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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT
FOR THE TRANSITION PERIOD FROM _______________ TO _______________
COMMISSION FILE NUMBER 000-30469
DECODE GENETICS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 04-3326704
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
STURLUGATA 8, REYKJAVIK, ICELAND
(Address of Principal Executive Offices)
+354-570-1900
(Registrant's Telephone Number, Including Area Code)
Indicate by check whether the registrant: (1) filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or such shorter period that the registrant is required to
file such reports), and (2) has been subject to such filing requirements for the
past 90 days.
Yes [X] No [ ]
The aggregate number of shares of the registrant's common stock outstanding on
November 6, 2002 was 53,538,399 shares of common stock $.001 par value.
DECODE GENETICS, INC.
INDEX
Page Number
-----------
PART I. FINANCIAL INFORMATION ........................................ 2
Item 1. Financial Statements ......................................... 2
Condensed Consolidated Statements of Operations for the three
and nine-month periods ended September 30, 2002 and 2001.... 2
Condensed Consolidated Balance Sheets as of September 30, 2002
and December 31, 2001 ...................................... 3
Condensed Consolidated Statements of Cash Flows for the
nine-month periods ended September 30, 2002 and 2001........ 4
Notes to Condensed Consolidated Financial Statements ......... 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................... 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk ... 23
Item 4. Controls and Procedures ...................................... 24
PART II. OTHER INFORMATION ........................................... 24
Item 1. Legal proceedings ............................................ 24
Item 4. Submission of Matters to a Vote of Security Holders .......... 24
Item 5. Other Information............................................. 25
(a) Stockholder Proposals for the 2003 Annual Meeting
of Stockholders .................................... 25
(b) Risk Factors and Forward Looking Statements and
Cautionary Factors That May Affect Future Results .. 25
Item 6. Exhibits and Reports on Form 8-K ............................. 34
(a) Exhibits ................................................. 34
(b) Reports on Form 8-K ...................................... 34
Signatures ........................................................... 35
Certifications ....................................................... 36
Index to Exhibits .................................................. 38
PAGE 1
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DECODE GENETICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------ ------------------------------
2002 2001 2002 2001
------------ ------------ ------------- ------------
REVENUE ....................................... $ 8,982,073 $ 9,720,955 $ 31,878,019 $ 20,951,848
OPERATING EXPENSES
Research and development .................... 23,466,980 16,836,656 64,679,878 53,384,144
Selling, general and administrative ......... 5,925,274 2,830,965 15,292,164 9,561,812
Impairment, employee termination benefits and
other charges ............................... 64,790,284 0 64,790,284 0
------------ ------------ ------------- ------------
Total operating expense ............. 94,182,538 19,667,621 144,762,326 62,945,956
------------ ------------ ------------- ------------
Operating loss ................................ (85,200,465) (9,946,666) (112,884,307) (41,994,108)
Interest income ............................... 711,658 1,514,099 2,269,225 6,037,700
Interest expense .............................. (812,072) (101,496) (2,422,044) (283,985)
Other non-operating income and (expense), net . (393,404) (333,360) (1,016,188) (1,005,297)
------------ ------------ ------------- ------------
Net loss before cumulative effect of change
in accounting principle .................... (85,694,283) (8,867,423) (114,053,314) (37,245,690)
Cumulative effect of change in milestone
revenue recognition method ................. 0 0 333,333 0
------------ ------------ ------------- ------------
Net Loss ...................................... $(85,694,283) $ (8,867,423) $(113,719,981) $(37,245,690)
============ ============ ============= ============
Basic and diluted net loss per share:
Net loss before cumulative effect of change
in accounting principle .................. $ (1.61) $ (0.20) $ (2.25) $ (0.84)
Cumulative effect of change in milestone
revenue recognition method ............... -- -- 0.01 --
Net Loss .................................... (1.61) (0.20) (2.24) (0.84)
Shares used in computing basic and
diluted net loss per share ............... 53,184,256 44,493,608 50,754,846 44,183,756
Pro forma amounts assuming new milestone
revenue recognition method is applied
retroactively:
Revenue................................... $ 8,982,073 $ 8,866,788 $ 31,878,019 $ 19,035,181
Net Loss ................................. (85,694,283) (9,721,590) (113,719,981) (39,162,357)
Basic and diluted net loss per share ..... (1.61) (0.22) (2.24) (0.89)
The accompanying notes are an integral part of the condensed consolidated
financial statements.
PAGE 2
DECODE GENETICS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents ..................... $ 98,912,864 $ 153,061,132
Restricted cash ............................... 0 14,000,000
Receivables ................................... 18,064,288 16,826,958
Assets held for sale .......................... 2,702,739 0
Other current assets .......................... 12,456,220 9,216,071
------------- -------------
Total current assets .................. 132,136,111 193,104,161
Restricted cash ................................. 6,000,000 0
Property and equipment, net ..................... 85,385,901 61,207,537
Goodwill ........................................ 8,862,739 0
Other long-term assets and deferred charges ..... 7,339,811 2,047,471
------------- -------------
Total assets .......................... $ 239,724,562 $ 256,359,169
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses ......... $ 19,972,057 $ 21,164,576
Current portion of capital lease obligations
and long-term debt .......................... 7,079,976 7,426,849
Deferred research revenue ..................... 7,289,078 6,147,247
------------- -------------
Total current liabilities ............. 34,341,111 34,738,672
Capital lease obligations and long-term
debt, net of current portion .................. 48,492,069 38,850,889
Deferred research revenue ....................... 9,500,000 7,000,000
Other long-term liabilities ..................... 7,193 427,675
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.001 par value;
Authorized: 6,716,666 shares
Issued and outstanding: none ............... 0 0
Common stock, $0.001 par value;
Authorized: 100,000,000 shares;
Issued: 53,657,056 and 45,328,227 shares
at September 30, 2002 and December 31, 2001,
respectively;
Outstanding: 53,538,399 and 45,257,386
shares at September 30, 2002 and
December 31, 2001, respectively ............ 53,657 45,328
Additional paid-in capital .................... 431,329,304 351,960,182
Notes receivable .............................. (7,707,584) (10,788,635)
Deferred compensation ......................... (3,114,069) (6,173,592)
Accumulated deficit ........................... (272,312,152) (158,592,171)
Accumulated other comprehensive income (loss) . (1,793) 52,596
Treasury stock, 118,657 and 70,841 shares
stated at cost at September 30, 2002 and
December 31, 2001, respectively ............ (863,174) (1,161,775)
------------- -------------
Total stockholders' equity ............ 147,384,189 175,341,933
------------- -------------
Total liabilities, and
stockholders' equity ............... $ 239,724,562 $ 256,359,169
============= =============
The accompanying notes are an integral part of the condensed consolidated
financial statements.
PAGE 3
DECODE GENETICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------
2002 2001
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ......................................... $(113,719,981) $ (37,245,690)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization ................. 10,110,978 7,325,947
Purchased in-process research and development . 480,000 0
Equity in net loss of affiliate ............... 200,000 294,551
Amortization of deferred stock compensation ... 2,488,952 3,515,302
Other stock-based remuneration and
stock contributions ........................ 0 52,500
Loss on disposal of equipment ................. 399,325 1,607,583
Impairment of property, equipment and
intangibles ................................. 7,474,132 0
Impairment of goodwill ........................ 53,400,000 0
Provision for obsolete and excess materials
and supplies................................. 1,758,439 0
Litigation settlement ......................... 0 1,292,642
Other ......................................... 148,967 0
Changes in operating assets and liabilities
net of effect of acquisition:
Receivables and other current assets ........... (1,682,154) 3,192,026
Accounts payable and accrued expenses .......... (5,750,980) 3,876,467
Deferred research revenue ...................... 2,814,429 9,430,341
Unbilled research revenue ...................... 0 (5,000,000)
Other .......................................... (544,019) (511,972)
------------- -------------
Net cash used in operating activities ....... (42,421,912) (12,170,303)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ............ (14,065,407) (37,159,254)
Transaction costs of MediChem acquisition,
net of cash acquired ........................ (570,511) 0
------------- -------------
Net cash used in investing activities ....... (14,635,918) (37,159,254)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from building financings .............. 18,694,643 0
Repayment of mortgage on Woodridge, IL discovery
center ...................................... (11,879,697) 0
Issuance of common stock ....................... 12,378 0
Forfeiture of common stock ..................... (259) (60)
Repayment of notes receivable for common stock . 193,473 331,617
Installment payments on capital lease
obligations .................................. (4,110,976) (1,303,505)
------------- -------------
Net cash provided by (used in)
financing activities ...................... 2,909,562 (971,948)
------------- -------------
Net decrease in cash ............................. (54,148,268) (50,301,505)
Cash and cash equivalents at beginning of period . 153,061,132 194,144,688
------------- -------------
Cash and cash equivalents at end of period ....... $ 98,912,864 $ 143,843,183
============= =============
The accompanying notes are an integral part of the condensed consolidated
financial statements.
PAGE 4
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THE COMPANY
References in this report to deCODE and "we" and "us" refer to deCODE genetics,
Inc., a Delaware company, and deCODE genetics, Inc.'s wholly owned subsidiary,
Islensk erfdagreining ehf., an Icelandic company registered in Reykjavik, and
its Icelandic subsidiaries Encode ehf., deCODE Cancer ehf. and Vetrargardurinn
ehf. as well as deCODE genetics, Inc.'s wholly owned subsidiary, MediChem Life
Sciences, Inc., a Delaware corporation, and its subsidiaries MediChem Research,
Inc., ThermoGen, Inc., Emerald BioStructures, Inc., Advanced X-Ray Analytical
Services, Inc. and MediChem Management, Inc.
deCODE is a genomics and health informatics company which applies and develops
modern informatics to collect and analyze data about the Icelandic population in
order to develop products and services for the healthcare industry. deCODE was
founded in 1996 in Reykjavik, Iceland.
In March 2002, deCODE completed the acquisition of MediChem Life Sciences, Inc.
