cash equivalentstogether with current investments) of $11.8 million as compared to $23.8million at June 30, 2008 and $64.2 million at December 31, 2007. Thenet utilization of liquid funds in the three and nine-month periods ended September 30,2008 was $12.0 million and $52.4 million, respectively. At September 30,2008, we had $35.5 million of cash, cash equivalents and investments, comprisedof $11.8 million of cash and cash equivalents, as well as $5.5 million inrestricted investments in U.S. Treasury Bills and $18.2 million in illiquid,non-current investments in auction rate securities. At December 31, 2007,we had $94.1 million in cash, cash equivalents, restricted cash equivalents andinvestments.

 

Availablecash is invested in accordance with our investment policy having primaryobjectives of liquidity and safety of principal while generating income fromour investments without significantly increasing risk. Our cash is depositedonly with financial institutions in the United States and Iceland having acredit standing of A-/A3 or better. We expect to maintain our portfolio of cashequivalents and current investments in accordance with our policy, having theobjective of preserving principal and maintaining a high degree of liquidity tomeet operating needs and obtaining returns subject to prevailing marketconditions. At September 30, 2008, our cash and cash equivalents areprimarily in U.S. Treasury Bills and money market funds and our non-currentinvestments are in auction rate securities. At present, we expect to maintainour portfolio of cash equivalents and current investments in government debtsecurities and money market funds, and to liquidate our remaining holdings ofnon-current investments in auction rate securities if and when auctions on thembegin to clear or when secondary markets for the auction rate securities beginto present themselves. At September 30, 2008, our cash and cashequivalents are largely invested in U.S. dollar denominated U.S. TreasuryBills, money market and checking accounts and also in Icelandic kronadenominated accounts.

 

*Operating Activities.* Net cash used in operating activitiesincreased to $47.5 million for the nine-months ended September 30, 2008 ascompared to $49.6 million for the nine-months ended September 30, 2007,the difference is principally due to working capital changes. Cash used inour operations is principally owing to cash used in diagnostic and therapeuticproduct development, research and general operations as more fully describedabove.

 

*Investing Activities.*Our investing activities have consisted ofcapital expenditures and the sale of investments in marketable securities.Capital expenditures have been principally replacement capital expendituresduring the nine-months ended September 30, 2008 and 2007, and weanticipate making only necessary replacement capital expenditures in the nearterm. Net cash used in investing activities may in the future fluctuatesignificantly from period to period due to timing of our capital expendituresand other investments as well as changing business needs.

 

*Financing Activities.* Net cash of $2.7 million was used infinancing activities during the nine-months ended September 30, 2008, ascompared to $18.6 million that was provided during the nine-months ended September 30,2007. Financing activities for the nine-month periods ended September 30,2008 consisted primarily of ongoing repayment of and installment payments ondebt, capital lease and finance obligations. Our most significantfinancing activity for the nine-month period ended September 30, 2007 wasthe sale and leaseback of our property in Woodridge, Illinois (netting us $18.4million after the payment of transaction costs and the repayment of ourexisting property mortgage).

 

*Contractual Commitments and Off-Balance Sheet Arrangements.*  Thefollowing summarizes our contractual obligations at September 30, 2008 andthe effects such obligations are expected to have on our liquidity and cashflows in future periods:

 
| ** **                                         | ** ** | ** **              | ** ** | **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 |       | $                       | 254,150    |                                      | $          | 8,050 |   | $ | 8,050 |   | $ | 238,050 |   | $ | — |   | $ | — |   | $ | — |   |
| Long-term debt, including interest                 |       | 417                     |       | 272                                       |       | 145 |   | — |   | — |   | — |   | — |   |
| Capital lease obligations, including  interest     |       | 3,058                   |       | 3,058                                     |       | — |   | — |   | — |   | — |   | — |   |
| Finance obligation, including interests            |       | 38,240                  |       | 2,022                                     |       | 2,072 |   | 2,124 |   | 2,177 |   | 2,232 |   | 27,613 |   |
| Operating leases (1)                               |       | 57,457                  |       | 5,307                                     |       | 5,136 |   | 5,080 |   | 5,080 |   | 4,938 |   | 31,916 |   |
| Total                                              |       | $                       | 353,322    |                                      | $          | 18,709 |   | $ | 15,403 |   | $ | 245,254 |   | $ | 7,257 |   | $ | 7,170 |   | $ | 59,529 |   |

 

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(1) Balanceincludes $56.4 million of Icelandic krona (ISK) denominated lease obligationswhich are variable based on the exchange rate of the ISK versus the U.S. dollarand also this amount is subject to periodic adjustments based on the IcelandicConsumer Price Index (ICPI). A hypothetical 10% increase or decrease in the ISKand U.S. dollar exchange rate would result in an increase or decrease of ourannual lease payments of $0.5 million. A hypothetical 100 basis point increaseof the ICPI would result in an increase or decrease of our annual leasepayments of $0.1 million.

