**SECURITIESAND EXCHANGE COMMISSION**

 

**WASHINGTON, D.C. 20549**

 

**FORM10-Q**

 

**(Mark One)**

 

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES**

**EXCHANGE ACT OF 1934.**

 

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003**

 

**OR**

 

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES**

**EXCHANGE ACT OF 1934**

 

**FOR THE TRANSITION PERIOD FROM           TO          **

 

**COMMISSION FILE NUMBER 000-30469**

 

**deCODEgenetics, Inc.**

(ExactName of Registrant as Specified in Its Charter)

 

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

 

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

(Addressof Principal Executive Offices, Zip Code)

 

**+354-570-1900**

(Registrant’sTelephone Number, Including Area Code)

 

Indicate by check whetherthe registrant: (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.Yes  ý No  o

 

Indicate by check whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act). Yes  ýNo  o

 

The aggregate number ofshares of the registrant’s common stock outstanding on October 26, 2003 was53,951,831 shares of common stock $.001 par value.

 

 

----

 

**deCODE genetics, Inc.**

** **

**INDEX**

 
| PART I.            | FINANCIAL INFORMATION                                                                                                    |
|--------------------|--------------------------------------------------------------------------------------------------------------------------|
|               |                                                                                                                     |
| Item 1.            | Financial Statements  (unaudited)                                                                                        |
|               |                                                                                                                     |
|               | Condensed  Consolidated Statements of Operations for the three and nine-month periods  ended September 30, 2003 and 2002 |
|               |                                                                                                                     |
|               | Condensed  Consolidated Balance Sheets as of September 30, 2003 and December 31, 2002                                    |
|               |                                                                                                                     |
|               | Condensed  Consolidated Statements of Cash Flows for the nine-month periods ended  September 30, 2003 and 2002           |
|               |                                                                                                                     |
|               | 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 5.            | Other Information                                                                                                        |
|               |                                                                                                                     |
|               | Risk factors                                                                                                             |
|               |                                                                                                                     |
| Item 6.            | Exhibits and  Reports on Form 8-K                                                                                        |
|               |                                                                                                                     |
|               | (a) Exhibits                                                                                                             |
|               |                                                                                                                     |
|               | (b)  Reports on Form 8-K                                                                                                 |
|               |                                                                                                                     |
| Signatures         |
|               |                                                                                                                     |
| Index  to Exhibits |
|                    |                                                                                                                          |  |

 

----

 

**PART I.FINANCIAL INFORMATION**

** **

**ITEM 1. FINANCIAL STATEMENTS**

 

**deCODE genetics, Inc.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

(inthousands, except share and per share amounts)

unaudited

 
|                                                                 |   | **FOR THE THREE MONTHS  ENDED SEPTEMBER 30,** |   | **FOR THE NINE MONTHS  ENDED SEPTEMBER 30,** |   |
|----------------------------------------------------------------------|--------|-----------------------------------------------|--------|----------------------------------------------|--------|
|                                                                 |   | **2003**                                      |   | **2002**                                     |   | **2003** |   | **2002** |   |
| REVENUE                                                              |   | $                                             | 12,763 |                                         | $      | 8,982 |   | $ | 35,141 |   | $ | 23,682 |   |
|                                                                 |   |                                          |   |                                         |   |   |   |   |   |
| OPERATING EXPENSES                                                   |   |                                          |   |                                         |   |   |   |   |   |
| Research and development, including cost  of revenue                 |   | 11,068                                        |   | 23,856                                       |   | 47,516 |   | 66,634 |   |
| Selling, general and administrative                                  |   | 3,989                                         |   | 5,753                                        |   | 11,975 |   | 14,235 |   |
| Impairment, employee termination costs  and other charges            |   | 115                                           |   | 64,790                                       |   | 906 |   | 64,790 |   |
| Total operating expense                                              |   | 15,172                                        |   | 94,399                                       |   | 60,397 |   | 145,659 |   |
| Operating loss                                                       |   | (2,409                                        | )      | (85,417                                      | )      | (25,256 | ) | (121,977 | ) |
| Interest income                                                      |   | 243                                           |   | 711                                          |   | 897 |   | 2,269 |   |
| Interest expense                                                     |   | (826                                          | )      | (589                                         | )      | (2,603 | ) | (2,199 | ) |
| Other non-operating income and (expense),  net                       |   | 1,706                                         |   | (144                                         | )      | 2,402 |   | 560 |   |
| Net loss before cumulative effect of  change in accounting principle |   | (1,286                                        | )      | (85,439                                      | )      | (24,560 | ) | (121,347 | ) |
| Cumulative effect of change in milestone  revenue recognition method |   | 0                                             |   | 0                                            |   | 0 |   | 333 |   |
| Net Loss                                                             |   | $                                             | (1,286 | )                                            | $      | (85,439 | ) | $ | (24,560 | ) | $ | (121,014 | ) |
|                                                                 |   |                                          |   |                                         |   |   |   |   |   |
| Basic and diluted net loss per share:                                |   |                                          |   |                                         |   |   |   |   |   |
|                                                                 |   |                                          |   |                                         |   |   |   |   |   |
| Net loss before cumulative effect of  change in accounting principle |   | $                                             | (0.03  | )                                            | $      | (1.68 | ) | $ | (0.48 | ) | $ | (2.51 | ) |
| Cumulative effect of change in milestone  revenue recognition method |   | —                                        |   | —                                       |   | — |   | 0.01 |   |
| Net Loss                                                             |   | (0.03                                         | )      | (1.68                                        | )      | (0.48 | ) | (2.50 | ) |
|                                                                 |   |                                          |   |                                         |   |   |   |   |   |
| Shares used in computing basic and  diluted net loss per share       |   | 51,399,816                                    |   | 50,958,332                                   |   | 51,262,995 |   | 48,425,673 |   |

 

Theaccompanying notes are an integral part of the condensed consolidated financialstatements

 

2

----

 

**deCODE genetics, Inc.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

(inthousands, except share amounts)

unaudited

 
|                                                                                                                                                                                                                                                                                      |   | **SEPTEMBER 30,  2003** |    | **DECEMBER 31,  2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|------------------------|--------|
| ASSETS                                                                                                                                                                                                                                                                                    |   |                    |    |                   |   |
| Current assets:                                                                                                                                                                                                                                                                           |   |                    |    |                   |   |
| Cash and cash equivalents                                                                                                                                                                                                                                                                 |   | $                       | 72,392  |                   | $      | 87,244 |   |
| Receivables                                                                                                                                                                                                                                                                               |   | 4,651                   |    | 5,293                  |   |
| Other current assets                                                                                                                                                                                                                                                                      |   | 7,416                   |    | 9,609                  |   |
| Total current assets                                                                                                                                                                                                                                                                      |   | 84,459                  |    | 102,146                |   |
| Restricted cash                                                                                                                                                                                                                                                                           |   | 6,000                   |    | 6,000                  |   |
| Property and equipment, net                                                                                                                                                                                                                                                               |   | 74,776                  |    | 83,499                 |   |
| Goodwill                                                                                                                                                                                                                                                                                  |   | 8,863                   |    | 8,863                  |   |
| Other long-term assets and deferred charges                                                                                                                                                                                                                                               |   | 15,846                  |    | 12,909                 |   |
| Total assets                                                                                                                                                                                                                                                                              |   | $                       | 189,944 |                   | $      | 213,417 |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                                                 |   |                    |    |                   |   |
| Current liabilities:                                                                                                                                                                                                                                                                      |   |                    |    |                   |   |
| Accounts payable                                                                                                                                                                                                                                                                          |   | $                       | 4,807   |                   | $      | 4,865 |   |
| Accrued expenses and other current liabilities                                                                                                                                                                                                                                            |   | 8,967                   |    | 10,613                 |   |
| Current portion of capital lease obligations                                                                                                                                                                                                                                              |   | 7,631                   |    | 4,311                  |   |
| Current portion of long-term debt                                                                                                                                                                                                                                                         |   | 4,628                   |    | 4,243                  |   |
| Deferred revenue                                                                                                                                                                                                                                                                          |   | 9,018                   |    | 7,606                  |   |
| Total current liabilities                                                                                                                                                                                                                                                                 |   | 35,051                  |    | 31,638                 |   |
| Capital lease obligations, net of current portion                                                                                                                                                                                                                                         |   | 2,514                   |    | 5,008                  |   |
| Long-term debt, net of current portion                                                                                                                                                                                                                                                    |   | 45,297                  |    | 44,961                 |   |
| Deferred revenue                                                                                                                                                                                                                                                                          |   | 4,500                   |    | 6,557                  |   |
| Other long-term liabilities                                                                                                                                                                                                                                                               |   | 7                       |    | 7                      |   |
|                                                                                                                                                                                                                                                                                      |   |                    |    |                   |   |
| Commitments and contingencies                                                                                                                                                                                                                                                             |   |                    |    |                   |   |
|                                                                                                                                                                                                                                                                                      |   |                    |    |                   |   |
| Stockholders’ equity:                                                                                                                                                                                                                                                                |   |                    |    |                   |   |
| Preferred stock, $0.001 par value;

Authorized:  6,716,666 shares  Issued and outstanding: none                                                                                                                                                                                           |   | 0                       |    | 0                      |   |
| Common stock, $0.001 par value;  Authorized: 100,000,000 shares;  Issued:  53,942,888 and 53,695,869  shares  at September 30, 2003 and December 31, 2002,  respectively;  Outstanding: 53,942,888 and 53,545,234 shares  at September 30, 2003 and December 31, 2002,  respectively |   | 54                      |    | 54                     |   |
| Additional paid-in capital                                                                                                                                                                                                                                                                |   | 429,823                 |    | 431,494                |   |
| Notes receivable                                                                                                                                                                                                                                                                          |   | (6,726                  | )       | (7,607                 | )      |
| Deferred compensation                                                                                                                                                                                                                                                                     |   | (930                    | )       | (2,642                 | )      |
| Accumulated deficit                                                                                                                                                                                                                                                                       |   | (319,647                | )       | (295,087               | )      |
| Accumulated other comprehensive income (loss)                                                                                                                                                                                                                                             |   | 1                       |    | (1                     | )      |
| Treasury stock, 0 and 150,635 shares stated at cost at September 30,  2003 and December 31, 2002, respectively                                                                                                                                                                            |   | 0                       |    | (965                   | )      |
| Total stockholders’ equity                                                                                                                                                                                                                                                           |   | 102,575                 |    | 125,246                |   |
| Total liabilities, and stockholders’ equity                                                                                                                                                                                                                                          |   | $                       | 189,944 |                   | $      | 213,417 |   |

 

Theaccompanying notes are an integral part of the condensed consolidated financialstatements.

 

3

----

 

**deCODE genetics, Inc.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

(inthousands)

unaudited

 
|                                                                         |   | **FOR  THE NINE-MONTHS ENDED SEPTEMBER 30,** |    |
|------------------------------------------------------------------------------|--------|----------------------------------------------|---------|
|                                                                         |   | **2003**                                     |    | **2002** |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                        |   |                                         |    |   |   |
| Net loss                                                                     |   | $                                            | (24,560 | ) | $ | (121,014 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |   |                                         |    |   |   |
| Depreciation and amortization                                                |   | 10,546                                       |    | 10,111 |   |
| Purchased in-process research and  development                               |   | 0                                            |    | 480 |   |
| Equity in net earnings of affiliate                                          |   | 0                                            |    | 200 |   |
| Amortization of deferred stock compensation                                  |   | 1,617                                        |    | 2,489 |   |
| Loss/(gain) on disposal of equipment                                         |   | (10                                          | )       | 399 |   |
| Gain on sale of investment in common  stock of eMR                           |   | (254                                         | )       | 0 |   |
| Impairment of property, equipment and  intangibles                           |   | 0                                            |    | 7,474 |   |
| Impairment of goodwill                                                       |   | 0                                            |    | 53,400 |   |
| Charges for write-down of obsolete and  excess materials and supplies        |   | 802                                          |    | 2,709 |   |
| Unrealized gain on derivative financial  instruments                         |   | (2,386                                       | )       | (1,576 | ) |
| Other                                                                        |   | 101                                          |    | 149 |   |
| Changes in operating assets and  liabilities net of effect of acquisition:   |   |                                         |    |   |   |
| Receivables and other assets                                                 |   | 2,560                                        |    | 5,364 |   |
| Accounts payable, accrued expenses and  other current liabilities            |   | (3,658                                       | )       | (5,540 | ) |
| Deferred revenue                                                             |   | (645                                         | )       | 3,964 |   |
| Other                                                                        |   | 0                                            |    | (1,031 | ) |
| Net cash used in operating activities                                        |   | (15,887                                      | )       | (42,422 | ) |
|                                                                         |   |                                         |    |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                        |   |                                         |    |   |   |
| Purchase of property and equipment                                           |   | (714                                         | )       | (14,065 | ) |
| Proceeds from sale of property and  equipment                                |   | 75                                           |    | 0 |   |
| Cash acquired in purchase of MediChem,  net of transaction costs             |   | 0                                            |    | (571 | ) |
| Net cash used in investing activities                                        |   | (639                                         | )       | (14,636 | ) |
|                                                                         |   |                                         |    |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                        |   |                                         |    |   |   |
| Proceeds from financing of property and  equipment                           |   | 4,750                                        |    | 18,695 |   |
| Proceeds from short-term borrowings                                          |   | 2,000                                        |    | 0 |   |
| Repayment of mortgage                                                        |   | 0                                            |    | (11,879 | ) |
| Issuance of common stock                                                     |   | 116                                          |    | 12 |   |
| Repayment of notes receivable for common  stock                              |   | 106                                          |    | 193 |   |
| Installment payments on debt and capital  lease obligations                  |   | (5,298                                       | )       | (4,111 | ) |
| Net cash provided by financing activities                                    |   | 1,674                                        |    | 2,910 |   |
| Net decrease in cash                                                         |   | (14,852                                      | )       | (54,148 | ) |
| Cash and cash equivalents at beginning of  period                            |   | 87,244                                       |    | 153,061 |   |
| Cash and cash equivalents at end of  period                                  |   | $                                            | 72,392  |   | $ | 98,913 |   |

 

The accompanying notes are an integral partof the condensed consolidated financial statements.

 

4

----

 

**deCODE genetics, Inc.**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

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

 

**THE COMPANY**

 

References in this report todeCODE and “we” and “us” refer to deCODE genetics, Inc., a Delaware company,and deCODE genetics, Inc.’s wholly owned subsidiary, Islensk erfdagreiningehf., an Icelandic company registered in Reykjavik, and its subsidiaries Encodeehf., deCODE Cancer ehf. and Vetrargardurinn ehf. as well as deCODE genetics,Inc.’s wholly owned subsidiary, MediChem Life Sciences, Inc., a Delawarecorporation, and its subsidiaries MediChem Research, Inc., ThermoGen, Inc.,Emerald BioStructures, Inc., Advanced X-Ray Analytical Services, Inc. andMediChem Management, Inc.

 

With its headquarters inReykjavik, Iceland, deCODE is a population genetics company developing drugsand DNA-based diagnostics based upon its discoveries in the inherited causes ofcommon diseases. deCODE’s population approach and resources have enabled it toisolate gene and targets directly involved in the development of many of thebiggest challenges to public health. deCODE is focused on turning these findings into a pipeline of productswhich it believes will be able to combat the cause of disease, not just thesigns and symptoms. deCODE’s customers include major pharmaceutical companies,biotechnology firms, pharmacogenomics companies, universities and otherresearch institutions. deCODE’s business is global, with its principal marketsin the United States and in Europe.