(MediChem) in a stock-for-stock exchange accounted for as a purchase
transaction. The acquisition gives deCODE capabilities in chemistry and
structural proteomics that will be used in the implementation of its strategy of
turning its targets identified by applying population genomics to common
diseases into novel drugs for the market. Originally founded in 1987, MediChem
provides contract chemistry research services specializing in chemical synthesis
for new drug discovery and development for the global pharmaceutical,
biotechnology, agricultural, chemical and personal care industries.
deCODE's business is organized according to product development offerings and
services. deCODE's product development activities encompass the company's
population genetics programs aimed at creating new DNA-based diagnostics and
therapeutics. deCODE's services include pharmacogenomic and clinical trial
services, the newly-acquired chemistry services business of MediChem, which
includes contract work in structural biology, medicinal chemistry and scale up
into the clinic, as well as a range of bioinformatics services including the
Clinical Genome Miner and other bioinformatics tools developed in the course of
deCODE's gene and drug target research.
BASIS OF PRESENTATION
The condensed consolidated financial statements included herein have been
prepared by deCODE, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. The condensed balance sheet as of December 31, 2001 has
been derived from the audited financial statements as of that date, but does not
include all disclosures required by generally accepted accounting principles.
deCODE believes the disclosures included in the condensed consolidated financial
statements when read in conjunction with the financial statements and the notes
thereto included in deCODE's Annual Report on Form 10-K are adequate to make the
information presented not misleading.
The condensed consolidated financial statements have been prepared on the same
basis as the annual financial statements and, in the opinion of management,
reflect all adjustments, which include only normal recurring adjustments,
necessary for a fair presentation of deCODE's financial position, results of
operations and cash flows for the periods presented. The results of operations
for the three and nine month periods ended September 30, 2002 and 2001 are not
necessarily indicative of the results that may be expected for any other interim
period or for the full fiscal year.
PRINCIPLES OF CONSOLIDATION
The unaudited condensed consolidated financial statements include the accounts
and operations of deCODE genetics, Inc. and its wholly owned subsidiaries,
Islensk erfdagreining ehf. and its subsidiaries, and MediChem Life Sciences,
Inc. and its subsidiaries. No dividends have been paid. All significant
intercompany accounts and transactions are eliminated upon consolidation.
Investments in which deCODE has significant influence, but does not control, are
accounted for using the equity method.
USE OF ESTIMATES
The preparation of the unaudited condensed consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make certain estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reported period. Actual results could differ from those
estimates.
PAGE 5
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
REVENUE RECOGNITION AND DEFERRED REVENUE
Revenues from research and development collaboration agreements are recorded and
recognized in accordance with the applicable performance requirements and terms
of the respective contracts either as contract research costs are incurred,
including the percentage of completion basis, or upon the achievement of certain
milestones. Such funding payments are not refundable in the event that the
related efforts are not successful. Non-refundable up-front payments are
deferred and recognized on a straight-line basis over the research term.
Contracted chemistry services revenue from negotiated rate contracts are
recognized on a per diem basis as services are rendered or on the percentage of
completion method based on the ratio of costs incurred to expected total costs
for fixed fee contracts based upon the terms of the underlying contract. Any
losses on contracts are provided for when they are determinable and estimable.
Included in revenue are billings to customers for the cost of materials
purchased for performance under the contract.
Prior to January 1, 2002, deCODE recorded all milestone payments received when
acknowledgement of having achieved applicable performance requirements was
received from the collaborator and recognized milestone payments as revenue on a
retrospective basis over the contractual term of the underlying agreement.
deCODE believes the milestone payment method to be a preferable method in
recognizing revenue for milestone payments made under particular contracts in
that it more closely relates to the underlying activity that results in the
revenue-generating milestone event under such contracts. Effective January 1,
2002, deCODE changed its method of recognizing milestone revenue to the
milestone payment method for contracts where (i) the milestone event is
substantive, (ii) there is substantial effort involved in achieving the
milestone, (iii) the milestone payment amount is commensurate with the magnitude
of the related achievement, and (iv) the associated follow-on revenue streams
bear a reasonable relationship to one another. Revenue under the milestone
payment method is recorded and recognized when acknowledgement of having
achieved applicable performance requirements is received from the collaborator.
As before, milestone payments without the above characteristics are recognized
on a retrospective basis over the contractual term of the underlying agreement.
The cumulative effect of the change in accounting principle on prior years
results $333,333 is included in income in the nine month period ended
September 30, 2002. Had the retrospective basis of milestone revenue recognition
been continued for the nine month period ended September 30, 2002, revenue, net
loss and basic and diluted net loss per share would have been $32.2 million,
$(113.7) million and $(2.24), respectively.
In general, prerequisites for billings are established by contractual terms
including predetermined payment schedules, the achievement of contract
milestones, or submission of appropriate billing detail. Unbilled costs and fees
arise when revenue has been recognized but customers have not been billed.
Contractual payments due to deCODE are recorded as deferred revenue until
earned. The following is a summary of deferred revenue:
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------ ------------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Revenue recorded during
the period ............. $ 13,975,608 $ 8,963,795 $ 35,025,780 $ 30,382,189
Revenue recognized during
the period ............. (8,982,073) (9,720,955) (31,878,019) (20,951,848)
Deferred revenue recorded
on acquisition of
MediChem ............... 0 0 827,403 0
Cumulative effect of change
in milestone revenue
recognition policy ..... 0 0 (333,333) 0
------------ ------------ ------------ ------------
4,993,535 (757,160) 3,641,831 9,430,341
Deferred revenue at
beginning of period .... 11,795,543 14,592,500 13,147,247 4,404,999
------------ ------------ ------------ ------------
Deferred revenue at
end of period .......... $ 16,789,078 $ 13,835,340 $ 16,789,078 $ 13,835,340
============ ============ ============ ============
PAGE 6
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Revenue for the nine-month period ended September 30, 2002 includes $97,786 in
services provided to Prokaria, a related party.
Roche accounted for 45% and 80% of consolidated revenue in the three-month
periods ended September 30, 2002 and 2001, respectively, and 38% and 89% of
consolidated revenue in the nine-month periods ended September 30, 2002 and
2001, respectively. ABG accounted for nil and 16% of consolidated revenue in the
three-month periods ended September 30, 2002 and 2001, respectively, and 26% and
7% of consolidated revenue in the nine-month periods ended September 30, 2002
and 2001, respectively.
STOCK-BASED COMPENSATION AND REMUNERATION
Stock-based compensation represents the expense charged in the statements of
operations relating to employee and non-employee stock options granted.
Stock-based remuneration represents the expense charged in the statements of
operations relating to shares of stock issued to non-employees in exchange for
services provided. Stock-based compensation and remuneration are included in the
condensed consolidated statements of operations in the following captions:
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Research and development expense... $ 498,244 $ 897,847 $1,686,967 $2,493,139
Selling, general and administrative
expense......................... 233,235 264,828 801,985 1,022,163
---------- ---------- ---------- ----------
Total.................... $ 731,479 $1,162,675 $2,488,952 $3,515,302
========== ========== ========== ==========
In addition, general and administrative expenses in the nine-month period ended
September 30, 2001 includes a charitable contribution of 5,000 shares of common
stock amounting to $52,500.
In March 2002, deCODE granted options to purchase 673,417 shares of common stock
to employees under the 1996 Equity Incentive Plan (the "Plan"), including
options to purchase 577,917 shares of common stock to employees in connection
with the acquisition of MediChem. In July 2002, deCODE granted additional
options to purchase 136,352 shares of common stock to employees in connection
with the acquisition of MediChem. In August 2002, deCODE granted an option to
purchase 60,000 shares of common stock to a Director in connection with his
reelection to the deCODE Board of Directors. In August 2002, options to purchase
15,281 shares were exercised. As of September 30, 2002, 275,057 options to
purchase shares of common stock were available for grant under the Plan.
In March 2002, 20,508 shares of deCODE common stock were issued to employees.
Compensation related to these shares has been expensed in December 2001 and is
included in accrued expenses at December 31, 2001.
In June 2002, deCODE adopted the deCODE genetics, Inc. 2002 Equity Incentive
Plan (the "2002 Plan"). A total of 3,000,000 shares of common stock are reserved
for grants under the terms of the 2002 Plan. The 2002 Plan provides for grants
of stock options to employees, members of the Board of Directors, and
consultants who are not employees. As of September 30, 2002, 3,000,000 options
to purchase shares of common stock were available for grant under the 2002 Plan.
PAGE 7
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
COMPUTATION OF NET LOSS PER COMMON SHARE
Basic net loss per share is computed using net loss available to common
stockholders and the weighted-average number of common shares outstanding. The
weighted-average number of common shares outstanding during the period is the
number of shares determined by relating the portion of time within a reporting
period that common shares have been outstanding to the total time in that
period.
Diluted net loss per share is computed using the weighted-average number of
common shares outstanding during the period, plus the dilutive effect of
potential common shares. Diluted net loss per share does not differ from basic
net loss per share in all periods presented as potential common shares are
antidilutive for all such periods and are, therefore, excluded from the
calculation. Potential common shares excluded from the calculation of diluted
net loss per share as their inclusion would have been antidilutive were:
SEPTEMBER 30, SEPTEMBER 30,
2002 2001
------------ ------------
(SHARES) (SHARES)
Warrants to purchase shares of common stock........ 1,851,300 1,167,500
Options to purchase shares of common stock......... 2,580,662 1,501,312
COMPREHENSIVE INCOME (LOSS)
Comprehensive income generally represents all changes in stockholders' equity
except those resulting from investments or contributions by stockholders.
Amounts reported in other comprehensive income include foreign currency
translation adjustments and gains and losses on derivative financial instruments
designated and effective as part of a foreign cash-flow hedge transaction. The
following table presents the calculation of comprehensive income:
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------ -------------------------------
2002 2001 2002 2001
------------ ------------ ------------- ------------
Net loss ................. $(85,694,283) $ (8,867,423) $(113,719,981) $(37,245,690)
Other comprehensive income
(loss):
Foreign currency
translation ..... (414) (144,071) (54,389) 40,342
------------ ------------ ------------- ------------
Total comprehensive income
(loss) ................ $(85,694,697) $ (9,011,494) $(113,774,370) $(37,205,348)
============ ============ ============= ============
PAGE 8
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
ACQUISITION OF MEDICHEM LIFE SCIENCES, INC.