 

Under the terms of certaintechnology licensing agreements, deCODE is obligated to make payments upon theachievement of established milestones leading to the discovery of definedproducts. These payments could total $5.0 million, with the timing of paymentsnot determinable at the current time. These potential payments are not includedin the above table.

 

In November 2007,deCODE adopted a Change In Control Benefits Plan that provides for, among otherthings, upon a change in control, all outstanding stock options, restrictedstock and stock appreciation rights, and any similar awards under any equitycompensation plan of deCODE, shall vest, become immediately exercisable orpayable and have all restrictions lifted. In the event of a change in control,the Plan also requires deCODE to make a lump sum payment to the CEO andexecutive officers based on their most recent salary and bonus history. Also,the Plan requires other benefits to be paid, to include life, disability,accident and health insurance for these employees for a period of 24 to 36months depending on employment. deCODE believes that it is unlikely that thesecircumstances will transpire, as such no charge has been recognized in itsStatements of Operations. Further, these potential payments are not included inthe above table. As of September 30, 2008, the potential minimum lump sumpayment (salary and bonus amounts only) under these change in controlprovisions would have totaled approximately $6.5 million (calculated as of September 20,2008).

 

Allmaterial intercompany balances and transactions have been eliminated. We do nothave any other significant relationships with unconsolidated entities orfinancial partnerships, such as entities often referred to as structuredfinance or special purpose entities, which would have been established for thepurpose of facilitating off-balance sheet arrangements or other contractuallynarrow or limited purposes. As such, we are not exposed to any financing,liquidity, market or credit risk that could arise if we had engaged in suchrelationships. Additionally, holders of our 3.5% senior convertible notes mayelect to convert their notes into shares of our common stock at any time at aprice of $14.00 per share.

 

**CriticalAccounting Policies**

** **

 Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires us to make certain estimates and assumptionsthat affect the reported amounts of assets and liabilities, the disclosure ofcontingent assets and liabilities at the date of the financial statements, andthe reported 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 making judgmentsabout carrying values of assets and liabilities that are not readily apparentfrom other sources. The impact and any associated risks related to these andour other accounting policies on our business or operations is discussedthroughout Management’s Discussion and Analysis of Financial Condition andResults of Operations where such policies affect our reported and expectedfinancial results. For a detailed discussion on the application of these andother 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 on Form 10-K.There can be no assurance that actual results may not differ from the estimatesreferred to above.

 

**FORWARD-LOOKING STATEMENTS AND CAUTIONARY FACTORS**

**THAT MAY AFFECT FUTURE RESULTS**

** **

This Quarterly Report on Form 10-Qcontains forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934. These statements relate to future events or our futurefinancial performance. In some cases, forward-looking statements can beidentified by terminology such as “may,” “should,” “could,” “expect,” “plan,” “anticipate,”“believe,” “estimate,” “predict,” “intend,” “potential” or “continue” or thenegative of such terms or other comparable terminology. These statements areonly expectations. We cannot assure you that our expectations and assumptionswill prove to be correct. We do not intend to update or revise anyforward-looking statements, whether as a result of future events, newinformation or otherwise, except to the extent that the reports we are requiredto file under the Securities Exchange Act of 1934, as amended, (the “ExchangeAct”) contain such updates or revisions. Actual events or results may differmaterially from the forward- looking statements due to a number of factors,including. but not limited to, those set forth in Item 1A of our AnnualReport on Form 10-K for the year ended December 31, 2007 as updatedby Item 1A of Part II of this Quarterly Report on Form 10-Q andelsewhere in this Quarterly Report on Form 10-Q and in the reports we fileunder the Exchange Act.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK**

** **

The primary objectives ofour investment activities are to preserve principal, maintain a high degree ofliquidity to meet operating

 