 

In March 2002, deCODEcompleted the acquisition of MediChem Life Sciences, Inc. (MediChem) in astock-for-stock exchange accounted for as a purchase transaction. Theacquisition gives deCODE capabilities in chemistry and structural proteomicsthat can be used in the implementation of its strategy of turning its targetsidentified by applying population genomics to common diseases into novel drugsfor the market both through its own programs and in alliances withcollaborators. Founded in 1987, MediChem (now our pharmaceuticals andbiostructures groups) provides contract chemistry research servicesspecializing in chemical synthesis for new drug discovery and development forthe global pharmaceutical, biotechnology, agricultural, chemical and personalcare industries.

 

deCODE’s operations are in asingle business segment, primarily focused on developing products for andproviding services to the healthcare industry from its population-based genediscovery work in Iceland. To date, deCODE’s revenues have been largely derivedfrom services provided, including product development service activities.Broadening that discovery work to development of products, deCODE is organizedaccording to product development offerings and services. deCODE’s productdevelopment activities encompass the discovery and commercialization of noveltherapeutics designed against targets identified in deCODE’s gene discoverywork, as well as the creation of DNA-based diagnostic and pharmacogenomic testsand the development of software systems for making correlations between geneticvariation and disease and drug response. deCODE’s service offerings includecontract service businesses in drug discovery and medicinal chemistry through itsChicago-based pharmaceuticals group, three-dimensional protein crystallographyproducts and contract services through its Seattle-based biostructures group,pharmacogenomics and clinical trials services through its wholly-ownedsubsidiary Encode, genotyping services carried out in Reykjavik, Iceland andbioinformatics services and tools developed in the course of deCODE’s gene anddrug target research.

 

**BASIS OFPRESENTATION**

 

The unaudited condensedconsolidated financial statements included herein have been prepared by deCODE,pursuant to the rules and regulations of the Securities and ExchangeCommission. Certain information and disclosures normally included in financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America have been condensed or omitted pursuant to suchrules and regulations. The condensed consolidated balance sheet as of December31, 2002 has been derived from the audited financial statements as of thatdate, but does not include all disclosures required by accounting principlesgenerally accepted in the United States. deCODE believes the disclosuresincluded in the condensed consolidated financial statements when read inconjunction with the financial statements and the notes thereto included indeCODE’s Annual Report on Form 10-K are adequate to make the informationpresented not misleading.

 

Certain reclassificationshave been made in the December 31, 2002 balance sheet and in the three and ninemonth periods ending September 30, 2002 to be consistent with the currentpresentation.  These financialstatements are reported in United States dollars, deCODE’s functional currency.

 

The condensed consolidatedfinancial statements have been prepared on the same basis as the annual financialstatements and, in the opinion of management, reflect all adjustments, whichinclude only normal recurring adjustments, necessary for a fair presentation ofdeCODE’s financial position, results of operations and cash flows for theperiods presented. The results of operations for the three and nine monthperiods ended September 30, 2003 and 2002 are not necessarily indicative of theresults that may be expected for any other interim period or for the fullfiscal year.

 

5

----

 

**REVENUERECOGNITION AND DEFERRED REVENUE**

 

Revenues from research anddevelopment collaboration agreements are recorded and recognized in accordancewith the applicable performance requirements and terms of the respectivecontracts, generally either (i) as contract research costs are incurred,usually ratably over the period of effort, (ii) according to the percentage ofcompletion method of contract accounting based on the ratio of costs incurredto expected total costs, or (iii) upon the achievement of substantivemilestones, that is where the milestone event is substantive, there issubstantial effort involved in achieving the milestone, the milestone paymentamount is commensurate with the magnitude of the related achievement, and the associatedfollow-on revenue streams bear a reasonable relationship to one another.Milestone payments without these characteristics are recognized on aretrospective basis over the contractual term of the underlying agreement.Funding payments are not refundable in the event that the related efforts arenot successful. Non-refundable, up-front payments are deferred and recognizedon a straight-line basis over the contract term. Contracted chemistry servicesrevenue from negotiated rate contracts are recognized on a per diem basis asservices are rendered or on the percentage of completion method based on theratio of costs incurred to expected total costs for fixed fee contracts basedupon the terms of the underlying contract. Any losses on contracts are providedfor when they are determinable. Included in revenue are billings to customersfor the cost of materials purchased by deCODE.

 

In general, prerequisitesfor billings are established by contractual terms including predeterminedpayment schedules, the achievement of contract milestones, or submission ofappropriate billing detail. Revenue recorded represents amounts billed inaccordance with contractual terms. Unbilled costs and fees arise when revenuehas been recognized but customers have not been billed. Contractual paymentsdue to deCODE are recorded as deferred revenue until earned. The following is asummary of deferred revenue:

 
|                                                                 |   | **FOR  THE THREE MONTHS  ENDED SEPTEMBER 30,** |   | **FOR  THE NINE MONTHS  ENDED SEPTEMBER 30,** |   |
|----------------------------------------------------------------------|--------|------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                 |   | **2003**                                       |   | **2002**                                      |   | **2003** |   | **2002** |   |
|                                                                 |   | **(in  thousands)**                            |   |
| Revenue recorded during the period                                   |   | $                                              | 13,592 |                                          | $      | 11,975 |   | $ | 34,496 |   | $ | 32,980 |   |
| Revenue recognized during the period                                 |   | (12,763                                        | )      | (8,982                                        | )      | (35,141 | ) | (23,682 | ) |
| Deferred revenue recorded on acquisition  of MediChem                |   | 0                                              |   | 0                                             |   | 0 |   | 827 |   |
| Cumulative effect of change in milestone  revenue recognition policy |   | 0                                              |   | 0                                             |   | 0 |   | (333 | ) |
|                                                                 |   | 829                                            |   | 2,993                                         |   | (645 | ) | 9,792 |   |
| Deferred revenue at beginning of period                              |   | 12,689                                         |   | 18,096                                        |   | 14,163 |   | 11,297 |   |
| Deferred revenue at end of period                                    |   | $                                              | 13,518 |                                          | $      | 21,089 |   | $ | 13,518 |   | $ | 21,089 |   |

 

deCODE’s collaborativerelationship include F. Hoffman-La Roche (“Roche”) and Merck & Co., Inc.(“Merck”).  Roche accounted for 38% and45% of consolidated revenue in three-month periods ended September 30, 2003 and2002, respectively.  Roche accounted for40% and 51% of consolidated revenue in nine-month periods ended September 30,2003 and 2002, respectively.  Merckaccounted for 28% and 20% of consolidated revenue in the three and nine-monthperiod ended September 30, 2003, respectively. Revenue for the nine-month periods ended September 30, 2003 and 2002includes $7,000 and $98,000, respectively, in services provided to Prokaria, arelated party.

 

**STOCK-BASEDCOMPENSATION AND REMUNERATION**

 

deCODE follows Statement ofFinancial Accounting Standards No. 123 (SFAS No. 123), Accounting forStock-Based Compensation. The provisions of SFAS No. 123 allow companies toeither expense the estimated fair value of stock options granted to employeesor to follow the intrinsic value method set forth in Accounting PrinciplesBoard Opinion No. 25 (APB No. 25), Accounting for Stock Issued to Employees,and disclose the pro forma effects on net loss and net loss per share had theestimated fair value of the options granted to employees been expensed. SFAS No.123 requires companies to expense the estimated fair value of stock optionsgranted to non-employees. deCODE has elected to follow the intrinsic valuemethod in accounting for its employee stock options and follows the fair valuemethod in accounting for its non-employee stock options.

 

6

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Stock-based compensationrepresents the expense charged in the statements of operations relating toemployee and non-employee stock options granted. Stock-based remunerationrepresents the expense charged in the statements of operations relating toshares of stock issued to non-employees in exchange for services provided.Stock-based compensation and remuneration are included in the condensedconsolidated statements of operations in the following captions:

 
|                                          |   | **FOR  THE THREE MONTHS  ENDED SEPTEMBER 30,** |   | **FOR  THE NINE MONTHS  ENDED SEPTEMBER 30,** |   |
|-----------------------------------------------|--------|------------------------------------------------|--------|-----------------------------------------------|--------|
|                                          |   | **2003**                                       |   | **2002**                                      |   | **2003** |   | **2002** |   |
|                                          |   | **(in  thousands)**                            |   |
| Research and development expense              |   | $                                              | 323    |                                          | $      | 498 |   | $ | 959 |   | $ | 1,687 |   |
| Selling, general and administrative  expense. |   | 196                                            |   | 233                                           |   | 658 |   | 802 |   |
| Total                                         |   | $                                              | 519    |                                          | $      | 731 |   | $ | 1,617 |   | $ | 2,489 |   |

 

 

Had compensation cost forall stock options been determined based on the fair value at the grant date forawards consistent with the provisions of SFAS No. 123, as amended by SFAS No.148, “Accounting for Stock-Based Compensation — Transition and Disclosure — anamendment of FASB Statement No. 123” (“SFAS 148”), deCODE’s net loss and basicand diluted net loss per share would have been changed to the pro forma amountsindicated below: 

 
|                                                                                                       |   | **FOR  THE THREE MONTHS  ENDED SEPTEMBER 30,** |   | **FOR  THE NINE MONTHS  ENDED SEPTEMBER 30,** |   |
|------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                                                       |   | **2003**                                       |   | **2002**                                      |   | **2003** |   | **2002** |   |
|                                                                                                       |   | **(in  thousands)**                            |   |
|                                                                                                       |   |                                           |   |                                          |   |   |   |   |   |
| Net loss attributable to common  stockholders - as reported                                                |   | $                                              | (1,286 | )                                             | $      | (85,439 | ) | $ | (24,560 | ) | $ | (121,014 | ) |
| Add: Stock-based employee compensation  expense included in reported net loss                              |   | 519                                            |   | 731                                           |   | 1,617 |   | 2,489 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value method for all awards |   | (1,135                                         | )      | (1,325                                        | )      | (3,731 | ) | (4,906 | ) |
| Net loss attributable to common  stockholders - pro forma                                                  |   | $                                              | (1,902 | )                                             | $      | (86,033 | ) | $ | (26,674 | ) | $ | (123,431 | ) |
| Basic and diluted net loss per share - as  reported                                                        |   | $                                              | (0.03  | )                                             | $      | (1.68 | ) | $ | (0.48 | ) | $ | (2.50 | ) |
| Basic and diluted net loss per share -  pro forma                                                          |   | (0.04                                          | )      | (1.69                                         | )      | (0.52 | ) | (2.55 | ) |

 

The effects of applying theprovisions of SFAS No. 123 on net loss and net loss per share as stated aboveis not necessarily representative of the effects on reported income or loss forfuture years due to, among other things, the vesting period of the stockoptions and the fair value of additional stock options that may be granted infuture years.

 

In May 2003, deCODE grantedoptions to purchase 633,400 shares of common stock to employees under the 1996 EquityIncentive Plan.  In October andNovember 2003, deCODE granted options to purchase 500,500 shares of commonstock to employees and a director under the 1996 Equity Incentive Plan.  In addition, 25,504 shares of common stockwere granted to employees under the 1996 Equity Incentive Plan.  Stock-based compensation of approximately$0.7 million with respect to these grants will be charged to the statement ofoperations in the fourth quarter.

 

**COMPUTATIONOF NET LOSS PER COMMON SHARE**

 

Basic net loss per share iscomputed using net loss available to common stockholders and theweighted-average number of common shares outstanding. The weighted-averagenumber of common shares outstanding during the period is the number of sharesdetermined by relating the portion of time within a reporting period thatcommon shares have been outstanding to the total time in that period.

 

Diluted net loss per shareis computed using the weighted-average number of common shares outstandingduring the period, plus the dilutive effect of potential common shares. Dilutednet loss per share does not differ from basic net loss per share in all periods

 

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presented as potentialcommon shares are antidilutive for all such periods and are, therefore,excluded from the calculation. Potential common shares excluded from thecalculation of diluted net loss per share as their inclusion would have beenantidilutive were:

 
|                                                                           |   | **SEPTEMBER 30,** |   |
|--------------------------------------------------------------------------------|--------|-------------------|--------|
|                                                                           |   | **2003**          |   | **2002** |   |
|                                                                           |   | **(shares)**      |   |
|                                                                           |   |              |   |   |   |
| Warrants to purchase shares of common  stock                                   |   | 1,400,467         |   | 1,851,300 |   |
| Options to purchase shares of common  stock                                    |   | 2,151,451         |   | 2,580,662 |   |
| Restricted shares with an associated  outstanding non-recourse promissory note |   | 2,089,783         |   | 2,972,625 |   |

 

In September 2003, warrantsto purchase 450,833 shares of common stock were exercised in accordance withthe terms of the original respective warrant agreements for a net common stockissuance of 425,785 shares.  Of the425,785 shares of common stock issued, 278,947 were issued from deCODE’streasury stock.

 

**COMPREHENSIVEINCOME (LOSS)**

 

Comprehensive income (loss)generally represents all changes in stockholders’ equity except those resultingfrom investments or contributions by stockholders. Amounts reported in othercomprehensive income (loss) include foreign currency translation adjustments.The following table presents the calculation of comprehensive income:

 
|                               |   | **FOR  THE THREE MONTHS  ENDED SEPTEMBER 30,** |   | **FOR  THE NINE MONTHS  ENDED SEPTEMBER 30,** |   |
|------------------------------------|--------|------------------------------------------------|--------|-----------------------------------------------|--------|
|                               |   | **2003**                                       |   | **2002**                                      |   | **2003** |   | **2002** |   |
|                               |   | **(in  thousands)**                            |   |
|                               |   |                                           |   |                                          |   |   |   |   |   |
| Net loss                           |   | $                                              | (1,286 | )                                             | $      | (85,439 | ) | $ | (24,560 | ) | $ | (121,014 | ) |
| Other comprehensive income (loss): |   |                                           |   |                                          |   |   |   |   |   |
| Foreign currency translation       |   | 1                                              |   | 0                                             |   | 2 |   | (54 | ) |
| Total comprehensive income (loss)  |   | $                                              | (1,285 | )                                             | $      | (85,439 | ) | $ | (24,558 | ) | $ | (121,068 | ) |

 

**EMPLOYEETERMINATION COSTS**

 

In September of 2002, deCODEimplemented a cost reduction program including charges related to terminationbenefits for 132 employees. Of the $2,158,000 then provided, $1,284,000 waspaid in 2002 and $874,000 remained accrued and unpaid as of December 31, 2002.Charges for termination benefits for 27 additional employees were added($485,000) and total termination benefits of $1,155,000 were paid in thethree-months ended March 31, 2003. Charges for termination benefits for 17 additional employees were added($306,000) and total termination benefits of $219,000 were paid in thethree-months ended June 30, 2003 leaving $291,000 accrued and unpaid as of June30, 2003.  Charges for terminationbenefits for 14 additional employees were added ($115,000) and totaltermination benefits of $328,000 were paid in the three-months ended September30, 2003 leaving $78,000 accrued and unpaid as of September 30, 2003.  Termination benefits remaining accrued andunpaid as of September 30, 2003 (10 employees) are expected to be settled incash over the next three months.