Under the terms of the merger agreement, MediChem shareholders received 0.3099
shares of newly issued deCODE common stock in exchange for each MediChem share
of common stock, or 8,362,893 shares of deCODE common stock. In addition,
options to purchase shares of MediChem common stock that vested immediately upon
consummation of the merger have been assumed by deCODE, resulting in the
issuance of 577,917 options to purchase deCODE common stock. In accordance with
the terms of the merger agreement, in July 2002 deCODE also granted a further
136,356 deCODE stock options to certain employees of MediChem under the 1996
Equity Incentive Plan.
The total consideration for the acquisition was approximately $85.9 million,
which consists of deCODE common stock issued in exchange for outstanding
MediChem common stock ($79.7 million), MediChem employee stock options assumed
($2.3 million) and estimated deCODE transaction costs ($3.9 million). deCODE's
common stock issued in the exchange has been valued using an average price for
the period from three days before to three days after the date the proposed
merger was announced. The fair value of options to be assumed is estimated using
the Black-Scholes method. The terms of MediChem's outstanding stock options
provided that the options fully vested upon a change of control; that is, there
were no unvested options upon consummation of this merger. deCODE's direct
transaction costs consist primarily of financial advisory, legal and accounting
fees.
Under the purchase method of accounting for business combinations as defined by
Statement of Financial Accounting Standard No. 141, "Business Combinations",
deCODE has allocated the purchase price to the tangible and identifiable
intangible assets acquired and liabilities assumed on the basis of their
estimated fair values on the acquisition date. Based upon independent valuations
of the tangible and intangible assets acquired, deCODE has allocated the total
cost of the acquisition to the net assets of MediChem as follows (in millions):
Net tangible assets acquired................................ $17.0
In-process research and development......................... 0.5
Identifiable intangible assets.............................. 6.1
Goodwill.................................................... 62.3
-----
$85.9
=====
The in-process research and development has been charged to operations as a
research and development expense in the nine month period ended September 30,
2002. Intangible assets of MediChem identified include developed technology,
patents, customer and other contracts and agreements that have estimated useful
lives ranging from three to ten years. The aggregate amortization charge for
these identifiable intangibles recorded in the MediChem acquisition is estimated
to amount to approximately $1.2 million annually. Resulting goodwill will not be
amortized but will be subject to annual impairment testing (see below).
deCODE's statements of operations include the results of MediChem from March 18,
2002, the date of acquisition. The following unaudited pro forma financial
information presents the consolidated results of deCODE as if the acquisition of
MediChem occurred at the beginning of 2001. Nonrecurring charges, such as the
acquired in-process research and development charge of $0.5 million is not
reflected in the following pro forma financial information but MediChem's
restructuring and impairment charges in 2001 are included. This pro forma
information is not intended to be indicative of future operating results (in
millions, except per share data).
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------
2002 2001
---------- ----------
Total revenues ................................. $ 36.0 $ 36.5
Net loss ....................................... (118.2) (85.1)
Basic and diluted net loss per share ........... (2.23) (1.62)
PAGE 9
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
IMPAIRMENT, EMPLOYEE TERMINATION BENEFITS AND OTHER CHARGES
In September of 2002, deCODE implemented a cost reduction program aimed at
achieving positive operating cashflow from existing operations by the end of
2003. In this regard, deCODE reduced total worldwide headcount by approximately
200 employees during the three-months ended September 30, 2002, focusing in
particular on utilizing ongoing process automation and increased productivity in
the core genetics operations in Reykjavik. Stemming from this initiative and
together with management's consideration of significant and pervasive declines
in the market environment for pharmaceutical and biotech industries, deCODE
determined that impairment tests of the carrying value of its goodwill and other
long-lived assets, including the long-lived assets acquired through the MediChem
acquisition, should be performed as of September 30, 2002. deCODE has completed
these tests and recorded the following impairment, employee termination benefits
and other charges during the three and nine-month periods ended September 30,
2002:
Employee termination benefits...................$ 2,157,713
Impairment of goodwill.......................... 53,400,000
Impairment of property and intangible asset..... 2,715,000
Write-down of assets held for sale.............. 2,706,379
Write-down of equipment......................... 2,052,753
Obsolete and excess materials and supplies...... 1,758,439
-------------
$ 64,790,284
=============
Charges related to termination benefits for 132 employees are accrued and
unpaid as of September 30, 2002 and are expected to be settled in cash over the
next 6 months.
For purposes of the goodwill impairment tests, deCODE identified its reporting
units, identified the assets and liabilities of the reporting units and
performed impairment tests on the net goodwill associated with them. Goodwill
that resulted from the acquisition of MediChem was assigned to the reporting
units based upon expectations of synergies to be gained from the integration of
the pharmaceutical and biostructures groups with deCODE. Goodwill impairment is
deemed to exist if the net book value of a reporting unit exceeds its estimated
fair value. To identify potential impairment, deCODE compares fair value of a
reporting unit with its carrying amount, including goodwill. For this purpose,
deCODE estimates fair value of a reporting unit using analyses of comparable
companies and recent comparable transactions. In measuring the amount of
impairment loss, deCODE compares the implied fair value of a reporting unit's
goodwill with the carrying amount of that goodwill, estimating the fair value of
an impaired reporting unit using discounted cash flow methodologies. The
goodwill impairment charge is associated solely with goodwill resulting from the
acquisition of MediChem and results largely from significant and pervasive
declines in the market environment for the pharmaceutical and biotech industries
impacting, among other things, market valuations of companies operating in those
industries.
In September 2002, deCODE committed to a plan to sell its Woodridge Discovery
Center and an agent was engaged and has initiated an active marketing program
to locate a buyer/investor in a sale and leaseback transaction. The sale and
leaseback transaction is expected to be completed by the early part of 2003.
Taking into account the estimated selling price of the building less estimated
costs to sell, deCODE recorded an impairment charge in the three and nine-month
periods ended September 30, 2002 amounting to $2.1 million. In addition,
certain intangible assets amounting to $0.6 million were determined to be
impaired utilizing a discounted cashflow methodology to estimate fair value.
In September 2002, deCODE committed to a plan to sell its former headquarters
facility that had been vacated in connection with the move to its new
headquarters facility in Reykjavik's University district earlier in the year.
In October 2002, an agent for the sale was engaged and an active marketing
program to locate a buyer was initiated. In November 2002, terms of sale were
agreed with a buyer in the amount of $2.8 million, that is contingent on
buyer-financing. Taking into account the expected selling price of the building
less estimated costs to sell, deCODE wrote-down the property in the three and
nine-month periods ended September 30, 2002 amounting to $2.7 million. The
remaining carrying value of the building ($2.7 million) is classified as an
asset held for sale in the September 30, 2002 consolidated balance sheet.
Ongoing process automation and increased productivity in the core genetics
operations in Reykjavik and changes in some of deCODE's target research
programs have affected deCODE's planned volume and timing of usage of its
materials and supplies. In this connection, management has recorded an
additional provision for excess and obsolete inventory in the three and
nine-month periods ended September 30, 2002.
Additionally, in September 2002 deCODE wrote-down the value of certain
laboratory equipment no longer in use.
PAGE 10
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
RECENT COLLABORATIONS
Pharmacia. In December 2001, deCODE formed a pharmacogenomics alliance with
Pharmacia Corporation (Pharmacia) to identify the role of genetics in the
development of advanced forms of heart disease. Under the amended and restated
agreement, deCODE will receive contract fees in exchange for employing its
population resources and Clinical Genome Miner discovery system to find genetic
markers that can be used to identify patients who are highly predisposed to
progressing from an early to an advanced form of heart disease.
F.Hoffman-La Roche. In January 2002, deCODE and Roche entered into a new
Collaboration and Cross-License Agreement. This new, three-year alliance
leverages deCODE's expanding capabilities in drug discovery into developing
novel treatments for common diseases. Under this new alliance, Roche will
provide research funding for a minimum of the next two years for deCODE to
conduct downstream research in a selection of four diseases, with the goal of
using the targets identified to discover and develop new therapeutic compounds
and to take these compounds into clinical trials. Also, deCODE may receive
development and regulatory approval milestone payments for therapeutic drug
compounds developed pursuant to the agreement as well as royalties on Roche's
sales of drugs developed under the agreement. Additionally, deCODE may pay Roche
royalties should deCODE develop and market drugs for certain common diseases.
Merck. In September 2002, deCODE and Merck & Co., Inc. (Merck) entered into an
alliance aimed at developing new treatments for obesity. Under the alliance,
deCODE and Merck will combine their research efforts in the genetics of obesity
to identify, validate and prioritize a series of drug targets to take into
development. The goal of the alliance is to accelerate the discovery of new
drugs to fight obesity, a condition that now represents one of the
fastest-growing public health challenges in the industrialized world. . Under
the terms of the three-year agreement, deCODE will receive research funding,
technology access, license fees, milestone payments as compounds developed under
the alliance advance in the development process, and royalties on successfully
marketed alliance drugs.
DEBT
In December 2001, deCODE established a $27.5 million bridge loan with an
Icelandic financial institution to finance the construction of its new
headquarters facility. The borrowings under the bridge loan were repaid in
January and March 2002 with the proceeds from deCODE's Tier A $13.5 million bond
offering, Tier C $7.3 million offering of privately placed bonds and Tier D $6.7
bank loan.
The Tier A bonds are denominated in Icelandic krona and are linked to the
Icelandic Consumer Price Index. The principal amount is payable annually
beginning December 2002. The Tier A bonds bear annual interest of 8.5% that is
payable annually beginning December 2002. The Tier C bonds are denominated in
Icelandic krona and are linked to the Icelandic Consumer Price Index. The
principal amount is payable in March 2007. The Tier C bonds bear annual interest
of 12.0% that is payable beginning March 2003. The Tier D bank loan is
denominated in U.S. dollars. The principal amount is payable in March 2007. The
Tier D bank loan bears annual interest of three-month LIBOR plus 6.0% that is
payable quarterly beginning June 2002. Tier C bonds may be prepaid at each
interest payment date and the Tier D bank loan may be prepaid on the anniversary
date of the loan starting December 2003.
Concurrently, deCODE entered into a cross-currency swap as an economic hedge
against foreign exchange rate fluctuations that may occur on the Tier C bonds.
