-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FmxRJFxFx8R1R2dTkN4RF3eMK1ekCv7lFBje6TF/WlI+rkg6cSLP4FMjjiWvhCY9 xB32yW1yrcKWNkuB4LZI8w== 0001047469-98-012202.txt : 19980331 0001047469-98-012202.hdr.sgml : 19980331 ACCESSION NUMBER: 0001047469-98-012202 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: IMMUNE RESPONSE CORP CENTRAL INDEX KEY: 0000817785 STANDARD INDUSTRIAL CLASSIFICATION: BIOLOGICAL PRODUCTS (NO DIAGNOSTIC SUBSTANCES) [2836] IRS NUMBER: 330255679 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-18006 FILM NUMBER: 98577310 BUSINESS ADDRESS: STREET 1: 5935 DARWIN COURT CITY: CARLSBAD STATE: CA ZIP: 92008 BUSINESS PHONE: 6194317080 MAIL ADDRESS: STREET 1: 5935 DARWIN COURT CITY: CARLSBAD STATE: CA ZIP: 92008 10-K405 1 10-K405 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K /X/ Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the fiscal year ended DECEMBER 31, 1997 or / / Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the transition period from __________ to __________. Commission file number: 0-18006 THE IMMUNE RESPONSE CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 33-0255679 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 5935 DARWIN COURT, CARLSBAD, CA 92008 Address of principal executive offices (760) 431-7080 Registrant's telephone number including area code Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, Par Value $.0025 Preferred Stock Purchase Rights (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] The aggregate market value of the Common Stock held by non-affiliates of the registrant, based upon the last sale price of the Common Stock reported on the National Association of Securities Dealers Automated Quotation National Market System on March 20, 1998, was $207,108,640. The number of shares of Common Stock outstanding as of March 20, 1998, was 22,832,428. DOCUMENTS INCORPORATED BY REFERENCE (To the Extent Indicated Herein) Registrant's Proxy Statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for the Registrant's 1998 Annual Meeting of Stockholders to be held on June 11, 1998 is incorporated by reference in Part III, Items 10 (as to directors), 11, 12 and 13 of this Form 10-K. 2 ITEM 1. BUSINESS GENERAL The Immune Response Corporation ("Immune Response" or the "Company") is a biopharmaceutical company developing immune-based therapies to induce specific T cell responses for the treatment of HIV, autoimmune diseases and cancer. The Company is conducting clinical trials for its immune-based therapies for HIV, rheumatoid arthritis, psoriasis, multiple sclerosis, colon cancer and brain cancer and preclinical studies for prostate cancer. In addition, the Company is developing a targeted delivery technology for gene therapy which is designed to enable the intravenous injection of genes for delivery directly to the liver. The Company's gene therapy program is currently focused on diseases of the liver and is in preclinical studies for the treatment of hemophilia and hepatitis. PRODUCTS UNDER DEVELOPMENT(1)
PRECLINICAL PHASE I PHASE II PHASE III ----------- ------- -------- --------- IMMUNE-BASED THERAPIES HIV --------------------------------------------------- Rheumatoid Arthritis -------------------------------------- Psoriasis ---------------------------------- Multiple Sclerosis ----------------------- Colon Cancer ----------------------- Brain Cancer --------------- Prostate Cancer ---------- GENE THERAPY ------------ Hemophilia A ---------- Hepatitis ----------
(1) The table describes the status of the current product candidates and is not intended to depict the relative lengths of time of any of the stages of drug discovery and preclinical and clinical development. The amount of time spent in any phase of development will vary substantially from product to product and there can be no assurance that any of the products will proceed beyond the phase depicted or will receive regulatory approval. See "Government Regulation." IMMUNE-BASED THERAPIES REMUNE HIV THERAPY BACKGROUND. AIDS is a condition that slowly destroys the body's immune defense system making the body vulnerable to opportunistic infections. AIDS is caused by a virus known as HIV. Shortly after an individual is infected with HIV, the virus multiplies rapidly and can be detected in the blood. The immune system responds by producing antibody and cellular immune responses capable of attacking HIV. While these and other responses are usually sufficient to temporarily arrest progress of the infection and reduce levels of virus in the blood, the virus continues to replicate and slowly destroy the immune system by infecting and killing critical T cells, known as CD4 cells, which are needed to maintain the immune system. As the infection progresses, the immune system's control of HIV levels weakens, the level of virus in the blood rises and the level of CD4 cells declines to a fraction of normal levels. These events are followed by progression of the disease and the collapse of the immune system, leaving the body susceptible to fatal infections and cancers. AIDS represents the "end stage" of the HIV infection, and is characterized by pneumonia and other infectious diseases of the pulmonary system, central nervous system, gastrointestinal tract and skin, as well as cancers such as Kaposi's sarcoma and lymphoma. The World Health Organization estimates there are approximately 20 million individuals, including 1.5 million children, around the world infected with HIV. In the United States, the number of HIV-infected individuals is estimated at 1.0 million. The HIV epidemic represents a significant societal threat to both developed and developing nations since most of the HIV-infected individuals are expected to ultimately develop AIDS, creating a significant burden on healthcare systems and economies around the world. 3 EXISTING THERAPIES FOR HIV. The spread of HIV is a result of the virus transferring its genetic material (RNA) into the host cell where it uses the host cell's protein synthesis capability to replicate. The first antiviral drugs approved in the United States to treat HIV were designed to inhibit the synthesis of DNA from viral RNA in infected cells by targeting reverse transcriptase enzymes. These reverse transcriptase inhibitors include: zidovudine (AZT), dideoxyinosine (ddI), stavudine (d4T), dideoxycytidine (ddC), lamivudine (3TC), nevirapine (Viramune) and delavirdine (Rescriptor). Worldwide sales of reverse transcriptase inhibitors were approximately $1.0 billion in 1996. A second class of HIV antiviral drugs inhibits HIV protease, a viral enzyme required to cleave newly synthesized viral proteins into the correct size so the virus can assemble itself into new infectious virus particles. Approved HIV protease inhibitors include: invirase (Saquinavir), norvir (Ritonavir), indinavir (Crixivan), and nelfinavir (Viracept). Worldwide sales of protease inhibitors were approximately $400 million in 1996 and are projected to grow significantly over the next several years. Currently available antiviral products have been shown to be effective at reducing the levels of virus in the blood, however, certain limitations in the therapy have prevented the antiviral products from being as effective as originally predicted. The antiviral products are often associated with significant toxicity and eventual induction of viral resistance. In addition, non-compliance with the strict dosage regimen may also reduce the effectiveness and can accelerate emergence of resistance. - - RESISTANCE. HIV is prone to mutations that produce resistance to reverse transcriptase and protease inhibitors. In an effort to overcome such resistance, physicians have begun to use reverse transcriptase and protease inhibitors in various combinations. Reverse transcriptase and protease inhibitors, in various combinations commonly referred to as "cocktail therapy" represent an advance in the treatment of HIV infection, though no cocktail therapy has yet proven to be a cure. Moreover, although these cocktail therapies have slowed the emergence of resistance, new mutant strains have been identified which are resistant to several of these drugs. - - TOXICITY. Accumulating data indicate that certain patients are unable to take reverse transcriptase and protease inhibitors, either alone or in combination, due to toxic side effects, including gastrointestinal disorders, peripheral neuropathy and kidney stones. Recent information has suggested that protease inhibitors may cause diabetes-like symptoms in some patients. - - COMPLIANCE. In order to maintain a high level of the drugs in the blood, many current drugs require complex dosing, with some medications to be taken with meals and some on an empty stomach. A typical cocktail therapy regimen includes 14 to 16 pills taken at six to eight times during the day. If a patient misses a dose or delays taking the drugs even for a short period of time, the drug level in the body may decline, allowing the virus to replicate and increasing the potential to develop resistant strains. It is currently estimated that only 20% to 30% of HIV-infected individuals in the United States use cocktail therapies, and up to 50% of these individuals discontinue treatment due to resistance, toxicity, lack of compliance or because the cocktail therapy was not effective in reducing the viral load. The Company believes HIV opinion leaders have begun to recognize that in order to effectively stop or slow the progression of HIV to AIDS, therapies must stimulate the infected individual's own immune system (HIV-specific T cell proliferation) in addition to reducing viral load through the use of antiviral drugs. In the November 21, 1997 issue of SCIENCE, Dr. Bruce Walker and his colleagues at Harvard University reported on the importance of maintaining an HIV-specific immune response. Specifically, Dr. Walker showed