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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
MARK ONE
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NO. 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
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
STURLUGATA 8, REYKJAVIK, ICELAND
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
+ 354-570-1900
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
None None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.001 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has 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 for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Act). Yes [X] No [ ]
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant, based on the closing price of the common
stock ($4.68 per share), as of June 28, 2002, was $217,747,123.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of March 1, 2003.
CLASS NUMBER OF SHARES
----- ----------------
Common Stock, $.001 par value 53,566,682
DOCUMENTS INCORPORATED BY REFERENCE
The Proxy Statement to be filed with respect to the 2003 Annual Meeting of
Stockholders is incorporated by reference into Part III.
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PART I
ITEM 1. BUSINESS
OVERVIEW
Based in Reykjavik, Iceland, deCODE is a population genetics company
developing drugs and DNA-based diagnostics based upon its discoveries in the
inherited causes of common diseases. Our population approach and resources have
enabled us to isolate genes and targets directly involved in the development of
many of the biggest challenges to public health. We are focused on turning these
findings into a pipeline of products which we believe will be able to combat the
causes of disease, not just the signs and symptoms.
Our business is divided into two components: products and services. Our
primary product focus is on the discovery and commercialization of novel
therapeutics designed against targets identified in our population-based gene
discovery work. Through the acquisition in 2002 of MediChem Life Sciences and
its subsidiary, Emerald BioStructures, now our pharmaceuticals and biostructures
groups, we have integrated capabilities for applying genetics findings to the
development of drugs, both through our own programs and in alliance with
corporate partners. We are also applying the links we have identified between
genetic factors and disease to create DNA-based diagnostic and pharmacogenomic
tests. We believe that such tests will become a standard part of healthcare
within the coming decade, making it possible to gauge individual predisposition
to particular illnesses and to design effective prevention strategies; to
complement traditional clinical diagnosis; and to identify patients who are
likely to respond or not respond to particular drugs. We are also marketing
software systems we have developed for making correlations between genetic
variation and disease and drug response.
Our service offerings include contract service businesses in drug discovery
and medicinal chemistry, through our Chicago-based pharmaceuticals group;
three-dimensional protein crystallography products and contract services,
through our Seattle-based biostructures group; pharmacogenomics and clinical
trials services, through our wholly-owned subsidiary Encode; database services,
through subscriptions to our Clinical Genome Miner(TM) system integrating
anonymized population data on disease, genotypes and genealogy; and genotyping
services through our genotyping laboratory in Reykjavik.
In Iceland, we have comprehensive population resources that enable our
scientists to efficiently conduct genome- and population-wide scans to identify
key genes and gene variations contributing to complex diseases. These include a
computerized genealogy database covering the entire Icelandic population and
going back as far as 1100 years to the settlement of the country; genotypic and
disease data from more than 90,000 volunteer participants in more than 50
different disease programs; one of the highest-throughput genotyping facilities
in the world; and statistical algorithms and software programs for rapidly
analyzing data from large numbers of individuals to identify genetic factors
that correlate with disease. As of late 2002, we had mapped genes involved in
more than two dozen common diseases and we are applying our discovery of key
genes, disease pathways and drug targets to the development of drugs and
diagnostics in many of these.
Along with our in-house programs in drug discovery and DNA-based diagnostic
development, we have formed corporate alliances across our business. Our
partners include Roche, Merck, Roche Diagnostics, IBM, Pharmacia, Wyeth, and
Affymetrix.
In this report, references to we or us refer to deCODE genetics, Inc., our
wholly-owned subsidiary, Islensk erfdagreining ehf., and its wholly-owned
subsidiaries, including Encode ehf., an Icelandic private limited company. After
the closing of the acquisition of MediChem Life Sciences Inc. (MediChem) on
March 18th 2002 we or us also refers to MediChem, a wholly owned subsidiary of
deCODE genetics, Inc., and to MediChem's wholly owned subsidiaries, including
Emerald BioStructures. Dollar amounts are in thousands except share and per
share amounts, unless otherwise noted.
deCODE was incorporated in Delaware in 1996. Our internet address is
www.decode.com. We make available free of charge through our internet website
our annual reports on Form 10-K, our quarterly reports on Form 10-Q, our current
reports on Form 8-K and amendments to these reports filed or furnished pursuant
to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as
reasonably practicable after we electronically file such material with the
Securities and Exchange Commission.
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PRODUCTS
The products we are developing include drugs, DNA-based diagnostic tests,
pharmacogenomic tests, and bioinformatics systems. Our drug and diagnostic
development programs are based upon genes and related targets we have identified
through our population genetics research in some 50 common diseases. We believe
that these diseases represent large market opportunities for therapeutic and
diagnostic products because their causes are not fully understood; current
treatments are of limited effectiveness; there are currently no approaches to
tailor treatment to cause; and large numbers of individuals are affected by
these diseases.
Through the discovery of the principal genetic factors that predispose
certain people to disease, we are able to gain an understanding of the key
biological mechanisms involved in disease processes. Targets within the disease
pathways can be used to develop DNA-based diagnostics for gauging disease
predisposition, and to discover therapeutic compounds that may be able to
disrupt the disease process by counteracting the basic mechanisms of disease.
Utilizing our integrated population data and genotyping capabilities, we are
able to efficiently conduct genome and population-wide scans for the inherited
causes of disease in a virtually hypothesis-free manner.
We are pursuing the commercial development of our gene- and drug-target
discovery programs through the development and marketing of drugs, DNA-based
diagnostics, pharmacogenomic tests, and bioinformatics systems we have developed
for making correlations between genetic variation and disease. We are pursuing
this strategy through the application of our own resources to turn discoveries
from our internal projects into therapeutic or diagnostic products and
developing our own marketing capabilities; by licensing our discoveries to
others who will be required to pay us royalties on sales of any products
developed using the results of our gene discovery programs; and by entering into
collaborative arrangements for the development and marketing of products from
these programs.
Our acquisition in early 2002 of MediChem Life Sciences and Emerald
BioStructures is a central element in our strategy to transform deCODE from a
company focused on gene discovery into a biopharmaceutical company capable of
creating and capturing the greatest possible value from its discovery
capabilities. The acquisition has benefited us in three ways: enabling us to
advance our in-house programs in drug discovery; enabling us to negotiate much
more favorable terms in our alliances with pharmaceutical companies, in which we
take our discoveries much further down the drug development process and receive
a more significant share of revenues from sales of products that are developed;
and providing us with a service business generating revenue in the short term
and maintaining the infrastructure for conducting drug discovery work on several
programs at once. At present, our pharmaceuticals group is focused mainly on
conducting work on our targets in collaboration with our corporate partners and
on drug discovery work for our fee-for-service customers.
GENE DISCOVERY
Our product development begins with gene discovery. We believe that we have
an unrivalled track record in the identification of the inherited components of
common diseases, and through these discoveries we are identifying novel markers
for diagnostics and targets for drug development. A detailed description of our
population approach to gene discovery can be found in the section "Population
approach and resources" below, and a brief description of some of our discovery
programs and achievements follows here.
Autoimmune Diseases. We are currently studying autoimmune diseases such as
atopy, inflammatory bowel disease (Crohn's and ulcerative colitis),
insulin-dependent diabetes, psoriasis, rheumatoid arthritis and ankylosing
spondilytis. We have located genes in atopy, psoriasis and psoriatic arthritis,
and rheumatoid arthritis.
Cardiopulmonary Diseases. We are studying a variety of common
cardiovascular conditions, and have identified novel genes in stroke, myocardial
infarction (heart attack), hypertension (high blood pressure), and peripheral
arterial occlusive disease (PAOD). We have mapped genes in asthma and chronic
obstructive pulmonary disease (COPD).
Central Nervous System Diseases. We are studying the genetic basis for
psychiatric and central nervous system diseases including Alzheimer's disease,
anxiety, bipolar disease/depression, familial essential tremor,
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multiple sclerosis, Parkinson's disease, schizophrenia, autism, attention
deficit and hyperactivity disorder, dyslexia, restless leg syndrome, and
migraine. We have identified a strong link between schizophrenia and the
Neuregulin 1 gene and confirmed this link in association studies in other
populations. We have mapped genes in Alzheimer's disease, Parkinson's disease,
anxiety disorder and depression, and familial essential tremor.
Metabolic and Other Diseases and Conditions. We have isolated genes in
osteoarthritis, osteoporosis and non-insulin-dependent diabetes (NIDDM), and
have mapped genes in obesity, familial combined hyperlipidemia, and longevity.
We are also studying nocturnal enuresis.
Eye Disease. We are studying a range of eye diseases, including macular
degeneration and myopia. We have mapped a gene linked to macular degeneration.
Women's Health. We are studying the genetic causes of women's health
problems including endometriosis and pre-eclampsia. We have mapped a
susceptibility gene for pre-eclampsia to chromosome 2p13.
Cancer. We are conducting research in many forms of cancer, including lung
cancer, melanoma, renal cancer, colon cancer, testicular cancer, thyroid cancer,
and prostate cancer. We have mapped a gene linked to benign prostatic
hypertrophy.
AN EXAMPLE OF OUR APPROACH: SCHIZOPHRENIA
Our work in schizophrenia offers one concrete example of how our population
genetics approach is pointing the way towards the development of new, more
effective drugs targeting the root biological causes of disease.
Schizophrenia is a chronic and progressive mental illness affecting between
0.5 and 1.0 percent of the adult population worldwide. Patients frequently
suffer from delusions, hallucinations, and blunted emotions, and current
treatments are effective only in alleviating some of these symptoms.
Our scientists established the link between schizophrenia and the
Neuregulin 1 gene, located on the short arm of chromosome 8, through the
analysis of detailed genotypic data from more than 800 volunteer patients and
unaffected relatives from across Iceland. By analyzing this data in the context
of our nationwide genealogy database, we were able to home in on a particular
haplotype -- a small segment of DNA that is inherited as a unit -- within
Neuregulin 1 that confers more than twice the average risk for developing
schizophrenia. Data from association studies in Western European and Asian
populations have confirmed the significant role of this and related haplotypes
in schizophrenia in other populations. The findings are further supported by at
least five previous international studies that offered suggestive linkage
between schizophrenia and the region on the short arm of chromosome 8 containing
the Neuregulin 1 gene.
Our subsequent functional studies in mice offer compelling additional
evidence for the involvement of the Neuregulin 1 pathway in some of the major
biological dysfunctions involved in schizophrenia. Neuregulin 1 is critical to
the proper transmission of messages within the central nervous system and to the
plasticity of neurons, an important factor in the way brain responds and adapts
to experience and stimuli in the environment. Our scientists analyzed mice in
which certain segments of the Neuregulin 1 or of one of its key receptors, ERB4,
were knocked out, and found that the knockout mice exhibited behaviors and
disruptions in normal neurotransmission similar to those seen in schizophrenics.
Using key proteins in the Neuregulin 1 pathway as drug targets, we are now
working to discover new compounds that can help to correct the biological
dysfunctions behind schizophrenia and thereby more effectively treat the
disease. We have performed a high-throughput screen against one promising target
to identify potentially useful therapeutic compounds. Under our alliance with
Roche, we are continuing drug discovery work on the initial results from our
compound screening at our Chicago-based pharmaceuticals group.