 

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## **RESEARCH ANDDEVELOPMENT**

 
|                                   |   | **FOR  THE THREE MONTHS  ENDED SEPTEMBER 30,** |   | **FOR  THE NINE MONTHS  ENDED SEPTEMBER 30,** |   |
|----------------------------------------|--------|------------------------------------------------|--------|-----------------------------------------------|--------|
|                                   |   | **2003**                                       |   | **2002**                                      |   | **2003** |   | **2002** |   |
|                                   |   | **(in  thousands)**                            |   |
| Gross research and development expense |   | $                                              | 14,289 |                                          | $      | 23,856 |   | $ | 50,737 |   | $ | 66,634 |   |
| Reversal of license fees               |   | (3,221                                         | )      | 0                                             |   | (3,221 | ) | 0 |   |
| Total                                  |   | $                                              | 11,068 |                                          | $      | 23,856 |   | $ | 47,516 |   | $ | 66,634 |   |

 

On January 22, 2000, the IcelandicMinistry of Health and Social Security (the “Ministry”), granted deCODE anoperating license (the “License”) to create, operate and commercialize theIcelandic Health Sector Database (the “IHD”), or the License.  As required by the License, and concurrentlywith its issuance, deCODE entered into an agreement (the “Agreement”) with theMinistry whereby deCODE would be obligated to pay the Icelandic government afixed annual fee of 70 million Icelandic kronas per year (approximately$920,000 as of September 2003) and an additional annual fee of 6% of its netprofit, up to a maximum of 70 million Icelandic krona per year as aconsideration for the rights granted to deCODE under the License.  Through June 2003, $3,221,000 in respect ofthese annual fees had been provided for and included in other accruedexpenses.  Under the terms of theAgreement, certain events needed to take place in order for the fixed annualfee to become due, including the consummation of certain data transferagreements with the two largest Icelandic hospitals, which have subsequentlymerged to from the National University Hospital (“NUH”).  No such agreement with the NUH has beenconsummated, and the IHD has not been commercialized primarily because theIcelandic Data Protection Authority has not issued the required securitycertification.  In light of thedevelopment of our business since the Agreement was entered into, the lack ofthe required agreement with the NUH and the fact that the Icelandic DataProtection Authority has not issued the required security certification, we donot expect to operate the IHD under the terms of the Agreement.  As such, management’s estimation afterconsultation with legal counsel is that it is no longer probable that theaccrued fixed annual fee will become due, and accordingly, a reversal of theaccrued fees has reduced recorded research and development expenses for thethree and nine month periods ended September 30, 2003.

 

**RECENTCOLLABORATIONS**

 

*Merck*. In September 2002, deCODE and Merck & Co.,Inc. (Merck) entered into an alliance aimed at developing new treatments forobesity. Under the alliance, deCODE and Merck will combine their researchefforts in the genetics of obesity to identify, validate and prioritize aseries of drug targets to take into development. Under the terms of thethree-year agreement, deCODE will receive research funding, technology accessfees, license fees, milestone payments as compounds developed under thealliance advance in the development process, and royalties on successfullymarketed alliance drugs.

 

*IBM*. In January 2003, deCODE announced athree-year strategic alliance with IBM under which deCODE and IBM will jointlymarket and sell deCODE’s Clinical Genome Miner (CGM) Discovery(TM) systemrunning on IBM hardware and software. CGM Discovery(TM) is the samestatistically-based application for isolating and analyzing genes and genevariations associated with particular diseases that deCODE has used its genediscovery programs. The alliance aims to take advantage of deCODE’s expertisein genetics and IBM’s leadership in hardware and software systems to createsolutions for what deCODE and IBM believe is a growing market forinformation-based medicine.

 

*Wyeth*. In November 2002, deCODE entered into apharmacogenomics alliance with Wyeth. Under the agreement, deCODE will use itsin vitro pharmacogenomics expertise to generate gene expression data for a drugcandidate targeted to treatment of certain respiratory diseases.

 

*VertexPharmaceuticals*. InJanuary 2003 deCODE announced an agreement with Vertex Pharmaceuticals underwhich we will gather and analyze pharmacogenomic data as part of clinicaltrials our subsidiary Encode conducts on Vertex developmental compounds. Thefirst project under the agreement is a phase IIa clinical trial for Vertex’sVX-148 treatment for psoriasis. Our pharmacogenomics capabilities will enableVertex to gain an understanding, in conjunction with clinical trial results, ofgenetic factors affecting the responses of individuals to treatment. Thisinformation may be useful in designing subsequent clinical strategies andpharmacogenomic tests. Based upon the results of work under this agreement, theparties may extend the collaboration to the development and commercializationof pharmacogenomic tests.

 

*Familiesof Spinal Muscular Atrophy*. In February 2003, deCODE and Families of Spinal Muscular Atrophy(FSMA), an organization founded to promote research leading to the effectivetreatment of this debilitating and often fatal disease, announced the signingof an agreement aimed at developing a new therapeutic compound for spinalmuscular atrophy. Using promising compounds identified through previousFSMA-funded gene- and drug-discovery work, deCODE’s Chicago-basedpharmaceuticals group will identify the 

 

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most promising leadcompounds, optimize these compounds, and conduct the medicinal chemistry andscale-up work to develop a potentially effective new drug ready for clinicaltrials. The three-year agreement is potentially worth $5.2 million, includingmilestones for the successful development of a compound approved for clinicaltrials.

 

**DERIVATIVEFINANCIAL INSTRUMENTS**

 

During the normal course ofbusiness, deCODE is exposed to foreign currency risk and interest rate risk.These risks can create volatility in earnings and cash flows from period toperiod. deCODE’s objective is to reduce volatility of earnings and cash flowsassociated with market risks. Derivative instruments held by the Company are usedfor hedging and non-speculative purposes. As of September 30, 2003, deCODEmaintains two cross-currency swaps for purposes of managing certain of theserisks.

 

deCODE seeks to maintain adesired level of floating-rate debt with respect to its overall debt portfoliodenominated in U.S. Dollars. To this end, deCODE uses interest rate andcross-currency swaps to manage interest rate and foreign currency risk arisingfrom long-term debt obligations denominated in Icelandic krona. These interestrate and cross-currency swaps with a remaining combined notional amount of1,930 million Icelandic krona (approximately $25 million at September 30, 2003)are designated as economic hedges of fixed rate foreign currency debt (Tier Aand Tier C bonds), but do not qualify for hedge accounting under SFAS 133. Theestimated fair value of these instruments is included in other long-term assetsis $10,711,000 and $6,361,000 as of September 30, 2003 and December 31, 2002,respectively. The unrealized gain for the three-month periods ended September30, 2003 and 2002 resulting from the recording of these instruments togetherwith the translation of the Tier A and Tier C bonds is $1,224,000 and $249,000,respectively, and for the nine-month periods ended September 30, 2003 and 2002is $2,386,000 and $1,576,000, respectively, and is included in othernon-operating income and (expense), net in the Consolidated Statements ofOperations.

 

The fair value of derivativeinstruments is sensitive to movements in the underlying market rates andvariables. Fair values are estimated for each derivative using common marketvaluation methods with reference to available market data as of the balancesheet date.

 

## **INVESTMENTS**

 

Included in othernon-operating income and expense for the three and nine months period endedSeptember 30, 2003 is a gain recorded on the sale of deCODE’s investment in thecommon stock of eMR ($254,000).  As ofSeptember 30, 2003, deCODE does not have any remaining ownership interest ineMR.

 

# **DEBT**

 

In June 2003, deCODE soldcertain laboratory equipment for $4,750,000 net cash proceeds and leased theequipment back from the counter-party (an Icelandic leasing company) for an18-month term.  As ownership of theequipment will be transferred to deCODE at the end of the lease without anyfurther significant payment, the transaction has been recorded as a financingand the gain ($1,418,000) has been deferred and is being amortized over theremaining useful life of the leased equipment (3 years).

 

Included inaccrued expenses and other current liabilities as of September 30, 2003 is a$2,000,000 loan with an Icelandic financial institution that is due on October30, 2003 and bears an interest rate of one month LIBOR plus 1% (2.12% atSeptember 30, 2003).  On October 30,2003, this loan was extended for a further ninety days at an interest rate ofthree month LIBOR plus 0.90%.

 

**GUARANTEES**

 

Under its bylaws, deCODE hasagreed to indemnify its officers and directors for certain events oroccurrences while the officer or director is, or was serving, at its request insuch capacity. The term of the indemnification period is for the officer’s ordirector’s lifetime. deCODE has a separate indemnification agreement with oneof its directors that requires it, subject to certain exceptions, to indemnifyhim to the fullest extent authorized or permitted by its bylaws and theDelaware General Corporation Law. The maximum potential amount of futurepayments deCODE could be required to make under these indemnificationagreements is unlimited; however, deCODE has a directors and officer liabilityinsurance policy that limits its exposure and enables it to recover a portionof any future amounts paid. As a result of its insurance policy coverage,deCODE believes the estimated fair value of these indemnification agreements isminimal. deCODE has no liabilities recorded for these agreements as ofSeptember 30, 2003.

 

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

 

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these liabilities as ofSeptember 30, 2003.

 

deCODE enters intoindemnification provisions under (i) its agreements with other companies in itsordinary course of business, typically with business partners, contractors,clinical sites and customers and (ii) its agreements with investors. Underthese provisions deCODE generally indemnifies and hold harmless the indemnifiedparty for losses suffered or incurred by the indemnified party as a result ofdeCODE’s activities or, in some cases, as a result of the indemnified party’sactivities under the agreement. These indemnification provisions generallysurvive termination of the underlying agreement. In addition, in some cases,deCODE has agreed to reimburse employees for certain expenses and to providesalary continuation during short-term disability. The maximum potential amountof future payments deCODE could be required to make under these indemnificationprovisions is unlimited. deCODE has not incurred material costs to defendlawsuits or settle claims related to these indemnification agreements. As aresult, the estimated fair value of these agreements is minimal. Accordingly,deCODE has no liabilities recorded for these agreements as of September 30, 2003.

 

**LITIGATION**

 

Other than claims and legalproceedings that arise from time to time in the ordinary course of its businesswhich are not material, deCODE has no pending legal proceedings except asfollows:

 

In February 2000, Mannvernd,an organization known as the Association of Icelanders for Ethics in Scienceand Medicine, issued a press release announcing its intention to file lawsuitsagainst the State of Iceland and any other relevant parties, including us, totest the constitutionality of the Act. In its press release, Mannverndindicated that it hopes to halt the construction and/or operation of theIcelandic Health Sector Database. In April 2001, a lawsuit was filed againstthe Icelandic Directorate of Public Health but Mannvernd has not commenced litigationagainst us. The ultimate resolution of this matter cannot yet be determined.

 

Onor about April 20, 2002, an amended class action complaint, captioned In redeCODE genetics, Inc. Initial Public Offering Securities Litigation (01 Civ.11219(SAS)), alleging violations of federal securities laws was filed in theUnited States District Court for the Southern District of New York on behalf ofcertain purchasers of deCODE common stock. The complaint names us, two of ourcurrent executive officers (the “Individual Defendants”), and the two leadunderwriters (the “Underwriter Defendants”) for our initial public offering inJuly 2000 (the “IPO”) as defendants.

 

Inthe amended pleading, the plaintiff alleges violations of Section 11 of theSecurities Act of 1933 and violations of Section 10(b) of the SecuritiesExchange Act of 1934 (and Rule 10b-5 promulgated thereunder) against us, theIndividual Defendants and the Underwriter Defendants. In addition, the amendedcomplaint alleges violations of Section 15 of the Securities Act of 1933, andSection 20(a) of the Securities Exchange Actof 1934 against the Individual Defendants.Generally, the amended complaint alleges that the Underwriter Defendants: (i)solicited and received excessive and undisclosed commissions from certaininvestors in exchange for which the Underwriter Defendants allocated to thoseinvestors material portions of the shares of our stock sold in the IPO; (ii)entered into agreements with customers whereby the Underwriter Defendantsagreed to allocate shares of our stock sold in the IPO to those customers inexchange for which the customers agreed to purchase additional shares of ourstock in the aftermarket at pre-determined prices; and (iii) improperly usedtheir analysts, who purportedly suffered from conflicts of interest, tomanipulate the market. The amended complaint further alleges that theprospectus incorporated into the registration statement for the IPO wasmaterially false and misleading in that it failed to disclose these arrangements.The amended complaint also alleges that we and the Individual Defendants hadnumerous interactions and contacts with the Underwriters from which we and theIndividual Defendants either knew of, or recklessly disregarded, theUnderwriters’ purported wrongful acts. The suit seeks unspecified monetary andrecissionary damages and certification of a plaintiff class consisting of allpersons who purchased shares of our common stock from July 17, 2000 to December6, 2000.

 

Weare aware that similar allegations have been made in hundreds of other lawsuitsfiled (many by some of the same plaintiff law firms) against numerousunderwriter defendants and issuer companies (and certain of their current andformer officers) in connection with various public offerings conducted inrecent years. All of the lawsuits that have been filed in the Southern Districtof New York have been consolidated for pretrial purposes before Honorable JudgeShira Scheindlin. Pursuant to the underwriting agreement executed in connectionwith our IPO, we have demanded indemnification from the Underwriter Defendants.The Underwriter Defendants have asserted that our request for indemnificationis premature.

 

Pursuantto an agreement the Individual Defendants have been dismissed from the case withoutprejudice. Along with numerous other issuers, we moved to dismiss the complaintfor failure to state a claim. On February 19, 2003, Judge Scheindlin grantedour motion with respect to the Section 10(b) claims and denied the motion withrespect to the Section 11 claims.

 

OnJuly 31, 2003, our Board of Directors (other than Dr. Stefansson) conditionallyapproved a proposed partial settlement with the plaintiffs in this matter.  The settlement would provide, among otherthings, a release of deCODE and of the Individual Defendants for the conductalleged in the amended complaint to be wrongful.  We would agree to undertake other responsibilities under thepartial settlement, including agreeing to assign away, and not assert orrelease, certain potential claims we may have against our underwriters.  Any direct financial impact of the proposedsettlement is expected to be borne by our insurers.  The Board agreed to approve the settlement subject to a number ofconditions, including the participation of a substantial number of other issuerdefendants in the 

 

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proposedsettlement, the consent of our insurers to the settlement, and the completionof acceptable final settlement documentation. Furthermore, the settlement is subject to a hearing on fairness andapproval by the Court overseeing the litigation.

 

Dueto the inherent uncertainties of litigation and the fact that the settlement isin its early stages, the ultimate outcome of this matter cannot be predicted.  If the settlement is not consummated, weexpect to contest the allegations against us and our officers vigorously.  If we were required to pay significantmonetary damages as a result of such litigation (or any other lawsuits allegingsimilar claims filed against us and our officers in the future), our businesscould be significantly harmed. Even if such suit concludes in our favor, we maybe required to expend significant funds to defend against the allegations. Weare unable to estimate the range of possible loss from the litigation and noamounts have been provided for such matters in our financial statements.

 

**NOTES RECEIVABLE**

 

On November 1, 2003, principal and accrued interest in the amount of$1,846,000 under a promissory note from an executive officer to the Company,which was delivered to the Company in 1999 in connection with the officer’searly exercise of a stock option for 260,000 shares of common stock and wassecured by a pledge of such shares, became due.  On November 3, 2003, and in accordance with the terms of thenote, the Company applied 240,096 shares of the pledged stock (valued at$1,846,000 based on the opening price on the Nasdaq Stock Market on November 3,2003) to payment of principal and interest due on the note.

 

**RECENT ACCOUNTINGPRONOUNCEMENTS**

 

In January 2003, the FASB issued FASB InterpretationNo. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, anInterpretation of ARB No. 51.” FIN 46 requires certain variable interestentities to be consolidated by the primary beneficiary of the entity if theequity investors in the entity do not have the characteristics of a controllingfinancial interest or do not have sufficient equity at risk for the entity tofinance its activities without additional subordinated financial support fromother parties. FIN 46 is effective for all new variable interest entitiescreated or acquired after January 31, 2003. For variable interest entitiescreated or acquired prior to February 1, 2003, the provisions of FIN 46 must beapplied for the first reporting period beginning after December 15, 2003.deCODE adopted this standard on July 1, 2003 and its adoption did not have animpact on deCODE’s financial position or results of operations.

 

In November 2002, theEmerging Issues Task Force reached a consensus on Issue No. 00-21 (“EITF00-21”), “Revenue Arrangements with Multiple Deliverables.” EITF 00-21 providesguidance on how to account for arrangements that involve the delivery orperformance of multiple products, services and/or rights to use assets. Theprovisions of EITF 00-21 apply to revenue arrangements entered into in afterOctober 1, 2003 and its adoption did not have a material impact on deCODE’sfinancial position or results of operations.