This contract with a face amount of $7.3 million expires in March 2007 and bears
annual interest of twelve-month LIBOR plus 6%.
PAGE 11
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
In connection with the Tier C bonds and the Tier D bank loan, deCODE issued a
warrant giving the holder the right to purchase a total of 933,800 shares of
deCODE common stock at $15.00 per share, as adjusted. The warrants expire in
March 2007 and convert into shares of deCODE common stock automatically in the
event the market value of a share of deCODE common stock should exceed $24.00
for thirty consecutive days of trading. A portion of the proceeds from the Tier
C bonds and the Tier D bank loan has been allocated to the warrant ($0.7
million) and recorded to additional paid-in capital. The resulting discount on
the Tier C bonds and the Tier D bank loan is being amortized to interest through
March 2007.
In June 2002, MediChem Research Inc. executed a mortgage for $11.8 million with
a financial institution for its Woodridge, IL discovery center. The debt carries
an interest rate of three-month LIBOR + 1.75%, is payable $49,167 monthly for
five years with a final payment of $8.8 million due in 2007. The mortgage is
collateralized by restricted cash reserves totaling $6,000,000.
LITIGATION
In January 2000, Thorsteinn Jonsson and Genealogia Islandorum hf., the alleged
holders of copyrights to approximately 100 books of genealogical information,
commenced an action against deCODE in the District Court of Reykjavik in
Iceland. They allege that deCODE's genealogy database infringes their copyrights
and seek damages in the amount of approximately 616 million Icelandic kronas and
a declaratory judgment to prevent deCODE from using the allegedly infringing
data. deCODE believes the suit is without merit and intends to defend this
action vigorously; however, the ultimate resolution of this matter cannot yet be
determined.
In February 2000, Mannvernd, an organization known as the Association of
Icelanders for Ethics in Science and Medicine, issued a press release announcing
its intention to file lawsuits against the State of Iceland and any other
relevant parties, including deCODE, to test the constitutionality of the Act. In
its press release, Mannvernd indicated that it hopes to halt the construction
and/or operation of the Icelandic Health Sector Database. In April 2001, a
lawsuit was filed against the Icelandic Directorate of Public Health but
Mannvernd has not commenced litigation against deCODE; however, the ultimate
resolution of this matter cannot yet be determined.
On or about April 20, 2002, an amended class action complaint, captioned In re
deCODE genetics, Inc. Initial Public Offering Securities Litigation (01 Civ.
11219(SAS)), alleging violations of federal securities laws was filed in the
United States District Court for the Southern District of New York on behalf of
certain purchasers of deCODE common stock. The complaint names deCODE, two of
deCODE's current executive officers (the "Individual Defendants"), and the two
lead underwriters (the "Underwriter Defendants") for our initial public offering
in July 2000 (the "IPO") as defendants.
In the amended pleading, the plaintiff alleges violations of Section 11 of the
Securities Act of 1933 and violations of Section 10(b) of the Securities
Exchange Act of 1934 (and Rule 10b-5 promulgated thereunder) against deCODE, the
Individual Defendants and the Underwriter Defendants. In addition, the amended
complaint alleges violations of Section 15 of the Securities Act of 1933, and
Section 20(a) of the Securities Exchange Act of 1934 against the Individual
Defendants. Generally, the amended complaint alleges that the Underwriter
Defendants: (i) solicited and received excessive and undisclosed commissions
from certain investors in exchange for which the Underwriter Defendants
allocated to those investors material portions of the shares of our stock sold
in the IPO; (ii) entered into agreements with customers whereby the Underwriter
Defendants agreed to allocate shares of our stock sold in the IPO to those
customers in exchange for which the customers agreed to purchase additional
shares of our stock in the aftermarket at pre-determined prices; and (iii)
improperly used their analysts, who purportedly suffered from conflicts of
interest, to manipulate the market. The amended complaint further alleges that
the prospectus incorporated into the registration statement for the IPO was
materially false and misleading in that it failed to disclose these
arrangements. The amended complaint also alleges that deCODE and the Individual
Defendants had numerous interactions and contacts with the Underwriters from
which deCODE and the Individual Defendants either knew of, or recklessly
disregarded, the Underwriters' purported wrongful acts. The suit seeks
unspecified monetary and recissionary damages and certification of a plaintiff
class consisting of all persons who purchased shares of our common stock from
July 17, 2000 to December 6, 2000.
deCODE is aware that similar allegations have been made in hundreds of other
lawsuits filed (many by some of the same plaintiff law firms) against numerous
underwriter defendants and issuer companies (and certain of their current and
former officers) in connection with various public offerings conducted in recent
years. All of the lawsuits that have been filed in the Southern District of New
York have been consolidated for pretrial purposes before Honorable Judge Shira
A. Scheindlin. The Individual Defendants have been dismissed from the action
without prejudice. Pursuant to the underwriting agreement executed in connection
with deCODE's IPO, deCODE has demanded indemnification from the Underwriter
Defendants. The Underwriter Defendants have asserted that deCODE's request for
indemnification is premature.
PAGE 12
DECODE GENETICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
deCODE believes that the allegations against deCODE and deCODE's officers are
without merit and deCODE intends to contest them vigorously. deCODE has filed a
motion to dismiss these allegations. Judge Scheindlin heard oral argument on
this motion on November 1, 2002. deCODE does not know when Judge Scheindlin will
rule on this motion. At this juncture, the litigation remains in its preliminary
stage, and deCODE cannot predict its outcome and the ultimate effect, if
any, on its financial condition. In addition, it is possible that further
lawsuits alleging substantially similar claims will be filed against deCODE and
its officers. If deCODE is required to pay significant monetary damages as a
result of such litigation, deCODE's business could be significantly harmed. Even
if such suit or suits conclude in deCODE's favor, deCODE may be required to
expend significant funds to defend against the allegations. deCODE is unable to
estimate the range of possible loss from the litigation and no amounts have been
provided for such matters in these financial statements.
RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations". SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. It requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset. deCODE is required to adopt SFAS No. 143 for fiscal
year 2003 and does not believe its adoption will have a significant impact on
its financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
SFAS No. 145 rescinds FASB Statement No. 4 (FAS 4), "Reporting Gains and Losses
from Extinguishment of Debt", the amendment to FAS 4, FASB Statement No. 64 (FAS
64), "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements", and
FASB Statement No. 44, "Accounting for Intangible Assets of Motor Carriers". In
addition, SFAS No. 145 amends paragraph 14(a) of FASB Statement No. 13,
Accounting for Leases, to eliminate an inconsistency between the accounting for
sale-leaseback transactions and certain lease modifications that have economic
effects that are similar to sale-leaseback transactions and makes several other
technical corrections to existing pronouncements. deCODE is required to adopt
FAS 145 for fiscal year 2003 and does not believe its adoption will have a
significant impact on its financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). This statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)" ("EITF 94-3"). SFAS 146 requires
that a liability for a cost associated with an exit cost liability to be
recognized at the date of an entity's commitment to an exit plan. SFAS 146 also
requires that liabilities recorded in connection with exit plans be initially
measured at fair value. deCODE is required to adopt SFAS No. 146 for exit or
disposal activities that are initiated from fiscal year 2003 and does not
believe its adoption will have a significant impact on its financial position or
results of operations.
OTHER
In February 2001, deCODE settled a payable for laboratory equipment of
$13,150,000, which amount is included in investing cash flows for the purchase
of property and equipment during the nine months ended September 30, 2001.
In 2002, deCODE completed the move to its new headquarters facility in
Reykjavik's University district. As of September 30, 2002, a portion ($0.9
million) of the amount remaining owed the contractor on the building is payable
in December 2002 and may be satisfied, according to agreed terms and at deCODE's
option, upon the issuance of deCODE common stock; the number of which will be
determined based upon the then fair market value of deCODE common stock.
deCODE has operating lease commitments for facilities that deCODE has or will be
vacating during 2002 as a result of the move to the new headquarters facility.
Management has assessed its alternatives in respect of these leased facilities,
including sub-leasing, and has recorded a provision of $0.8 million in the nine
month period ended September 30, 2002 with respect to the remaining commitments.
In May 2002, deCODE issued 141,665 shares of common stock upon the exercise of
warrants to purchase shares of common stock.
PAGE 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This Management's Discussion and Analysis of Financial Condition and Results of
Operations as of September 30, 2002 and for the three and nine-month periods
ended September 30, 2002 and 2001 should be read in conjunction with the
unaudited condensed consolidated financial statements and notes thereto set
forth in Item 1 of this report.
This quarterly report on Form 10-Q contains forward-looking statements,
including our expectations of future industry conditions, strategic plans and
forecasts of operational results. Various risks may cause our actual results to
differ materially. A list and description of some of the risks and uncertainties
is contained below and in the summary of risk factors included in Item 5 - Other
Information.
The preparation of financial statements in conformity with generally accepted
accounting principles requires us to make certain estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reported period. On an
ongoing basis we evaluate our estimates, which include, among others, those
related to collaborative arrangements, property and equipment, income taxes,
litigation and other contingencies, materials and supplies, derivatives,
intangible assets, and bad debts. We base our estimates on historical experience
and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form our basis for making judgments about
carrying values of assets and liabilities that are not readily apparent from
other sources. The impact and any associated risks related to these and our
other accounting policies on our business or operations is discussed throughout
Management's Discussion and Analysis of Financial Condition and Results of
Operations where such policies affect our reported and expected financial
results. For a detailed discussion on the application of these and other
accounting policies, please refer to our notes to the Consolidated Financial
Statements. There can be no assurance that actual results may not differ from
the estimates referred to above.
OVERVIEW
deCODE was incorporated in August 1996. We are a population genetics company
that is providing and developing a range of products and services for the
healthcare industry. Our approach to the discovery of healthcare knowledge
brings together three key types of non-personally identifiable population data
derived from the Icelandic nation: information from the healthcare system,
information about genealogical relationships among individuals covered by this
system, and molecular genetics data from participants in our research into the
genetics of common diseases.
Our business is organized according to product development offerings and
services. Our product development activities encompass our population genetics
programs aimed at creating new DNA-based diagnostics and therapeutics for common
diseases. Our services include pharmacogenomic and clinical trial services, the
newly-acquired chemistry services business of MediChem, which includes contract
work in structural biology, medicinal chemistry and scale up into the clinic, as
well as bioinformatics services including the Clinical Genome Miner and other
bioinformatics tools developed in the course of our gene and drug target
research.