DRUG DISCOVERY PIPELINE
The principal goal of our gene discovery work and the main focus of our
product development strategy is to discover and bring to market new drugs to
treat common diseases. In all of the diseases for which we have isolated genes
we have identified "druggable" targets, that is, targets against which medicinal
chemists have
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proven that drugs can be made. These targets are either products of the genes
themselves or are located within the pathways we have identified through our
functional analyses of those genes.
Our most advanced drug discovery programs are in schizophrenia, stroke and
PAOD. In each case we have isolated key disease genes through our population
genetics research, conducted extensive functional work on our findings and
identified drug targets within the disease pathways. We have also conducted
high-throughput screens and identified lead series of compounds against targets
in each of these diseases, and are working on identifying lead compounds at our
pharmaceuticals group. Our schizophrenia and stroke programs are part of our
drug discovery and development alliance with Roche, while our drug discovery
program in PAOD is proprietary to deCODE. We aim to file our first
investigational new drug application (IND) from these programs in 2004.
In our target discovery work on our findings in myocardial infarction and
hypertension, we believe we may be able to bypass much of the drug discovery
process and enter directly into phase II clinical trails as early as mid-2003.
In both of these diseases, the genes we have isolated have led us to drug
targets against which drugs have already been developed for other conditions. If
we are able to license these compounds from the companies that developed them,
we would be able to eliminate the customarily lengthy process of identifying
leads and developing them into safe compounds and instead enter directly into
clinical trials to test for the efficacy of compounds in treating these
conditions.
DIAGNOSTICS
DNA-based diagnostic tests represent a key element in the development of
personalized medicine and a key additional avenue for creating value from our
gene discoveries. Since pinpointing genetic variations linked to disease
involves the identification of genetic markers of disease susceptibility, we can
apply the same findings we employ in our drug discovery efforts to the
development of diagnostics tests.
We believe that such tests will become an integral part of health care
within the next ten years. In the clinic, physicians will be able to use these
tests to diagnose disease as early and as accurately as possible, making it
possible to implement more timely and effective treatment. Moreover, by
understanding which individuals are highly predisposed towards a certain
disease, doctors may be able to assist patients in developing effective disease
prevention strategies that can help them to stay healthy. For example, a DNA-
based diagnostic test for stroke would enable individuals to find out if they
are at a particularly high risk of developing a stroke. Those who were could
work with their doctors to develop prevention strategies that could reduce the
risk of the predisposition ever developing into disease. These strategies could
include changes in diet and lifestyle, as well as the use of effective available
treatments for leading risk factors such as high blood pressure and high
cholesterol.
In 2001, we established a partnership with Roche Diagnostics to develop and
market DNA-based diagnostics for common diseases. One of our most advanced
programs is in osteoporosis, where we have identified a series of seven SNPs
(genetic variations know as single nucleotide polymorphisms) within a gene on
chromosome 20 that can be used to identify individuals who are at a nearly
threefold average increased risk of developing osteoporosis. We are also
advancing in our programs in stroke, type 2 diabetes and several other major
diseases. We hope to be able to offer our first DNA-based diagnostic test under
this alliance in 2004.
PHARMACOGENOMICS
We are developing and plan to market pharmacogenomic tests that can, by
analyzing genetic markers, identify individuals who are likely to respond well
to specific drugs. We believe that such tests will become another important
element in the realization of personalized medicine and a standard part of the
prescription process. The potential applications and benefits of this technology
are many. It may lead to tailor-made treatments, maximizing efficacy and
minimizing side effects. The use of pharmacogenomic tests may also lead to
faster and more successful clinical trials, which may reduce the time and cost
involved in developing new drugs. Similarly, such tests may enable
pharmaceutical companies to explore the use of existing compounds which may have
been abandoned as investigational drugs because they were only effective a small
subgroup of patients.
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We have two capabilities for identifying the genetic basis of drug
response. Through our wholly-owned pharmacogenomics and clinical trials
subsidiary Encode we use in vitro expression profiling to prospectively identify
responders and non-responders. In this process, we establish clinical drug
response baselines by administering a drug of interest to patients in a small
clinical trial. Specimens such as peripheral blood mononuclear cells are
obtained to develop an in vitro model of response from these patients. The
specimens are challenged with or without drug, and gene expression profiles are
derived using gene-array technology. We then apply proprietary algorithms to
select a panel of differentially expressed genes that most accurately predicts
the clinical response to the drug under investigation. We are further able to
examine these genes for polymorphisms, such as SNPs, which correlate with
responsiveness to a given drug and which can thus be used to design a DNA-based
predictive test.
We can complement this approach by using our population resources in the
same way that we would in our gene studies, but using drug response, rather than
disease, as the trait we wish to analyze. We utilize our genealogical database
and proprietary bioinformatic tools to cluster drug responders and
non-responders into extended families. Patients are genotyped to identify the
linkage between genetic variations and drug response. These results can be
combined with the results of in vitro profiling to contribute to the selection
of the most informative gene expression patterns.
As a proof of principle, we have developed an assay that can, by measuring
expression levels in a set of eight genes, predict responsiveness to
glucocorticoid treatments for asthma with an accuracy of approximately 90%.
Through our partnership with Affymetrix, we have developed accurate and
efficient assays for identifying responders and non-responders to several
popular brand-name drugs used in treating many common conditions.
INFORMATICS
We have developed statistical and data mining tools to generate, assemble
and analyze our vast sets of genealogical, disease and genotypic information. We
believe we have unique informatics tools for utilizing large datasets to
identify correlations between genetic variation and disease, and we are now
attempting to capture additional value from our investments in informatics by
commercializing these tools for use by other research organizations.
Our principal informatics product is the Clinical Genome Miner
Discovery(TM) system, which we are marketing in alliance with IBM. CGM
Discovery(TM) is a computer based application for sale to customers and which
can be used for isolating and analyzing genes and gene variations associated
with particular diseases. It includes the same interfaces, and statistical
analysis tools that we use in our gene discovery programs. The system enables
users to input their own data on disease, genotypes and genealogy and to mine
this data, in real time, for correlations. The results can then be analyzed in
the context of our annotated human and animal genome sequence data. The system
utilizes our proprietary Identity Protection System(TM), developed and employed
in Iceland through the Icelandic Data Protection Authority to securely and
automatically anonymize clinical and genetic data. We are adapting the CGM
Discovery(TM) to run on IBM servers, and plan to have the product ready to
deliver to customers in the middle of 2003.
SERVICES
Through our service offerings, we aim to generate significant near-term
revenue from the same capabilities and assets that we are employing in the
development of drugs, diagnostics and pharmacogenomics. The following is a brief
description of our service businesses.
DRUG DISCOVERY AND DEVELOPMENT
In March 2002 we acquired MediChem Life Sciences in a stock-for-stock
transaction. We did so in order to gain the advanced drug discovery and
development capabilities necessary to take our targets into proprietary
development, and thereby to maximize the value we are able to create from our
work in the genetics of common diseases. At the same time, the acquisition
provided us with MediChem's contract service business. The advantage of this for
deCODE is that it enables us to generate near-term revenue, helping to cover the
overhead cost of maintaining a substantial and integrated drug discovery
operation and thereby defraying some of the cost of pursuing our proprietary
projects.
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This business is built upon the demand by pharmaceutical and biotechnology
companies for contract chemistry services. Recent advances in genomics have
resulted in the rapid growth in the number of novel biological targets that can
be exploited for drug discovery. This has created a significant demand by
pharmaceutical and biotechnology companies for the synthesis of small molecule
drugs. Founded in 1987, MediChem, now our pharmaceuticals group, is a
full-service drug discovery technology and services company focused on using its
high-throughput integrated chemistry platform to streamline genomics-based drug
discovery and development. The group is focused on chemistry-based drug
discovery and development ranging from early-stage lead discovery and
optimization to the identification of viable synthetic routes required to
manufacture cGMP materials in quantities for pre-clinical and clinical studies.
It provides us, our partners and our contract customers with substantial
expertise in structural proteomics; lead discovery and optimization;
combinatorial, computational and medicinal chemistry; biocatalysis; analytical
and separations chemistry; chemical synthesis and scale-up; and clinical trials
management and regulatory approvals.
The customer base of our pharmaceuticals group includes large
pharmaceutical companies, biotechnology firms, and patient organizations
pursuing drug discovery for particular diseases.
PHARMACOGENOMICS AND CLINICAL TRIAL SERVICES
In November 2000, we launched Encode as a wholly owned subsidiary for
pharmacogenomics and clinical trials. In addition to conducting pharmacogenomics
work for our proprietary programs, Encode conducts pharmacogenomic studies for
contract customers, as well as clinical trials on new and existing therapeutics
for pharmaceutical companies.
We believe that one of Encode's most unique and valuable capabilities is
that for conducting pharmacogenomic analyses in parallel with clinical trials.
The ability to understand which patients are best suited for a given drug will,
in our view, provide several important potential benefits to our pharmaceutical
and biotechnology customers. These include the ability to stratify and thus
speed clinical trials, and to aid in capturing significant market share for new
products entering competitive therapeutic areas.
In all of our pharmacogenomics alliances we negotiate for the right to
participate in potential sales of tests developed using our capabilities in this
field.
CLINICAL GENOME MINER(TM)
Another of our service offerings is subscription to the Clinical Genome
Miner(TM) (CGM), a computer-based discovery system that allows users to perform
real-time analyses to study the association between variation in human genes and
human disease. The Clinical Genome Miner(TM) combines the statistical and
datamining tools of the Clinical Genome Miner Discovery(TM) system (described
above under Products: informatics) with the ability to conduct statistical
queries of deCODE's population data on genotypes, genealogy and disease. Users
can define a phenotype, conduct a genome-wide, population linkage scan using our
framework marker set, and focus on the known genes in any chromosomal region of
interest. They can also identify a gene, place it within the most detailed
genetic and physical maps of the genome available -- developed by deCODE -- and
view the population linkage correlations between the chromosomal location of the
gene and more than 30 diseases.
We believe that subscriptions to the CGM are particularly valuable to
deCODE as an element in product development alliances with major pharmaceutical
companies, such as those we have with Merck and Roche Diagnostics. We believe
that the principal value of the service lies in the ability to complement other
companies' genomics-based target development efforts, for example to
characterize and prioritize large numbers of drug and diagnostic targets whose
links to human genetics and disease may not be well understood.
CGM users' interactions with the system are confined to the query layer;
users do not have direct access to the data itself, which remains proprietary to
deCODE. We are marketing the CGM on the basis of non-exclusive, multi-year
subscriptions.
GENOTYPING
We believe that our assets and expertise in genotyping present a
significant opportunity for contract services and give us important competitive
advantages. Our population research into the genetic factors that
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contribute to common diseases involves, in the first stage, the gathering,
management and genotyping of thousands of biological samples. At our main
research facility in Reykjavik, we have one of the highest-throughput genotyping
laboratories in the world, capable of generating tens of millions of genotypes
per month. We have developed high density genetic maps which enable us to
accurately locate millions of microsatellite and SNP markers across the genome.