there was a direct correlation between HIV-specific T cell proliferation and the successful control of virus replication in the absence of antiviral drug therapy in certain HIV-infected individuals. Dr. Walker and other researchers suggest that these results provide some hope that an immune response could be boosted even in people who show little evidence of having an HIV-specific immune response, possibly by combining powerful antiviral therapies with anti-HIV immune-based therapies. The Company believes its published studies have shown that the administration of REMUNE to HIV-infected individuals elicits not only HIV-specific T cell proliferation, but also appears to impact other markers of disease progression, such as chemokines and gamma interferon along with a reduction in tumor necrosis factor, all of which are believed by scientists to have a favorable impact on disease progression. REMUNE - PRODUCT DESCRIPTION. REMUNE is an immune-based therapy intended to treat HIV-infected individuals by preventing or delaying the progression of HIV to AIDS. REMUNE is designed to stimulate an HIV-infected 4 individual's immune system to attack HIV. The Company believes results from its previous clinical trials demonstrated that REMUNE has a statistically significant impact on boosting HIV-specific immune responses in HIV-infected individuals. The Company believes REMUNE stimulates the immune system against the virus and also stimulates specific antiviral substances, such as chemokines, which are produced by the immune system and naturally protect T cells from HIV infection. By utilizing an immune-based therapy such as REMUNE, the Company believes it may be possible to augment the natural immune system against the virus and further optimize the effects of antiviral drug therapy. The Company is currently conducting a Phase III clinical endpoint trial involving approximately 2,500 HIV-infected individuals to determine whether REMUNE is effective in halting or delaying the progression of HIV to AIDS. The Company anticipates the trial will conclude in the second quarter of 1999. The Company's technology in developing REMUNE employs the whole virus, inactivated and depleted of its outer coat ("envelope" or "gp120"). REMUNE is based on the core proteins of the virus which are consistent across multiple strains of HIV. Earlier approaches to HIV immune-based therapies were based on the envelope, proteins located on the outside of the virus, which may not have been effective due to virus mutations. The Company believes REMUNE has been shown to be safe and well tolerated after repeated use in thousands of individuals. The Company believes REMUNE may be an appropriate treatment for HIV-infected individuals to take alone or in combination with other treatments. REMUNE is administered by intramuscular injection, by a healthcare professional, once every three months. HUMAN CLINICAL TRIALS. To support the Phase III clinical endpoint trial, the Company has established relationships with leading academic and clinical institutions in order to place control of the design, statistical results, data and laboratory results under the control of independent third parties. There are over 70 clinical sites participating in the trial. Physicians from the University of California-San Francisco, Brown University and Cornell University assisted in the design of this trial and are participating in managing the trial as Principal Investigators. The statistical plans for the trial were developed and data analyses are being conducted by biostatisticians at Harvard University. Data management and analysis of patient samples for this trial are being conducted by Quintiles, Inc., while an independent data safety monitoring board of these clinicians and statisticians will review the data during the interim and final analyses of the Phase III trial. This trial design was reviewed by a FDA Advisory Committee, and the trial was designated by the FDA as a pivotal Phase III clinical endpoint trial. The first statistical interim analysis of data from this Phase III trial is scheduled for June 1998. The interim data, if positive, will most likely result in the continuation of the trial. The Company would consider this result to be considered an indication that the trial is progressing as expected. The FDA has also granted expanded access to REMUNE. Expanded access is a procedure whereby patients who were ineligible to enroll in the existing clinical trials are provided treatment under a separate clinical trial protocol. Under this protocol, all patients are treated with REMUNE and are monitored primarily for safety. Prior to commencing its U.S. Phase III clinical endpoint trial, the Company completed several Phase I and Phase II clinical trials of REMUNE involving over 280 HIV-infected individuals. The Phase I clinical trials conducted at the University of Southern California involved 107 individuals at various stages of HIV infection. In these trials, REMUNE was well tolerated without serious side effects and indicated its ability to enhance an immune system response against HIV. In one of these open-label Phase I clinical trials, which began in 1987, 25 HIV-positive individuals were treated with REMUNE. Of those individuals, 12 developed an HIV-specific immune response (as measured by a skin test), of whom 11 have not experienced significant progression of the disease. The long-term follow-up results from this clinical trial were published in the JOURNAL OF ACQUIRED IMMUNE DEFICIENCY SYNDROMES AND HUMAN RETROVIROLOGY in April 1996. Many of the participants in these Phase I trials have elected to continue treatment with REMUNE, some for up to ten years. These patients are being observed to assess the long-term safety of the therapy. Two Phase II clinical trials of REMUNE were conducted to assess the ability of this therapy to stimulate immune system responses against HIV, to evaluate the effect of REMUNE on early markers of progression in asymptomatic HIV-infected individuals and to monitor safety. A double-blind, placebo-controlled Phase II dose-ranging clinical trial involving 60 asymptomatic HIV-infected individuals was conducted to determine the ability of REMUNE administered at various doses to enhance responses to HIV proteins. The Company believes the results of the trial demonstrated, in a statistically significant manner, that REMUNE can stimulate enhanced immune responses in HIV- 5 infected individuals. The trial was not designed to evaluate the effectiveness of REMUNE as a treatment for HIV infection. The results of this Phase II trial were published in the British scientific journal AIDS in October 1994. A second double-blind, placebo-controlled Phase II clinical trial of REMUNE was conducted to evaluate the effect of the therapy on the level of virus in the blood and other potential surrogate markers for disease progression. The Company believes the results of this trial, involving 103 HIV-infected individuals, indicated that treatment with REMUNE is safe, well tolerated and may slow the rate of increase in the levels of HIV in blood cells. In addition, the Company believes the results of the trial indicated that REMUNE has a favorable impact on multiple markers of HIV disease progression, including viral burden, CD4 cell count, HIV-specific cell-mediated immunity, antibody production and weight gain. The Company believes the trial results also indicated that REMUNE may slow the rate of decline in key immune cells known to be attacked by HIV, as well as enhance the immune system's attack against HIV proteins. The results of this clinical trial were published in THE JOURNAL OF INFECTIOUS DISEASES in June 1994 and in a supplement to THE JOURNAL OF ACQUIRED IMMUNE DEFICIENCY SYNDROME in October 1994. REMUNE IN COMBINATION WITH ANTIVIRAL THERAPIES - ----------------------------------------------- REMUNE is designed to work alone or in conjunction with antiviral drugs. By combining these therapies, the Company believes an HIV-infected individual may be able to attack the virus from two fronts: boosting the immune system with REMUNE to eliminate HIV-infected cells and reducing the level of the virus in the blood with antiviral drugs. The Company has initiated several combination drug trials which are designed to determine whether the combination of REMUNE and antiviral drug therapies will act synergistically (e.g. the antiviral drug therapies lowering viral load and REMUNE boosting the immune system). One goal of the combination approach may prolong the impact of antiviral drug therapies on viral load by increasing the immune response to HIV-infected cells. If successful, a delay in drug resistance and a prolonged duration of low levels of virus in the blood coupled with an increase in the immune response to HIV could translate into clinical benefit. [GRAPHIC] (1) HIV infects T cells and takes over the cell machinery such that the cell becomes a manufacturing facility that makes and releases infectious HIV (RNA) particles into the bloodstream where the virus infects other cells. (2) Antiviral drugs interfere with the infected cells ability to manufacture infectious virus particles, but does not impact or eliminate the infected T cell. (3) Treatment with REMUNE is intended to increase an HIV-specific immune response believed to be associated with the destruction of the HIV-infected T cell. (4) The combination of REMUNE and antiviral drugs may act synergistically --REMUNE potentially boosts the immune response while the drugs lower the viral load. The Company has combination drug trials underway in which REMUNE is used in combination with antiviral drugs manufactured or distributed by Glaxo Wellcome, Merck & Co. and Hoffman La Roche. In addition, the Company is currently conducting a number of other clinical trials to obtain additional data with respect to the use of REMUNE. The following table summarizes the clinical trials the Company is conducting with REMUNE. 6 CLINICAL TRIALS USING REMUNE