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needs, and obtaincompetitive returns subject to prevailing market conditions. At September 30,2008, our cash and cash equivalents are in U.S. Treasury Bills and money marketfunds, our current investments are in U.S. Treasury Bills and our non-currentinvestments are in auction rate securities. At present, we expect to maintainour portfolio of cash equivalents and current investments in government debtsecurities and money market funds, and to liquidate our remaining holdings ofnon-current investments in auction rate securities if and when auctions on thembegin to clear or when secondary markets for the auction rate securities beginto present themselves. At September 30, 2008, our cash and cash equivalentsare largely invested in U.S. dollar denominated U.S. Treasury Bills, moneymarket and checking accounts and also in Icelandic krona denominated accounts.Our investments are subject to risk of default, changes in credit rating andchanges in market value. These investments are also subject to interest raterisk and will decrease in value if market interest rates increase. Ahypothetical 100 basis point increase in interest rates would result in anapproximate $0.1 million decrease in the fair value of our investments asof September 30, 2008. Changes in interest rates do not affect interestexpense incurred on deCODE’s Convertible Notes, because they bear interest at afixed rate. Using the price in the latest trade in September 2008, themarket value of the Convertible Notes was approximately $73.8 million on September 30,2008.

 

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 gain of approximately $0.2 million on our Icelandic krona denominated nonU.S. dollar assets and liabilities. We have historically purchased instrumentsto hedge these general risks through the use of derivative financialinstruments.

 

**ITEM 4. CONTROLS AND PROCEDURES**

** **

a)*Evaluation of disclosure controls and procedures.* Our ChiefExecutive Officer and our Chief Financial Officer evaluated the effectivenessof our disclosure controls and procedures (as defined in Rule 13a-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of theend of the fiscal quarter covered by this Quarterly Report on Form 10-Q.Based upon that evaluation, the Chief Executive Officer and the Chief FinancialOfficer have concluded that as of the end of such fiscal quarter deCODE’sdisclosure controls and procedures are adequate and effective to ensure thatinformation required to be disclosed in the reports deCODE files under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the Securities and Exchange Commission’s rules andforms. Disclosure controls and procedures include without limitation, controlsand procedures designed to ensure that information required to be disclosed byan issuer in the reports that it files or submits under the Act is accumulatedand communicated to the issuer’s management including its principal executiveand principal financial officers or persons performing similar functions asappropriate to allow timely decisions regarding required disclosures.

 

In designing and evaluatingour disclosure controls and procedures, our management recognizes that anycontrols and procedures, no matter how well designed and operated, can provideonly reasonable assurance that the desired objectives of the control systemwill be met. In addition, the design of any control system is based in partupon certain assumptions about the likelihood of future events and theapplication of judgment in evaluating the cost-benefit relationship of possiblecontrols and procedures. Because of these and other inherent limitations ofcontrol systems, there is only reasonable assurance that our controls willsucceed in achieving their goals under all potential future conditions.

 

b) *Changes in Internal Controls.* We arecontinuously seeking to improve the efficiency and effectiveness of ourinternal controls. This results in periodic refinements to internal controlprocesses throughout the company. However, there was no change in our internalcontrol over financial reporting (as defined in Rule 13a-15(f) underthe Exchange Act) during the fiscal quarter covered by this Quarterly Report onForm 10-Q that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

**PART II OTHER INFORMATION**

** **

**ITEM 1. LEGAL PROCEEDINGS**

** **

Otherthan claims and legal proceedings that arise from time to time in the ordinarycourse of business which are not material, and matters described below, therehas been no change in the matters reported in our Annual Report on Form 10-Kfor the year ended December 31, 2007.

 

Inthe matter of In re deCODE genetics, Inc. Initial Public Offering, whichis described in deCODE’s Annual Report on Form 10-K for the year ended December 31,2007, on June 25, 2007, the United States District Court for the SouthernDistrict of New York entered an order formally denying the motion for finalapproval of the settlement agreement because the settlement class could not becertified. On August 14, 2007, the plaintiffs filed their second consolidatedamended class action complaints against the “focus cases” and on September 27,2007, again moved for class certification, seeking certification of threeseparate classes. The focus cases are a small group of cases that were selectedas test cases due to the large number of nearly identical actions which wereconsolidated in the Initial Public Offering litigation. The court has indicatedthat the focus cases are intended to provide strong guidance for the othercases. The case involving deCODE is not a focus case. On November 12,2007, certain of the defendants in the focus cases moved to dismiss the secondconsolidated amended class action complaints. On March 26, 2008, thedistrict court denied the motions to dismiss except as to Section 11claims raised by those plaintiffs who sold their securities for a price inexcess of the initial public offering price and those who purchased outside thepreviously certified class period. Briefing on the class certification motionwas completed