We also have in place efficient, automated systems for all stages of the
genotyping process, from DNA isolation to plate preparation and the generation,
storage and analysis of genotypic data.
Given the high overhead costs involved in setting up a genotyping facility
and the continued growth of applied genetics, we believe that there will be
significant demand for these services from both the industrial and academic
sectors.
POPULATION APPROACH AND RESOURCES
POPULATION GENETICS AND COMMON DISEASES
We believe that human population genetics offers a means of discovering
powerful new methods for preventing and treating common diseases.
Most of the medical care that we have today has developed through a focus
on the diagnosis of disease according to broadly accepted criteria of signs and
symptoms, and the prescription of drugs that have been shown to alleviate the
manifestations of disease once a patient has already become ill. The obvious
shortcomings of this approach are due in large measure to the fact that
relatively little has been known about the underlying biology of most of the
common diseases. These conditions -- such as stroke, heart attack, Alzheimer's
disease, asthma, osteoarthritis, to name but a few -- are common precisely
because they are complex. These diseases arise from the confluence of various
inherited and environmental factors which are present in large segments of most
societies and which, taken independently, do not generally pose any particular
risk to public health.
Genetics offers a means of unraveling this complexity and of gaining a
foothold in the biology of disease. Once the key genes and mutations that
underlie a predisposition to develop a given illness are identified, it is
possible to identify the proteins they encode, the function of these proteins or
gene products in the body, and their interaction with other proteins. In short,
it is possible to tease out the biological mechanisms and pathways of disease.
Using genetic markers and biological targets within these pathways, we believe
it is possible to develop DNA-based diagnostics that can measure predisposition
to disease and drugs that can disrupt the disease process.
We believe that deCODE's advantage in identifying genetic variations linked
to disease arises from the complexity of the task. Unlike the rarer, "simple"
genetic disorders, in which specific mutations lead directly to the development
of disease, the complexity of the common diseases means that the correlation
between any single genetic factor and the occurrence of the disease will be
statistically significant but not direct.
The fundamental question for applying genetics to improve healthcare is:
what genetic factors do people who have a given disease tend to share that
people who do not develop the disease do not? Because the genome is in essence
composed of serial bits of information, we have always approached this as an
information challenge. In order to meet this challenge it is necessary to
assemble large and detailed datasets on disease and genetic variation from as
large a group as possible -- ideally an entire population. It is also critical
to have accurate and comprehensive genealogical records. Genealogy is the only
means for systematically tracking the genetic components as they have been
passed from one generation to the next across a population.
THE ICELANDIC ADVANTAGE
We believe that the scarce resource in genetics is a population with all
three sets of data -- genealogical, genetic, and phenotypic. In Iceland, we have
brought these resources together with advanced data mining tools to create what
we believe is the world's leading gene-discovery engine for common diseases.
Iceland offers several advantages for conducting population genetics
research. These include:
Extensive Genealogies. There exist genealogical records for the entire
population, stretching from the present day back to the settlement of the
country in the ninth century.
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Relative Homogeneity. We believe that in a small and historically isolated
population such as Iceland's, the variety of genetic factors involved in any
given disease is likely to be smaller than in larger and more diverse
populations. Iceland also presents many instances of "founder" effects, in which
the principal inherited factors in a disease affecting many present day patients
can be traced back to a single individual or "founder" ancestor. These factors
simplify the task of finding and subsequently understanding the disease genes
and mutations causing common diseases.
Sufficient but Manageable Size. The Icelandic population, which numbers
approximately 280,000, is small enough to make feasible population-wide studies
of the genetics of common diseases with a minimum of sampling bias. At the same
time, it is large enough to deliver meaningful results without an increased
incidence of recessive genetic conditions which can arise as a result of
intermarriage. The prevalence of the common diseases in Iceland is very similar
to that seen elsewhere in the industrialized world, and the genes we have
identified in Iceland have been shown to be key genes in the same conditions in
larger and more diverse populations.
Centralized Healthcare System. Iceland has had a universal, single-payer
national healthcare system since 1915. It presently consists of a base of 55
primary care centers; a large teaching and research hospital in Reykjavik formed
through the merger of the country's two largest hospitals; one central hospital
in the country's second-largest city, Akureyri; and several smaller regional
hospitals. Outside the primary care centers, the healthcare system is highly
specialized. Specialty clinics care for most of the patients with major
illnesses. Our clinical collaborators work at these specialty clinics, as well
as in the major hospitals. This system makes both patient care and medical data
universal, standardized and easily accessible for scientific research.
Well-Educated Population. The level of public education is high in Iceland
and illiteracy is negligible. Historically, the Icelandic population has been
willing to participate in biomedical research in the Icelandic community.
OUR POPULATION RESOURCES
deCODE has utilized these advantages to develop its gene discovery engine.
Our key resources include a computerized genealogy database that can in real
time draw the familial connections of any group of present-day Icelanders;
genotypic and detailed medical data from more than 90,000 volunteers in our
research in some 50 diseases; one of the world's highest-throughput genotyping
facilities; and statistical algorithms and software systems we have developed
for storing this data and mining it for correlations between genetic variation
and disease.
The success of our gene research is due in large part to the participation
of tens of thousands of Icelanders in our research programs. We believe that
participation is encouraged by the fact that we have one of the most advanced
privacy and data protection systems anywhere in the world. All data on
individuals used in our research is made personally non-identifiable and held
under encrypted identifiers generated by the Icelandic government's Data
Protection Authority. All genetic and medical data being used in the company's
gene research has been obtained under the strictest standards of informed
consent. Approximately 95% of all those who are asked to take part in our
genetic studies agree to do so, as do over 99% of those asked to participate in
a second study.
OUR GENE DISCOVERY PROCESS
Using our population approach, we can efficiently conduct genome-and
population-wide scans to identify the key genetic factors involved in virtually
any common disease. In the study of any particular disease, we first define the
disease classification broadly but rigorously. For example, in our research on
stroke we first defined patients using the broad classification of the disease,
including the principal subtypes, hemorrhagic and ischemic stroke, as well as
less serious "mini-strokes" known as transitory ischemic events. In every
disease we work with a group of general practitioners and specialist physicians
who see patients with a given disease or group of diseases. Once the National
Bioethics Committee has approved a research protocol for a given disease
project, our clinical collaborators compile a list of all patients in Iceland
who have been diagnosed with the disease. This list is encrypted by the Data
Protection Authority, which also encrypts our genealogy
8
database using the same key. We then run the list of patients through the
genealogy database, yielding very large extended families of patients,
frequently encompassing hundreds of individuals.
The genealogy links together both closely and distantly related patients;
by definition, these families will tend to share inherited risk factors for the
disease. Our statisticians examine these large pedigrees and determine which
patients would provide the maximum statistical power for genotypic analysis. We
then send the encrypted IDs for this group of patients back through the Data
Protection Authority, which decrypts the list and sends the names of the
patients on to the collaborating physicians. The physicians then contact the
patients, explain the nature of the gene discovery project and ask patients if
they have close relatives who do not have the disease who might also be willing
to participate. All those who wish to participate must sign an informed consent
form, and are then asked to go to a special center located in Reykjavik where
they can give blood from which DNA will be isolated. All blood samples are
likewise labeled with encrypted IDs by the Data Protection Authority before
being sent to deCODE. Those who give blood are also usually asked to meet with
their doctor for a clinical examination to provide detailed information on
health factors relevant to the disease or group of diseases under study. This
information is likewise made personally non-identifiable by the Data Protection
Authority before being sent to deCODE.
We genotype all DNA samples with a framework set of approximately 1000
microsatellite markers -- polymorphic genetic signposts -- spread across the
entire genome. Using the genealogies and our datamining algorithms we can then
determine which small segments of the genome related patients share to a
statistically much higher degree than one would expect given their relatedness.
We are thus able to "map" to small segments of particular chromosomes the
genetic factors that correlate with the disease. Through detailed analysis of
these regions using denser sets of microsatellite and SNP markers, we are able
to efficiently isolate the key disease genes and disease-linked haplotypes and
mutations.
We validate our findings by conducting association studies in other, more
heterogeneous populations. When we have carried out such studies, we have found
that the genes we have isolated in Iceland also play a critical role in the same
diseases in other populations, although the variety of mutations or haplotypes
we find is frequently greater. Understanding the range of mutations or
haplotypes contributing to disease is particularly vital for the development of
DNA-based diagnostic tests suitable for use around the world.
FROM GENES TO TARGETS
Our approach thus allows for a virtually hypothesis-free discovery process
that homes in directly on the inherited components of human disease. This
provides us with population-validated drug targets and diagnostic markers that
are directly involved in the disease process.
In a majority of cases where we have isolated disease genes, the products
of the genes themselves have provided "druggable" targets -- that is, classes of
proteins or enzymes against which chemists have previously been successful in
designing compounds. However, once we have succeeded in identifying a disease
gene, we also seek to define molecular pathways in which the disease gene plays
a role. This is essential information both for understanding the biology of the
disease and also for identifying additional drug targets that interact with the
disease genes.
We have established complementary systems to isolate specific drug targets
from "upstream," "downstream" and "proximal" pathways that may be involved in
the disease process. These approaches can expand the number of potential drug
targets that can be used to identify compounds for disrupting the disease
process.
Our proximal analysis identifies proteins that physically interact with the
disease-gene product. As very few proteins work alone in the body, these partner
proteins are likely to be involved in the normal biology of the disease gene. We
carry out the screening in yeast cells, using methods which involve increasing
stringency in order to eliminate false positive protein-protein interactions. We
are also able to crossmatch the genes identified as partners of the first
disease gene with additional population genomics data, as these genes may also
be mutated in the same disease.
Potential drug targets from upstream pathways include proteins that control
the expression level of the disease gene (i.e., those gene products that are
responsible for turning the disease gene "on" or "off" in
9
particular tissues or under particular conditions). We link the control region
of newly identified disease genes to a "reporter" gene and establish precisely
which region governs expression. DNA from this region is used to retrieve
specific binding proteins that are responsible for turning the disease gene
"on." Finally, we perform gene expression analysis using Affymetrix GeneChip(TM)
technology to validate our conclusions and to identify other genes which are
regulated in tandem with the disease gene.
Our downstream analysis is designed to uncover genes that are influenced by
the overexpression, underexpression or misexpression of the disease gene. We
have established efficient systems to turn genes "on" or "off" in cells, as well
as to express mutated versions revealed in the course of gene discovery. We
employ DNA chip technology in our efforts to find genes the expression patterns
of which are altered by the differential expression of the disease gene under
study. Some of these genes may interact with the disease gene product in
disrupting normal biology and leading to disease.
COMPARISON TO OTHER APPROACHES
We believe that our approach, because it enables us to home in directly on
the inherited components of human disease with a minimum of hypothetical bias,
provides us with targets that of a uniquely high quality for drug and diagnostic
development.