CURRENT U.S. TRIALS - ------------------- INTENDED DATE PATIENT STAGE INITIATED ENROLLMENT OBJECTIVES - ----- --------- ---------------- ---------- Phase III (pivotal efficacy) 1996 2,500 Intended to measure the ability of REMUNE to (fully enrolled) impact progression to AIDS and death Phase II (combination) 1997 50 Intended to measure HIV-specific immune response during antiviral drug usage (Merck/Glaxo Wellcome) Phase I (pediatric) 1996 32 Intended to measure safety and ability to stimulate an immune response in children (National Institutes of Health) Expanded Access 1996 1,000 Intended to measure long-term safety CURRENT INTERNATIONAL TRIALS - ---------------------------- INTENDED DATE PATIENT STAGE INITIATED ENROLLMENT OBJECTIVES - ----- --------- ---------------- ---------- Phase II (safety and activity) 1996 300 Intended to measure safety, HIV-specific Thailand immune response and effects on indicators of disease progression Phase II (combination) 1996 300 Intended to measure HIV-specific immune Spain response during antiviral drug usage Phase II (combination) 1998 30 Intended to measure HIV-specific immune Switzerland response during antiviral drug usage (Hoffman La Roche/Glaxo Wellcome) Phase II (combination) 1998 40 Intended to measure HIV-specific immune United Kingdom response during antiviral drug usage - ------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------ COMPLETED U.S. TRIALS - --------------------- # OF STAGE DATE PATIENTS RESULTS - ----- ----------- ---------------- ------- Phase I (safety) 1987 - 1995 25 Safety indicated and long-term survival observed in patients with strong, HIV-specific, immune response Phase I (safety) 1988 - 1995 82 Safety indicated and HIV-specific immune response observed Phase II (dose ranging) 1990 - 1992 60 Safety indicated and HIV-specific immune response observed Phase II (activity) 1990 - 1993 103 Safety indicated, HIV-specific immune response and positive effect on indicators of disease progression observed Phase II (drug interaction) 1992 - 1993 27 REMUNE treatment indicated safe when combined with antiviral drug therapy Phase II (long-term safety) 1995 - 1996 175 Safety indicated
7 TECHNOLOGY. REMUNE is composed of inactivated HIV, depleted of its envelope, and emulsified in Incomplete Freund's Adjuvant ("IFA"), an agent which elicits a more potent immune response by more effectively presenting the inactivated virus to the immune system. REMUNE is manufactured by first culturing HIV-infected human T cells. The virus is then purified from this cell culture and inactivated using two separate procedures. The virus is first inactivated with betapropiolactone, a chemical agent commonly used for viral inactivation, and then physically inactivated with irradiation. Each of these procedures alone is capable of inactivating HIV. During processing and purification, the outer envelope protein of the virus, known as gp120, is depleted from the inactivated HIV. The final envelope-depleted HIV is emulsified in IFA and is filled in syringes. When introduced into HIV-infected individuals, REMUNE appears to stimulate an HIV-specific immune system response, which the Company believes may provide a safe, effective and long-lasting benefit to these individuals. MANUFACTURING. The Company subleases a 51,000 square foot facility in King of Prussia, Pennsylvania to manufacture REMUNE for clinical trials and, if the product is approved by the FDA, initial commercial production. In February 1996, the Company received clearance from the FDA to release the product for use in clinical trials. The Company believes the facility, which is a full-scale, GMP commercial process facility, is capable of supplying clinical trial quantities and, providing initial commercial quantities. The Company relies on a third party for the final inactivation step of the manufacturing process. If the existing manufacturing operations prove inadequate, there can be no assurance that any arrangement with a third party can be established on a timely basis, or that the Company can establish other manufacturing capacity on a timely basis. The Company believes that the raw materials necessary to produce REMUNE are readily available from various sources. COMMERCIALIZATION STRATEGY. It is the Company's intent that if REMUNE is approved by the FDA it will retain domestic distribution rights for REMUNE and seek an international distribution partner. The Company has begun discussions with organizations that specialize in the distribution of pharmaceutical products to physicians and other healthcare providers in the U.S. The Company has begun to conduct physician and patient focus group sessions to begin preparations for a commercial marketing launch of REMUNE, subject to the successful conclusion of the clinical trials and final approval of the product by the FDA. If REMUNE is successfully developed and approved for marketing, the Company will seek third party reimbursement for the costs of related treatments from government health administration authorities, private health coverage insurers, managed care organizations and other organizations. REMUNE INACTIVATION PROCESS [GRAPHIC] 1. Fully intact, infectious HIV 2. Inactivation of the virus 3. The outer envelope protein of the virus, gp120, has been depleted from the inactivated virus 4. Final envelope-depleted, inactivated "whole-killed" HIV emulsified in IFA 8 IMMUNE-BASED THERAPIES FOR AUTOIMMUNE DISEASES BACKGROUND. The normal immune system is closely regulated. The body is able to distinguish its own proteins from those that are present due to infection or abnormalities. Aberrations in immune response are not uncommon and at times may cause an individual's immune system to react inappropriately to a component of one's own body as if the component were foreign. In these instances, it is often T cells that exhibit aberrant behavior resulting in the development of autoimmune diseases. These "autoreactive" T cells are believed responsible for the incorrect identification and destruction of the individual's own tissue. While autoimmune diseases may involve any organ system, common targets include the lining of the joints in rheumatoid arthritis, the skin in psoriasis and the white matter of the brain and spinal cord in multiple sclerosis. Current treatments for these diseases address only the symptoms and are ineffective in halting the progressive tissue destruction caused by the autoreactive T cells. This progression often results in severe debilitation or death. TECHNOLOGY. The Company's proprietary autoimmune immune-based therapies under development are designed to inhibit or downregulate the autoreactive T cells that the Company believes cause the tissue damage in certain autoimmune diseases. These therapies are designed to induce specific immune responses by targeting markers on the T cell receptor ("TCR") present on autoreactive T cells and inhibiting the disease-causing autoreactive T cells. The Company's proprietary technology platform from which it is seeking to develop immune-based therapies involves identifying receptors on autoreactive T cells and synthesizing a therapeutic vaccine based on peptides (amino acid sequences) located within these receptors. The Company is pursuing this approach for the treatment of rheumatoid arthritis, psoriasis and multiple sclerosis. [GRAPHIC] 1. T cells believed to be involved in autoimmune diseases are identified by the T cell receptor, a unique "fingerprint like" structure that distinguishes one type of T cell from another T cell. 2. A small section (peptide) of the T cell receptor is identified. This peptide represents the principal component of the potential immune-based therapy. 3. The immune-based therapy under development is intended to stimulate the immune system to downregulate (turn off) those T cells believed to cause inflammation and tissue destruction. The Company believes that its approach to the treatment of autoimmune diseases may provide several advantages over existing therapies and competing approaches based on immune system regulation. In Phase I and Phase II studies, the Company's immune-based therapies using T cell receptor peptides have indicated a lack of toxicity and a specific impact on the disease-causing cells. These results, combined with the ease of administration through 9 infrequent intramuscular injections and the potential for a long-lasting response of an active immune-based therapy, may provide an important treatment compared to existing therapies. The Company is in discussions with major pharmaceutical companies regarding a corporate collaboration using this immune-based technology. There can be no assurance that the Company will be able to negotiate collaborative arrangement on favorable terms, or at all, or that any collaborative arrangements would be successful. RHEUMATOID ARTHRITIS. Rheumatoid arthritis is a chronic inflammatory disease characterized by persistent inflammation of the lining of the joints accompanied by stiffness and pain or tenderness on motion. It is estimated that approximately four million individuals in the United States, and 53 million worldwide, suffer from rheumatoid arthritis, and up to $2 billion is spent annually in the U.S. on medications which are designed to treat only the symptoms of this debilitating disease. EXISTING THERAPIES. There is currently no cure for rheumatoid arthritis. Currently, management of rheumatoid arthritis requires early diagnosis and aggressive treatment before functional impairment and irreversible joint damage has occurred. Available therapies generally have adverse side effects and address only the symptoms of the disease. Objectives of disease management include relief of pain, reduction of inflammation, minimization of