 

In April 2003, the FinancialAccounting Standards Board  (FASB)released Statement of Financial Accounting Standards  (SFAS) No. 149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities.” SFAS No. 149 clarifies under what circumstances a contract with aninitial net investment meets the characteristics of a derivative, amends thedefinition of an underlying contract, and clarifies when a derivative containsa financing component in order to increase the comparability of accountingpractices under SFAS No. 133. The statement is effective for contracts enteredinto or modified after June 30, 2003, and for hedging relationships designatedafter June 30, 2003.  deCODE adoptedthis standard on July 1, 2003 and its adoption did not have any impact ondeCODE’s financial position or results of operations.

 

In May 2003, the FASB issuedSFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity.” This Statement establishesstandards for how an issuer classifies and measures certain financialinstruments with characteristics of both liabilities and equity. It requiresthat an issuer classify a financial instrument that is within its scope as aliability (or an asset in some circumstances). Many of those instruments were previously classified as equity.  The Statement is effective for financialinstruments entered into or modified after May 31, 2003.  deCODE adopted this standard on June 1, 2003and its adoption did not have any impact on deCODE’s financial position orresults of operations.

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS. (TABULAR AMOUNTS IN THOUSANDS,EXCEPT SHARE AND PER SHARE AMOUNTS)**

 

This Management’s Discussionand Analysis of Financial Condition and Results of Operations as of September30, 2003 and for the three and nine month periods ended September 30, 2003 and2002 should be read in conjunction with the unaudited condensed consolidatedfinancial statements and notes thereto set forth in Item 1 of this report.

 

**OVERVIEW**

 

We are a population geneticscompany developing drugs and DNA-based diagnostics based upon our discoveriesin the inherited causes of common diseases. Our population approach andresources have enabled us to isolate genes and targets directly involved in thedevelopment of many of the most common diseases. We are focused on turningthese findings into a growing pipeline of products and services which webelieve will be able to combat the causes of disease, not just the signs andsymptoms. Our approach to the discovery of healthcare knowledge brings togetherthree key types of non-personally identifiable data derived from our populationresearch in Iceland: genotypic data and disease data from more than 90,000volunteer participants in some 50 disease gene research programs, andgenealogical data linking together the entire present-day population of Icelandand going back to the settlement of the country in the ninth century.

 

Our business is divided intotwo components: products and services. Our primary product focus is on thediscovery and commercialization of novel therapeutics designed against targetsidentified in our population-based gene discovery work. Through the 

 

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acquisition in March 2002 ofMediChem Life Sciences and its subsidiary, Emerald Biostructures, now ourpharmaceuticals and biostructures groups, we have integrated capabilities forapplying genetic findings to the development of drugs, both through our ownprograms and in alliance with our corporate partners. We are also applying thelinks we have identified between genetic factors and disease to createDNA-based diagnostic and pharmacogenomic tests.  We believe that such tests will become a standard part ofhealthcare within the coming decade, making it possible to gauge individualpredisposition to a particular illnesses and to design effective preventivestrategies; to complement traditional clinical diagnoses; and to identifypatients who are likely to respond or not respond to particular drugs. We arealso marketing software systems we have developed for making correlationsbetween genetic variation and disease and drug response.

 

Our services offeringsinclude contract service businesses in drug discovery and medicinal chemistry,through our Chicago-based pharmaceuticals group; three-dimensional proteincrystallography products and contract services, through our Seattle-basedbiostructures group; pharmacogenomics and clinical trial services, through ourwholly-owned subsidiary Encode; database services, through subscriptions to ourClincial Genome MinerTM system integrating anonymized population data ondisease, genotypes and genealogy; and genotyping services through ourgenotyping laboratory in Reykjavik.

 

We have incurred lossessince our inception, principally as a result of research and development andgeneral and administrative expenses in support of our operations. As ofSeptember 30, 2003 we had an accumulated deficit of $319.6 million. On thebasis of our current range of activities, and following the implementation inSeptember 2002 of a plan to reduce costs and maximize the use of automation inour core genetics operations, we have achieved positive cash flow fromoperations for the quarter. At the same time, we believe that the initiation ofsubstantial new activities by the end of 2003 and into 2004 would requiresignificant additional expenditures such that we may not continue to achievepositive cash flow from operations. For example, in our target discovery work onour findings in myocardial infarction and hypertension, we believe we may beable to bypass much of the drug discovery process and enter directly into phaseII clinical trials in 2004. We anticipate incurring additional net losses atleast through the next two years, due to, among other factors, depreciation andamortization, as well as stock-based compensation and other non-cash charges.We expect that our revenues and losses will fluctuate from quarter to quarterand that such fluctuations may be substantial, especially because progress inour scientific work and milestone payments that are related to progress canfluctuate between quarters. We do not believe that comparisons of ourquarter-to-quarter performance are a good indication of future performance.

 

We believe that currentconditions in the global financial markets and in the pharmaceutical industrypose significant near-term challenges to biotechnology companies such asourselves, as well as important opportunities. The principal challenge to us posedby the downturn in the market valuations of biotechnology companies and of theequity markets more generally over the past three years is that it restrictsour present ability to raise additional capital on favorable terms. In a verybroad sense, it appears that the equity markets continue to be more risk-aversethan they have been in the past. The markets are therefore less willing toascribe value to companies such as ourselves which, although developing newtechnologies that may have the potential for generating successful products,are still considered early-stage and are not yet profitable. This is a generaltrend affecting not only the biotechnology industry but all industries involvedin developing new technologies and products that are unproven in themarketplace. Moreover, it is not certain how long this sentiment in the equitymarkets will last.

 

In order to mitigate therisk to our product development programs posed by the current conditions in thefinancial markets, we have implemented measures aimed at preserving our cashresources. We believe that we have sufficient cash resources to continue tofund our current research and operations for several years, and we are alsoinvestigating the possibility of alternative avenues of financing for ourproduct development programs.

 

At the same time, thepharmaceutical industry, which is the principal customer base for ourgene-discovery and contract chemistry businesses, is experiencing difficultiesin maintaining historical rates of growth. This presents near-term challengesand significant longer-term opportunities. One of the main challenges facingthe pharmaceutical industry is developing pipelines of effective new drugs totreat major indications. As many leading brand-name drugs come off patent andface generic competition, developing successful new medicines will becomecritical for filling the gap. In the short term, the financial pressures onpharmaceutical companies may be reflected in their research and developmentspending, making it more difficult for us to sign corporate alliances withsignificant upfront funding, or lengthening the time required to negotiate suchdeals. This will likely also lead to pressure on budgets for the outsourcing ofchemistry services, which are an important source of revenue for us. We believethat in the medium to longer term, however, companies such as ours may be wellpositioned to play an important role in filling the gap in the pipeline of newdrugs, either on their own or as partners of pharmaceutical companies. Our genediscovery programs are aimed at identifying novel drug targets that areinvolved in the basic biology of common diseases and we are focused ondiscovering new drugs against these targets, both on our own and with majorpharmaceutical partners. Our partnerships with Roche and Merck demonstrate thatthe industry is already investing in the development of new therapeutics basedon our approach. Similarly, it is possible that the pharmaceutical industry, inthe interest of reducing internal overhead, may opt to increase its outsourcingof contract chemistry services.

 

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**COLLABORATIONSAND ALLIANCES**

 

Collaborations and furthergrowth in our medicinal chemistry, pharmacogenomics and informatics serviceswill remain an important element of our business strategy and future revenues.Our ability to generate revenue growth and become profitable is dependent, inpart, on our ability to enter into additional collaborative arrangements, andon our ability and our collaborative partners’ ability to successfullycommercialize products incorporating, or based on, our work. It is alsodependent on our ability to maintain and grow our service lines of business.There can be no assurance that we will be able to maintain or expand ourexisting collaborations, enter into future collaborations to developapplications based on existing or future research agreements, sign additionalsubscribers to our database services, or successfully expand our medicinalchemistry or pharmacogenomics businesses. Our failure to successfully developand market products over the next several years, or to realize productrevenues, would have a materially adverse effect on our business, financialcondition and results of operations. We do not expect to receive royalties orother revenues from commercial sales of products developed using ourtechnologies in the near term. It may be several years before product revenuesmaterialize, if they do at all.

 

We have entered intoresearch, development and commercialization alliances and collaborations withmajor pharmaceutical and biotechnology companies across our business model.These alliances provide us with varied combinations of fixed funding forresearch, technology access fees, royalties and milestones. Our partnersinclude Merck, Wyeth, Roche, Roche Diagnostics, Pharmacia (now Pfizer) andVertex. These agreements are generally established for a set term, usuallythree to five years.

 

**ACQUISITIONS**

 

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

 

On March 18, 2002, weacquired MediChem Life Sciences, Inc. in a stock-for-stock exchange accountedfor as a purchase transaction. The acquisition gives us capabilities inchemistry and structural proteomics that will be used in the implementation ofits strategy of turning its targets identified by applying population genomicsto common diseases into novel drugs for the market. Building upon theacquisition of MediChem (now our pharmaceutical and biostructures groups), wewill be creating an integrated biopharmaceutical company capable of bringingour own targets into proprietary drug discovery. Through the acquisition weadded approximately 160 new employees and facilities in Illinois andWashington.

 

Our consolidated financialstatements include the cash flows and results of MediChem from March 18, 2002.The following unaudited pro forma financial information presents ourconsolidated results as if the acquisition of MediChem occurred at thebeginning of 2002. Nonrecurring charges, such as the acquired in-processresearch and development charge of $480,000 are not reflected in the followingpro forma financial information. This pro forma information is not intended tobe indicative of future operating results.

 

 
|                                 |   | **FOR  THE NINE-MONTHS  ENDED SEPTEMBER 30,**  |   |                |
|--------------------------------------|--------|------------------------------------------------|--------|---------------------|
|                                 |   | **Actual  2003**                               |   | **Pro-forma  2002** |   |   |
|                                 |   | **(in  thousands, except  per share amounts)** |   |                |
|                                 |   |                                           |   |                |   |
| Total Revenues                       |   | $                                              | 35,141 |                | $ | 27,770 |   |
| Net loss                             |   | (24,560                                        | )      | (125,446            | ) |
| Basic and diluted net loss per share |   | (0.48                                          | )      | (2.47               | ) |
|                                      |        |                                                |        |                     |  |  |  |  |

 

With MediChem, our revenueshave increased as have our operating expenses. We expect to fund the workingcapital needs and operating activities of MediChem in the near term. The extentto which MediChem will ultimately impact our results of operations andfinancial condition in the longer term is largely dependant upon whatproportion MediChem’s capacity is brought to bear on our in-house programs andhow much of their existing contract services business is maintained anddeveloped.

 

**CRITICALACCOUNTING POLICIES**

 

The preparation of financialstatements in conformity with generally accepted accounting principles requiresus to make certain estimates and assumptions that affect the reported amountsof assets and liabilities, the disclosure of contingent assets and liabilitiesat the date of the financial statements, and the reported amounts of revenuesand expenses during the reported period. On an ongoing basis we evaluate ourestimates, which include, among others, those related to collaborativearrangements, long-lived assets, materials and supplies, foreign exchangetransactions, income taxes and litigation and other commitments andcontingencies. We base our estimates on historical experience and on variousother assumptions that we believe to be reasonable under the circumstances, theresults of which form our basis for making judgments about carrying values ofassets and liabilities that are not readily apparent from 

 

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other sources. The impactand any associated risks related to these and our other accounting policies onour business or operations is discussed throughout Management’s Discussion andAnalysis of Financial Condition and Results of Operations where such policiesaffect our reported and expected financial results. For a detailed discussionon the application of these and other accounting policies, please refer to ournotes to the Condensed Consolidated Financial Statements in this quarterlyreport on Form 10Q and the Consolidated Financial Statements in the Annual Reporton Form 10-K. There can be no assurance that actual results may not differ fromthe estimates referred to above.

 

**RESULTS OFOPERATIONS FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2003 AND2002**

 

Our results of operationshave fluctuated from period to period and may continue to fluctuate in thefuture based upon, among other things, the timing and composition of fundingunder our various collaborative agreements, as well as the progress of our ownresearch and development efforts. Results of operations for any period may beunrelated to results of operations for any other period. In addition,historical results should not be viewed as indicative of future operatingresults. We are subject to risks common to companies in our industry and at ourstage of development, including risks inherent in our research and developmentefforts, reliance upon collaborative partners, development by us or ourcompetitors of new technological innovations, ability to market products orservices, dependence on key personnel, dependence on key suppliers, protectionof proprietary technology, ability to obtain additional financing, ability tonegotiate collaborative arrangements, reliance on the license to create and runthe Icelandic Health Sector Database, and compliance with governmental andother regulations. In order for a product to be commercialized based on ourresearch, we and our collaborators must conduct preclinical tests and clinicaltrials, demonstrate the efficacy and safety of our product candidates, obtainregulatory approvals or clearances and enter into manufacturing, distributionand marketing arrangements, as well as obtain market acceptance. We do notexpect to receive revenues or royalties based on therapeutic or diagnosticproducts for a period of years, if at all.

 

*Revenues*. Our revenues from research and developmentcollaboration agreements are recorded and recognized in accordance with theapplicable performance requirements and terms of the respective contracts,generally either (i) as contract research costs are incurred, usually ratablyover the period of effort, (ii) according to the percentage of completionmethod of contract accounting based on the ratio of costs incurred to expectedtotal costs, or (iii) upon the achievement of substantive milestones, that iswhere the milestone event is substantive, there is substantial effort involvedin achieving the milestone, the milestone payment amount is commensurate withthe magnitude of the related achievement, and the associated follow-on revenuestreams bear a reasonable relationship to one another. Milestone paymentswithout these characteristics are recognized on a retrospective basis over thecontractual term of the underlying agreement. Funding payments are notrefundable in the event that the related efforts are not successful.Non-refundable, up-front payments are deferred and recognized on astraight-line basis over the contract term. Contracted chemistry servicesrevenue from negotiated rate contracts are recognized on a per diem basis asservices are rendered or on the percentage of completion method based on theratio of costs incurred to expected total costs for fixed fee contracts basedupon the terms of the underlying contract. Any losses on contracts are providedfor when they are determinable. Included in revenue are billings to customersfor the cost of materials purchased by deCODE.