We have incurred losses since our inception, principally as a result of research
and development and general and administrative expenses in support of our
operations. As of September 30, 2002 we had an accumulated deficit of $272
million. On the basis of our current range of activities, and following the
implementation in September of a plan to reduce headcount and maximize the use
of automation in our core genetics operations, we anticipate that we will be
able to achieve positive cashflow from operations by the end of 2003. At the
same time, we believe that the initiation of possible substantial new activities
within this timeframe, such as clinical trials of a drug against one of our
proprietary targets, would require additional expenditures that could delay for
some time our achievement of positive cashflow from operations. We anticipate
incurring additional net losses at least into the medium term, due to, among
other factors, depreciation and amortization, as well stock-based compensation
and other non-cash charges. We expect that our revenues and losses will
fluctuate from quarter to quarter and that such fluctuations may be substantial
especially because progress in our scientific work and milestone payments that
are related to progress can fluctuate between quarters.
We believe that current conditions in the global financial markets and in the
pharmaceutical industry pose significant near-term challenges to biotechnology
companies such as ourselves, as well as important opportunities. The principal
challenge to us posed by the downturn in the market valuations of biotechnology
companies and of the equity markets more generally is that it restricts our
present ability to raise additional capital on favorable terms. In a very broad
sense, it appears that the equity markets are currently more risk-averse than
they have been in the recent past. The markets are therefore less willing to
ascribe value to companies such as ourselves which, although developing new
technologies that may have the potential for generating successful products, are
not currently selling products on the market and are not yet profitable. This is
a general trend affecting not only the biotechnology industry but all industries
involved in developing new technologies and products that are unproven in the
marketplace. Moreover, it is not certain how long this sentiment in the equity
markets will last.
PAGE 14
In order to mitigate the risk to our product development programs posed by the
current conditions in the financial markets, we have implemented measures aimed
at preserving our cash resources. We recently implemented a plan to reduce our
staffing and overhead costs to a level that the we anticipate will make it
possible to achieve positive cashflow from operations by the end of next year.
We believe that we have sufficient cash resources to continue to fund our
current research and operations for several years, and we are also investigating
the possibility of alternative avenues of financing for our product development
programs.
At the same time, the pharmaceutical industry, which is the principal customer
base for our gene-discovery and contract chemistry businesses, is experiencing
difficulties in maintaining historical rates of growth. This presents near-term
challenges and significant longer term opportunities. One of the main
challenges facing the pharmaceutical industry is developing pipelines of
effective new drugs to treat major indications. As many leading brand-name drugs
come off patent and face generic competition, the successful new medicines will
become critical for filling the gap. In the short term, the financial pressures
on pharmaceutical companies may be reflected in their research and development
spending, making it more difficult for us to sign corporate alliances with
significant upfront funding, or lengthening the time required to negotiate such
deals. This will likely also lead to pressure on budgets for the outsourcing of
chemistry services, which are an important source of revenue for us. In the
medium to longer term, however, companies such as ours may be well positioned to
play an important role in filling the gap in the pipeline of new drugs, either
on their own or as partners of pharmaceutical companies. Our gene discovery
programs are aimed at identifying novel drug targets that are involved in the
basic biology of common diseases and we are focused on discovering new drugs
against these targets, both on our own and with major pharmaceutical partners.
Our partnerships with Roche and Merck demonstrate that the industry is already
investing in the development of new therapeutics based on our approach.
Similarly, it is possible that the pharmaceutical industry, in the interest of
reducing internal overheads, may opt to increase its outsourcing of contract
chemistry services.
Collaborations and further growth in our medicinal chemistry, pharmacogenetics
and informatics services will remain an important element of our business
strategy and future revenues. Our ability to generate revenue growth and become
profitable is dependent, in part, on our ability to enter into additional
collaborative arrangements, and on our ability and our collaborative partners'
ability to successfully commercialize products incorporating, or based on, our
work. It is also dependent on our ability to maintain and grow our service lines
of business. There can be no assurance that we will be able to maintain or
expand our existing collaborations, enter into future collaborations to develop
applications based on existing or future research agreements, sign additional
subscribers to our database services, or successfully expand our medicinal
chemistry or pharamacogenetics businesses. Our failure to successfully develop
and market products over the next several years, or to realize product revenues,
would have a material adverse effect on our business, financial condition and
results of operations. We do not expect to receive royalties or other revenues
from commercial sales of products developed using our technologies in the near
term. It may be several years before product revenues materialize, if they do at
all.
COLLABORATIONS AND ALLIANCES
In February 1998, we entered into a research collaboration and cross-license
agreement with F. Hoffmann-La Roche, or Roche, regarding research into the
genetic causes of twelve diseases. Under the terms of the agreement, Roche has
made equity investments and funded gene discovery programs in the twelve
diseases through January 2002 when the term of the agreement expired.
In June 2001, we entered into a collaboration and cross-license agreement with
Roche regarding diagnostics. Under the terms of this new agreement, we are
collaborating on the development and marketing of DNA-based diagnostics for
major diseases. We are working with Roche to identify and validate molecular
targets which are useful for developing products and services that accurately
establish a patient's current diagnosis, predict future risk of disease, predict
drug response and determine responses to treatment or the health status of
individuals and enable early prevention or treatment of disease. We will also be
focusing on developing related informatics products and services, which will
include software tools and databases. Under the agreement we will receive
payments including research funding, research milestones and royalties on any
products that are commercialized. The research term under the agreement is five
years.
In June 2001, we entered into a collaboration agreement with Genmab A/S and
Medarex, Inc. pursuant to which we are collaborating on the research,
development, and commercialization of new antibody therapeutic products. Under
this five-year collaboration, we are utilizing novel targets discovered in our
research on the genetics of common diseases along with Genmab's human antibody
technology. The collaboration covers a broad range of disease areas including
cardiovascular disease, inflammatory disease and cancer. Together with Genmab
and Medarex, we will share equally in the development costs and revenues
generated from the outlicensing or sales of products developed under the
agreement. Under the terms of this collaboration, Medarex will also contribute
resources and will share certain costs and commercial rights.
PAGE 15
In July 2001, we entered into a pharmacogenomics collaboration and license
agreement with Affymetrix, Inc. Under the terms of the agreement the parties are
collaborating in the research and development of gene expression tests and
nucleic acid based tests to predict the response of individual patients to
various drugs. We are undertaking the initial research activities to be
performed with respect to the initial ten drugs to be studied under the
collaboration. Affymetrix will supply various chips in connection with the
research. We will share revenues resulting from the collaboration, including
those from licensing and product commercialization, with Affymetrix.
In July 2001, we entered into a joint development and commercialization
agreement with Applied Biosystems Group, or ABG. Under the terms of the
agreement, we are working with ABG to jointly develop and commercialize software
products for the collection, organization and analysis of genotyping
information. The agreement provides for the development to be overseen by a
joint steering committee that has specific responsibilities for the
implementation and management of the joint development and joint
commercialization programs. Under this agreement, ABG and we have granted to
each other licenses to products developed under the joint development program.
In December 2001, we formed a pharmacogenomics alliance with Pharmacia
Corporation to identify the role of genetics in the development of advanced
forms of heart disease. Under the amended and restated agreement, we will
receive contract fees in exchange for employing our population resources and
Clinical Genome Miner discovery system to find genetic markers that can be used
to identify patients who are highly predisposed to progressing from an early to
an advanced form of heart disease.
In January 2002, we entered into a new collaboration and cross-license agreement
with Roche. This new, three-year alliance leverages our expanding capabilities
in drug discovery into developing novel treatments for common diseases. Under
this new alliance, Roche will provide research funding for a minimum of the next
two years for us to conduct downstream research in a selection of four diseases,
with the goal of using the targets identified to discover and develop new
therapeutic compounds and to take these compounds into clinical trials. Also, we
may receive development and regulatory approval milestone payments for
therapeutic drug compounds developed pursuant to the agreement as well as
royalties on Roche's sales of drugs developed under the agreement. Additionally,
we may pay Roche royalties should we develop and market drugs for certain common
diseases.
In September 2002, we entered into an alliance with Merck & Co., Inc. aimed at
developing new treatments for obesity. Under the alliance, we will combine our
research efforts in the genetics of obesity to identify, validate and prioritize
a series of drug targets to take into development. The goal of the alliance is
to accelerate the discovery of new drugs to fight obesity, a condition that now
represents one of the fastest-growing public health challenges in the
industrialized world. Under the terms of the three-year agreement, we will
receive research funding, technology access, license fees, milestone payments as
compounds developed under the alliance advance in the development process, and
royalties on successfully marketed alliance drugs.
We have a number of collaborative agreements with local medical institutions and
doctors regarding particular disease research. These agreements generally extend
for a period of five years. Under the agreements, these institutions and/or
physicians contribute data or other clinical information and we contribute
equipment, research supplies and our molecular genetics and experimental design
expertise. The agreements also require us to reimburse all project-related
expenses. If we sell project results, the agreements require us to make
specified payments and pay a portion of performance-based milestone payments
that we receive.
We have a settlement agreement with a U.S. medical institution whereby we are
committed to pay royalties and milestone payments if we are successful in
developing and commercializing products that result from a particular technology
jointly owned by the medical institution and us.
ACQUISITION OF MEDICHEM
On March 18, 2002, we acquired MediChem Life Sciences, Inc. in a stock-for-stock
exchange accounted for as a purchase transaction. The acquisition gives us
capabilities in chemistry and structural proteomics that will be used in the
implementation of its strategy of turning its targets identified by applying
population genomics to common diseases into novel drugs for the market. Building
upon the acquisition of MediChem, we will be creating an integrated
biopharmaceutical company capable of bringing our own targets into proprietary
drug discovery. Through the acquisition we added approximately 160 new employees
and facilities in Illinois and Washington.
The total consideration for the acquisition was approximately $85.9 million,
which consists of deCODE common stock issued in exchange for outstanding
MediChem common stock ($79.7 million), MediChem employee stock options assumed
($2.3 million) and estimated deCODE transaction costs ($3.9 million).