undesirable side effects, preserving muscle strength and joint function, and the return to a normal lifestyle. Drugs are necessary for treatment, but are often unsatisfactory. Nonsteroidal anti-inflammatory drugs are a widely used therapy. They require large doses and close monitoring. Steroidal and other drugs may be used, but usually are accompanied by more severe side effects and toxicity. By contrast, the Company's rheumatoid arthritis therapy is intended to target and inhibit the specific T cells thought to be involved in the disease process. The Company believes this inhibition may reduce the inflammatory events that occur as the disease progresses. PRODUCT DESCRIPTION. IR501 is the Company's proprietary rheumatoid arthritis immune-based therapy under development and is based on a combination of three peptides from the VBETA 3, VBETA 14 and VBETA 17 T cell receptors emulsified in IFA. The Company published, in the PROCEEDINGS OF THE NATIONAL ACADEMY OF SCIENCES in December 1991, the discovery of these specific T cell populations that the Company believes may cause rheumatoid arthritis. The treatment being developed is designed to stimulate the immune system of a rheumatoid arthritis patient to control these T cells. The Company believes that eliminating or inhibiting these T cells may prevent further damage to the tissue of joints. Several scientific publications since 1991 by research groups independent of the Company have confirmed the involvement of one or more of these T cell populations in rheumatoid arthritis. HUMAN CLINICAL TRIALS. In December 1996, the Company completed a Phase II clinical trial evaluating the safety and ability of its rheumatoid arthritis treatment to elicit an immune response. This double-blind, placebo-controlled trial involved 99 rheumatoid arthritis patients and was designed to generate additional safety data, determine the ability of the rheumatoid arthritis therapy to stimulate responses against the T cell receptor peptides used in the vaccine and to determine an optimal dose of the therapy. While this trial was designed to show trends, results from this trial indicated safety and a statistically significant clinical improvement in disease condition using the American College of Rheumatology guidelines (ACR 20). The ACR 20 criteria require an improvement in tender and swollen joint counts of at least 20% from baseline, along with improvement in three of five other disease-related criteria. Patients who showed improvement after treatment also had evidence of a favorable reduction in the circulating level of the inflammatory cytokine tumor necrosis factor alpha (TNF-ALPHA). In December 1997, the Company initiated a Phase IIb clinical trial intended to confirm and expand clinical results from the completed Phase II clinical trial. This Phase IIb trial will include up to 300 individuals with rheumatoid arthritis. This 24 week trial is a double-blind, placebo-controlled, multi-center trial with patients being treated at 22 clinical sites. Results from this trial are expected to be available by the end of 1998. PSORIASIS. Psoriasis is a chronic and recurrent proliferative disease of the skin characterized by irritating and sometimes painful, defined red patches covered with silvery-white scales. According to the National Psoriasis Foundation, psoriasis affects over six million Americans. Annual outpatient costs for treatment are currently estimated at up to $3 billion per year. A distinguishing feature of the disease is the rapid sloughing of skin layers. While normal skin cells mature in 28 to 30 days, skin cells of psoriasis patients move to the surface of the skin in approximately four days. EXISTING THERAPIES. Current treatments, which range from topical ointments to phototherapy, address the symptoms of psoriasis rather than the cause of the disease. Not all treatments work for every individual. These treatments 10 often require individuals to experiment and/or combine therapies in order to discover the regimen that is most effective. Treatment success requires faithful compliance to the regimen and provides varying degrees of relief from the disease. By contrast, the Company's psoriasis therapy is intended to target and inhibit the immune system cells that may be involved in the initiation of the disease process. PRODUCT DESCRIPTION. The Company's proprietary immune-based therapy under development for psoriasis, IR502, is based on a combination of two peptides from the VBETA 3 and VBETA 13.1 T cell receptors emulsified in IFA. The Company published, in the PROCEEDINGS OF THE NATIONAL ACADEMY OF SCIENCES in 1994, the discovery of these two T cell populations, which the Company believes initiate the events that lead to the irritating and sometimes painful lesions found on the skin of psoriasis sufferers. The treatment being developed by the Company is designed to stimulate the immune system of a psoriasis patient to control these T cells. The Company believes that eliminating or inhibiting these T cells may alleviate the effects of this disease. HUMAN CLINICAL TRIALS. In December 1996, the Company completed a Phase II clinical trial evaluating the safety and the ability of its psoriasis treatment to elicit an immune response. This double-blind, placebo-controlled clinical trial involved 93 psoriasis patients and was designed to test the safety of the therapy, determine the ability of the psoriasis therapy to stimulate responses against the T cell receptor peptides used in the vaccine and to determine an optimal dose of the therapy. Results of the trial indicated the product was well tolerated. Although patients in the trial improved after treatment, there was no statistically significant difference between the treated and control groups. Based on strong immunological results seen the Phase II trial, the Company began a second Phase II clinical trial in November 1997. This Phase II trial involves 84 individuals with moderate to severe psoriasis. It is a 16 week double-blind, placebo-controlled, multi-center trial with patients being treated at six clinical sites. Results from this trial are expected to be available by mid-1998. MULTIPLE SCLEROSIS. Multiple sclerosis afflicts approximately 250,000 individuals in the United States and more than 1.1 million individuals worldwide. Multiple sclerosis is a chronic disease of the central nervous system and one of the most common causes of chronic neurologic disability in young adults. PRODUCT DESCRIPTION. The Company's proprietary immune-based therapy under development for multiple sclerosis, IR208, also uses peptides from the VBETA 6.2 T cell receptors, emulsified in IFA. The T cells from individuals afflicted with multiple sclerosis were found in the cerebrospinal fluid. HUMAN CLINICAL TRIALS. In January 1995, in collaboration with the Sidney Kimmel Cancer Center ("SKCC"), the Company completed a Phase I clinical trial in multiple sclerosis patients, which provided evidence that this therapy is safe and well tolerated and that it may stimulate immunological responses against the specific T cells. In February 1997, the Company began a compassionate use program in California for certain individuals. IMMUNE-BASED THERAPIES FOR CANCER BACKGROUND. Cancer is characterized by the uncontrolled growth of abnormal cells that spread from the anatomic site of origin. This growth, if uncontrolled, invades vital organs and may result in death. However, many cancers can be cured if they are detected early and treated promptly; others can be controlled for many years with a variety of treatment approaches. Cancer is most often treated by surgery, radiation, chemotherapy, hormones and more recently, immunotherapy. EXISTING THERAPIES. There are currently several ways to treat cancer, all of which have significant and often severe side effects. The most common combination of treatment is surgery or radiotherapy followed by chemotherapy. Unfortunately, certain tumors are drug resistant from the beginning while others develop resistance with repeated treatments. The problem of drug resistance is particularly serious in chemotherapy when tumors develop a resistance to multiple drugs after only one drug has been administered. TECHNOLOGY. The Company is utilizing proprietary immune-based cancer vaccine technologies for the development of more effective cancer therapies. The Company initially intends to focus on treatments for colon, brain and prostate cancers. Each of the technologies being developed uses advanced molecular gene therapy techniques combined with vaccine technology to enable the immune system to recognize and control tumor growth. 