Some other companies are using an approach to locate disease genes that
relies on associating specific, predetermined variations in DNA, whether
scattered throughout the genome or in particular genes, with a propensity to
develop a disease. We believe that this is an effective means of validating
discoveries, but that as the basis for a discovery process it is analogous to
searching for a single needle that is present in one of a hundred haystacks. We
believe that our population genomics approach will allow us to find the haystack
using our large families before we begin searching for the needle using genetic
markers to isolate genes and haplotypes.
Other companies are using functional genomics to help select potential drug
targets. Most of these approaches depend on expression analysis using DNA chips
that compare the genes turned "on" or "off" in diseased tissue with those in
normal tissue. We, on the other hand, apply functional genomics more
selectively, focusing on the disease genes identified through our population
genomics approach to more specifically define their molecular pathways.
There may be some limitations to our population genomics approach because
disease genes found in Iceland may not always be directly relevant in other
populations, although there is much overlap in disease genes that have been
found in Iceland over the last 15 years and the rest of the world. The Icelandic
population is probably too small to study diseases that are not common. However,
our aim is to continue to focus on the diseases in Iceland that have the
greatest public health prevalence worldwide.
THE ICELANDIC HEALTH SECTOR DATABASE
In January 2000, our wholly-owned Icelandic subsidiary Islensk
erfdagreining ehf., received from the Icelandic Ministry of Health a twelve-year
license to create and operate the Icelandic Health Sector Database (IHD). Now
under construction, the IHD will be a centralized database of personally
non-identifiable and encrypted copies of health information from medical records
in Iceland's national health system. The IHD will enable users to conduct
statistical, population-based analyses of longitudinal healthcare data and
trends. The system will assemble from medical records data on, for example,
clinical measurements, disease diagnoses, treatments and outcomes. Users who
will be able to query the IHD on a non fee-paying basis include the Health
Ministry, doctors in Iceland's national health system, and Icelandic scientists
engaged in non-commercial research. Potential fee-paying customers include
pharmaceutical and biotechnology firms as well as healthcare providers.
We believe that the IHD will provide a valuable resource for better
understanding the environmental components that, along with genetic factors, lie
behind the onset of most common diseases. Using the Icelandic Data Protection
Authority's encryption protocols, we will be able to query the data in the IHD
for statistical correlations with our datasets on genotypes, genealogies, and
disease data from volunteer participants in our gene discovery programs. As the
data within the IHD is broader in scope and time frame than is the health data
that we have gathered in the course of our gene research, this may enable us to
gain novel
10
insights into environmental influences on health, the nature of disease, disease
prevention strategies, responsiveness to treatment, and the ability of certain
people to resist illness. The ability to query our existing datasets in
conjunction with the IHD will constitute the deCODE Combined Data Processing
(DCDP) system. We believe that this system will be much like the CGM service
that we currently offer, complemented by the ability to query the data in the
IHD.
In addition to the costs of developing the system, under the terms of the
license we pay the Icelandic government a fixed fee for operating the IHD of 70
million Icelandic Krona per year (approximately $913 USD as of March 2003), and
will pay an additional 6% per annum of any profits from its commercialization.
We believe that the IHD will have the most comprehensive legally-mandated
data and privacy protection provisions of any such database anywhere in the
world. It will also be, we believe, one of the only such systems that will meet
the World Medical Association's recently published ethical and data protection
standards. In contrast to most medical research databases and epidemiological
research protocols in Iceland and elsewhere, individuals who wish not to have
their medical data included in the IHD have a legal right, under the 1998 law
authorizing its creation, at any time to request that information about them not
be entered into the IHD. Since 1998, some 20,000 people in Iceland have
requested that the Icelandic Director of Public Health exclude their data. We
believe that the IHD therefore provides a vanguard example of how to enable the
use of large data collections to advance medical research while safeguarding the
autonomy of individuals and providing the best available protection of
potentially sensitive information.
As of March 2003, we are awaiting the conclusion of a government-mandated
review of the IHD's data encryption and protection protocols. We are unable at
present to predict the timing or outcome of this review, but believe that any
delay will not affect our ability to pursue our principal business objectives.
COLLABORATIONS
Our business strategy is focused on turning our discoveries and assets into
to a broad range of products for the market, at the same time as we leverage our
capabilities to generate near-term service revenue. In some instances we are
pursuing product development on our own. In others, we have formed alliances
with pharmaceutical and biotechnology firms through which we can cover some of
the cost of conducting basic research and spread the risk and investment
involved in product development. Depending on the nature of each prospective
business opportunity, these alliances may include one or more of the following:
up-front equity investments; direct payments for research; payments upon the
achievement of scientific milestones; shared or exclusive rights to diagnostics
and therapeutics; and royalties on products that our collaborators may bring to
market. In some instances, we may negotiate for access to our collaborators
technologies, for example libraries of chemical compounds, to enhance our
operations.
Our principal partners include:
F. Hoffmann-La Roche. In January 2002, we extended our alliance with Roche
through a three-year agreement focused on turning the achievements of our 1998
gene discovery collaboration into novel therapeutics ready for clinical trials.
Under our 1998 agreement, we identified key genetic factors involved in ten
major diseases: osteoarthritis, Alzheimer's disease, schizophrenia, peripheral
arterial occlusive disease (PAOD), stroke, osteoporosis, obesity, anxiety, type
2 diabetes and rheumatoid arthritis. The new alliance extends our partnership
with Roche to leverage our expanding capabilities in drug discovery and
development. Under this new alliance, Roche will provide us with research
funding to increasingly focus over the next two years on downstream research in
a selection of four of the diseases covered by the earlier agreement. The two
most advanced programs are those in schizophrenia and stroke. Under this
alliance we will receive milestone payments for the development of compounds as
well as royalties on the sales of drugs that are developed. We retain
therapeutic development rights to those targets identified under the 1998
alliance and not carried over into the new alliance.
Merck. In September 2002, we entered into an alliance Merck & Co., Inc.
(Merck) aimed at developing new treatments for obesity. Under the alliance, we
are combining 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
11
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.
Roche Diagnostics. In June 2001, we signed with Roche's diagnostics
division a five-year alliance to develop and market DNA-based diagnostics for
major diseases. The alliance represents an important element in our strategy of
turning our research achievements into products for the market. The alliance
brings together what we believe are important deCODE and Roche assets: our
comprehensive population genomics resources and bioinformatics expertise, and
Roche's prominence in the development and marketing of molecular diagnostics. In
addition to the development of novel DNA-based diagnostic and predisposition
screening products, we will be working under this alliance to use our Clinical
Genome Miner(TM) system to develop point-of-care informatics products that can
assist doctors in evaluating the results of DNA-based diagnostic tests.
IBM. In January 2003, we announced a three-year strategic alliance with
IBM under which we will jointly market and sell our Clinical Genome Miner (CGM)
Discovery(TM) system running on IBM hardware and software. CGM Discovery(TM) is
the same statistically-based application for isolating and analyzing genes and
gene variations associated with particular diseases that we have used in our
gene discovery programs. The alliance aims to take advantage of our expertise in
genetics and IBM's leadership in hardware and software systems to create
solutions for what we believe is a growing market for information-based
medicine. By understanding illnesses on the molecular level, including gene
variations linked to disease or drug response, doctors may be able to make more
precise diagnoses and tailor treatment decisions to better meet the needs of
individual patients. Also, drug makers may be able to develop more targeted
treatment therapies and identify potential clinical trial participants more
effectively. Our joint solution is expected to be available globally to
pharmaceutical biotechnology firms, government-sponsored research organizations,
research hospitals and medical care facilities beginning in mid-2003.
Wyeth. In November 2002, we entered into a pharmagenomics alliance with
Wyeth. Under the agreement, we are using our in vitro pharmacogenomics approach
to generate gene expression data for a drug candidate targeted to treatment of
certain respiratory diseases.
Pharmacia. 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 agreement, we are employing our
population resources and Clinical Genome Miner(TM) 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.
Vertex Pharmaceuticals. In January 2003 we announced an agreement with
Vertex Pharmaceuticals under which we will gather and analyze pharmacogenomic
data as part of clinical trials our subsidiary Encode conducts on Vertex
developmental compounds. The first project under the agreement is a Phase IIa
clinical trial for Vertex's VX-148 treatment for psoriasis. Our pharmacogenomics
capabilities will enable Vertex to gain an understanding, in conjunction with
clinical trial results, of genetic factors affecting the responses of
individuals to treatment. This information may be useful in designing subsequent
clinical strategies and pharmacogenomic tests. Based upon the results of work
under this agreement, we and Vertex may extend our collaboration to the
development and commercialization of pharmacogenomic tests.
Affymetrix. In July 2001, we formed a pharmacogenomics alliance with
Affymetrix, Inc., under which we are developing DNA-based tests to predict the
responsiveness of individual patients to treatments for common diseases. We are
bringing together our population-based approach to pharmacogenomics and
Affymetrix' GeneChip(R) technology, focusing initially on conducting gene
expression analysis to understand the response to drugs used in the treatment of
several common diseases. These include high-cholesterol, depression, asthma,
hypertension, breast cancer, schizophrenia and migraine. Clinical work under
this collaboration is being performed by Encode, our wholly-owned subsidiary.
Through Encode, we will share the revenues from the sale of tests developed
under the collaboration.
Academic, Hospital and Physician Collaborations. We have ongoing
collaborations with a number of academic, healthcare and research organizations
in other countries, including Emory University (Atlanta),
12
Partners HealthCare System (Boston), the University of Pennsylvania
(Philadelphia), the University of Aberdeen (Scotland), the National Cancer
Institute (Washington, DC), the Karolinska Institute (Stockholm), and the Center
for Clinical and Basic Research (Denmark). These collaborations enable us to
broaden our knowledge about the genetics discoveries we have made in Iceland in
other patient populations, and provide our partners with access to our tools and
expertise in human genetics. In all such collaborations we negotiate to retain
intellectual property and product development rights on results obtained using
our discoveries and expertise.
We have entered into collaboration agreements and arrangements with the
Icelandic Heart Association and several groups of physicians in Iceland. The
goal of these collaborations is the discovery of genetic factors which
contribute to the genesis of certain disorders on which the various physician
groups maintain patient information. Our collaborators contribute data and/or
other clinical information to the project, while we provide our expertise in
molecular genetics and experimental design, as well as necessary equipment and
research supplies. We are responsible for the reimbursement of all expenses
related to the projects. We share the ability to make management decisions
regarding the projects with these collaborators, and we jointly form executive
or steering committees to monitor the projects. Our collaboration agreements
with these parties normally continue for a term of no more than five years.
To further facilitate our research projects and enable us to construct
lists of patients with specific diseases, we have also entered into
collaboration agreements and arrangements with two of the largest hospitals in
Iceland. Under the terms of these agreements, the hospitals contribute research
data, and surveillance committees that we jointly appoint with the hospitals
monitor our projects. We are obligated to pay all the hospitals' out-of-pocket
expenses incurred as a result of the collaboration. Our agreements with the
hospitals will continue until terminated by the parties.
We have also entered into agreements with 27 Icelandic health institutions
as required by the Icelandic Health Sector Database Act and License in order to
have data transferred from those institutions to the IHD.