PAGE 16
We have recorded the transaction as a purchase for accounting purposes and have
allocated the purchase price, based upon independent valuations, to the assets
purchased and liabilities assumed based upon their respective estimated fair
values. We have allocated the excess of the purchase price over the estimated
fair market value of net tangible assets acquired to identified intangibles,
including developed technology, patents, customer and other contracts and
agreements that have estimated useful lives ranging from three to ten years. In
the first quarter 2002 we recorded a charge to earnings for acquired in-process
research and development amounting $0.5 million. In addition, amortization
charges for other identifiable intangibles recorded in the MediChem acquisition
will amount to approximately $1.2 million annually. Under SFAS No. 142,
resulting goodwill ($62.3 million) will not be amortized but is subject to
annual impairment testing (refer below).
Our consolidated financial statements include the cash flows and results of
MediChem from March 18, 2002. The integration of MediChem has impacted and will
continue to impact our results of operations and our financial position. With
MediChem, our revenues have increased and will increase but our operating
expenses have increased and will further increase and, at least for the near
term, likely our net losses will increase. In addition, we expect to continue to
fund the working capital needs and operating activities of MediChem in the near
term. The extent to which MediChem will ultimately impact our results of
operations and financial condition is largely dependant upon the extent that
MediChem's capacity is brought to bear on our in-house programs and how much of
their existing contract services business is maintained and developed.
Our statements of operations include the results of MediChem from March 18,
2002, the date of acquisition. The following unaudited pro forma financial
information presents our consolidated results as if the acquisition of MediChem
occurred at the beginning of 2001. Nonrecurring charges, such as the acquired
in-process research and development charge of $0.5 million is not reflected in
the following pro forma financial information but MediChem's restructuring and
impairment charges in 2001 are included. This pro forma information is not
intended to be indicative of future operating results (in millions, except per
share data).
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------
2002 2001
---------- ----------
Total revenues ................................. $ 36.0 $ 36.5
Net loss ....................................... (118.2) (85.1)
Basic and diluted net loss per share ........... (2.23) (1.62)
RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30,
2002 AND 2001
Our revenues and results of operations have fluctuated from period to period and
may continue to fluctuate in the future based upon, among other things, the
timing and composition of funding under our various collaborative agreements, as
well as the progress of our own research and development efforts and the extent
to which MediChem's capacity is brought to bear on our in-house programs.
Results of operations for any period may be unrelated to results of operations
for any other period. In addition, historical results should not be viewed as
indicative of future operating results. We are subject to risks common to
companies in our industry and at our stage of development, including risks
inherent in our research and development efforts, reliance upon collaborative
partners, development by us or our competitors of new technological innovations,
ability to market products or services, dependence on key personnel, dependence
on key suppliers, protection of proprietary technology, ability to obtain
additional financing, ability to negotiate collaborative arrangements, reliance
on the license to create and run the Icelandic Health Sector Database, and
compliance with governmental and other regulations. In order for a product to be
commercialized based on our research, we and our collaborators must conduct
preclinical tests and clinical trials, demonstrate the efficacy and safety of
our product candidates, obtain regulatory approvals or clearances and enter into
manufacturing, distribution and marketing arrangements, as well as obtain market
acceptance. We do not expect to receive revenues or royalties based on
therapeutic or diagnostic products for a period of years, if at all.
Revenues. Our revenues from research and development collaboration agreements
are recorded and recognized in accordance with the applicable performance
requirements and terms of the respective contracts either as contract research
costs are incurred, including the percentage of completion basis, or upon the
achievement of certain milestones. Such funding payments are not refundable in
the event that the related efforts are not successful. Non-refundable up-front
payments we receive are deferred and recognized on a straight-line basis over
the research term. Our contracted chemistry services revenue from negotiated
rate contracts are recognized on a per diem basis as services are rendered or on
the percentage of completion method based on the ratio of costs incurred to
expected total costs for fixed fee contracts based upon the terms of the
underlying contract. Any losses on contracts are provided for when they are
determinable and estimable. Included in revenue are billings to customers for
the cost of materials purchased for performance under the contract.
PAGE 17
Prior to January 1, 2002, we recorded all milestone payments received when
acknowledgement of having achieved applicable performance requirements was
received from the collaborator and we recognized milestone payments as revenue
on a retrospective basis over the contractual term of the underlying agreement.
We believe the milestone payment method to be a preferable method in recognizing
revenue for milestone payments made under particular contracts in that it more
closely relates to the underlying activity that results in the
revenue-generating milestone event under such contracts. Effective January 1,
2002, we changed our method of recognizing milestone revenue to the milestone
payment method for contracts where (i) the milestone event is substantive, (ii)
there is substantial effort involved in achieving the milestone, (iii) the
milestone payment amount is commensurate with the magnitude of the related
achievement, and (iv) the associated follow-on revenue streams bear a reasonable
relationship to one another. Under the milestone payment method we record
revenue when the milestone has been achieved and payment is due and payable
under the terms of the respective agreement and we recognize revenue when
acknowledgement of having achieved applicable performance requirements is
received from the collaborator. As before, milestone payments without the above
characteristics are recognized on a retrospective basis over the contractual
term of the underlying agreement.
The cumulative effect of the change in accounting principle on prior years
results $333,333 is included in income in the nine-month period ended
September 30, 2002. Had the retrospective basis of milestone revenue recognition
been continued for the nine-month period ended September 30, 2002, revenue, net
loss and basic and diluted net loss per share would have been $32.2 million,
$(113.7) million and $(2.24), respectively.
The following is a summary of deferred revenue:
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------ ------------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Revenue recorded during
the period ............. $ 13,975,608 $ 8,963,795 $ 35,025,780 $ 30,382,189
Revenue recognized during
the period ............. (8,982,073) (9,720,955) (31,878,019) (20,951,848)
Deferred revenue recorded
on acquisition of
MediChem ............... 0 0 827,403 0
Cumulative effect of change
in milestone revenue
recognition policy ..... 0 0 (333,333) 0
------------ ------------ ------------ ------------
4,993,535 (757,160) 3,641,831 9,430,341
Deferred revenue at
beginning of period .... 11,795,543 14,592,500 13,147,247 4,404,999
------------ ------------ ------------ ------------
Deferred revenue at
end of period .......... $ 16,789,078 $ 13,835,340 $ 16,789,078 $ 13,835,340
============ ============ ============ ============
Our revenues decreased to $8,982,073 for the three-month period ended September
30, 2002 as compared to $9,720,955 for the three-month period ended September
30, 2001, an decrease of 8%. Our revenues increased to $31,878,019 for the
nine-month period ended September 30, 2002 as compared to $20,951,848 for the
nine-month period ended September 30, 2001, an increase of 52%. The increase in
the nine-month period ended September 30, 2002 as compared to the same period in
2001 is attributable to the addition of deCODE's recently acquired
pharmaceuticals and biostructures groups and to the work conducted under the
joint development and commercialization agreement with ABG. The decrease in the
three-month period ended September 30, 2002 is due to there being no revenue
recognized from the joint development and commercialization agreement with ABG
under the percentage-of-completion basis of revenue recognition. The decrease in
the three-month period ended September 30, 2002 as compared to the same period
in 2001 is also due to that fact but also reflects the recognition of revenue
from milestone achievements under the 1998 research collaboration with Roche
during 2001. We are evaluating our collaboration with ABG. Depending upon the
outcome of our evaluation, we may not recognize ABG collaboration revenue in the
future to the extent or in the manner that we have in the past. In addition, we
expect that our revenues will fluctuate from quarter to quarter and that such
fluctuations may be substantial especially because progress in our scientific
work, including milestone payments that are related to progress, can fluctuate
between quarters.
PAGE 18
At September 30, 2002, the total amount of deferred research revenue that will
be recognized in future periods aggregated $16,789,078. Revenues recorded
increased to $13,975,608 for the three-month period ended September 30, 2002 as
compared to $8,963,795 for the three-month period ended September 30, 2001 and
increased to $35,025,780 for the nine-month period ended September 30, 2002 as
compared to $30,382,189 for the nine-month period ended September 30, 2001. We
recorded significant revenues in the three and nine-month periods ended
September 30, 2001 principally as a result of the then new diagnostics
collaboration with Roche and also milestone achievements under our 1998 research
collaboration with Roche. Revenue recorded in the three-month period ended
September 30, 2002 notably includes access fees and research funding under the
alliance with Merck. Work completed under the joint development and
commercialization agreement with ABG and under the therapeutics and diagnostics
collaborations with Roche largely account for the remainder of revenues recorded
to-date in 2002.
Research and Development Expenses. Our research and development expenses
increased to $23,466,980 for the three-month period ended September 30, 2002 as
compared to $16,836,656 for the three-month period ended September 30, 2001, an
increase of 39%. Our research and development expenses increased to $64,679,878
for the nine-month period ended September 30, 2002 as compared to $53,384,144
for the nine-month period ended September 30, 2001, an increase of 21%. The
change period-to-period is largely attributable to the addition of our
newly-acquired pharmaceutical and biostructures groups from March 2002 and
atypical charges in the nine-month period ended September 30, 2001 for
consumables in support of, among other things, our then new ABI Prism 3700 DNA
Analyzers and the disposal of laboratory equipment. Without regard to costs
attributed to our pharmaceutical and biostructures groups in the three and
nine-month periods ended September 30, 2002 and to atypical charges in the
nine-month period September 30, 2001 our research and development expenditures
have increased 20% and 25% in the three and nine-month periods ended September
30, 2002 as compared to the same periods in 2001. The increases reflect spending
related to the range of our disease-gene research programs and the initiation of
downstream work on targets already identified.
Selling, General and Administrative Expenses. Our selling, general and
administrative expenses increased to $5,925,274 for the three-month period ended
September 30, 2002 as compared to $2,830,965 for the three-month period ended
September 30, 2001, an increase of 109%. Our selling, general and administrative
expenses increased to $15,292,164 for the nine-month period ended September 30,
2002 as compared to $9,561,812 for the nine-month period ended September 30,
2001, an increase of 60%. The change period-to-period is largely attributable to
the addition of selling, general and administrative costs of our pharmaceutical
and biostructures groups offset somewhat by a one-time litigation settlement for
the three and nine-month periods ended September 30, 2001. Without regard to the
additional costs attributed to our pharmaceutical and biostructures groups in
the three and nine-month periods ended September 30, 2002 and to the litigation
settlement during the nine-month period ended September 30, 2001, our general
and administrative expenses increased 26% and 17% in the three and nine-month
periods ended September 30, 2002, respectively as compared to those same periods
in 2001 largely as a result of expanded sales efforts across our businesses and
contractor services.