 

In general, prerequisitesfor billings are established by contractual terms including predeterminedpayment schedules, the achievement of contract milestones, or submission ofappropriate billing detail. Revenue recorded represents amounts billed inaccordance with contractual terms. Unbilled costs and fees arise when revenuehas been recognized but customers have not been billed. Contractual paymentsdue to deCODE are recorded as deferred revenue until earned. The following is asummary of deferred revenue:

 
|                                                                 |   | **FOR  THE THREE MONTHS  ENDED SEPTEMBER 30,** |   | **FOR  THE NINE MONTHS  ENDED SEPTEMBER 30,** |   |
|----------------------------------------------------------------------|--------|------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                 |   | **2003**                                       |   | **2002**                                      |   | **2003** |   | **2002** |   |
|                                                                 |   | **(in  thousands)**                            |   |
| Revenue recorded during the period                                   |   | $                                              | 13,592 |                                          | $      | 11,975 |   | $ | 34,496 |   | $ | 32,980 |   |
| Revenue recognized during the period                                 |   | (12,763                                        | )      | (8,982                                        | )      | (35,141 | ) | (23,682 | ) |
| Deferred revenue recorded on acquisition  of MediChem                |   | 0                                              |   | 0                                             |   | 0 |   | 827 |   |
| Cumulative effect of change in milestone  revenue recognition policy |   | 0                                              |   | 0                                             |   | 0 |   | (333 | ) |
|                                                                 |   | 829                                            |   | 2,993                                         |   | (645 | ) | 9,792 |   |
| Deferred revenue at beginning of period                              |   | 12,689                                         |   | 18,096                                        |   | 14,163 |   | 11,297 |   |
| Deferred revenue at end of period                                    |   | $                                              | 13,518 |                                          | $      | 21,089 |   | $ | 13,518 |   | $ | 21,089 |   |

 

15

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Our revenue increased 21%from the second quarter 2003 to $12.8 million for the three-month period endedSeptember 30, 2003 which compares to $9.0 million for the three-month periodended September 30, 2002, an increase of 42%. Our revenue increased to $35.1million for the nine month period ended September 30, 2003 as compared to $23.7million for the nine month period ending September 30, 2002, an increase of48%.  These revenues reflect performanceacross our business, including revenue from new partnerships we have formed andthe contributions of our pharmaceuticals and biostructures groups, as well asresearch and product development milestones. Revenue recognized in the three and nine month period ended September30, 2003 results largely from our diagnostics and therapeutics collaborationswith Roche, from funding in our alliance with Merck and from the contributionof our pharmaceuticals and biostructures groups. The increase in revenue in thethree and nine month period ended September 30, 2003 as compared to the sameperiod in 2002 largely is attributable the contribution of our pharmaceuticalsand biostructures groups and to the addition of funding in our alliance withMerck.  Roche accounted for 38% and 45%of consolidated revenue in three-month periods ended September 30, 2003 and2002, respectively, and 40% and 51% of consolidated revenue in nine-monthperiods ended September 30, 2003 and 2002, respectively, and Merck accountedfor 28% and 20% of consolidated revenue in the three and nine month periodsended September 30, 2003, respectively.

 

At September 30, 2003, thetotal amount of deferred revenue that will be recognized in future periodsaggregated $13.5 million. Revenue recorded increased  30% from the second quarter 2003 to $13.6 million for the threemonth period ended September 30, 2003 as compared to $12.0 million for thethree month period ended September 30, 2002, a 14% increase.  Revenues recorded increased 5% to $34.5million for the nine month period ended September 30, 2003 as compared to $33.0million for the nine month period ended September 30, 2002.  The differences in revenue recorded in the2003 periods as compared to revenue recorded in the 2002 periods is largelyattributable to the contribution of our pharmaceuticals and biostructuresgroups and to our collaboration with Merck, offset somewhat by access feesrecorded in 2002 in connection with our diagnostics collaboration with Roche.

 

*Researchand Development Expenses, including Cost of Revenue*. Our research and development expenses weredown 34% from the second quarter 2003 to $11.1 million for the three-monthsended September 30, 2003, which compares to $23.9 million for the three-monthsended September 30, 2002, a decrease of 54%. Included in our research and development expenses is a non-cash reversalof accrued database license fees amounting to $3.2 million.  Excluding the reversal, research and developmentexpenses for the three-month period ended September 30, 2003 were $14.3million, a decrease of 15% from the second quarter 2003 and a decrease of 40%as compared to same period in 2002.  Ourresearch and development expenses decreased to $47.5 million for the nine-monthperiod ended September 30, 2003 as compared to $66.6 million for the nine-monthperiod ended September 30, 2002, a decrease of 29%.  Excluding the reversal, research and development expenses for thenine-month period ended September 30, 2003 were $50.7 million, a decrease of24% over the same period in 2002.  Ourresearch and development expenses for the three and nine month periods endedSeptember 30, 2003 reflect spending related to the range of our disease-generesearch programs, including product development and downstream work on targetsalready identified as well as our pharmaceutical and biostructures groups,which are now an integral part of our operations. Our research and developmentexpenses for the three and nine month periods ended September 30, 2003 reflectthe impact of the cost reduction measures we implemented late in 2002, takingadvantage of investments in automation in our disease-gene research programsand with notable reductions in salary expense, usage of chemicals andconsumables and research and development overheads.

 

On January 22, 2000, theIcelandic Ministry of Health and Social Security (the “Ministry”), granteddeCODE an operating license (the “License”) to create, operate andcommercialize the Icelandic Health Sector Database (the “IHD”), or the License.  As required by the License, and concurrentlywith its issuance, deCODE entered into an agreement (the “Agreement”) with theMinistry whereby deCODE would be obligated to pay the Icelandic government afixed annual fee of 70 million Icelandic kronas per year (approximately $920,000as of September 2003) and an additional annual fee of 6% of its net profit, upto a maximum of 70 million Icelandic krona per year as a consideration for therights granted to deCODE under the License. Through June 2003, $3,221,000 in respect of these annual fees had beenprovided for and included in other accrued expenses.  Under the terms of the Agreement, certain events needed to takeplace in order for the fixed annual fee to become due, including the consummationof certain data transfer agreements with the two largest Icelandic hospitals,which have subsequently merged to from the National University Hospital(“NUH”).  No such agreement with the NUHhas been consummated, and the IHD has not been commercialized primarily becausethe Icelandic Data Protection Authority has not issued the required securitycertification.  In light of thedevelopment of our business since the Agreement was entered into, the lack ofthe required agreement with the NUH and the fact that the Icelandic DataProtection Authority has not issued the required security certification, we donot expect to operate the IHD under the terms of the Agreement.  As such, management’s estimation afterconsultation with legal counsel is that it is no longer probable that theaccrued fixed annual fee will become due, and accordingly, a reversal of theaccrued fees has reduced recorded research and development expenses for thethree and nine month periods ended September 30, 2003.

 

*Selling,General and Administrative Expenses*. Our selling, general and administrative expenses increased  7% from the second quarter 2003 to $4.0million for the three-month period ended September 30, 2003, which compares to$5.8 million for the three-month period ended September 30, 2002, a decrease of31%. Our selling, general and administrative expenses decreased to $12.0million for the nine-month period ended September 30, 2003 as compared to $14.2million for the nine month period ended September 30, 2002, a decrease of16%.  Our selling, general andadministrative expenses for three and nine month periods ended September 30,2003 mark 

 

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the impact of the costreduction measures we implemented late in 2002 offset by a notable increase inour annual Director’s and Officer’s insurance premiums ($1.2 million annually).

 

*Impairment,Employee Termination Costs and Other Charges*. In September of 2002, we implemented a costreduction program including charges related to termination benefits for 132employees. Of the $2.2 million then provided, $1.3 million was paid in 2002 and$0.9 million remained accrued and unpaid as of December 31, 2002. Charges fortermination benefits for 27 additional employees were added ($0.5 million) andtotal termination benefits of $1.2 million were paid in the three-months endedMarch 31, 2003, leaving $0.2 million accrued and unpaid as of March 31, 2003.Charges for termination benefits for 17 additional employees were added ($0.3million) and total termination benefits of $0.2 million were paid in thethree-months ended June 30, 2003 leaving $0.3 million accrued and unpaid as ofJune 30, 2003.  Charges for terminationbenefits for 14 additional employees were added ($0.1 million) and totaltermination benefits of $0.3 million were paid in the three-months endedSeptember 30, 2003 leaving $0.1 million accrued and unpaid as of September 30,2003.Termination benefits remaining accrued and unpaid as of September 30, 2003(10 employees) are expected to be settled in cash over the next three months.

 

*Stock-BasedCompensation and Remuneration*. Stock-based compensation and remuneration expense was $0.5 millionfor the three-month period ended September 30, 2003 as compared to $0.7 millionfor the three-month period ended September 30, 2002, a decrease of 29%.  Stock-based compensation and remunerationexpense was $1.6 million for the nine-month period ended September 30, 2003 ascompared to $2.5 million for the nine-month period ended September 30, 2002, adecrease of 35%.  With littlecompensation being attributed to our more recent stock option grants,stock-based compensation and remuneration expense has been decreasing as grantsmade to employees in earlier years become fully vested or forfeited. Historicalstock-based compensation and remuneration is not necessarily representative ofthe effects on reported income or loss for future years due to, among otherthings, the vesting period of the stock options, the value of stock optionsthat have been granted in recent times and the value of additional options thatmay be granted in future years.

 

*InterestIncome*. Our interestincome decreased to $0.2 million for the three-month period ended September 30,2003 as compared to $0.7 million for the three-month period ended September 30,2002, a decrease of 66%.  Our interestincome decreased to $0.9 million for the nine-month period ended September 30,2003 as compared to $2.3 million for the nine-month period ended September 30,2002, a decrease of 60%.  The decreaseis attributable to the relative decline of prevailing interest rates and alsofrom an overall decrease in our average cash balance.

 

*InterestExpense*. Our interestexpense increased to $0.8 million expense for the three-month period endedSeptember 30, 2003 as compared to $0.6 million for the three-month period endedSeptember 30, 2002, an increase of 40%. Our interest expense increased to $2.6 million for the nine-month periodended September 30, 2003 as compared to $2.2 million for the nine-month periodended September 30, 2002, an increase of 18%. Our interest expense reflects the cost of financings put into placesince the late part of 2001.  Theincrease for the three month period ended September 30, 2003 as compared to thethree month period ended September 30, 2002 is largely attributable to the $4.8million financing of certain laboratory equipment in June 2003.

 

*Othernon-operating income and (expense), net*. Our other non-operating income and expense,net was a net income of $1.7 and $2.4 million for the three and nine monthperiods ended September 30, 2003, respectively and expense of $0.1 and incomeof $0.6 million for the three and nine month periods ended September 30, 2002.Our other non-operating income and expense, net for the three and nine monthperiods ended September 30, 2003 comprises unrealized swap gains ($1.2 millionand $2.4 million, respectively), the net impact of foreign exchange ($0.2million gain and $0.3 million loss, respectively) and the gain on the sale ofdeCODE’s investment in the common stock of eMR ($0.3 million and $0.3 million,respectively).

 

*IncomeTaxes*. As ofSeptember 30, 2003, we had an accumulated deficit of $319.6 million and did notowe any Icelandic or U.S. federal income taxes nor did we pay any in the threeand nine month periods ended September 30, 2003 or 2002. As of December 31,2002, we had net operating losses able to be carried forward for U.S. federalincome tax purposes of approximately $32.2 million to offset future taxableincome in the United States that expire at various dates through 2022. Also, asof December 31, 2002 our foreign subsidiaries had net operating losscarryforwards of approximately $107.4 million that expire in varying amountsbeginning in 2006.

 

*Net Lossand Basic and Diluted Net Loss Per Share*. Net loss and basic and diluted net loss pershare were $1.3 million and $0.03 per share, respectively, for the three-monthperiod ended September 30, 2003, as compared to $85.4 million and $1.68 pershare, respectively, for the three-month period ended September 30, 2002, adecrease of 98% in both net loss and diluted net loss per share.  Net loss and basic and diluted net loss pershare were $24.6 million and $0.48 per share, respectively, for the nine-monthperiod ended September 30, 2003, as compared to $121.0 million and $2.50 pershare, respectively, for the nine-month period ended September 30, 2002, adecrease of 80% in net loss and a decrease of 81% in basic and diluted net lossper share.  Increased revenue and theintroduction of significant operational efficiencies account for thesedecreases in the 2003 periods as compared to the 2002 periods together with theimpact of significant impairment, employee termination costs and other gainsand charges in all periods presented.

 

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

We have financed our operations primarily through funding fromcollaborative agreements and the issuance of equity securities and 

 

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debt instruments ($486 million from the beginning of 1999to-date).  As of September 30, 2003,future funding under terms of our existing agreements is approximately $50million excluding milestone payments and royalties that we may earn under suchcollaborations.

 

*Cash andCash Equivalents*. Asof September 30, 2003, we had $78.4 million in cash and cash equivalents,including $6 million of restricted cash. Available cash is invested inaccordance with our investment policy’s primary objectives of liquidity, safetyof principal and diversity of investments. Our cash is deposited only with financialinstitutions in Iceland, the United Kingdom and the United States having a highcredit standing. This cash is largely invested in U.S. dollar denominated moneymarket and checking accounts and also in Icelandic krona denominated accounts.

 

***Operating Activities***. Working capital needs resulted in $1.7 million offunds used in the nine-month period ended September 30, 2003 and provided $2.8million in the nine-month period ended September 30, 2002. Net cash used inoperating activities decreased $26.5 million in the nine-month period endedSeptember 30, 2003 as compared to the nine-month period ended September 30,2002.  As more fully described above,this is as a result of our increased revenue base and the impacts of the costreduction measures we implemented late in 2002.

 

*InvestingActivities*. Ourinvesting activities have consisted of capital expenditures and long-termstrategic equity investments in, and acquisitions of, technologies andbusinesses that are complementary to our business. Purchases of property andequipment during the nine-month period ended September 30, 2003 were $0.7million as compared to $14.1 million in the nine-month period ended September30, 2002. We principally made replacement capital expenditures during thenine-month period ended September 30, 2003. During the nine-month period endedSeptember 30, 2002 we expended $5.7 million in respect of the new building,$2.8 million for the purchase of DNA analyzers under our supply agreement withABG and acquired $3.3 million of cash in the purchase of MediChem. There werealso $3.9 million of MediChem transaction costs, resulting in a net outlay ofcash for the nine month period ended September 30, 2002 in connection with theacquisition of $0.6 million.  Althoughwe expect to continue to make simply replacement capital expenditures, net cashused in investing activities may in the future fluctuate significantly fromperiod to period due to the timing of our capital expenditures and otherinvestments.

 

*FinancingActivities*. Net cashof $1.7 million was provided by financing activities in the nine-month periodended September 30, 2003 as compared to $2.9 million provided in the nine-monthperiod ended September 30, 2002. Financing activities for the nine-month periodended September 30, 2003 largely consisted of the sale and 18-month leasebackof certain laboratory equipment ($4.8 million), short-term borrowings ($2.0million) and installment payments on our existing debt and capital leaseobligations ($5.3 million).  In December2001, we established a $27.5 million bridge loan with an Icelandic financialinstitution to finance the construction of our new headquarters facility. Werepaid the borrowings under the bridge loan in January and March 2002 with theproceeds from our Tier A $13.5 million bond offering, Tier C $7.3 millionoffering of privately placed bonds and Tier D $6.7 million bank loan.  $14 million of cash that was restricted asof December 31, 2001 was provided in 2002 in the final financing (Tiers C andD) of our new headquarters facility.

 

We seek to maintain adesired level of floating-rate debt with respect to our overall debt portfoliodenominated in U.S. Dollars. To this end, we have entered into two interestrate and cross-currency swaps to manage interest rate and foreign currency riskarising from long-term debt obligations denominated in Icelandic krona. Theseinterest rate and cross-currency swaps with a remaining combined notionalamount of 1,930 million Icelandic krona are designated as economic hedges offixed rate foreign currency debt (Tier A and Tier C bonds), but do not qualifyfor hedge accounting under SFAS 133. The estimated fair value of theseinstruments is included in other long-term assets is $10.7 million and $6.4million as of September 30, 2003 and December 31, 2002, respectively. Theunrealized gain for the nine-month periods ended September 30, 2003 and 2002resulting from the recording of these instruments together with the translationof the Tier A and Tier C bonds is $2.4 million and $1.6 million, respectively,and is included in other non-operating income and (expense), net in theConsolidated Statements of Operations.

 

*General*. Following the implementation in September2002 of a plan to reduce headcount and maximize the use of automation in our coregenetics operations and based upon current plans, we believe that our existingresources will be adequate to satisfy our capital needs for several years. Ourcash requirements depend on numerous factors, including our ability to obtainnew research collaboration agreements, to obtain subscription and collaborationagreements for the database services; to obtain and maintain contract serviceagreements in our chemistry services and clinical research trials groups;expenditures in connection with alliances, license agreements and acquisitionsof and investments in complementary technologies and businesses; competingtechnological and market developments; the cost of filing, prosecuting,defending and enforcing patent claims and other intellectual property rights;the purchase of additional capital equipment, including capital equipmentnecessary to ensure that our sequencing and genotyping operations remaincompetitive; and capital expenditures required to expand our facilities.Changes in our research and development plans, the entry into clinical trialsof a drug based on our discoveries, or other changes affecting our operatingexpenses may result in changes in the timing and amount of expenditures of ourcapital resources.