PATENTS AND PROPRIETARY RIGHTS
Patents and other proprietary rights protections are an essential element
of our business. We currently rely on patents, trade secret law and contractual
non-disclosure and confidentiality arrangements to protect our proprietary
information. We will be able to protect our proprietary rights from unauthorized
use by third parties only to the extent that our proprietary rights are covered
by valid and enforceable patents or are effectively maintained as trade secrets.
Accordingly, we actively seek patent protection in the United States and
other jurisdictions to protect technology, inventions and improvements to
inventions that are commercially important to the development of our business.
These include, among other things, genes we discover; mutations of genes and
related processes and inventions; technologies which may be used to discover and
characterize genes; and therapeutic and diagnostic processes and other
inventions based on these genes. As of year-end 2002, we had 20 issued U.S.
patents and two issued patents in non-US jurisdictions. We also had 45 pending
patent applications in the US and 63 pending patent applications in non-US
jurisdictions. We claim priority under the Patent Cooperation Treay for those of
our U.S. applications that we consider to be of significant commercial value. We
also intend to seek patent protection or rely upon trade secret rights to
protect other technologies that may be used to develop databases and healthcare
informatics products and services.
COMPETITION
We face, and will continue to face, intense competition in our gene
discovery programs from organizations such as major pharmaceutical companies,
specialized biotechnology firms, pharmacogenomics companies, universities and
other research institutions, the Human Genome Project and other
government-sponsored entities. A number of entities are attempting to rapidly
identify and patent genes responsible for causing diseases or an increased
susceptibility to diseases and to develop products based on these discoveries.
Many of our competitors, either alone or together with their collaborative
partners, have substantially greater financial resources and larger research and
development staffs than we do. These competitors may discover, characterize or
develop important genes, drug targets or drug leads before we or our
collaborators do
13
or may obtain regulatory approvals of their drugs more rapidly than we or our
collaborators do. They may develop healthcare informatics and database products
before we do or which are technically superior to ours or prove to be more
useful to our potential customers.
Developments by others may render pharmaceutical product candidates or
technologies that we or our collaborators develop obsolete or non-competitive.
Any product candidate that we or our collaborators successfully develop may
compete with existing therapies that have long histories of safe and effective
use.
Our competitors may obtain patent protection or other intellectual property
rights that could limit our rights, or our customers' ability, to use our
technologies or databases, or commercialize therapeutic or diagnostics products.
In addition, we face, and will continue to face, intense competition from other
companies for collaborative arrangements with pharmaceutical and biotechnology
companies, for establishing relationships with academic and research
institutions and for licenses to proprietary technology.
Our ability to compete successfully will depend, in part, on our ability,
and that of our collaborators, to: develop proprietary products; develop and
maintain products that reach the market first, and are technologically superior
to and more cost effective than other products on the market; obtain patent or
other proprietary protection for our products and technologies; attract and
retain scientific and product development personnel; obtain required regulatory
approvals; and manufacture, market and sell products that we develop.
GOVERNMENT REGULATION
Regulation by governmental authorities will be a significant factor in our
ongoing research and development activities and in the development of the
Icelandic Health Sector Database. In addition, the development, production and
marketing of any pharmaceutical and diagnostic products which we or a partner
may develop is subject to regulation by governmental authorities. Strict
regulatory controls on the clinical testing, manufacture, labeling, supply and
marketing of the products will influence our and our partners' ability to
successfully manufacture and market therapeutic or diagnostic products.
Our success will depend, in part, on the development and marketing of
products based on our research and development. Strict regulatory controls on
the clinical testing, manufacture, labeling, supply and marketing of the
products will influence our and our partners' ability to successfully
manufacture and market therapeutic or diagnostic products. Most countries
require a company to obtain and maintain regulatory approval for a product from
the relevant regulatory authority to enable the product to be marketed.
Obtaining regulatory approval and complying with appropriate statutes and
regulations is time-consuming and requires the expenditure of substantial
resources.
Most European countries and the United States have very high standards of
technical appraisal and consequently, in most cases, a lengthy approval process
for pharmaceutical products. The regulatory approval processes, which usually
include pre-clinical and clinical studies, as well as post-marketing
surveillance to establish a compound's safety and efficacy, can take many years
and require the expenditure of substantial resources. Data obtained from such
studies is susceptible to varying interpretations that could delay, limit or
prevent regulatory approval. Delays or rejections may also be encountered based
upon changes in drug approval policies in applicable jurisdictions. There can be
no assurance that we or our collaborative customers will obtain regulatory
approval for any drugs or diagnostic products developed as the result of our
gene discovery programs.
14
Because many of the products which may result from our research and
development programs are likely to involve the application of new technologies,
various governmental regulatory authorities may subject such products to a
greater degree of review. As a result, regulatory approvals for such products
may require more time than for products using more conventional technologies. In
addition, ethical concerns about the use of genetic predisposition testing, and
in particular about the risk that such testing could lead to discrimination by
insurance providers or employers, may lead to poor market acceptance or to
regulatory controls that would adversely affect the development of or demand for
diagnostic products based on our research.
Our creation and operation of the Icelandic Health Sector Database and the
deCODE Combined Data Processing system will involve oversight by the Icelandic
Ministry of Health, with the assistance of an Icelandic Health Sector Database
Monitoring Committee, an Interdisciplinary Ethics Committee, the Bioethics
Committee of Iceland and the Data Protection Authority of Iceland. These bodies
will help to ensure our compliance with applicable laws and regulations.
ENVIRONMENTAL
deCODE's research facilities and laboratory are located in Reykjavik,
Iceland. We operate under applicable Icelandic and European Union laws and
standards, with which we believe that we comply, relating to environmental,
hazardous materials and other safety matters. Our research and manufacturing
activities involve the generation, use and disposal of hazardous materials and
wastes, including various chemicals and radioactive compounds. These activities
are subject to standards prescribed by Iceland and the EU. We do not believe
that compliance with these laws and standards will have any material effect upon
our capital expenditures, earnings or competitive position, nor that we will
have any material capital expenditures for environmental control facilities for
the remainder of this fiscal year or any succeeding fiscal year.
The activities of MediChem (now our pharmaceuticals group) involve the
controlled use of hazardous materials. We are subject to U.S. federal, state and
local laws and regulations governing the use, manufacture, storage, handling and
disposal of such materials and certain waste products. Although we believe that
our pharmaceuticals group's activities currently comply with the standards
prescribed by such laws and regulations, the risk of accidental contamination or
injury from these materials cannot be eliminated. In the event of such an
accident, we could be held liable for any damages that result and any such
liability could exceed our resources. In addition, there can be no assurance
that we will not be required to incur significant costs to comply with
environmental laws and regulations in the future.
EMPLOYEES
At December 31, 2002, deCODE and all of its subsidiaries employed 530
full-time staff. Of the total number at the end of 2002, approximately 140 were
employed in the US, and 390 in Iceland. More than 100 held Ph.D or M.D. degrees
and approximately 370 held college degrees. Four hundred and forty-five
employees were engaged in, or directly supported, research and development
activities, of whom 350 worked within the laboratory facilities and 95 held
positions associated with the development and support of informatics. Forty-four
employees were engaged in various professional support functions such as
Finance, Business Development, Legal, Communications, Human Resources and
Clinical Collaborations, and some 41 are employed in administrative support,
facilities management, cleaning and security. In addition, we utilized part-time
employees and outside contractors and consultants as needed and plan to continue
to do so.
CERTAIN FINANCIAL INFORMATION
RESEARCH AND DEVELOPMENT EXPENSES
Our research and development expenses were $86.6 million in the year ended
December 31, 2002, $71.0 million in 2001 and $45.7 million in 2000. Of these
amounts, we estimate that $30 million, $26 million and $23 million were spent on
customer-sponsored research and development activities in 2002, 2001 and 2000,
respectively. These estimates of customer-sponsored research and development are
approximated based upon the number of personnel performing research work, and
these estimates are not necessarily fully-burdened costs of revenue for the
respective years in accordance with generally accepted accounting principles.
15
SIGNIFICANT CUSTOMERS
Historically, a substantial portion of deCODE's revenue has been derived
from contracts with a limited number of significant customers. deCODE's largest
customer, Roche, accounted for approximately 96% of the company's consolidated
revenue in 2001 and Roche accounted for 41% of consolidated revenue in 2002.
Revenues under the joint development and commercialization agreement with ABG,
which was terminated in the fourth quarter of 2002, accounted for 15% of
consolidated revenue in the year ended December 31, 2002. The loss of any
significant customer may significantly lower deCODE's revenues and affect
deCODE's progression to profitability.
RISK FACTORS, FORWARD-LOOKING STATEMENTS, AND CAUTIONARY FACTORS
THAT MAY AFFECT FUTURE RESULTS
This annual report on Form 10-K contains forward-looking statements. These
statements relate to future events or our future financial performance. In some
cases, forward-looking statements can be identified by terminology such as
"may," "will," "should," "could," "expect," "plan," "anticipate," "believe,"
"estimate," "predict," "intend," "potential" or "continue" or the negative of
such terms or other comparable terminology. These statements are only
predictions. We cannot assure our investors that our expectations and
assumptions will prove to have been correct. We undertake no intention or
obligation to update or revise any forward-looking statements, whether as a
result of future events, new information or otherwise. Actual events or results
may differ materially due to a number of factors, including those set forth in
this section and elsewhere in this Form 10-K. These factors include, but are not
limited to, the risks set forth below. Dollar amounts are in thousands, except
share and per share amounts unless otherwise noted.
RISKS RELATED TO OUR BUSINESS
DECODE MAY NOT SUCCESSFULLY DEVELOP OR DERIVE REVENUES FROM ANY PRODUCTS OR
SERVICES.
deCODE uses its technology and research capabilities primarily to identify
genes or gene fragments that are responsible for certain diseases, indicate the
presence of certain diseases or cause or predispose individuals to certain
complex diseases. Although deCODE has identified some genes that it believes are
likely to cause certain diseases, deCODE may not be correct and may not be
successful in identifying any other similar genes. Many experts believe that
some of the diseases deCODE is targeting are caused by both genetic and
environmental factors. Even if deCODE identifies specific genes that are partly
responsible for causing diseases, any gene-based therapeutic or diagnostic
products may not detect, prevent, treat or cure a particular disease.
Accordingly, even if deCODE is successful in identifying specific genes, its
discoveries may not lead to the development of commercial therapeutic or
diagnostic products.
Any pharmaceutical or diagnostic products that deCODE or its collaborators
are able to develop will fail to produce revenues unless deCODE:
- establishes that they are safe and effective;
- successfully competes with other technologies and products;
- ensures that they do not infringe on the proprietary rights of others;
- establishes that they can be manufactured in sufficient quantities at
reasonable costs; and
- can market them successfully.
deCODE may not be able to meet these conditions. deCODE expects that it
will be years, if ever, before it will recognize revenue from the development of
therapeutic or diagnostic products.
deCODE's Clinical Genome Miner contains tools to discover or validate
disease linked genes based on non-personally identifiable genotypic,
genealogical and phenotypic data. deCODE cannot be sure that marketing the
Clinical Genome Miner or the Clinical Genome Miner Discovery(TM) will lead to
additional collaborations with potential clients.