Stock-Based Compensation and Remuneration. Stock-based compensation and
remuneration expense was $731,479 for the three-month period ended September 30,
2002 as compared to $1,162,675 for the three-month period ended September 30,
2001, a decrease of 37%. Stock-based compensation and remuneration expense was
$2,488,952 for the nine-month period ended September 30, 2002 as compared to
$3,515,302 for the nine-month period ended September 30, 2001, a decrease of
29%. With little compensation being attributed to our more recent stock option
grants, stock-based compensation and remuneration expense has been decreasing as
grants made to employees in earlier years become fully vested. Historical
stock-based compensation and remuneration is not necessarily representative of
the effects on reported income or loss for future years due to, among other
things, the vesting period of the stock options, the value of stock options that
have been granted in recent times and the value of additional options that may
be granted in future years.
Impairment, Employee Termination Benefits and Other Costs. In September of 2002,
we implemented a cost reduction program aimed at achieving positive operating
cashflow from existing operations by the end of 2003. In this regard, we reduced
total worldwide headcount by approximately 200 employees during the three-months
ended September 30, 2002, focusing in particular on utilizing ongoing process
automation and increased productivity in the core genetics operations in
Reykjavik. Stemming from this initiative and together with our consideration of
significant and pervasive declines in the market environment for pharmaceutical
and biotech industries, we determined that impairment tests of the carrying
value of our goodwill and other long-lived assets, including the long-lived
assets acquired through the MediChem acquisition, should be performed as of
September 30, 2002. We have completed these tests and recorded the following
impairment, employee termination benefits and other charges during the three and
nine-month periods ended September 30, 2002:
Employee termination benefits...................$ 2,157,713
Impairment of goodwill.......................... 53,400,000
Impairment of property and intangible asset..... 2,715,000
Write-down of assets held for sale.............. 2,706,379
Write-down of equipment......................... 2,052,753
Obsolete and excess materials and supplies...... 1,758,439
-----------
$64,790,284
===========
PAGE 19
Charges related to termination benefits for 132 employees are accrued and
unpaid as of September 30, 2002 and are expected to be settled in cash over the
next 6 months.
For purposes of the goodwill impairment tests, we identified our reporting
units, identified the assets and liabilities of the reporting units and
performed impairment tests on the net goodwill associated with them. Goodwill
that resulted from the acquisition of MediChem was assigned to the reporting
units based upon expectations of synergies to be gained from the integration of
the pharmaceutical and biostructures groups with the overall group. Goodwill
impairment is deemed to exist if the net book value of a reporting unit exceeds
its estimated fair value. To identify potential impairment, we compare fair
value of a reporting unit with its carrying amount, including goodwill. For this
purpose, we estimate fair value of a reporting unit using analyses of comparable
companies and recent comparable transactions. In measuring the amount of
impairment loss, we compare the implied fair value of a reporting unit's
goodwill with the carrying amount of that goodwill, estimating the fair value of
an impaired reporting unit using discounted cash flow methodologies. The
goodwill impairment charge is associated solely with goodwill resulting from the
acquisition of MediChem and results largely from significant and pervasive
declines in the market environment for the pharmaceutical and biotech industries
impacting, among other things, market valuations of companies operating in those
industries.
In September 2002, we committed to a plan to sell our Woodridge Discovery
Center and an agent was engaged and has initiated an active marketing program
to locate a buyer/investor in a sale and leaseback transaction. The sale and
leaseback transaction is expected to be completed by the early part of 2003.
Taking into account the estimated selling price of the building less estimated
costs to sell, we recorded an impairment charge in the three and nine-month
periods ended September 30, 2002 amounting to $2.1 million. In addition,
certain intangible assets amounting to $0.6 million were determined to be
impaired utilizing a discounted cashflow methodology to estimate fair value.
In September 2002, we committed to a plan to sell our former headquarters
facility that had been vacated in connection with the move to our new
headquarters facility in Reykjavik's University district earlier in the year.
In October 2002, an agent for the sale was engaged and an active marketing
program to locate a buyer was initiated. In November 2002, terms of sale were
agreed with a buyer in the amount of $2.8 million, that is contingent on
buyer-financing. Taking into account the expected selling price of the building
less estimated costs to sell, we wrote-down the property in the three and
nine-month periods ended September 30, 2002 amounting to $2.7 million. The
remaining carrying value of the building ($2.7 million) is classified as an
asset held for sale in the September 30, 2002 consolidated balance sheet.
Ongoing process automation and increased productivity in the core genetics
operations in Reykjavik and changes in some of our target research programs have
affected our planned volume and timing of usage of its materials and supplies.
In this connection, we have recorded an additional provision for excess and
obsolete inventory in the three and nine-month periods ended September 30, 2002.
Additionally, in September 2002 we wrote-down the value of certain laboratory
equipment no longer in use.
Interest Income. Our interest income was $711,658 for the three-month period
ended September 30, 2002 as compared to $1,514,099 for the three-month period
ended September 30, 2001, a decrease of 53%. Our interest income was $2,269,225
for the nine-month period ended September 30, 2002 as compared to $6,037,700 for
the nine-month period ended September 30, 2001, a decrease of 62%. In general,
the decreased returns are attributable to the decline of prevailing interest
rates but also from an overall decrease in the amount of our cash.
Interest Expense. Our interest expense was $812,072 for the three-month period
ended September 30, 2002 as compared to $101,496 for the three-month period
ended September 30, 2001. Our interest expense was $2,422,044 for the nine-month
period ended September 30, 2002 as compared to $283,985 for the nine-month
period ended September 30, 2001. The increases in interest expense reflect the
cost of financings put into place during the late part of 2001 and early part of
2002.
Other non-operating income and (expense), net. Our other non-operating income
and (expense), net was $(393,404) for the three-month period ended September 30,
2002 as compared to $(333,360) for the three-month period ended September 30,
2001, and was $(1,016,188) for the nine-month period ended September 30, 2002 as
compared to $(1,005,297) for the nine-month period ended September 30, 2001. Our
other non-operating income and (expense), net is principally comprised of our
share in the earnings (losses) of eMR and foreign exchange differences. The
weakening of the U.S dollar vis-a-vis the Icelandic krona during 2002 has been
significant and these currency fluctuations may continue to adversely affect our
financial results.
PAGE 20
Income Taxes. As of September 30, 2002, we had an accumulated deficit of $272
million and did not owe any Icelandic or U.S. federal income taxes nor did we
pay any in the three and nine-month periods ended September 30, 2002 or 2001.
Realization of deferred tax assets is dependent on future earnings, if any. As
of December 31, 2001, we had net operating losses able to be carried forward for
U.S. federal income tax purposes of approximately $4.1 million to offset future
taxable income in the United States that expire at various dates through 2021.
Also, as of December 31, 2001 our foreign subsidiaries had net operating loss
carryforwards of approximately $22.0 million that expire in varying amounts
beginning in 2004.
Net Loss and Basic and Diluted Net Loss Per Share. Net loss and basic and
diluted net loss per share were $85,694,283 and $1.61 for the three-months ended
September 30, 2002, respectively, as compared to $8,867,423 and $0.20 for the
three-months ended September 30, 2001, respectively. Net loss and basic and
diluted net loss per share were $113,719,981 and $2.24 for the nine-months ended
September 30, 2002, respectively, as compared to $37,245,690 and $0.84 for the
nine-months ended September 30, 2001, respectively. The increases in net loss
and basic and diluted net loss per share are primarily attributable to the
impairment, employee termination benefits and other charges recorded in the
three and nine-month periods ended September 30, 2002 offset in part by the
higher average number of shares outstanding for the 2002 periods. The
difference in the average number of shares outstanding is the result of our
acquisition of MediChem in March 2002.
Pro Forma Net Loss and Basic and Diluted Net Loss Per Share. Net loss and basic
and diluted net loss per share were $85,694,283 and $1.61, respectively, for the
three months ended September 30, 2002 as compared to pro forma net loss and
basic and diluted net loss per share calculated assuming our new milestone
revenue recognition method is applied retroactively of $9,721,590 and $0.22,
respectively, for the three-months ended September 30, 2001. Net loss and basic
and diluted net loss per share were $113,719,981 and $2.24, respectively, for
the nine-months ended September 30, 2002, as compared to pro forma net loss and
basic and diluted net loss per share calculated assuming our new milestone
revenue recognition method is applied retroactively of $39,162,357 and $0.89,
respectively, for the nine-months ended September 30, 2001.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations primarily through funding from collaborative
agreements and the issuance of equity securities and debt instruments. From the
beginning of 1999 to-date, we have received cash of approximately $88 million
from collaborative research agreements, $183 million from the issuance of common
stock, $79 million from the issuance of preferred stock and warrants, and $64
million from privately placed bonds, bank loans and equipment financing. To-date
we have received approximately $79 million in research and development funding
from Roche. As of September 30, 2002 future funding under terms of our existing
agreements is approximately $64 million excluding milestone payments and
royalties that we may earn under such collaborations.
Cash and Cash Equivalents. As of September 30, 2002, we had $98.9 million in
cash and cash equivalents. Available cash is invested in accordance with our
investment policy's primary objectives of liquidity, safety of principal and
diversity of investments. Our cash is deposited only with financial institutions
in Iceland, the United Kingdom and the United States having a high credit
standing. This cash is largely invested in U.S. dollar denominated money market
and checking accounts and also in Icelandic krona denominated accounts.