 

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in May 2008. Thatmotion was withdrawn without prejudice on October 10, 2008. On December 28,2007, the underwriter defendants moved to strike class allegations in 26 casesin which the Plaintiffs failed to identify proposed class representatives, andthe issuer defendants joined in the motion. On May 13, 2008, the DistrictCourt granted the motion in part in eight of the 26 cases, striking the classallegations as to one of the three classes because the proposed classrepresentatives were not a member of the proposed classes. The case againstdeCODE is one of these eight cases. Due to the inherent uncertainties oflitigation, deCODE cannot accurately predict the ultimate outcome of thematter.

 

**ITEM 1A. RISK FACTORS**

** **

Other than with respect tothe risk factors set forth below, there have been no material changes from therisk factors disclosed in Item 1A of our Annual Report on Form 10-K forthe year ended December 31, 2007. The risk factors set forth below havebeen updated to provide data for and as of the quarter ended September 30,2008.

 

***If we are not able to obtain sufficient additional funding to meet ourcapital requirements, we may be forced to reduce or terminate our researchand product development programs.***

 

Wehave spent 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; and to continue other research and development activities. Manyfactors 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 our discoveriesand the resources we devote to commercialization;

 

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

 

·             the costs and timing of regulatory approvals.

 

Wehave relied 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.

 

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.

 

Ifwe raise 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.

 

We are carrying out a review of our long-termbusiness strategy and have engaged professional advisors to assist inevaluating our strategic alternatives and in executing swiftly on the resultsof this review through the identification of buyers and partners for non-corebusiness units, programs and intellectual property. The goal of this strategicreview is to optimize the value of these assets and sharpening the focus ofdeCODE’s business, selling non-core assets, securing strategic partnerships,and utilizing the resources generated to underpin product development andmarketing efforts in our core business. We have utilized a 30-day grace periodfor the scheduled October 15 interest payment on our 3.5% SeniorConvertible Notes due 2011 and are reviewing methods for making this payment. Given our current liquid assets, and withoutpaying the interest on our Notes from our present funds, we must obtain furtherfinancial resources through either the implementation of strategicalternatives, corporate partnerships, or the sale of or loans secured by ourauction rate securities in order to continue operations beyond the end of thisyear. We are focused on reducing expenses and speeding the evaluation of ourstrategic options to achieve this goal.

 

***If we continue to incur operating losses longer than anticipated, or inamounts greater than anticipated, we may be unable to continue ouroperations.***

 

Weincurred a net loss of $62.9 million and $63.1 million for the nine-monthsended September 30, 2008 and 2007, respectively, and $95.5 millionfor the year ended December 31, 2007, and had an accumulated deficit of$694.1 million at September 30, 2008. We have never generated a profit andwe have not generated significant revenues except for payments received inconnection with our research and development collaborations with Roche, Merckand others, from contract services, Emerald BioSystems products and

 

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instruments, and undergrants. Our research and development expenditures and general andadministrative costs have exceeded our revenue to date, and we expect to spendsignificant additional amounts to develop our diagnostics and deCODEmeTMproducts and services, fund research and development in order to enhance ourcore technologies and undertake product development (including drug developmentand related clinical trials). We do not expect to receive royalties or otherrevenues from commercial sales of products developed using our technology inthe near term. It may be several years before product revenuesmaterialize, if they do at all. As a result, we expect to incur net losses forseveral years. If the time required to generate product revenues and achieveprofitability is longer than we currently anticipate or the level of losses isgreater than we currently anticipate, we may not be able to continue ouroperations.