The success of deCODE's informatics services and tools depends on its
ability to:
- create database and cross reference software that is free from design
defects or errors;
16
- effectively use the information derived from the Clinical Genome
Miner(TM) and other bioinformatics services and tools in disease
management, analysis of drug response, gene discovery and drug target
validation; and
- develop marketing and pricing methods that the intended users of the
deCODE's determining and other informatic services will accept.
Because only a small portion of the Icelandic population may carry certain
mutations, the unwillingness of even a small portion of the population to
participate in deCODE's programs could diminish its ability to develop and
market information based on the use of genotypic data. If deCODE fails to
successfully commercialize its database services, it will not realize revenues
from this part of its business.
These products may not meet the needs of potential customers. deCODE has
generated little revenues from sales or licenses of informatics products. deCODE
cannot assure you that it can successfully develop or commercialize, or that
there will be a market for, its informatics products.
IF THE COSTS ASSOCIATED WITH THE MEDICHEM ACQUISITION EXCEED THE BENEFITS,
DECODE MAY EXPERIENCE ADVERSE FINANCIAL RESULTS, INCLUDING INCREASED LOSSES.
In March 2002, deCODE acquired MediChem Life Sciences Inc., or MediChem,
with the expectation that the combination of deCODE's unique population genomics
approach to identifying novel targets in major therapeutic areas with MediChem's
high-throughput integrated chemistry platform would facilitate drug discovery
and development. The acquisition was also expected to provide deCODE with
revenue from MediChem's contract service businesses and to facilitate the
formation of drug discovery and development alliances with pharmaceutical
companies. Realization of these expectations and development and
commercialization of potential drug candidates will depend not only on deCODE's
successful integration of MediChem's business and the achievement of research
objectives by MediChem and its collaborators, but also on each of MediChem's
client's own financial, competitive, marketing and strategic considerations, all
of which are beyond deCODE's control.
deCODE may continue to incur consolidation and integration expenses which
it cannot accurately estimate fully at this time. Actual integration costs may
substantially exceed deCODE's current estimates and may affect its financial
condition and operating results negatively. If the benefits of the acquisition
do not exceed the costs associated with the acquisition, deCODE's financial
results could be adversely affected, including increased losses.
IF DECODE CONTINUES TO INCUR OPERATING LOSSES LONGER THAN ANTICIPATED, OR IN
AMOUNTS GREATER THAN ANTICIPATED, IT MAY BE UNABLE TO CONTINUE ITS OPERATIONS.
deCODE incurred a net loss of $131.9 million for the year ended December
31, 2002, including $64.8 million of employee termination, impairment and other
costs, and has an accumulated deficit of $295.1 million at December 31, 2002.
deCODE has never generated a profit and it has not generated revenues except for
payments received in connection with its research and development collaborations
with Roche, Merck and other collaborations, and from contract services and
interest revenues. deCODE must continue to make substantial expenditures over
the next several years to develop its technologies and its internal research
programs and to prepare the Clinical Genome Miner(TM), the CGM Discovery(TM),
the Iceland Health Sector Database and other informatics. The integration of
MediChem has and will continue to impact deCODE's results of operations and
financial position. With MediChem, deCODE's revenues have increased but
operating expenses and, at least for the near term, likely net losses will also
increase. In addition, deCODE expects 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 deCODE's results of operations and financial
condition is largely dependent upon the extent to which MediChem's capacity is
brought to bear on deCODE's in-house programs and how much of their existing
contract services business is maintained and developed. As a result, deCODE
expects to incur net losses for several years. If the time required to generate
product revenues and achieve profitability is longer than deCODE currently
anticipates or the level of losses is greater than deCODE currently anticipates,
deCODE may not be able to continue its operations.
17
IF DECODE'S ASSUMPTION ABOUT THE ROLE OF GENES IN DISEASE IS WRONG, IT MAY NOT
BE ABLE TO DEVELOP USEFUL PRODUCTS.
The products deCODE hopes to develop involve new and unproven approaches.
They are based on the assumption that information about genes may help
scientists to better understand complex disease processes. Scientists generally
have a limited understanding of the role of genes in diseases, and few products
based on gene discoveries have been developed. Of the products that exist, all
are diagnostic products. To date, deCODE knows of no therapeutic products based
on disease-gene discoveries. If deCODE's assumption about the role of genes in
the disease process is wrong, its gene discovery programs may not result in
products, the genetic data included in its database and informatics products may
not be useful to its customers and those products may lose any competitive
advantage.
BECAUSE REVENUES ARE CONCENTRATED, THE LOSS OF A SIGNIFICANT CUSTOMER WOULD HARM
DECODE'S BUSINESS.
Historically, a substantial portion of deCODE's revenue has been derived
from contracts with a limited number of significant customers. deCODE's largest
customer, Roche, accounted for approximately 96% of its consolidated revenue in
2001 and 41% of consolidated revenue in the year ended December 31, 2002.
Revenues under the joint development and commercialization agreement with ABG,
which was terminated in the fourth quarter of 2002, accounted for 15% of
consolidated revenue in the year ended December 31, 2002. The loss of any
significant customer may significantly lower deCODE's revenues and affect
deCODE's progression to profitability.
IF DECODE IS NOT ABLE TO OBTAIN SUFFICIENT ADDITIONAL FUNDING TO MEET ITS
CAPITAL REQUIREMENTS, DECODE MAY BE FORCED TO REDUCE OR TERMINATE ITS RESEARCH
PROGRAMS AND PRODUCT DEVELOPMENT.
deCODE has spent substantial amounts of cash to fund its research and
development activities and expects to continue to spend substantial amounts for
these activities over the next several years. deCODE expects to use cash to
collect, generate and analyze genotypic and disease data from volunteers in its
disease-gene research programs; to conduct drug discovery and development
activities; to continue to develop the Clinical Genome Miner and Clinical Genome
Miner Discovery; to develop healthcare informatics products; and to continue
other research and development activities. Many factors will influence its
future capital needs, including:
- the number, breadth and progress of its discovery and research programs;
- its ability to attract customers;
- its ability to commercialize its discoveries and the resources it devotes
to commercialization;
- the amount it spends to enforce patent claims and other intellectual
property rights; and
- the costs and timing of regulatory approvals.
deCODE intends to rely on Roche, Merck and other existing and future
collaborators for significant funding of its research efforts. In addition,
deCODE may seek additional funding through public or private equity offerings
and debt financings. deCODE may not be able to obtain additional financing when
it needs it or the financing may not be on terms favorable to deCODE or its
stockholders. Stockholders' ownership will be diluted if deCODE raises
additional capital by issuing equity securities.
If deCODE raises additional funds through collaborations and licensing
arrangements, it may have to relinquish rights to some of its technologies or
product candidates, or grant licenses on unfavorable terms. If adequate funds
are not available, deCODE would have to scale back or terminate its discovery
and research programs and product development.
The Icelandic parliament has enacted legislation authorizing the Minister
of Finance to provide an Icelandic government guarantee of a convertible bond
offering of up to $200 million by deCODE for the purpose of financing new
activities of deCODE in the area of drug development. To become effective, this
legislation must be approved by the EFTA (i.e. the European Free Trade
Association) Surveillance Authority (ESA) for compatibility with the state aid
stipulations of the agreement on the European Economic Area (EEA), to which
Iceland is a signatory. As of the end of March 2003, the measure was still under
review by ESA. deCODE cannot be certain that ESA will approve the legislation,
that the Icelandic government will
18
make use of the authorization and offer the guarantee to deCODE for any or all
of the permitted amount, that such offer to deCODE by the Icelandic Government,
if effectuated, will be on terms acceptable to deCODE, or that even with such an
authorization deCODE will be able to find a market for such an offering of
convertible bonds.
DECODE'S CURRENT FACILITIES AND STAFF ARE INADEQUATE FOR COMMERCIAL PRODUCTION
AND DISTRIBUTION OF PRODUCTS.
If in the future deCODE chooses to engage directly in the development,
manufacturing and marketing of certain products, it will require substantial
additional funds, personnel and production facilities.
DECODE'S RELIANCE ON THE ICELANDIC POPULATION MAY LIMIT THE APPLICABILITY OF ITS
DISCOVERIES TO CERTAIN POPULATIONS
The genetic make-up and prevalence of disease generally varies across
populations around the world. Common complex diseases generally occur with a
similar frequency in Iceland and other European populations. However, the
populations of other nations may be genetically predisposed to certain diseases
because of mutations not present in the Icelandic population. As a result,
deCODE and its partners may be unable to develop diagnostic and therapeutic
products that are effective on all or a portion of people with such diseases.
Any difference between the Icelandic population and other populations may have
an effect on the usefulness of the Clinical Genome Miner and Icelandic Health
Sector Database in studying populations outside of Iceland. For deCODE's
business to succeed, it must be able to apply discoveries that it makes on the
basis of the Icelandic population to other markets.
IF DECODE FAILS TO PROTECT CONFIDENTIAL DATA ADEQUATELY, IT COULD INCUR
LIABILITY OR LOSE ITS DATABASE LICENSE.
Under laws and regulations in force in Iceland, including applicable
European laws, directives and regulations, all information on individuals that
is used in deCODE's population research is anonymized under the protocols and
supervision of the Data Protection Authority of Iceland. To extent that any of
this data held or generated by the company were to become personally
identifiable deCODE would risk losing public support for participation in its
research, and could be liable to legal action. Any failure to comply fully with
all confidentiality requirements could lead to liability for damages incurred by
individuals whose privacy is violated, the loss of its customers and reputation
and the loss of the goodwill and cooperation of the Icelandic population,
including healthcare professionals. These eventualities could materially
adversely affect deCODE's work in Iceland.
The same general privacy and data protection laws and regulations as well
as specific laws and regulations apply to deCODE's license to build and operate
the Icelandic Health Sector Database (IHD). Were any data sent to or contained
in the IHD to become personally identifiable, deCODE would incur the same risks
above and potentially lose its database license.
DECODE'S CREATION AND OPERATION OF THE ICELANDIC HEALTH SECTOR DATABASE MAY BE
MORE EXPENSIVE AND TIME CONSUMING THAN DECODE ANTICIPATES, AND MAY LEAD TO
LITIGATION
deCODE's development of the Icelandic Health Sector Database (IHD) involves
substantial government regulation and oversight, compliance with which can be
expensive and time-consuming and may delay, prevent or increase the cost of
development of the IHD. Data collection and use activities will be supervised by
the Icelandic Health Sector Database Monitoring Committee, the Data Protection
Authority of Iceland, and an Interdisciplinary Ethics Committee. In addition,
the Icelandic Bioethics Committee will review deCODE's operation of the
database.
Iceland is subject to both European Free Trade Association and European
Union competition and public procurement rules. If it is determined that the
Database Act or the Database License breaches such rules, the Database License
could be revoked or diluted. In addition to the costs of developing the system,
under the terms of the license we pay the Icelandic government a fixed fee for
operating the IHD of 70 million Icelandic Krona per year (approximately $913 USD
as of March 2003), and will pay an additional 6% of any profits per annum from
its commercialization.