11 [GRAPHIC] 1. Inactivated tumor cells are combined with cells that stimulate the immune system (interleukin-2 or other cytokines) 2. Through immunization, the immune system is presented with the structure of the tumor cell in the presence of the stimulating agent 3. Activated T cells migrate to the site of residual tumor cells and destroy them COLON CANCER. It is estimated that nearly 140,000 individuals in the United States annually develop colon cancer, with an estimated 55,000 deaths attributable to the disease. HUMAN CLINICAL TRIALS. In June 1995, the Company, in conjunction with the Sidney Kimmel Cancer Center ("SKCC"), initiated a Phase I clinical trial of this potential therapy in colon cancer patients that had failed conventional therapy. The Phase I clinical trial in patients involved the preparation of a custom therapy for each patient. Results from this trial indicated the treatment was well tolerated. The Company is developing therapies that would alleviate the need for isolating fibroblasts and tumor cells from each patient with the objective of creating a universal, non-patient specific, treatment. Success in this development program may lead to the application of this technology to other solid tumors. The Company has submitted an Investigational New Drug application ("IND") to the FDA for a universal cell line vaccine to treat colon cancer, and plans to begin a Phase I clinical trial in late 1998. BRAIN CANCER. Brain tumors are responsible for significant morbidity and mortality in both pediatric and adult populations. The most common type of brain cancer is glioma, a tumor that arises in the supportive tissue of the brain. Glioma tumor cells are known to overproduce the cytokine TGF-BETA , which can suppress the activity of the immune system cells that are needed to destroy tumors, and it is believed to be one of the mechanisms by which tumor cells evade immune system recognition. HUMAN CLINICAL TRIALS. The Company has submitted an IND to the FDA for a universal cell line vaccine to treat brain cancer, and plans to begin a Phase I clinical trial in late 1998. RECURRENT PROSTATE CANCER. Prostate cancer is the second leading cause of cancer death among men. According to the American Cancer Society, in 1996 approximately 317,000 American men were diagnosed with prostate cancer and an estimated 40,000 died of the disease. According to recent articles, recurrent disease will occur in up to 40% of patients who undergo radical prostatectomy or radiation therapy. Preclinical work is being conducted on a potential prostate cancer vaccine. 12 GENE THERAPY TECHNOLOGY. The Company's proprietary GeneDrug products under development are based on a patented delivery technology which can be used to treat a variety of diseases, with initial focus on the liver. This technology was exclusively licensed from The University of Connecticut Research Foundation ("University of Connecticut"), for intravenous injection and targeting of genes or drugs directly to liver cells. The Company believes this technology may have several advantages over current therapies including; targeted delivery to the liver, versatility to treat different diseases with the same technology, and safety since viruses are not used. Other competitive gene therapy systems under development use disabled viruses to carry the gene to the cell nucleus. COMMERCIAL POTENTIAL: Each gene therapy product under development by the Company is intended to be prepared and distributed like a traditional injectable pharmaceutical. These therapies would not require patient-specific processing of cells outside the body compared to other gene therapy systems under development. [GRAPHIC] HEMOPHILIA Hemophilia A, a hereditary blood clotting disorder, results from the dysfunction or absence of the Factor VIII protein. Approximately one of every 5,000 live male births in the United States results in a child afflicted with hemophilia A. Current treatments for hemophilia A are expensive, with total annual cost ranging from $60,000 to $100,000. The Company's GeneDrug technology system is designed to produce therapeutic concentrations of Factor VIII by delivering the gene that produces this protein. Once delivered to the liver cells, the Factor VIII gene may express the desired protein and secrete this protein into the bloodstream on a continuous basis for several weeks. If successful, this product would eliminate the regular bleeding episodes associated with hemophilia by allowing the patient to receive periodic injections in order to maintain therapeutic levels of Factor VIII. In July 1996, Immune Response entered into an agreement with Bayer Corporation, the United States affiliate of Bayer AG of Leverkusen, Germany, to develop gene therapy products for the treatment of hemophilia A. HEPATITIS. Hepatitis B is a viral infection of the liver. As many as 300 million individuals are infected with hepatitis B virus ("HBV") worldwide and in the United States there are approximately 300,000 new cases of HBV infection each year. Hepatitis C virus ("HCV") was recently identified as the major cause of non-A/non-B hepatitis, of which there are at least 75,000 new cases in the United States each year. Recombinant interferon-alpha (IFN-ALPHA) is currently approved for treatment of both HBV and HCV. Many patients treated with recombinant IFN-ALPHA do not respond and whether there is a long-term benefit among those who have responses is uncertain. A preclinical study evaluating delivery of the IFN-ALPHA gene to the liver has demonstrated successful expression of IFN-ALPHA protein IN VITRO and IN VIVO for up to six weeks. The Company's GeneDrug system is designed to enhance interferon therapy by achieving continuous, low-level expression and secretion of the protein specifically in liver cells. The Company is in 13 discussions with a major pharmaceutical company regarding a corporate collaboration for hepatitis using this gene delivery technology. There can be no assurance that the Company will be able to negotiate a collaborative arrangement on favorable terms, or at all, or that any collaborative arrangements would be successful. MANUFACTURING The Company has established a pilot manufacturing facility at its headquarters in Carlsbad, California for the production of the immune-based and gene therapies. This facility is expected to be adequate to supply limited clinical trial quantities for these therapies. Additional manufacturing capacity will be needed for commercial scale production, if these therapies are approved for commercial sale. For the manufacture of the autoimmune disease therapies under development, the Company obtains synthetic peptides from third party manufacturers. The Company believes that the synthetic peptides and other materials necessary to produce the autoimmune disease therapies are readily available from various sources and several suppliers may be capable of supplying the autoimmune disease therapies in both clinical and commercial quantities. PATENTS REMUNE - HIV THERAPY. In 1993, the Company received a United States patent relating to REMUNE. The Company has also received similar patents in Australia, certain European countries, Japan and Russia. The Company has additional patent applications relating to REMUNE on file in the United States, as well as in other countries. The patent applications cover, in part, certain products and methods of their use for the immunotherapeutic treatment of HIV-infected patients and/or preventive treatment of uninfected individuals. There can be no assurance that any additional HIV-related patents will be issued to the Company. Further, there can be no assurance that the issued patents, or any patent that may be issued in the future, will survive opposition or provide meaningful proprietary protection. AUTOIMMUNE DISEASES. During January 1994, the European Patent Office granted the Company a patent covering vaccination and methods against diseases resulting from pathogenic responses by specific T cell populations. In March 1997, the Company was issued a broad patent covering this technology in the United States. In May 1994, the Australian Industrial Property Organisation accepted a similar application of the Company. These patents include composition and method claims for the prevention or treatment of certain autoimmune diseases, such as rheumatoid arthritis, psoriasis and multiple sclerosis. The Company also has patent applications relating to its autoimmune technology on file in the United States and other countries, including members of the European Patent Convention and Japan. These patent applications cover certain compositions and methods relating to the use of T cell receptor peptide sequences to vaccinate against autoreactive T cells involved in autoimmune disease. There can be no assurance that any further autoimmune disease patents will be issued to the Company or that any issued patents, or any patent that may be issued in the future, will survive opposition or provide meaningful proprietary protection. The Company is aware that Connetics Corporation ("Connetics") has been granted U.S. and European patents related to autoimmune disease which covers technology similar to that used by the Company. The Company is in discussions with Connetics to resolve any conflict between the Company's and Connetics' patents. However, there can be no assurance that a cross license or other resolutions satisfactory to the Company will result. A failure to resolve this dispute in a manner favorable to the Company, could have a material adverse effect on the Company. In March 1998, the Company successfully defended its European patent with respect to its immune-based therapies for autoimmune disease technology that was under opposition. CANCER. Technology to genetically modify fibroblasts with cytokine genes or genes to inhibit TGF-BETA production has been exclusively licensed to the Company from SKCC. The technology to use cytokine modified fibroblasts to increase sensitivity to chemotherapy was jointly developed by SKCC and the Company, and the Company retains exclusive rights to develop this technology. SKCC has applied for patent protection in the United States and Europe related to the technologies licensed exclusively to the Company. There can be no assurance that the issued patents, or any patent that may be issued in the future, will survive opposition or provide meaningful proprietary protection. GENE THERAPY. In November 1992, the Company obtained an exclusive license to a U.S. patent, received by the University of Connecticut, covering the Company's core gene delivery system technology, including methods and compositions for delivering DNA to the liver via receptors on the surface of liver cells. In addition, during 1995 and 1996, one additional Australian patent issued and four patent applications were allowed in the United States, Europe and Australia, all of which are exclusively licensed by the Company. In June 1997, a second related U.S. patent issued, extending the Company's gene delivery protection to include the delivery of any polynucleotide to any mammalian cell via