 

***We may be adversely impacted by economic factors beyond our control andmay incur additional impairment charges to our investment portfolio***

 

As of September 30, 2008,we had $33.5 million of principal invested in auction rate securities (“ARS”),all of which are classified as non-current investments on our balance sheet.These investments represent interests in debt obligations, namely lifeinsurance wrapped issues, of companies offering credit derivatives, and ofentities on which monoline insurers retain capital put rights. The remainingARS investments are generally collateralized by pools of commercial paper,investment-grade corporate debt, asset and mortgage-backed securities,government and money-market issues and other ARS. Consistent with ourinvestment policy guidelines, all of the ARS investments were rated asinvestment grade (at least A or better) at the time of purchase and subsequentto year end remain rated as investment grade. The estimated market value of ournon-current ARS holdings at September 30, 2008 was $18.2 million, whichreflects a $15.3 million adjustment to the principal value of $33.5 million.Although the ARS continue to pay interest according to their stated terms,based on valuation models and an analysis of other-than-temporary impairmentfactors, we have recorded a further impairment charge of $6.6 million in thenine months ended September 30, 2008, which includes $0.9 million relatedto ARS impairments previously recorded as a temporary or unrealized loss at December 31,2007.

 

The credit and capitalmarkets have continued to be volatile in 2008. If uncertainties in these creditand capital markets continue, these markets deteriorate further or weexperience additional downgrades on our investments, we may incur additionalimpairments, realized or unrealized, to our investment portfolio, which couldnegatively affect our financial condition, cash flows and reported earnings.While the current lack of liquidity in the credit and capital markets isimpacting our financial flexibility, we do not believe the conditions will havea material impact on our cash flows or our ability to fund our operationsduring the fiscal year 2008, however if the situation does not improve it willhave significant impact on our operations during fiscal year 2009.

 

***We may be at risk of our Common Stock being de-listed from Nasdaq***

*** ***

On October 31, 2008,deCODE received a Staff Determination Letter from The Nasdaq Stock Market LLCindicating that deCODE had not regained compliance with Nasdaq Marketplace Rule 4450(b)(1)(A),which requires a minimum market value of listed securities of $50 million,during the time period provided by Nasdaq in a previous notice and thereforeits common stock is subject to delisting from The Nasdaq Global Market at theopening of business on November 11, 2008. deCODE has requested a hearing before a NasdaqListing Qualifications Panel, which is scheduled for December 18, 2008.deCODE’s common stock will continue to be listed on The Nasdaq Global Marketpending the conclusion of the hearing process and during any extension periodwhich may be granted by the Panel. The Panel has discretion to grant anextension not to exceed 180 days from the date of the Staff notification fordeCODE to regain compliance with applicable listing standards. There can be noassurance that the Panel will grant deCODE’s request for continued listing.

 

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**ITEM 6. EXHIBITS**

 

The following is a list ofexhibits 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         |       | Certificate of Amendment  to Amended and Restated Certificate of Incorporation dated May 11, 2007  (Incorporated by reference to Exhibit 3.3 to the Company’s Quarterly  Report on Form 10-Q filed August 9, 2007).                                                 |
|        |       |                                                                                                                                                                                                                                                                                         |
| 3.4         |       | 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).                                                                          |
|        |       |                                                                                                                                                                                                                                                                                         |
| 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.                                                                                                                                                                                                               |

 

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*       Constitutes a management contract orcompensatory plan or arrangement.

 

Note: Unless otherwisenoted, the SEC File number of each of the above referenced documents is000-30469.

 

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**SIGNATURES**

 

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

 

Dated:  November 10,2008

 
|   |   | deCODE genetics, Inc.            |                |
|--------|--------|---------------------------------------|---------------------|
|   |   |                                  |                |
|   |   |                                  |                |
|   |   |                                  | /s/ Kari Stefansson |   |
|   |   | Kari Stefansson                       |                |
|   |   | Chairman, President,                  |                |
|   |   | and Chief Executive Officer           |                |
|   |   |                                  |                |
|   |   |                                  |                |
|   |   |                                  | /s/ Lance Thibault  |   |
|   |   | Lance Thibault                        |                |
|   |   | Chief Financial Officer and Treasurer |                |

 

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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         |       | Certificate of Amendment  to Amended and Restated Certificate of Incorporation dated May 11, 2007  (Incorporated by reference to Exhibit 3.3 to the Company’s Quarterly  Report on Form 10-Q filed August 9, 2007).                                                 |
|        |       |                                                                                                                                                                                                                                                                                         |
| 3.4         |       | 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).                                                                          |
|        |       |                                                                                                                                                                                                                                                                                         |
| 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.                                                                                                                                                                                                               |

 

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*       Constitutes a management contract orcompensatory plan or arrangement.

 

Note: Unless otherwisenoted, the SEC File number of each of the above referenced documents is000-30469.

 

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