19
Even if deCODE is able to successfully create and market the Icelandic
Health Sector Database, the Database License will expire in January 2012. There
is no assurance that deCODE will obtain further access rights on favorable
terms, if at all.
The Icelandic parliament's passage of the Database Act and the Health
Ministry's granting of the Database License have encountered some opposition in
Iceland and internationally. Opponents of the IHD may initiate litigation in
U.S., Icelandic or other national or international courts (for example, on the
basis of an alleged breach of the patient-doctor confidentiality, constitutional
privacy issues, international conventions dealing with protection of privacy
issues or human rights conventions). In February 2000, certain Icelandic
opponents of the IHD issued a press release announcing their intention to file
lawsuits against the State of Iceland and any other relevant parties, including
deCODE, to test the constitutionality of the Database Act. According to the
press release, the lawsuit will allege human rights violations and challenge the
validity of provisions of the Database Act. To date no such suit has been
brought against deCODE. One lawsuit has been brought in Icelandic courts against
the Directorate of Public Health in Iceland challenging the constitutionality of
the Database Act. In the event that the Icelandic State by a final judgment is
found to be liable or subject to payment to any third party as a result of the
passage of legislation on the Icelandic Health Sector Database and/or the
issuance of the Database License, deCODE's agreement with the Health Ministry
requires deCODE to indemnify the Icelandic State against all damages and costs
incurred in connection with such litigation. In addition, the pendency of such
litigation could lead to delay in the development of the Icelandic Health Sector
Database and an unfavorable outcome could prevent deCODE from developing and
operating the Icelandic Health Sector Database.
SOME PARTS OF DECODE'S PRODUCT DEVELOPMENT SERVICES CREATE A RISK OF LIABILITY
FROM CLINICAL TRIAL PARTICIPANTS AND THE PARTIES WITH WHOM IT CONTRACTS.
deCODE, through its wholly-owned subsidiary Encode ehf., contracts with
drug companies to perform a wide range of services to assist them in bringing
new drugs to market. deCODE also contracts with physicians to serve as
investigators in conducting clinical trials. deCODE's services include:
- supervising clinical trials;
- data and laboratory analysis;
- patient recruitment;
- acting as investigators in conducting clinical trials; and
- engaging in Phase I clinical trials.
If, in the course of these trials or activities deCODE does not perform its
services to contractual or regulatory standards;
- patients or volunteers suffer personal injury caused by or death from
adverse reactions to the test drugs or otherwise;
- there are deficiencies in the professional conduct of the investigators
with whom deCODE contracts;
- one of deCODE's laboratories inaccurately reports or fails to report lab
results; or
- deCODE's informatics products violate rights of third parties,
deCODE could then be held be held liable for these eventualities by the drug
companies with whom it contracts or by study participants. deCODE maintains
insurance to cover ordinary risks, but such insurance may be inadequate and it
would not cover the risk of a customer deciding not to do business with deCODE
as a result of poor performance.
USE OF THERAPEUTIC OR DIAGNOSTIC PRODUCTS DEVELOPED AS A RESULT OF DECODE'S
PROGRAMS MAY RESULT IN PRODUCT LIABILITY CLAIMS FOR WHICH DECODE HAS INADEQUATE
INSURANCE.
The users of any therapeutic or diagnostic products developed as a result
of deCODE's discovery or research programs or the use of its database or medical
decision-support products may bring product liability claims against deCODE.
deCODE currently does not carry liability insurance to cover such claims. deCODE
is not certain that it or its collaborators will be able to obtain such
insurance or, if obtained, that sufficient
20
coverage can be acquired at a reasonable cost. If deCODE cannot protect against
potential liability claims, deCODE's collaborators or deCODE may find it
difficult or impossible to commercialize products.
DECODE MAY BE UNABLE TO HIRE AND RETAIN THE KEY PERSONNEL UPON WHOM ITS SUCCESS
DEPENDS.
deCODE depends on the principal members of its management and scientific
staff, including Dr. Kari Stefansson, Chairman, President and Chief Executive
Officer, Hannes Smarason, Executive Vice President and Senior Business Officer,
and Dr. Jeffrey Gulcher, Vice President, Research and Development. deCODE
genetics, Inc. has not entered into agreements with any of the named persons
that bind them to a specific period of employment. If any of these people leaves
deCODE, deCODE's ability to conduct its operations may be negatively affected.
deCODE's future success also will depend in part on its ability to attract, hire
and retain additional personnel. There is intense competition for such qualified
personnel and deCODE cannot be certain that it will be able to continue to
attract and retain such personnel. Failure to attract and retain key personnel
could have a material adverse effect on deCODE.
CURRENCY FLUCTUATIONS MAY NEGATIVELY AFFECT DECODE'S FINANCIAL CONDITION.
deCODE publishes its consolidated financial statements in U.S. dollars.
Currency fluctuations can affect its financial results because a portion of its
cash reserves and its operating costs are in Icelandic kronas. A fluctuation of
the exchange rates of the Icelandic krona against the U.S. dollar can thus
adversely affect the "buying power" of deCODE's cash reserves and revenues. Most
of deCODE's long-term liabilities are U.S. dollar denominated. However, deCODE
may enter into hedging transactions if it has substantial foreign currency
exposure in the future. deCODE may have increased exposure as a result of
investments or payments from collaborative partners.
DECODE'S CONTRACTS MAY BE TERMINABLE UPON SHORT NOTICE.
Many of deCODE's contracts are terminable on short notice. Specifically,
MediChem's contracts are generally terminable upon 10 to 90 days' notice. This
means that deCODE's contracts could be terminated for numerous reasons, any of
which may be beyond its control such as a reduction or reallocation of a
customer's research and development budget or a change in a customer's overall
financial condition. The loss of a large contract or multiple smaller contracts,
or a significant decrease in revenue derived from a contract, could
significantly reduce deCODE's profitability and require it to reallocate
under-utilized physical and professional resources.
RISKS RELATED TO OUR COLLABORATORS
DECODE MAY NOT BE ABLE TO FORM AND MAINTAIN THE COLLABORATIVE RELATIONSHIPS THAT
ITS BUSINESS STRATEGY REQUIRES AND THE RELATIONSHIPS MAY LEAD TO DISPUTES OVER
TECHNOLOGY RIGHTS.
Our ability to generate revenue growth and become profitable is dependent,
in part, upon our ability to enter into additional collaborative arrangements,
and upon our ability and that of our collaborative partners to successfully
commercialize products incorporating, or based upon, our work.
deCODE must form research collaborations and licensing arrangements with
several partners at the same time in order to execute its business strategy.
deCODE currently has only six substantial collaborative relationships, including
two with Roche. To succeed, deCODE will have to maintain or expand these
relationships and establish additional collaborations. 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.
If deCODE's collaborations are not successful or deCODE is not able to
manage multiple collaborations successfully, its programs will suffer. If deCODE
increases the number of collaborations, it will become more
21
difficult to manage the various collaborations successfully and the potential
for conflicts among the collaborators as to rights and products generated under
work conducted with deCODE will increase.
DEPENDENCE ON COLLABORATIVE RELATIONSHIPS MAY LEAD TO DELAYS IN PRODUCT
DEVELOPMENT AND DISPUTES OVER RIGHTS TO TECHNOLOGY.
deCODE is dependent on collaborators for the pre-clinical study and
clinical development of therapeutic and diagnostic products and for regulatory
approval, manufacturing and marketing of any products that result from its
technology. deCODE's agreements with collaborators typically allow them
significant discretion in electing whether to pursue such activities. deCODE
cannot control the amount and timing of resources collaborators will devote to
its programs or potential products.
AGREEMENTS WITH COLLABORATORS MAY HAVE THE EFFECT OF LIMITING THE AREAS OF
RESEARCH THAT DECODE MAY PURSUE EITHER ALONE OR WITH OTHERS.
deCODE's arrangements may place responsibility for key aspects of
information technology, product development and marketing on its collaborative
partners. If deCODE's collaborators fail to perform their obligations, deCODE's
information technology products could contain erroneous data, design defects,
viruses or software defects that are difficult to detect and correct and may
adversely affect its revenues and the market acceptance of its products.
deCODE's collaborators may stop supporting its products or providing services to
it if they develop or obtain rights to competing products. Disputes may arise in
the future over the ownership of rights to any technology developed with
collaborators. These and other possible disagreements between deCODE's
collaborators and deCODE could lead to delays in the collaborative research,
development or commercialization of products. Such disagreements could also
result in litigation or require arbitration to resolve.
RISKS RELATED TO OUR INDUSTRY
CONCERNS REGARDING THE USE OF GENETIC TESTING RESULTS MAY LIMIT THE COMMERCIAL
VIABILITY OF ANY PRODUCTS DECODE DEVELOPS.
Other companies have developed genetic predisposition tests that have
raised ethical concerns. It is possible that employers or others could
discriminate against people who have a genetic predisposition to certain
diseases. Concern regarding possible discrimination may result in governmental
authorities enacting restrictions or bans on the use of all, or certain types
of, genetic testing. Similarly, such concerns may lead individuals to refuse to
use genetic tests even if permissible. These factors may limit the market for,
and therefore the commercial viability of, products that deCODE's collaborators
and/or deCODE may develop.
DECODE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY WITH OTHER COMPANIES AND
GOVERNMENT AGENCIES IN THE DEVELOPMENT AND MARKETING OF PRODUCTS AND SERVICES.
A number of companies are attempting to rapidly identify and patent genes
that cause diseases or an increased susceptibility to diseases. Competition in
this field and deCODE's other areas of business, including drug discovery and
development as well as database services and healthcare informatics, is intense
and is expected to increase. deCODE has numerous competitors, including major
pharmaceutical and diagnostic companies, specialized biotechnology firms,
universities and other research institutions, the United States-funded Human
Genome Project and other government-sponsored entities and companies providing
healthcare information products. deCODE's collaborators, including Roche and
Merck, may also compete with deCODE. Many of deCODE's competitors, either alone
or with collaborators, have considerably greater capital resources, research and
development staffs and facilities, and technical and other resources than deCODE
does, which may allow them to discover important genes before deCODE does.
deCODE believes that a number of its competitors are developing competing
products and services that may be commercially successful and that are further
advanced in development than its potential products and services. To succeed,
deCODE, together with its collaborators, must discover disease-predisposing
genes, characterize their functions, develop genetic tests or therapeutic
products and related information services based on such discoveries, obtain
regulatory and other approvals, and launch such services or products before
competitors. Even if deCODE's collaborators or deCODE is successful in
developing effective products or services,
22
deCODE's products and services may not successfully compete with those of its
competitors. deCODE's competitors may succeed in developing and marketing
products and services that are more effective than deCODE's or that are marketed
before deCODE's.
Competitors have established, and in the future may establish, patent
positions with respect to gene sequences related to deCODE's research projects.