Operating Activities. Working capital needs resulted in the net use of $5.2
million of funds in the nine-month period ended September 30, 2002 as compared
to $11.0 million that was provided by working capital sources in the nine-month
period ended September 30, 2001. On account of this and significant non-cash
impairment and other charges in the nine-month period ended September 30, 2002,
although net loss increased $76.5 million for the nine-month period ended
September 30, 2002 as compared to the nine-month period ended September 30,
2001, net cash used in operating activities increased $30.3 million in the
nine-month period ended September 30, 2002 as compared to the nine-month period
ended September 30, 2001. Notably, in the nine-month period ended September 30,
2002 we made significant payments to our vendors and particularly to ABG for
reagents, other supplies and DNA analyzers. On the basis of our current range of
activities, and following the implementation in September of a plan to reduce
headcount and maximize the use of automation in our core genetics operations, we
anticipate that we will be able to achieve positive cashflow from operations by
the end of 2003. At the same time, we believe that the initiation of possible
substantial new activities within this timeframe, such as clinical trials of a
drug against one of our proprietary targets, would require additional
expenditures that could delay for some time our achievement of positive cashflow
from operations.
Investing Activities. Our investing activities have consisted of capital
expenditures and long-term strategic equity investments in, and acquisitions of,
technologies and businesses that are complementary to our business. Purchases of
property and equipment during the nine-month period ended September 30, 2002
were $14,065,407 as compared to $37,159,254 in the nine-month period ended
September 30, 2001. Notably, during the nine-month period ended September 30,
2002 we expended $5.7 million in respect of the new building to house our
operations in the University District of Reykjavik and purchased new DNA
analyzers under our supply agreement with ABG in the total amount of $2.8
million. During the nine-month period ended September 30, 2001 we expended $15.2
million in respect of our new headquarters building and we paid $13.1 million
for DNA analyzers acquired late in 2000. Cash acquired in the purchase of
MediChem was $3.3 million and we paid $3.9 million of transaction costs,
resulting in a net
PAGE 21
cash outlay for the nine-month period ended September 30, 2002 in connection
with the acquisition of $570,511. Net cash used in investing activities may in
the future fluctuate significantly from period to period due to the timing of
our capital expenditures and other investments.
Financing Activities. Net cash of $2,909,562 was provided in financing
activities in the nine-month period ended September 30, 2002 as compared to
$971,948 used in the nine-month period ended September 30, 2001. $14 million of
cash that was restricted as of December 31, 2001 was provided in the nine-month
period ended September 30, 2002 in the final financing (Tiers C and D) of our
new headquarters facility. In addition, we repaid the existing mortgage on our
Woodridge, IL discovery center ($11.9 million) and re-financed the property in
June 2002, resulting in proceeds of $5.8 million. Installment payments on
capital lease obligations have increased with new financings that were put into
place during 2001. Total capital lease payments were $4,110,976 for the
nine-month period ended September 30, 2002 as compared to $1,303,505 for the
same period in 2001. We expect to continue to finance future property and
equipment purchases through similar such leasing arrangements.
In December 2001, we established a $27.5 million bridge loan with an Icelandic
financial institution to finance the construction of our new headquarters
facility. We repaid the borrowings under the bridge loan in January and March
2002 with the proceeds from our Tier A $13.5 million bond offering, Tier C $7.3
million offering of privately placed bonds and Tier D $6.7 bank loan.
The Tier A bonds are denominated in Icelandic krona and are linked to the
Icelandic Consumer Price Index. The principal amount is payable annually
beginning December 2002. The Tier A bonds bear annual interest of 8.5% that is
payable annually beginning December 2002. The Tier C bonds are denominated in
Icelandic krona and are linked to the Icelandic Consumer Price Index. The
principal amount is payable in March 2007. The Tier C bonds bear annual interest
of 12.0% that is payable beginning March 2003. The Tier D bank loan is
denominated in U.S. dollars. The principal amount is payable in March 2007. The
Tier D bank loan bears annual interest of three-month LIBOR plus 6.0% that is
payable quarterly beginning June 2002. Tier C bonds may be prepaid at each
interest payment date and the Tier D bank loan may be prepaid on the anniversary
date of the loan starting December 2003.
In connection with the Tier C bonds and the Tier D bank loan, we issued a
warrant giving the holder the right to purchase a total of 933,800 shares of our
common stock at $15.00 per share, as adjusted. The warrants expire in March 2007
and convert into shares of our common stock automatically in the event the
market value of a share of our common stock should exceed $24.00 for thirty
consecutive days of trading.
In June 2002, we executed a mortgage with a financial institution for our
Woodridge, IL discovery center. The debt carries an interest rate of three-month
LIBOR + 1.75%, matures in 2007 and is collateralized by restricted cash reserves
totaling $6,000,000.
General. Following the implementation in September of a plan to reduce headcount
and maximize the use of automation in our core genetics operations and based
upon current plans, we believe that our existing resources will be adequate to
satisfy our capital needs for several years. Our cash requirements depend on
numerous factors, including our ability to obtain new research collaboration
agreements, to obtain subscription and collaboration agreements for the database
services; to obtain and maintain contract service agreements in our chemistry
services and clinical research trials groups; expenditures in connection with
alliances, license agreements and acquisitions of and investments in
complementary technologies and businesses; competing technological and market
developments; the cost of filing, prosecuting, defending and enforcing patent
claims and other intellectual property rights; the purchase of additional
capital equipment, including capital equipment necessary to ensure that our
sequencing and genotyping operations remain competitive; and capital
expenditures required to expand our facilities. Changes in our research and
development plans, the entry into clinical trials of a drug based on our
discoveries, or other changes affecting our operating expenses may result in
changes in the timing and amount of expenditures of our capital resources.
We will require significant additional capital in the future, which we may seek
to raise through further public or private equity offerings, additional debt
financing or added collaborations and licensing arrangements. No assurance can
be given that additional financing or collaborations and licensing arrangements
will be available when needed, or that if available, will be obtained on
favorable terms. If adequate funds are not available when needed, we may have to
curtail operations or attempt to raise funds on unattractive terms.
RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. It requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset. We are required to adopt SFAS No. 143 for fiscal year
2003 and we do not believe its adoption will have a significant impact on our
financial position or results of operations.
PAGE 22
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
SFAS No. 145 rescinds FASB Statement No. 4 (FAS 4), "Reporting Gains and Losses
from Extinguishment of Debt", the amendment to FAS 4, FASB Statement No. 64 (FAS
64), "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements", and
FASB Statement No. 44, "Accounting for Intangible Assets of Motor Carriers".
In addition, SFAS No. 145 amends paragraph 14(a) of FASB Statement No. 13,
Accounting for Leases, to eliminate an inconsistency between the accounting for
sale-leaseback transactions and certain lease modifications that have economic
effects that are similar to sale-leaseback transactions and makes several other
technical corrections to existing pronouncements. We are required to adopt FAS
145 for our fiscal year 2003 and we do not believe its adoption will have a
significant impact on our financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," or SFAS 146. This statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)," or EITF 94-3. SFAS 146 requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. EITF 94-3 allowed for an exit cost
liability to be recognized at the date of an entity's commitment to an exit
plan. SFAS 146 also requires that liabilities recorded in connection with exit
plans be initially measured at fair value. We are required to adopt SFAS No. 146
for exit or disposal activities that are initiated from fiscal year 2003 and do
not believe its adoption will have a significant impact on our financial
position or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary objective of our investment activities is to preserve principal
while maximizing income we receive from our investments without significantly
increasing risk. Some of the securities in our investment portfolio may be
subject to market risk. This means that a change in prevailing interest rates
may cause the market value of the investment to fluctuate. For example, if we
hold a security that was issued with a fixed interest rate at the
then-prevailing rate and the prevailing interest rate later rises, the market
value of our investment will probably decline. To minimize this risk in the
future, we intend to maintain our portfolio of cash equivalents and short-term
investments in a variety of securities, including commercial paper, money market
funds and government and non-government debt securities. In general, money
market funds are not subject to market risk because the interest paid on such
funds fluctuates with the prevailing interest rate. As of September 30, 2002,
all of our cash and cash equivalents were in money market and checking accounts.
We are exposed to market risks from changes in foreign currency exchange rates,
interest rates and investment prices. These changes may adversely affect our
operating results and financial condition. We seek to manage these risks through
regular operating and financing activities and, when deemed appropriate, through
the use of derivative financial instruments. We control and manage foreign
exchange risk, interest rate risk, and investment price risk by continually
monitoring changes in key economic indicators and market information.
As a consequence of the nature our business and operations our reported
financial results and cash flows are exposed to the risks associated with
fluctuations in the exchange rates of the U.S. dollar, the Icelandic krona and
other world currencies. We continue to monitor our exposure to currency risk but
have not yet purchased instruments to hedge these general risks through the use
of derivative financial instruments.
We hold various interest rate sensitive assets and liabilities to manage the
liquidity and cash needs of our day-to-day operations. As a result, we are
exposed to risks due to changes in interest rates. In order to mitigate risks
associated with interest rate sensitive liabilities we use interest rate
derivative instruments, such as cross currency interest rate swaps, and may in
future use other instruments to achieve the desired interest rate maturities and
asset/liability structures.
We are exposed to credit (or repayment) risk, as well as market risk from the
use of derivative instruments. If the counterparty fails to fulfill its
performance obligations under a derivative contract, our credit risk will equal
the positive market value in a derivative. Consequently, when the fair market
value of a derivative contract is positive, this indicates that the counterparty
owes us, thus creating a repayment risk for us. When the fair market value of a
derivative contract is negative, we owe the counterparty and therefore, assume
no repayment risk.
In order to minimize the credit risk in derivative instruments, we enter into
transactions with high quality counterparties such as financial institutions
that satisfy our established credit approval criteria. We review the credit
ratings of such counterparties on a regular basis.
PAGE 23
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Within the 90 days prior
to the date of this Quarterly Report on Form 10-Q, our Chief Executive Officer
and our Chief Financial Officer evaluated the effectiveness of deCODE's
disclosure controls and procedures as defined in Rule 13a-14(c) under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). Based upon
that evaluation, the Chief Executive Officer and the Chief Financial Officer
have concluded that deCODE's current disclosure controls and procedures are
adequate and effective to ensure that information required to be disclosed in
the reports deCODE files under the Exchange Act is recorded, processed,
summarized and reported on a timely basis.
(b) Changes in internal controls. There have been no significant changes in
deCODE's internal controls or in other factors that could significantly affect
internal controls subsequent to the date of their evaluation by the Chief
Executive Officer and the Chief Financial Officer.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There