 

We will require significantadditional capital in the future, which we may seek to raise through furtherpublic or private equity offerings, additional debt financing or addedcollaborations and licensing arrangements. No assurance can be given thatadditional financing or collaborations and licensing arrangements will beavailable when needed, or that if available, will be obtained on favorableterms. If adequate funds are not available when needed, we may have to curtailoperations or attempt to raise funds on 

 

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unattractive terms.

 

**RECENTACCOUNTING PRONOUNCEMENTS**

 

In January 2003, the FASB issued FASB InterpretationNo. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, anInterpretation of ARB No. 51.” FIN 46 requires certain variable interestentities to be consolidated by the primary beneficiary of the entity if theequity investors in the entity do not have the characteristics of a controllingfinancial interest or do not have sufficient equity at risk for the entity tofinance its activities without additional subordinated financial support fromother parties. FIN 46 is effective for all new variable interest entitiescreated or acquired after January 31, 2003. For variable interest entitiescreated or acquired prior to February 1, 2003, the provisions of FIN 46 must beapplied for the first reporting period beginning after December 15, 2003. Weadopted this standard on July 1, 2003 and its adoption did not have an impacton our financial position or results of operations.

 

In November 2002, theEmerging Issues Task Force reached a consensus on Issue No. 00-21 (“EITF00-21”), “Revenue Arrangements with Multiple Deliverables.” EITF 00-21 providesguidance on how to account for arrangements that involve the delivery or performanceof multiple products, services and/or rights to use assets. The provisions ofEITF 00-21 apply to revenue arrangements entered into after October 1, 2003 andits adoption did not have a material impact on our financial position orresults of operations.

 

In April 2003, the FinancialAccounting Standards Board  (FASB)released Statement of Financial Accounting Standards  (SFAS) No. 149, “Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities.”  SFAS No. 149clarifies under what circumstances a contract with an initial net investmentmeets the characteristics of a derivative, amends the definition of anunderlying contract, and clarifies when a derivative contains a financingcomponent in order to increase the comparability of accounting practices underSFAS No. 133. The statement is effective for contracts entered into or modifiedafter June 30, 2003, and for hedging relationships designated after June 30,2003.  We adopted this standard on July1, 2003 and its adoption did not have any impact on our financial position orresults of operations.

 

In May 2003, the FASB issuedSFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity.” This Statement establishesstandards for how an issuer classifies and measures certain financialinstruments with characteristics of both liabilities and equity. It requiresthat an issuer classify a financial instrument that is within its scope as aliability (or an asset in some circumstances). Many of those instruments were previously classified as equity.  The Statement is effective for financialinstruments entered into or modified after May 31, 2003.  We adopted this standard on June 1, 2003 andits adoption did not have any impact on our financial position or results ofoperations.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

 

The primary objective of ourinvestment activities is to preserve principal while maximizing income wereceive from our investments without significantly increasing risk. Some of thesecurities in our investment portfolio may be subject to market risk. Thismeans that a change in prevailing interest rates may cause the market value ofthe investment to fluctuate. For example, if we hold a security that was issuedwith a fixed interest rate at the then-prevailing rate and the prevailinginterest rate later rises, the market value of our investment will probablydecline. To minimize this risk in the future, we intend to maintain ourportfolio of cash equivalents and short-term investments in a variety ofsecurities, including commercial paper, money market funds and government andnon-government debt securities. In general, money market funds are not subjectto market risk because the interest paid on such funds fluctuates with theprevailing interest rate. As of September 30, 2003, all of our cash and cashequivalents were in money market and checking accounts.

 

We are exposed to marketrisks from changes in foreign currency exchange rates, interest rates andinvestment prices. These changes may adversely affect our operating results andfinancial condition. We seek to manage these risks through regular operatingand financing activities and, when deemed appropriate, through the use ofderivative financial instruments. We control and manage foreign exchange risk,interest rate risk, and investment price risk by continually monitoring changesin key economic indicators and market information.

 

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 but have not yet purchasedinstruments to hedge these general risks through the use of derivativefinancial instruments.

 

We hold various interestrate sensitive assets and liabilities to manage the liquidity and cash needs ofour day-to-day operations. As a result, we are exposed to risks due to changesin interest rates. In order to mitigate risks associated with interest ratesensitive liabilities we use interest rate derivative instruments, such ascross currency interest rate swaps, and may in future use other instruments toachieve the desired interest rate maturities and asset/liability structures.

 

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We are exposed to credit (orrepayment) risk, as well as market risk from the use of derivative instruments.If the counterparty fails to fulfill its performance obligations under aderivative contract, our credit risk will equal the positive market value in aderivative. Consequently, when the fair market value of a derivative contractis positive, this indicates that the counterparty owes us, thus creating arepayment risk for us. When the fair market value of a derivative contract isnegative, we owe the counterparty and therefore, assume no repayment risk.

 

In order to minimize thecredit risk in derivative instruments, we enter into transactions with highquality counterparties such as financial institutions that satisfy ourestablished credit approval criteria. We review the credit ratings of suchcounterparties on a regular basis.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

** **

a)     Evaluation of disclosure controls andprocedures.  Our Chief Executive Officerand our Chief Financial Officer evaluated the effectiveness of deCODE’sdisclosure controls and procedures (as defined in Rule 13a-15(e) under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the endof the fiscal quarter covered by this Quarterly Report on Form 10-Q.  Based upon that evaluation, the ChiefExecutive Officer and the Chief Financial Officer have concluded that as of theend of such fiscal quarter deCODE’s current disclosure controls and proceduresare adequate and effective to ensure that information required to be disclosedin the reports deCODE files under the Exchange Act is recorded, processed,summarized and reported on a timely basis.

 

**b)     Changes ininternal control over financial reporting. There was no change in deCODE’s internal control over financialreporting (as defined in Rule 13a-15(f) under the Exchange Act) during thefiscal quarter covered by this Quarterly Report on Form 10-Q that hasmaterially affected, or is reasonably likely to materially affect, deCODE’sinternal control over financial reporting. As discussed in our Annual Report on Form 10-K for the year endedDecember 31, 2002, during the fiscal 2002 financial process, managementidentified certain deficiencies in disclosure controls and procedures relatedto (1) notice provisions in, and waivers and amendments of, our contracts, (2)identification of, and communications by, non-executive personnel of deCODE ofany material information that they may receive and (3) our financial closingprocedures.  We have taken correctiveactions with respect to these matters. We do not believe that these changes have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.**

 

**PART IIOTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

There has been no change inthe matters reported in our annual report on Form 10-K for the year endedDecember 31, 2002 as supplemented by our quarterly report on Form 10-Q for thequarter ended June 30, 2003.

 

**ITEM 5****. OTHER INFORMATION**

 

**RISK****FACTORS, FORWARD-LOOKINGSTATEMENTS, AND CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS**

 

This report containsforward-looking statements. These statements relate to future events or ourfuture financial performance. In some cases, forward-looking statements can beidentified by terminology such as “may,” “will,” “should,” “could,” “expect,”“plan,” “anticipate,” “believe,” “estimate,” “predict,” “intend,” “potential”or “continue” or the negative of such terms or other comparable terminology.These statements are only predictions. We cannot assure our investors that ourexpectations and assumptions will prove to have been correct. We undertake nointention or obligation to update or revise any forward-looking statements,whether as a result of future events, new information or otherwise. Actualevents or results may differ materially due to a number of factors, includingthose set forth in this section and elsewhere in this Form 10-Q. These factorsinclude, but are not limited to, the risks set forth below.

 

**RISKSRELATED TO OUR BUSINESS**

 

**DECODE MAYNOT SUCCESSFULLY DEVELOP OR DERIVE REVENUES FROM ANY PRODUCTS OR SERVICES.**

 

deCODE uses its technologyand research capabilities primarily to identify genes or gene fragments thatare responsible for certain diseases, indicate the presence of certain diseasesor cause or predispose individuals to certain complex diseases. Although deCODEhas identified some genes that it believes are likely to cause certaindiseases, deCODE may not be correct and may not be successful in identifyingany other similar genes. Many experts believe that some of the diseases deCODEis targeting are caused by both genetic and environmental factors. Even ifdeCODE identifies specific genes that are partly responsible for causingdiseases, any gene-based therapeutic or diagnostic products may not detect,prevent, treat or cure a particular disease. Accordingly, even if deCODE is 

 

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successful in identifyingspecific genes, its discoveries may not lead to the development of commercialtherapeutic or diagnostic products.

 

Any pharmaceutical ordiagnostic products that deCODE or its collaborators are able to develop willfail to produce revenues unless deCODE:

 

• establishes that they are safe andeffective;

 

• successfully competes with othertechnologies and products;

 

• ensures that they do not infringe on theproprietary rights of others;

 

• establishes that they can be manufactured insufficient quantities at reasonable costs; and

 

• can market them successfully.

 

deCODE may not be able tomeet these conditions. deCODE expects that it will be years, if ever, before itwill recognize revenue from the development of therapeutic or diagnosticproducts.

 

deCODE’s Clinical GenomeMiner contains tools to discover or validate disease linked genes based onnon-personally identifiable genotypic, genealogical and phenotypic data. deCODEcannot be sure that marketing the Clinical Genome Miner or the CGMDiscovery(TM) will lead to additional collaborations with potential clients.

 

The success of deCODE’sinformatics services and tools depends on its ability to:

 

• create database and cross reference softwarethat is free from design defects or errors;

 

• effectively use the information derived fromthe Clinical Genome Miner(TM) and other bioinformatics services and tools indisease management, analysis of drug response, gene discovery and drug targetvalidation; and

 

• develop marketing and pricing methods thatthe intended users of the deCODE’s datamining and other informatics serviceswill accept.

 

Because only a small portionof the Icelandic population may carry certain mutations, the unwillingness ofeven a small portion of the population to participate in deCODE’s programscould diminish its ability to develop and market information based on the useof genotypic data. If deCODE fails to successfully commercialize its databaseservices, it will not realize revenues from this part of its business.

 

deCODE’s informaticsproducts may not meet the needs of potential customers. deCODE has generatedlittle revenues from sales or licenses of informatics products. deCODE cannotassure you that it can successfully develop or commercialize, or that therewill be a market for, its informatics products.

 

**IF DECODECONTINUES TO INCUR OPERATING LOSSES LONGER THAN ANTICIPATED, OR IN AMOUNTSGREATER THAN ANTICIPATED, IT MAY BE UNABLE TO CONTINUE ITS OPERATIONS.**

 

deCODE incurred a net lossof $24.6 million for the nine-month period ended September 30, 2003, and has anaccumulated deficit of $319.6 million at September 30, 2003. deCODE has nevergenerated a profit and it has not generated revenues except for paymentsreceived in connection with its research and development collaborations withRoche, Merck and other collaborations, and from contract services and interestincome. Our research and development expenditures and general andadministrative costs have exceeded our revenue to date, and we expect to spendsignificant additional amounts to fund research and development in order toenhance our core technologies and undertake product development (including drugdevelopment and related clinical trials) and to prepare our informaticsproducts.  We do not expect to receiveroyalties or other revenues from commercial sales of products developed usingour technology in the near term.  It maybe several years before product revenues materialize, if they do at all.  As a result, deCODE expects to incur netlosses for several years. If the time required to generate product revenues andachieve profitability is longer than deCODE currently anticipates or the levelof losses is greater than deCODE currently anticipates, deCODE may not be ableto continue its operations.

 

**IF DECODE’SASSUMPTION ABOUT THE ROLE OF GENES IN DISEASE IS WRONG, IT MAY NOT BE ABLE TODEVELOP USEFUL PRODUCTS.**

 

The products deCODE hopes todevelop involve new and unproven approaches. They are based on the assumption thatinformation about genes may help scientists to better understand complexdisease processes. Scientists generally have a limited understanding of 

 

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the role of genes indiseases, and few products based on gene discoveries have been developed. Ofthe products that exist, all are diagnostic products. To date, deCODE knows ofno therapeutic products based on disease-gene discoveries. If deCODE’sassumption about the role of genes in the disease process is wrong, its genediscovery programs may not result in products, the genetic data included in itsdatabase and informatics products may not be useful to its customers and thoseproducts may lose any competitive advantage.

 

**BECAUSEREVENUES ARE CONCENTRATED, THE LOSS OF A SIGNIFICANT CUSTOMER WOULD HARMDECODE’S BUSINESS.**

 

Historically, a substantialportion of deCODE’s revenue has been derived from contracts with a limitednumber of significant customers. deCODE’s largest customer, Roche, accountedfor approximately 41% of its consolidated revenue in 2002 an 40% ofconsolidated revenue in the nine-month period ended September 30, 2003. Revenueunder deCODE’s alliance with Merck accounted for approximately 4% ofconsolidated revenue in 2002 and 20% of consolidated revenue in the nine-monthperiod ended September 30, 2003. Revenues under the joint development andcommercialization agreement with ABG, which was terminated in the fourthquarter of 2002, accounted for 15% of consolidated revenue in the year ended December31, 2002. The loss of any significant customer may significantly lower deCODE’srevenues and affect deCODE’s progression to profitability.

 

**IF DECODE IS NOT ABLE TOOBTAIN SUFFICIENT ADDITIONAL FUNDING TO MEET ITS CAPITAL REQUIREMENTS, DECODEMAY BE FORCED TO REDUCE OR TERMINATE ITS RESEARCH PROGRAMS AND PRODUCTDEVELOPMENT.**

 

deCODE has spent substantialamounts of cash to fund its research and development activities and expects tocontinue to spend substantial amounts for these activities over the nextseveral years. deCODE expects to use cash to collect, generate and analyzegenotypic and disease data from volunteers in its disease-gene researchprograms; to conduct drug discovery and development activities; to continue todevelop database and healthcare informatics products; and to continue otherresearch and development activities. Many factors will influence its futurecapital needs, including:

 

• the number, breadth and progress of itsdiscovery and research programs;

 

• its ability to attract customers;

 

• its ability to commercialize its discoveriesand the resources it devotes to commercialization;

 

• the amount it spends to enforce patent claimsand other intellectual property rights; and

 

• the costs and timing of regulatoryapprovals.

 

deCODE intends to rely onRoche, Merck and other existing and future collaborators for significantfunding of its research efforts. In addition, deCODE may seek additionalfunding through public or private equity offerings and debt financings. deCODEmay not be able to obtain additional financing when it needs it or thefinancing may not be on terms favorable to deCODE or its stockholders.Stockholders’ ownership will be diluted if deCODE raises additional capital byissuing equity securities.

 

If deCODE raises additionalfunds through collaborations and licensing arrangements, it may have torelinquish rights to some of its technologies or product candidates, or grantlicenses on unfavorable terms. If adequate funds are not available, deCODEwould have to scale back or terminate its discovery and research programs andproduct development.

 

The Icelandic parliament hasenacted legislation authorizing the Minister of Finance to provide an Icelandicgovernment guarantee of a convertible bond offering of up to $200 million bydeCODE for the purpose of financing new activities of deCODE in the area ofdrug development. To become effective, this legislation must be approved by theEuropean Free Trade Association Surveillance Authority, or ESA forcompatibility with the state aid stipulations of the agreement on the EuropeanEconomic Area, to which Iceland is a signatory. The measure is still underreview by ESA, which announced on July 16, 2003 that it would conduct a formalinvestigation procedure with regard to the proposed state guarantee.  deCODE cannot be certain that ESA willapprove the legislation, that the Icelandic government will make use of theauthorization and offer the guarantee to deCODE for any or all of the permittedamount, that such offer to deCODE by the Icelandic Government, if effectuated,will be on terms acceptable to deCODE, or that even with such an authorizationdeCODE will be able to find a market for such an offering of convertible bonds.