Such patent positions or the public availability of gene sequences comprising
substantial portions of the human genome could decrease the potential value of
deCODE's research projects and make it more difficult for deCODE to compete.
deCODE may also face competition from other entities in gaining access to DNA
samples used for research and development purposes. Our competitors may also
obtain patent protection or other intellectual property rights that could limit
our rights, or our customers' ability, to use our technologies or databases, or
commercialize therapeutic or diagnostics products. In addition, we face, and
will continue to face, intense competition from other companies for
collaborative arrangements with pharmaceutical and biotechnology companies, for
establishing relationships with academic and research institutions and for
licenses to proprietary technology.
deCODE expects competition to intensify as technical advances are made and
become more widely known. deCODE's future success will depend in large part on
maintaining a competitive position in the genomics field. Others' or deCODE's
rapid technological development may result in products or technologies becoming
obsolete before deCODE recovers the expenses it incurs in developing them.
Our ability to compete successfully will depend, in part, on our ability,
and that of our collaborators, to: develop proprietary products; develop and
maintain products that reach the market first, and are technologically superior
to and more cost effective than other products on the market; obtain patent or
other proprietary protection for our products and technologies; attract and
retain scientific and product development personnel; obtain required regulatory
approvals; and manufacture, market and sell products that we develop.
CHANGES IN OUTSOURCING TRENDS AND ECONOMIC CONDITIONS IN THE PHARMACEUTICAL AND
BIOTECHNOLOGY INDUSTRIES COULD ADVERSELY AFFECT DECODE'S GROWTH
Economic factors and industry trends that affect deCODE's primary
customers, pharmaceutical and biotechnology companies, also affect deCODE's
business. For example, the practice of many companies in these industries has
been to outsource to organizations like deCODE to conduct genetic research,
clinical research, sales and marketing projects and chemistry research and
development projects. If these industries reduce their present tendency to
outsource those projects, deCODE's operations, financial condition and growth
rate could be materially and adversely affected. These alliances and
arrangements are both time consuming and complex and we face substantial
competition in establishing these relationships. In addition, our ability to
generate new business could be impaired by general economic downturns in our
customers' industries.
REGULATORY APPROVALS FOR PRODUCTS RESULTING FROM DECODE'S GENE DISCOVERY
PROGRAMS MUST BE OBTAINED OR DECODE WILL NOT BE ABLE TO DERIVE REVENUES FROM
THESE PRODUCTS.
Government agencies must approve new drugs and diagnostic products in the
countries in which they are to be marketed. deCODE cannot be certain that it can
obtain regulatory approval for any drugs or diagnostic products resulting from
its gene discovery programs. The regulatory process can take many years and
require substantial resources. Because some of the products likely to result
from deCODE's disease research programs involve the application of new
technologies and may be based upon a new therapeutic approach, various
government regulatory authorities may subject such products to substantial
additional review. As a result, these authorities may grant regulatory approvals
for these products more slowly than for products using more conventional
technologies. Furthermore, regulatory approval may impose limitations on the use
of a drug or diagnostic product.
After initial regulatory approval, a marketed product and its manufacturer
must undergo continuing review. Discovery of previously unknown problems with a
product may have adverse effects on deCODE's business, financial condition and
results of operations, including withdrawal of the product from the market.
Our success will depend, in part, on the development and marketing of
products based upon our research and development. Strict regulatory controls on
the clinical testing, manufacture, labeling, supply and
23
marketing of the products will influence our and our partners' ability to
successfully manufacture and market therapeutic or diagnostic products. Most
countries require a company to obtain and maintain regulatory approval for a
product from the relevant regulatory authority to enable the product to be
marketed. Obtaining regulatory approval and complying with appropriate statutes
and regulations is time-consuming and requires the expenditure of substantial
resources.
Most European countries and the United States have very high standards of
technical appraisal and consequently, in most cases, a lengthy approval process
for pharmaceutical products. The regulatory approval processes, which usually
include pre-clinical and clinical studies, as well as post-marketing
surveillance to establish a compound's safety and efficacy, can take many years
and require the expenditure of substantial resources. Data obtained from such
studies is susceptible to varying interpretations that could delay, limit or
prevent regulatory approval. Delays or rejections may also be encountered based
upon changes in drug approval policies in applicable jurisdictions. There can be
no assurance that we or our collaborative customers will obtain regulatory
approval for any drugs or diagnostic products developed as the result of our
gene discovery programs.
EFFORTS TO REDUCE HEALTHCARE COSTS MAY REDUCE MARKET ACCEPTANCE OF DECODE'S
PRODUCTS.
deCODE's success will depend in part on the price and extent to which it
will be paid for its products by government and health administration
authorities, private health insurers and other third party payors. Reimbursement
for newly approved healthcare products is uncertain. Third party payors,
including Medicare in the United States, are increasingly challenging the prices
charged for medical products and services. They are increasingly attempting to
contain healthcare costs by limiting both coverage and the level of
reimbursement for new therapeutic products. deCODE cannot be certain that any
third party insurance coverage will be available to patients for any products
deCODE discovers or develops. If third party payors do not provide adequate
coverage and reimbursement levels for deCODE's products, the market acceptance
of these products may be materially reduced.
Numerous governments have undertaken efforts to control growing healthcare
costs through legislation, regulation and voluntary agreements with medical care
providers and pharmaceutical companies. If cost containment efforts limit the
profits that can be derived from new drugs, deCODE's customers may reduce their
research and development spending which could reduce the business they outsource
to deCODE.
RISKS RELATED TO OUR INTELLECTUAL PROPERTY
DECODE MAY NOT BE ABLE TO PROTECT THE PROPRIETARY RIGHTS THAT ARE CRITICAL TO
ITS SUCCESS.
deCODE's success will depend in part on its ability to protect its
genealogy database and genotypic data and any other proprietary databases that
it develops and its proprietary software and other proprietary methods and
technologies. Despite deCODE's efforts to protect its proprietary rights,
unauthorized parties may be able to obtain and use information that deCODE
regards as proprietary. deCODE's commercial success will depend in part on
obtaining patent protection. The patent positions of pharmaceutical,
biopharmaceutical and biotechnology companies, including deCODE's, are generally
uncertain and involve complex legal and factual considerations. deCODE cannot be
sure that any of its pending patent applications will result in issued patents,
that it will develop additional proprietary technologies that are patentable,
that any patents issued to deCODE genetics, Inc. or deCODE's partners will
provide a basis for commercially viable products, will provide deCODE with any
competitive advantages or will not be challenged by third parties, or that the
patents of others will not have an adverse effect on deCODE's ability to do
business. If deCODE is unable to obtain patent protection for its technology or
discoveries, the value of its proprietary resources will be adversely affected.
In addition, patent law relating to the scope of claims in the area of
genetics and gene discovery is still evolving. There is substantial uncertainty
regarding the patentability of genes or gene fragments without known functions.
The laws of some European countries provide that genes and gene fragments may
not be patented. The Commission of the EU has passed a directive that prevents
the patenting of genes in their natural state. The U.S. Patent and Trademark
Office initially rejected a patent application by the National Institutes of
Health on partial genes. Accordingly, the degree of future protection for
deCODE's proprietary
24
rights is uncertain and, deCODE cannot predict the breadth of claims allowed in
any patents issued to it to others. deCODE could also incur substantial costs in
litigation if it is required to defend itself in patent suits brought by third
parties or if it initiates such suits.
Others may have filed and in the future are likely to file patent
applications covering genes or gene products that are similar or identical to
deCODE's products. deCODE cannot be certain that its patent applications will
have priority over any patent applications of others. The mere issuance of a
patent does not guarantee that it is valid or enforceable; thus even if deCODE
is holding or is granted patents it cannot be sure that they would be valid and
enforceable against third parties. Further, a patent does not provide the patent
holder with freedom to operate in a way that infringes the patent rights of
others. Any legal action against deCODE or its partners claiming damages and
seeking to enjoin commercial activities relating to the affected products and
processes could, in addition to subjecting deCODE to potential liability for
damages, require deCODE or its partners to obtain a license in order to continue
to manufacture or market the affected products and processes. There can be no
assurance that its partners or deCODE would prevail in any action or that any
license required under any patent would be made available on commercially
acceptable terms, if at all. If licenses are not available, its partners or
deCODE may be required to cease marketing its products or practicing its
methods.
If expressed sequence tags, single nucleotide polymorphisms, or SNPs, or
other sequence information become publicly available before deCODE applies for
patent protection on a corresponding full-length or partial gene, deCODE's
ability to obtain patent protection for those genes or gene sequences could be
adversely affected. In addition, other parties are attempting to rapidly
identify and characterize genes through the use of gene expression analysis and
other technologies. If any patents are issued to other parties on these partial
or full-length genes or gene products or uses for such genes or gene products,
the risk increases that the sale of deCODE's or its collaborators' potential
products or processes may give rise to claims of patent infringement. The amount
of supportive data required for issuance of patents for human therapeutics is
highly uncertain. If more data than deCODE has available is required, our
ability to obtain patent protection could be delayed or otherwise adversely
affected. Even with supportive data, the ability to obtain patents is uncertain
in view of evolving examination guidelines, such as the utility and written
description guidelines that the U.S. Patent and Trademark Office has adopted.
While deCODE requires employees, academic collaborators and consultants to
enter into confidentiality agreements, there can be no assurance that
proprietary information will not be disclosed, that others will not
independently develop substantially equivalent proprietary information and
techniques, otherwise gain access to our trade secrets or disclose such
technology, or that deCODE can meaningfully protect its trade secrets.
ITEM 2. PROPERTIES
In January 2002, we moved our headquarters and laboratories to an
approximately 150,000 square feet, three-story building owned by us and located
on property subject to a 50-year ground lease at Sturlugata 8 Reykjavik,
Iceland. Furthermore, we own a total of 28,000 square feet and have leased an
additional 3,000 square feet in a building at Krokhals 5, Reykjavik, to house
additional laboratory facilities and storage including Encode's operation and
maintain a facility for approximately 7 genealogist located in Thverholt 14,
Reykjavik.
Our principal executive offices and discovery laboratories in the United
States are located in Woodridge, Illinois, and encompass approximately 100,000
square feet with the capability to expand our offices and laboratories to
200,000 square feet. Additionally, we occupy approximately 50,000 square feet of
additional leased office and laboratory space in Lemont, Illinois, which lease
expires in October 2003, 15,000 square feet of additional laboratory space in
Des Plaines, Illinois, which lease ran through October 2002 at which point we
vacated the facility, and a 8,500 square foot leased facility located near
Seattle, Washington.
We also lease approximately 6,500 square feet of office space in Waltham,
Massachusetts, for business development and finance.
25
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any material legal proceedings except as follows:
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 us in the District Court of Reykjavik
in Iceland. They alleged that our genealogy database infringes their copyrights
and sought damages in the amount of approximately 616 million Icelandic kronas
and a declaratory judgment to prevent us from using the allegedly infringing
data. Subsequently, we acquired the copyrights at issue in the matter for 10
million Icelandic kronas (approximately $120). On December 20, 2002, the case
was dismissed without prejudice.
In February 2000, Man