any internalizing cell surface receptor. Thus, the Company's patent protection in the United States is no longer limited to the delivery of genes to the liver. In 1997, a corresponding Japanese patent 14 application also was accepted, covering the delivery of any polynucleotide to mammalian cells via non-protein (e.g., synthetic) liver-specific ligands. This Japanese patent application is expected to issue during 1998. In addition, during 1997, another U.S. patent issued, four U.S. patent applications were allowed, and one Australian patent application was accepted, all either owned or exclusively licensed by the Company. These patents and patent applications cover the delivery of hepatitis B antiviral polynucleotides to mammalian cells via any cell surface receptor, and compositions and methods for increasing expression of genes targeted to cells. The Company also exclusively licenses two Australian patents covering the targeted delivery of genes encoding immunogenic proteins to cells for the purpose of eliciting an immune response, and the targeted delivery of viruses or cells for selective internalization by liver cells. The Company continues to file patent applications covering novel genes and other aspects of its proprietary gene delivery technology which the Company develops. The Company is presently seeking to obtain licenses for certain genes from several different third parties. There can be no assurance that the Company will be able to obtain such licenses on commercially favorable terms, if at all, and if these licenses are not obtained, the Company might be prevented from using certain of its technologies. The Company's failure to obtain a license required to continue practicing its own technologies would have a material adverse effect on the Company. There can be no assurance that any additional gene therapy patents will be issued to the Company. Further, there can no assurance that the issued patents, or any patent that may be issued in the future, will survive opposition or provide meaningful proprietary protection. COMPETITION HIV. The Company is engaged in segments of the biopharmaceutical industry, including the treatment of HIV, that are intensely competitive and rapidly changing. If successfully developed and approved, the product candidates and compounds that the Company is currently developing will compete with numerous existing therapies. For example, 11 drugs are currently approved for the treatment of HIV. In addition, a number of companies are pursuing the development of novel pharmaceutical products that target the same diseases that the Company is targeting, and some companies, including several multinational pharmaceutical companies, are simultaneously marketing several different drugs and may therefore be able to market their own combination drug therapies. The Company believes that a significant number of drugs are currently under development and will become available in the future for the treatment of HIV. Although the Company believes that there is a significant future market for therapeutics to treat HIV and other viral diseases, the Company anticipates that even if it successfully develops REMUNE and REMUNE is approved for marketing, it will face intense and increasing competition in the future as new products enter the market and advanced technologies become available. There can be no assurance that existing products or new products for the treatment of HIV developed by the Company's competitors, including Glaxo Wellcome, plc, Merck & Co. and Abbott Laboratories, will not be more effective, or more effectively marketed and sold, than REMUNE, should it be successfully developed and receive regulatory approval, or any other therapeutic for HIV that may be developed by the Company. Competitive products or the development by others of a cure or new treatment methods may render the Company's technologies and products and compounds obsolete, noncompetitive or uneconomical prior to the Company's recovery of development or commercialization expenses incurred with respect to any such technologies or products or compounds. Many of the Company's competitors have significantly greater financial, technical and human resources than the Company and may be better equipped to develop, manufacture, sell, market and distribute products. In addition, many of these companies have extensive experience in preclinical testing and clinical trials, obtaining FDA and other regulatory approvals and manufacturing and marketing pharmaceutical products. For use individually or in combination therapy, many of these competitors also have products that have been approved or are in late-stage development and operate large, well-funded research and development programs. Smaller companies may also prove to be significant competitors, particularly through collaborative arrangements with large pharmaceutical and biotechnology companies. Furthermore, academic institutions, governmental agencies and other public and private research organizations are becoming increasingly aware of the commercial value of their inventions and are more actively seeking to commercialize the technology they have developed. New developments in areas in which the Company is conducting its research and development are expected to continue at a rapid pace in both industry and academia. If the Company's product candidates and compounds are successfully developed and approved, the Company will face competition based on the safety and effectiveness of its products and compounds, the timing and scope of regulatory approvals, availability of manufacturing, sales, 15 marketing and distribution capabilities, reimbursement coverage, price and patent position. There can be no assurance that the Company's competitors will not develop more effective or more affordable technology or products, or achieve earlier patent protection, product development or product commercialization than the Company. Accordingly, the Company's competitors may succeed in commercializing products more rapidly or effectively than the Company, which could have a material adverse effect on the Company's business, financial condition and results of operations. TREATMENTS FOR AUTOIMMUNE DISEASE. Several emerging technologies related to immune system regulation, if successfully developed, could compete with the Company's autoimmune disease treatments under development. The Company believes that its principal competition in the autoimmune disease area will come from companies conducting research in the areas of T cell receptors, interaction between T cells and the target antigen and tissue, specific targeting of activated T cell populations, and mechanisms of tolerance including oral tolerance approaches. Scientific reports on T cell receptor research have also discussed approaches similar to that of the Company. TREATMENTS FOR CANCER. New cancer therapies are being developed by a number of individual investigators and companies. Some of these approaches involve modification of tumor cells with a variety of cytokines, which approaches may prove competitive with the technologies being developed by the Company. Many of the Company's competitors have substantially greater experience, financial and technical resources and production, marketing and development capabilities than the Company. There can be no assurance that competitors have not or will not succeed in developing technologies and products more quickly or that are more effective than any which have been or are being developed by the Company or which would render the Company's technology and products obsolete and noncompetitive. GENE THERAPY. The Company believes that competition in the treatment of the diseases targeted by its gene therapy program will be of two types: chronic treatment with pharmaceutical products; and other gene therapy systems under development for insertion of the correct gene. There currently exist a number of approved therapies for treatment of hemophilia, and hepatitis B and C. Both purified and recombinant forms of Factor VIII have been approved by the FDA for treatment of hemophilia and are effective in stopping bleeding episodes. Interferon alpha-2b is currently approved for treatment of chronic hepatitis B and C. Other interferons are being tested for the treatment of viral hepatitis. In addition to interferons, a variety of nucleoside analogs have been tested for treatment of chronic hepatitis B, including 3TC. Several major pharmaceutical companies are investigating gene therapy treatments for the delivery of proteins to treat these diseases. If these prove effective, they may compete with the Company's gene delivery therapies. Many of the Company's competitors have substantially greater experience, financial and technical resources and production, marketing and development capabilities than the Company. There can be no assurance that competitors have not or will not succeed in developing technologies and products more quickly or that are more effective than any which have been or are being developed by the Company or which would render the Company's technology and products obsolete and noncompetitive. GOVERNMENT REGULATION Clinical testing, manufacture, promotion and sale of the Company's drug products are subject to extensive regulation by numerous governmental authorities in the United States, principally the FDA, and corresponding state and foreign regulatory agencies. The Company believes that REMUNE and most of its other potential immune-based therapies will be regulated by the FDA as biological drug products under current regulations of the FDA. Biological products must be shown to be safe, pure and potent (i.e., effective) and are subject to the same regulatory requirements as nonbiological products under the Food and Drug Administration Act ("FDA Act"), as amended by the Food and Drug Administration Modernization