 

**DECODE’SCURRENT FACILITIES AND STAFF ARE INADEQUATE FOR COMMERCIAL PRODUCTION ANDDISTRIBUTION OF PRODUCTS.**

 

If in the future deCODEchooses to engage directly in the development, manufacturing and marketing ofcertain products, it will require substantial additional funds, personnel andproduction facilities.

 

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**DECODE’SRELIANCE ON THE ICELANDIC POPULATION MAY LIMIT THE APPLICABILITY OF ITS**

**DISCOVERIESTO CERTAIN POPULATIONS.**

 

The genetic make-up andprevalence of disease generally varies across populations around the world.Common complex diseases generally occur with a similar frequency in Iceland andother European populations. However, the populations of other nations may begenetically predisposed to certain diseases because of mutations not present inthe Icelandic population. As a result, deCODE and its partners may be unable todevelop diagnostic and therapeutic products that are effective on all or aportion of people with such diseases. Any difference between the Icelandicpopulation and other populations may have an effect on the usefulness of theClinical Genome Miner and Icelandic Health Sector Database in studyingpopulations outside of Iceland. For deCODE’s business to succeed, it must beable to apply discoveries that it makes on the basis of the Icelandicpopulation to other markets.

 

**IF DECODEFAILS TO PROTECT CONFIDENTIAL DATA ADEQUATELY, IT COULD INCUR A LIABILITY ORLOSE THE ICELANDIC HEALTH SECTOR DATABASE LICENSE.**

 

Under laws and regulationsin force in Iceland, including applicable European laws, directives andregulations, all information on individuals that is used in deCODE’s populationresearch is anonymized under the protocols and supervision of the DataProtection Authority of Iceland. If any of this data held or generated by deCODEwere to become personally identifiable deCODE would risk losing public supportfor participation in its research, and could be liable to legal action. Anyfailure to comply fully with all confidentiality requirements could lead toliability for damages incurred by individuals whose privacy is violated, theloss of our customers and reputation and the loss of the goodwill andparticipation of the Icelandic population, including healthcare professionals.These eventualities could materially adversely affect deCODE’s work in Iceland.

 

The same general privacy anddata protection laws and regulations as well as specific laws and regulationsapply to deCODE’s license to build and operate the Icelandic Health SectorDatabase, or IHD. Were any data sent to or contained in the IHD to becomepersonally identifiable, deCODE would incur the same risks above andpotentially lose its database license.

 

**DECODE’S CREATION ANDOPERATION OF THE ICELANDIC HEALTH SECTOR DATABASE MAY BE MORE EXPENSIVE ANDTIME CONSUMING THAN DECODE ANTICIPATES, AND MAY LEAD TO LITIGATION.**

 

deCODE’s development of theIcelandic Health Sector Database involves substantial government regulation andoversight, compliance with which can be expensive and time-consuming and maydelay, prevent or increase the cost of development of the IHD. Data collectionand use activities will be supervised by the Icelandic Health Sector DatabaseMonitoring Committee, the Data Protection Authority of Iceland, and anInterdisciplinary Ethics Committee. In addition, the Icelandic BioethicsCommittee will review deCODE’s operation of the database.

 

Iceland is subject to bothEuropean Free Trade Association and European Union competition and publicprocurement rules. If it is determined that the Database Act or the DatabaseLicense breaches such rules, the Database License could be revoked or diluted. 

 

Even if deCODE is able tosuccessfully create and market the Icelandic Health Sector Database, theDatabase License will expire in January 2012. There is no assurance that deCODEwill obtain further access rights on favorable terms, if at all.

 

The Icelandic parliament’spassage of the Database Act and the Health Ministry’s granting of the DatabaseLicense have encountered some opposition in Iceland and internationally. Opponentsof the IHD may initiate litigation in U.S., Icelandic or other national orinternational courts (for example, on the basis of an alleged breach of thepatient-doctor confidentiality, constitutional privacy issues, internationalconventions dealing with protection of privacy issues or human rightsconventions). In February 2000, certain Icelandic opponents of the IHD issued apress release announcing their intention to file lawsuits against the State ofIceland and any other relevant parties, including deCODE, to test theconstitutionality of the Database Act. According to the press release, thelawsuit will allege human rights violations and challenge the validity ofprovisions of the Database Act. To date no such suit has been brought againstdeCODE. One lawsuit has been brought in Icelandic courts against theDirectorate of Public Health in Iceland challenging the constitutionality ofthe Database Act. In the event that the Icelandic State by a final judgment isfound to be liable or subject to payment to any third party as a result of thepassage of legislation on the Icelandic Health Sector Database and/or theissuance of the Database License, deCODE’s agreement with the Health Ministryrequires deCODE to indemnify the Icelandic State against all damages and costsincurred in connection with such litigation. In addition, the pendency of suchlitigation could lead to delay in the development of the Icelandic HealthSector Database, and an unfavorable outcome could prevent deCODE fromdeveloping and operating the Icelandic Health Sector Database.

 

**SOME PARTSOF DECODE’S PRODUCT DEVELOPMENT SERVICES CREATE A RISK OF LIABILITY FROMCLINICAL TRIAL PARTICIPANTS AND THE PARTIES WITH WHOM IT CONTRACTS.**

 

deCODE, through itswholly-owned subsidiary Encode ehf., contracts with drug companies to perform awide range of services to assist them in bringing new drugs to market. deCODEalso contracts with physicians to serve as investigators in conducting clinical

 

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trials. deCODE’s servicesinclude:

 

• supervising clinical trials;

 

• data and laboratory analysis;

 

• patient recruitment;

 

• acting as investigators in conductingclinical trials; and

 

• engaging in Phase I clinical trials.

 

If, in the course of these trialsor activities,

 

• deCODE does not perform its services tocontractual or regulatory standards;

 

• patients or volunteers suffer personalinjury caused by or death from adverse reactions to the test drugs orotherwise;

 

• there are deficiencies in the professionalconduct of the investigators with whom deCODE contracts;

 

• deCODE’s laboratories inaccurately report orfail to report lab results; or

 

• deCODE’s informatics products violate rightsof third parties,

 

then, deCODE could be heldliable for these eventualities by the drug companies with whom it contracts orby study participants. deCODE maintains insurance to cover ordinary risks, butsuch insurance may be inadequate and it would not cover the risk of a customerdeciding not to do business with deCODE as a result of poor performance.

 

**USE OF THERAPEUTIC ORDIAGNOSTIC PRODUCTS DEVELOPED AS A RESULT OF DECODE’S PROGRAMS MAY RESULT INPRODUCT LIABILITY CLAIMS FOR WHICH DECODE HAS INADEQUATE INSURANCE.**

 

The users of any therapeuticor diagnostic products developed as a result of deCODE’s discovery or researchprograms or the use of its database or informatics products may bring productliability claims against deCODE. deCODE currently does not carry liabilityinsurance to cover such claims. deCODE is not certain that it or itscollaborators will be able to obtain such insurance or, if obtained, thatsufficient coverage can be acquired at a reasonable cost. If deCODE cannotprotect against potential liability claims, deCODE’s collaborators or deCODE mayfind it difficult or impossible to commercialize products.

 

**DECODE MAYBE UNABLE TO HIRE AND RETAIN THE KEY PERSONNEL UPON WHOM ITS SUCCESS DEPENDS.**

 

deCODE depends on theprincipal members of its management and scientific staff, including Dr. KariStefansson, Chairman, President and Chief Executive Officer, Hannes Smarason,Executive Vice President and Senior Business Officer, and Dr. Jeffrey Gulcher,Vice President, Research and Development. deCODE genetics, Inc. has not enteredinto agreements with any of these people that bind them to a specific period ofemployment. If any of these people leaves deCODE, deCODE’s ability to conductits operations may be negatively affected. deCODE’s future success also willdepend in part on its ability to attract, hire and retain additional personnel.There is intense competition for such qualified personnel and deCODE cannot becertain that it will be able to continue to attract and retain such personnel.Failure to attract and retain key personnel could have a material adverseeffect on deCODE.

 

**CURRENCYFLUCTUATIONS MAY NEGATIVELY AFFECT DECODE’S FINANCIAL CONDITION.**

 

deCODE publishes itsconsolidated financial statements in U.S. dollars. Currency fluctuations canaffect its financial results because a portion of its cash reserves and itsoperating costs are in Icelandic kronas. A fluctuation of the exchange rates ofthe Icelandic krona against the U.S. dollar can thus adversely affect the“buying power” of deCODE’s cash reserves and revenues. Most of deCODE’s long-termliabilities are U.S. dollar denominated. However, deCODE may enter into hedgingtransactions if it has substantial foreign

currency exposure in thefuture. deCODE may have increased exposure as a result of investments orpayments from collaborative partners.

 

**DECODE’SCONTRACTS MAY TERMINATE UPON SHORT NOTICE.**

 

Many of deCODE’s contractsare terminable on short notice. This means that deCODE’s contracts could beterminated for numerous reasons, any of which may be beyond its control such asa reduction or reallocation of a customer’s research and development budget ora change in a customer’s overall financial condition. The loss of a largecontract or multiple smaller contracts, or a significant decrease in revenuederived from a contract, could significantly reduce deCODE’s profitability andrequire it to reallocate under-utilized physical and professional resources.

 

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**RISKSRELATED TO OUR COLLABORATORS**

 

**DECODE MAY NOT BE ABLE TOFORM AND MAINTAIN THE COLLABORATIVE RELATIONSHIPS THAT ITS BUSINESS STRATEGYREQUIRES AND THE RELATIONSHIPS MAY LEAD TO DISPUTES OVER TECHNOLOGY RIGHTS.**

 

Our ability to generaterevenue growth and become profitable is dependent, in part, upon our ability toenter into additional collaborative arrangements, and upon our ability and thatof our collaborative partners to successfully commercialize productsincorporating, or based upon, our work.

 

deCODE must form researchcollaborations and licensing arrangements with several partners at the sametime in order to execute its business strategy. deCODE currently has a numberof collaborative relationships and only three substantial collaborativerelationships, including two with Roche. To succeed, deCODE will have tomaintain or expand these relationships and establish additional collaborations.There can be no assurance that we will be able to maintain or expand ourexisting collaborations, enter into future collaborations to developapplications based on existing or future research agreements, sign additionalsubscribers to our database services, or successfully expand our medicinalchemistry or pharmacogenetics businesses.

 

If deCODE’s collaborationsare not successful or deCODE is not able to manage multiple collaborationssuccessfully, its programs will suffer. If deCODE increases the number ofcollaborations, it will become more difficult to manage the variouscollaborations successfully and the potential for conflicts among thecollaborators as to rights to the technology and products generated under workconducted with deCODE will increase.

 

**DEPENDENCEON COLLABORATIVE RELATIONSHIPS MAY LEAD TO DELAYS IN PRODUCT DEVELOPMENT,PRODUCT DEFECTS AND DISPUTES OVER RIGHTS TO TECHNOLOGY.**

 

deCODE depends oncollaborators for the pre-clinical study and clinical development oftherapeutic and diagnostic products and for regulatory approval, manufacturingand marketing of any products that result from its technology. deCODE’sagreements with collaborators typically allow them significant discretion inelecting whether to pursue such activities. deCODE cannot control the amountand timing of resources collaborators will devote to its programs or potentialproducts.

 

In addition, deCODE’sarrangements may place responsibility for key aspects of informationtechnology, product development and marketing on its collaborative partners. IfdeCODE’s collaborators fail to perform their obligations, deCODE’s informationtechnology products could contain erroneous data, design defects, viruses orsoftware defects that are difficult to detect and correct and may adverselyaffect its revenues and the market acceptance of its products.

 

deCODE’s collaborators maystop supporting its products or providing services to it if they develop orobtain rights to competing products. Disputes may arise in the future over theownership of rights to any technology developed with collaborators. These andother possible disagreements between deCODE’s collaborators and deCODE couldlead to delays in the collaborative research, development or commercializationof products. Such disagreements could also result in litigation or requirearbitration to resolve.

 

**RISKSRELATED TO OUR INDUSTRY**

 

**CONCERNSREGARDING THE USE OF GENETIC TESTING RESULTS MAY LIMIT THE COMMERCIAL VIABILITYOF ANY PRODUCTS DECODE DEVELOPS.**

 

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

 

**DECODE MAYNOT BE ABLE TO COMPETE SUCCESSFULLY WITH OTHER COMPANIES AND GOVERNMENTAGENCIES IN THE DEVELOPMENT AND MARKETING OF PRODUCT SERVICES.**

 

A number of companies areattempting to rapidly identify and patent genes that cause diseases or anincreased susceptibility to diseases. Competition in this field and deCODE’sother areas of business, including drug discovery and development as well asdatabase services and healthcare informatics, is intense and is expected toincrease. deCODE has numerous competitors, including major pharmaceutical anddiagnostic companies, specialized biotechnology firms, universities and otherresearch institutions, the United States-funded Human Genome Project and othergovernment-sponsored entities and companies providing healthcare informationproducts. deCODE’s collaborators, including Roche and Merck, may also competewith deCODE. Many of deCODE’s competitors, either alone or with collaborators,have considerably greater capital resources, research and development staffsand facilities, and technical and other resources than deCODE does, which mayallow them to discover important genes before deCODE 

 

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does. deCODE believes that anumber of its competitors are developing competing products and services thatmay be commercially successful and that are further advanced in developmentthan its potential products and services. To succeed, deCODE, together with itscollaborators, must discover disease-predisposing genes, characterize theirfunctions, develop genetic tests or therapeutic products and relatedinformation services based on such discoveries, obtain regulatory and otherapprovals, and launch such services or products before competitors. Even ifdeCODE’s collaborators or deCODE is successful in developing effective productsor services, deCODE’s products and services may not successfully compete withthose of its competitors. deCODE’s competitors may succeed in developing andmarketing products and services that are more effective than deCODE’s or thatare marketed before deCODE’s.

 

Competitors haveestablished, and in the future may establish, patent positions with respect togene sequences related to deCODE’s research projects. Such patent positions orthe public availability of gene sequences comprising substantial portions ofthe human genome could decrease the potential value of deCODE’s researchprojects and make it more difficult for deCODE to compete. deCODE may also facecompetition from other entities in gaining access to DNA samples used forresearch and development purposes. Our competitors may also obtain patentprotection or other intellectual property rights that could limit our rights,or our customers’ ability, to use our technologies or databases, orcommercialize therapeutic or diagnostics products. In addition, we face, andwill continue to face, intense competition from other companies forcollaborative arrangements with pharmaceutical and biotechnology companies, forestablishing relationships with academic and research institutions and forlicenses to proprietary technology.

 

deCODE expects competitionto intensify as technical advances are made and become more widely known.deCODE’s future success will depend in large part on maintaining a competitiveposition in the genomics field. Others’ or deCODE’s rapid technologicaldevelopment may result in products or technologies becoming obsolete beforedeCODE recovers the expenses it incurs in developing them.

 

Our ability to competesuccessfully will depend, in part, on our ability, and that of ourcollaborators, to:

 

• develop proprietary products;

 

• develop and maintain products that reach themarket first, and are technologically superior to and more cost effective thanother

products on the market;

 

• obtain patent or other proprietaryprotection for our products and technologies;

 

• attract and retain scientific and productdevelopment personnel;

 

• obtain required regulatory approvals; and

 

• manufacture, market and sell products thatwe develop.