Act of 1997 ("FDA Modernization Act"), except that a biological product licensed under the PHS Act ("PHS Act") is not required to have an approved New Drug Application ("NDA") under the Federal Food, Drug and Cosmetic Act ("FDC Act"). The FDA Modernization Act directed the FDA to take measures to minimize the differences in the review and approval of marketing applications for biological and nonbiological products. The FDA Modernization Act also made significant revisions to the statutory requirements with regard to the approval of new biologics and nonbiological products. Among other things, the FDA Modernization Act established a new statutory program for the approval of fast track drugs, streamlined clinical research, and revised the content of product approval applications and the FDA review process. The FDA is required to issue regulations and guidelines in order to implement certain of these new requirements. Until the FDA implements these regulations and guidelines, it is impossible to predict the impact of the FDA Modernization Act on the review and approval of any marketing applications that the Company may submit to the FDA in the future. The 16 FDC Act, the PHS Act and other federal and state statutes and regulations govern or influence the testing, manufacture, safety, effectiveness, labeling, storage, recordkeeping, approval, advertising, distribution and promotion of biological prescription drug products. Noncompliance with applicable requirements can result in, among other things, fines, injunctions, seizure of products, total or partial suspension of product marketing, failure of the government to grant premarket approval, withdrawal of marketing approvals and criminal prosecution. The steps required before a biological drug product may be marketed in the United States generally include preclinical studies and the filing of an IND application with the FDA, which must become effective pursuant to FDA regulations before human clinical trials may commence. Reports of results of preclinical studies and clinical trials for biological drug products are submitted to the FDA in the form of a Biologics License Appliction (the "BLA") for approval for marketing and commercial shipment. Submission of a BLA does not assure FDA approval for marketing. The BLA review process may take a number of years to complete, although reviews of applications for treatments of AIDS, cancer and other life-threatening diseases may be accelerated or expedited. Failure of the Company to receive FDA marketing approval for REMUNE or any of its other products under development on a timely basis could have a material adverse effect on the Company's business, financial condition and results of operations. In the past, in addition to obtaining approval for each biological drug product, an Establishment License Application (the "ELA") usually was required to be filed and approved by the FDA. However, the FDA Modernization Act repealed the statutory requirement for an ELA for a biological product. Now only a single BLA covering both the biological product and the facility in which the product is manufactured is required. The FDA also has been directed by the FDA Modernization Act to take measures to minimize the differences in the review and approval of biological drugs required to have approved BLAs under the PHS Act and nonbiological drugs required to have approved NDAs under the FDC Act. Among the other requirements for BLA approval is the requirement that prospective manufacturers conform to the Good Manufacturing Practices (the "GMP") regulations specifically for biological drugs, as well as for other drugs. In complying with the GMP regulations, manufacturers must continue to expend time, money and effort in production, recordkeeping and quality control to assure that the product meets applicable specifications and other requirements. The FDA periodically inspects biological drug product manufacturing facilities in order to assure compliance with applicable GMP requirements. Failure to comply with the GMP regulations subjects the manufacturer to possible FDA regulatory action, such as the suspension of manufacturing, product recall or seizure, injunction and criminal prosecution. There can be no assurance that the Company or its contract manufacturers, if any, will be able to maintain compliance with the GMP regulations on a continuing basis. Failure to maintain such compliance could have a material adverse effect on the Company's business, financial condition and results of operations. The Company believes its proprietary GeneDrug and cancer treatment therapies also will likely be regulated as biological products. This is because the Company's gene products are subject to the FDA's Human Somatic Cell Therapy Products and Gene Therapy Products Notice that the FDA issued in 1993 (the "1993 Notice"). The 1993 Notice defines gene therapy products as biological products subject to biological licensure requirements. In addition, the 1993 Notice covers many ancillary products used as part of the manufacturing process for gene therapy products. The FDA states that such ancillary products may be subject to medical device requirements or to new drug application or BLA requirements. No assurance exists that the Company or its suppliers can meet all the requirements of the 1993 Notice covering gene therapy products. As with the Company's other potential products, the gene therapy products will be subject to extensive FDA regulation throughout the product development process, and there can be no assurance that any of these products will be successful at securing the requisite FDA marketing approval on a timely basis, if at all. The preclinical and clinical testing process to obtain FDA approval of a biological drug is expensive and time consuming. Preclinical studies are conducted in animals usually to evaluate the potential safety of a product. The results of preclinical studies are submitted to the FDA as part of the IND application, which must become effective pursuant to FDA regulations before human clinical trials may begin. Human clinical trials typically are conducted in three phases and are subject to detailed protocols. Each protocol indicating how the clinical trial will be conducted must usually be submitted for review to the FDA as part of the IND application. The FDA's review of a trial protocol does not necessarily mean that, if the trial is completed, it will constitute proof of safety or efficacy (including potency). Further, each clinical trial must be conducted under the auspices of an independent Institutional Review Board ("IRB") established pursuant to FDA regulations. The IRB considers, among other 17 things, ethical concerns, informed consent requirements and the possible liability of the institution conducting the trials. The FDA or IRB may require changes in a protocol both prior to and after the commencement of a clinical trial. There is no assurance that the IRB or FDA will permit a trial to go forward or, once started, to be completed. The three phases of clinical trials are generally conducted sequentially, but they may overlap. In Phase I, the initial introduction of the drug into humans, the drug is tested for safety, side effects, dosage tolerance, metabolism and clinical pharmacology. Phase I testing for an indication typically takes at least one year to complete. Phase II involves controlled tests in a large but still limited patient population to determine the preliminary effectiveness of the drug for specific indications, to determine optimal dosage and to identify possible side effects and safety risks. Phase II trials typically take at least from one and one-half to two and one-half years to complete. If preliminary evidence suggesting effectiveness has been obtained during Phase II evaluations, expanded Phase III trials are undertaken to gather the additional information about safety and effectiveness that is needed to evaluate the overall benefit-risk relationship of the product and to provide an adequate basis for physician labeling. Phase III trials for an indication generally take from two and one-half to five years to complete. There can be no assurance that Phase I, Phase II or Phase III testing will be completed successfully within any specified time period, if at all, with respect to any of the Company's products that have not completed any such testing. Nor can there be any assurance that completion of clinical testing will result in FDA approval. Furthermore, the FDA may suspend clinical trials at any time if the patients are believed to be exposed to a significant health risk. The FDA Modernization Act amended the FDC Act to streamline clinical research on biological and nonbiological drugs. Under the new law, a clinical investigation may begin 30 days after the FDA receives an IND application containing information about the drug and clinical investigation that includes: 1. Information about the design of the investigation and adequate reports of basic information, certified by the applicant, necessary to assess the drug's safety in a clinical trial 2. Adequate information on the chemistry and manufacturing of the drug, controls available for the drug and primary data tabulations from animal or human studies. The FDA is authorized by the new law to halt a clinical study at any time by issuing a clinical hold, confirmed in writing, prohibiting the sponsor from conducting the investigation. The clinical hold may be issued based on the FDA's determination that the drug presents an unreasonable risk to the safety of the research subjects, taking into account the qualifications of the investigators, information about the drug, the design of the clinical investigation, the conditions for which the drug is to be investigated, and the health status of the subjects. Clinical holds also may be imposed by the FDA for