 

**CHANGES INOUTSOURCING TRENDS AND ECONOMIC CONDITIONS IN THE PHARMACEUTICAL ANDBIOTECHNOLOGY INDUSTRIES COULD ADVERSELY AFFECT DECODE’S GROWTH.**

 

Economic factors andindustry trends that affect deCODE’s primary customers, pharmaceutical andbiotechnology companies, also affect deCODE’s business. For example, thepractice of many companies in these industries has been to outsource toorganizations like deCODE to conduct genetic research, clinical research, salesand marketing projects and chemistry research and development projects. Ifthese industries reduce their present tendency to outsource those projects,deCODE’s operations, financial condition and growth rate could be materiallyand adversely affected. These alliances and arrangements are both timeconsuming and complex and we face substantial competition in establishing theserelationships. In addition, our ability to generate new business could beimpaired by general economic downturns in our customers’ industries.

 

**IF REGULATORY APPROVALSFOR PRODUCTS RESULTING FROM DECODE’S GENE DISCOVERY PROGRAMS ARE NOT OBTAINED,OR DECODE WILL NOT BE ABLE TO DERIVE REVENUES FROM THESE PRODUCTS.**

 

Government agencies mustapprove new drugs and diagnostic products in the countries in which they are tobe marketed. deCODE cannot be certain that it can obtain regulatory approvalfor any drugs or diagnostic products resulting from its gene discoveryprograms. The regulatory process can take many years and require substantialresources. Because some of the products likely to result from deCODE’s diseaseresearch programs involve the application of new technologies and may be basedupon a new therapeutic approach, various government regulatory authorities maysubject such products to substantial additional review. As a result, theseauthorities may grant regulatory approvals for these products more slowly thanfor products using more conventional technologies. Furthermore, regulatoryapproval may impose limitations on the use of a drug or diagnostic product.

 

After initial regulatoryapproval, a marketed product and its manufacturer must undergo continuingreview. Discovery of previously unknown problems with a product may haveadverse effects on deCODE’s business, financial condition and results ofoperations, including withdrawal of the product from the market.

 

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Our success will depend, inpart, on the development and marketing of products based upon our research anddevelopment. Strict regulatory controls on the clinical testing, manufacture,labeling, supply and marketing of the products will influence our and our partners’ability to successfully manufacture and market therapeutic or diagnosticproducts. Most countries require a company to obtain and maintain regulatoryapproval for a product from the relevant regulatory authority to enable theproduct to be marketed. Obtaining regulatory approval and complying withappropriate statutes and regulations is time-consuming and requires theexpenditure of substantial resources.

 

Most European countries andthe United States have very high standards of technical appraisal andconsequently, in most cases, a lengthy approval process for pharmaceuticalproducts. The regulatory approval processes, which usually include pre-clinicaland clinical studies, as well as post-marketing surveillance to establish acompound’s safety and efficacy, can take many years and require the expenditureof substantial resources. Data obtained from such studies is susceptible tovarying interpretations that could delay, limit or prevent regulatory approval.Delays or rejections may also be encountered based upon changes in drugapproval policies in applicable jurisdictions. There can be no assurance thatwe or our collaborative customers will obtain regulatory approval for any drugsor diagnostic products developed as the result of our gene discovery programs.

 

**EFFORTS TOREDUCE HEALTHCARE COSTS MAY REDUCE MARKET ACCEPTANCE OF DECODE’S PRODUCTS.**

 

deCODE’s success will dependin part on the price and extent to which it will be paid for its products bygovernment and health administration authorities, private health insurers andother third party payors. Reimbursement for newly approved healthcare productsis uncertain. Third party payors, including Medicare in the United States, areincreasingly challenging the prices charged for medical products and services.They are increasingly attempting to contain healthcare costs by limiting bothcoverage and the level of reimbursement for new therapeutic products. deCODEcannot be certain that any third party insurance coverage will be available topatients for any products deCODE discovers or develops. If third party payorsdo not provide adequate coverage and reimbursement levels for deCODE’sproducts, the market acceptance of these products may be materially reduced.

 

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

 

**RISKSRELATED TO OUR INTELLECTUAL PROPERTY**

 

**DECODE MAYNOT BE ABLE TO PROTECT THE PROPRIETARY RIGHTS THAT ARE CRITICAL TO ITS SUCCESS.**

 

deCODE’s success will dependin part on its ability to protect its genealogy database and genotypic data andany other proprietary databases that it develops and its proprietary softwareand other proprietary methods and technologies. Despite deCODE’s efforts toprotect its proprietary rights, unauthorized parties may be able to obtain anduse information that deCODE regards as proprietary. deCODE’s commercial successwill depend in part on obtaining patent protection. The patent positions ofpharmaceutical, biopharmaceutical and biotechnology companies, includingdeCODE’s, are generally uncertain and involve complex legal and factualconsiderations. deCODE cannot be sure that:

 

• any of its pending patent applications willresult in issued patents;

 

• that it will develop additional proprietarytechnologies that are patentable;

 

• that any patents issued to deCODE ordeCODE’s partners will provide a basis for commercially viable products, willprovide

deCODE with any competitiveadvantages or will not be challenged by third parties; or

 

• that the patents of others will not have anadverse effect on deCODE’s ability to do business.

 

If deCODE is unable toobtain patent protection for its technology or discoveries, the value of itsproprietary resources will be adversely affected.

 

In addition, patent lawrelating to the scope of claims in the area of genetics and gene discovery isstill evolving. There is substantial uncertainty regarding the patentability ofgenes or gene fragments without known functions. The laws of some Europeancountries provide that genes and gene fragments may not be patented. TheCommission of the EU has passed a directive that prevents the patenting ofgenes in their natural state. The U.S. Patent and Trademark Office initiallyrejected a patent application by the National Institutes of Health on partialgenes. Accordingly, the degree of future protection for deCODE’s proprietaryrights is uncertain and, deCODE cannot predict the breadth of claims allowed inany patents issued to it or others. deCODE could also incur substantial costsin litigation if it is required to defend itself in patent suits brought bythird parties or if it initiates such suits.

 

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Others may have filed and inthe future are likely to file patent applications covering genes or geneproducts that are similar or identical to deCODE’s products. deCODE cannot becertain that its patent applications will have priority over any patentapplications of others. The mere issuance of a patent does not guarantee thatit is valid or enforceable; thus even if deCODE is holding or is grantedpatents it cannot be sure that they would be valid and enforceable againstthird parties. Further, a patent does not provide the patent holder with freedomto operate in a way that infringes the patent rights of others. Any legalaction against deCODE or its partners claiming damages and seeking to enjoincommercial activities relating to the affected products and processes could, inaddition to subjecting deCODE to potential liability for damages, requiredeCODE or its partners to obtain a license in order to continue to manufactureor market the affected products and processes. There can be no assurance thatits partners or deCODE would prevail in any action or that any license requiredunder any patent would be made available on commercially acceptable terms, ifat all. If licenses are not available, its partners or deCODE may be requiredto cease marketing its products or practicing its methods.

 

If expressed sequence tags,single nucleotide polymorphisms, or SNPs, or other sequence information becomepublicly available before deCODE applies for patent protection on acorresponding full-length or partial gene, deCODE’s ability to obtain patentprotection for those genes or gene sequences could be adversely affected. Inaddition, other parties are attempting to rapidly identify and characterizegenes through the use of gene expression analysis and other technologies. Ifany patents are issued to other parties on these partial or full-length genesor gene products or uses for such genes or gene products, the risk increasesthat the sale of deCODE’s or its collaborators’ potential products or processesmay give rise to claims of patent infringement. The amount of supportive datarequired for issuance of patents for human therapeutics is highly uncertain. Ifmore data than deCODE has available is required, our ability to obtain patentprotection could be delayed or otherwise adversely affected. Even with supportivedata, the ability to obtain patents is uncertain in view of evolvingexamination guidelines, such as the utility and written description guidelinesthat the U.S. Patent and Trademark Office has adopted.

 

While deCODE requiresemployees, academic collaborators and consultants to enter into confidentialityagreements, there can be no assurance that proprietary information will not bedisclosed, that others will not independently develop substantially equivalentproprietary information and techniques, otherwise gain access to our tradesecrets or disclose such technology, or that deCODE can meaningfully protectits trade secrets.

 

**ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K**

 

(a) 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 furtheramended  (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 Certificateof  Incorporation dated August 30, 2002 (Incorporated by reference  to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q  filed on November 14, 2002).                                  |
|                |   |                                                                                                                                                                                                                                                               |
| 3.3                 |   | Bylaws,  as amended (Incorporated by reference to Exhibit 3.2to the  Company’s Registration Statement on Form S-1 (Registration No. 333-31984) which  became effective on July 17, 2000).                                                                     |
|                |   |                                                                                                                                                                                                                                                               |
| 4.1                 |   | Specimen  Common Stock Certificate (Incorporated by referenceto  Exhibit 4.1 to the Company’s Registration Statement on Form S-1  (Registration No. 333-31984) which became effective on July 17,  2000).                                                     |
|                |   |                                                                                                                                                                                                                                                               |
| 4.2                 |   | Form  of Warrant to Purchase Series A Preferred Stock(Incorporated  by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-1  (Registration No. 333-31984) which became effective on July 17, 2000).                                   |

 

28

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| 4.3    |   | Form  of Warrant to Purchase Series C Preferred Stock(Incorporated  by reference to Exhibit 4.3 to the Company’s Registration Statement on Form S-1  (Registration No. 333-31984) which became effective on July 17, 2000). |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                             |
| 4.4    |   | Warrant  Certificate, dated May 6, 2002 issued toIslandsbanki-FBA  hf. (Incorporated by reference to Exhibit 4.1 to the Company’s Quarterly Report  on Form 10-Q filed on May 15, 2002).                                    |
|   |   |                                                                                                                                                                                                                             |
| 4.5    |   | Form  of Indexed Bond (Tier A) (Incorporated by reference toExhibit  4.2 to the Company’s Quarterly Report on Form 10-Q filed on  May 15, 2002).                                                                            |
|   |   |                                                                                                                                                                                                                             |
| 4.6    |   | Form  of Indexed Bond (Tier C) (Incorporated by reference toExhibit  4.3 to the Company’s Quarterly Report on Form 10-Q filed on  May 15, 2002).                                                                            |
|   |   |                                                                                                                                                                                                                             |
| 10.1*# |   | Employment  Agreement between Islensk erfdagreining ehf. andHakon  Hakonarson dated as of July 23, 2003.                                                                                                                         |
|   |   |                                                                                                                                                                                                                             |
| 10.2*  |   | Agreement  between deCODE genetics, Inc. and J. Neal Armstrong dated as of August 18,  2003 and effective as of October 3, 2003.                                                                                                 |
|   |   |                                                                                                                                                                                                                             |
| 31.1   |   | Certification  pursuant to Section 302 of the Sarbanes-OxleyAct of  2002.                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                             |
| 31.2   |   | Certification  pursuant to Section 302 of the Sarbanes-OxleyAct of  2002.                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                             |
| 32.1   |   | Certification  pursuant to Section 906 of the Sarbanes-OxleyAct of  2002.                                                                                                                                                        |

 

----

*  Constitutes a management contract or compensatory plan orarrangement.

#  Confidential treatment has been requested for a portion of thisexhibit.  The copy which is filed as anexhibit omits the information subject to the request for confidentialtreatment.

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

 

(b)REPORTS ON FORM 8-K

 

No Current Reports on Form8-K were filed during the period covered by this Quarterly Report on Form 10-Q

 

29

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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 13, 2003 |                                       |                            |
|--------------------------------|--------------------------------------------|---------------------------------|
|                           |                                       |                            |
|                           | deCODE genetics, Inc.                      |
|                           |                                       |                            |
|                           |                                       |                            |
|                           |                                       | /s/ Kári Stefánsson   |   |
|                           |                                       | Kári Stefánsson       |   |
|                           |                                       | Chairman,  President,           |   |
|                           |                                       | and  Chief Executive Officer    |   |
|                           |                                       |                            |   |
|                           |                                       |                            |   |
|                           |                                       | /s/ Lance Thibault              |   |
|                           |                                       | Lance  Thibault                 |   |
|                           |                                       | Chief  Financial Officer and    |   |
|                           |                                       | Treasurer  (principal financial |   |
|                           | officer  and principal accounting officer) |                            |

 

30

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| **EXHIBIT  NUMBER** |   | **DESCRIPTION OF EXHIBIT**                                                                                                                                                                                                                                         |
|---------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                                               |
| 3.1                 |   | Amended  and Restated Certificate of Incorporation, as furtheramended  (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 Certificateof  Incorporation dated August 30, 2002 (Incorporated by reference  to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q  filed on November 14, 2002).                                  |
|                |   |                                                                                                                                                                                                                                                               |
| 3.3                 |   | Bylaws,  as amended (Incorporated by reference to Exhibit 3.2to the  Company’s Registration Statement on Form S-1 (Registration No. 333-31984) which  became effective on July 17, 2000).                                                                     |
|                |   |                                                                                                                                                                                                                                                               |
| 4.1                 |   | Specimen  Common Stock Certificate (Incorporated by referenceto  Exhibit 4.1 to the Company’s Registration Statement on Form S-1  (Registration No. 333-31984) which became effective on July 17,  2000).                                                     |
|                |   |                                                                                                                                                                                                                                                               |
| 4.2                 |   | Form  of Warrant to Purchase Series A Preferred Stock(Incorporated  by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-1  (Registration No. 333-31984) which became effective on July 17, 2000).                                   |
|                |   |                                                                                                                                                                                                                                                               |
| 4.3                 |   | Form  of Warrant to Purchase Series C Preferred Stock(Incorporated  by reference to Exhibit 4.3 to the Company’s Registration Statement on Form S-1  (Registration No. 333-31984) which became effective on July 17, 2000).                                   |
|                |   |                                                                                                                                                                                                                                                               |
| 4.4                 |   | Warrant  Certificate, dated May 6, 2002 issued toIslandsbanki-FBA  hf. (Incorporated by reference to Exhibit 4.1 to the Company’s Quarterly Report  on Form 10-Q filed on May 15, 2002).                                                                      |
|                |   |                                                                                                                                                                                                                                                               |
| 4.5                 |   | Form  of Indexed Bond (Tier A) (Incorporated by reference toExhibit  4.2 to the Company’s Quarterly Report on Form 10-Q filed on  May 15, 2002).                                                                                                              |
|                |   |                                                                                                                                                                                                                                                               |
| 4.6                 |   | Form  of Indexed Bond (Tier C) (Incorporated by reference toExhibit  4.3 to the Company’s Quarterly Report on Form 10-Q filed on  May 15, 2002).                                                                                                              |
|                |   |                                                                                                                                                                                                                                                               |
| 10.1*#              |   | Employment  Agreement between Islensk erfdagreining ehf. andHakon  Hakonarson dated as of July 23, 2003.                                                                                                                                                           |
|                |   |                                                                                                                                                                                                                                                               |
| 10.2*               |   | Agreement  between deCODE genetics, Inc. and J. Neal Armstrong dated as of August 18,  2003 and effective as of October 3, 2003.                                                                                                                                   |
|                |   |                                                                                                                                                                                                                                                               |
| 31.1                |   | Certification  pursuant to Section 302 of the Sarbanes-OxleyAct of  2002.                                                                                                                                                                                          |
|                |   |                                                                                                                                                                                                                                                               |
| 31.2                |   | Certification  pursuant to Section 302 of the Sarbanes-OxleyAct of  2002.                                                                                                                                                                                          |
|                |   |                                                                                                                                                                                                                                                               |
| 32.1                |   | Certification  pursuant to Section 906 of the Sarbanes-OxleyAct of  2002.                                                                                                                                                                                          |

 

----

*  Constitutes a management contract or compensatory plan orarrangement.

#  Confidential treatment has been requested for a portion of thisexhibit.  The copy which is filed as anexhibit omits the information subject to the request for confidentialtreatment.

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

 

31

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