other reasons, as established by regulations. The new law, however, largely codifies current regulations albeit with several significant changes. First, the new law potentially reduces the amount of data required to be submitted as part of an IND (most importantly by sanctioning the use of "primary data tabulations from animal and human studies" rather than full reports from such studies). Second, it codifies the procedural safeguards for issuance of clinical holds and strengthens certain rights of the manufacturer, including the right to obtain a written decision from the FDA regarding the removal of a clinical hold within 30 days of a written request from the IND sponsor. Under the FDA's current IND regulations, a number of procedures are available to expedite approval or to allow expanded access to investigational drugs. Certain investigational drugs, including products for the treatment of AIDS, can be distributed outside of traditional IND requirements on a "treatment" basis. Generally, the FDA may permit an investigational drug, including an investigational biological drug, to be used for "treatment" of patients outside of controlled clinical trials, if: (1) the drug is intended to treat a serious or immediately life-threatening disease; (2) there is no comparable or satisfactory alternative drug or other therapy available to treat that stage of the disease in the intended patient population; (3) the drug is under investigation in a controlled clinical trial, or all clinical trials have been completed; and (4) the sponsor of the controlled clinical trial is actively pursuing marketing approval of the investigational drug with due diligence. Although the FDA has granted expanded access to REMUNE for those patients who are ineligible to enroll in the Phase III clinical endpoint trial, the FDA has to date not designated expanded access protocols for REMUNE as "treatment" protocols. Either expanded access or a treatment protocol designation might permit third party reimbursement of some of the costs associated with making REMUNE available to patients in such an expanded access context. There can be no assurance that the FDA will determine that REMUNE meets all of the FDA's criteria for use of an investigational drug for treatment use or that, even if the product is allowed for treatment use, that third party payers will provide reimbursement for any of the costs of REMUNE treatment. The FDA Modernization Act also amended the FDC Act to permit expanded access to 18 individuals and larger groups to unapproved new therapeutic and diagnostic products. Although the new law largely codifies existing FDA regulations in this area, it expands access to all investigational therapies. First, the new law allows the FDA to authorize the emergency shipment of investigational new drugs for the diagnosis, monitoring, or treatment of a serious disease or condition. Second, the new law permits any person, through a licensed physician, to request and obtain from a manufacturer or distributor an investigational drug for the diagnosis, monitoring, or treatment of a serious disease or condition if the following conditions are met: 1. A comparable or satisfactory alternative therapy is not available. 2. There is sufficient evidence of the drug's safety and effectiveness to permit such use. 3. The use will not interfere with the conduct of clinical investigations to support marketing approval. 4. A clinical protocol is submitted to the FDA describing the use of the investigational drug in a single patient or small group of patients. The new law also authorizes expanded patient access to investigational drugs under a treatment IND application. The FDA also has issued regulations to accelerate the approval of or to expedite the review of new biological drug products for serious or life-threatening illnesses that provide meaningful therapeutic benefit to patients over existing treatments (e.g., the ability to treat patients unresponsive to, or intolerant of, available therapy, or improved patient response over available therapy). Under the accelerated approval program, the FDA may grant marketing approval for a biological or nonbiological drug product earlier than would normally be the case, based on an effect on a surrogate endpoint or a clinical endpoint other than survival. Under the program, the sponsor must agree to conduct postmarketing studies to verify and describe the clinical benefits of the product. In addition to the accelerated approval process, the FDA has established procedures designed to expedite the development, evaluation and marketing of new therapies intended to treat persons with life-threatening and severely-debilitating illnesses, especially when no satisfactory alternative therapy exists. The term "life-threatening" is defined by the FDA to mean: (1) disease or conditions where the likelihood of death is high unless the course of the disease is interrupted and (2) diseases or conditions with potentially fatal outcomes, where the endpoint of clinical trial analysis is survival. "Severely debilitating" is defined by the FDA to mean diseases or conditions that cause major irreversible morbidity. As a condition of approval, the FDA may require the sponsor to conduct certain postmarketing studies to delineate additional information about the drug's risks, benefits and optimal use. The FDA Modernization Act establishes a new statutory program for the approval of fast track drugs, including biological products. Fast track drugs are defined as new drugs or biological products intended for the treatment of serious or life-threatening conditions and that demonstrate the potential to address unmet medical needs for such conditions. Under the new fast track program, a request for designation may be submitted concurrently with, or any time after, submission of an IND application. If a product meets the statutory criteria, the FDA is required to designate the product as a fast track drug within 60 days of the request for designation. A BLA or NDA for a fast track drug may be approved by the FDA upon a determination that the drug has an effect on a clinical endpoint or a surrogate endpoint that is reasonably likely to predict clinical benefits. The FDA can condition approval of a fast track drug upon a requirement to conduct post-approval studies and submit copies of promotional materials to the FDA prior to dissemination. The new law also provides procedures for the expedited withdrawal of marketing approval of a fast track. There can be no assurance that the FDA will consider REMUNE, or any other of the Company's products under development, to be an appropriate candidate for accelerated approval, expedited review or fast track designation. Since 1992, non-biological and biological drugs have been subject to the Prescription Drug User Fee Act of 1992 ("PDUFA"). PDUFA requires that companies submitting marketing applications for such products pay fees in connection with review of the applications. In return, the FDA has committed to reviewing a certain percentage of the applications within certain timeframes. For example, in its Fiscal Year 1997 Report to Congress on PDUFA, the FDA reported that 96% of all original premarketing applications for biological and nonbiological drugs received in Fiscal Year 1996 were reviewed within 12 months of the application submission date. The FDA's PDUFA performance goal in Fiscal Year 1996 was to complete 80% of such applications within 12 months of the submission date. Although PDUFA was scheduled to expire on September 30, 1997, the Food and Drug Administration Modernization Act of 1997 reauthorized PDUFA for five years (i.e., until September 30, 2002). The FDA has committed to reaching an approval, disapproval or additional-data-required decisions on 90% of standard original NDAs and BLAs filed during Fiscal Year 1998 within 12 months of receipt of the marketing application and to review and act on 90% of priority original NDAs and BLAs (i.e., applications offering significant advances over existing treatments) within six months of receipt. There can be no assurance, however, that any BLA the Company submits to the FDA for any of its biological products will be reviewed and acted upon within the 19 timeframes set out above. The Company also is subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act and other present and potential future federal, state or local regulations. Regulations concerning biotechnology may affect the Company's research and development programs. Furthermore, existing or additional government regulations may be applied that could prevent or delay regulatory approval of the Company's products, or affect the pricing or distribution of such products. The Company also is subject to foreign regulatory requirements governing human clinical trials and pharmaceutical sales that vary widely from country to country. Whether or not FDA approval has been obtained, approval of a product by comparable regulatory authorities of foreign countries must be obtained prior to marketing the product in those countries. The approval process may be more or less rigorous from country to country and the time required may be longer or shorter than that required in the United States. The Company may seek to use foreign marketing partners to assist in obtaining foreign regulatory approval for REMUNE and other products. EMPLOYEES As of December 31, 1997, the Company had 143 full-time employees, of whom 41 hold Ph.D. or other advanced degrees. Of these employees, 112 are engaged in, or directly support, research and development. A significant number of the Company's management and professional employees have had prior experience with pharmaceutical and biotechnology companies. None of the Company's employees is covered by a collective bargaining agreement. RISK FACTORS UNCERTAINTY OF PRODUCT DEVELOPMENT AND CLINICAL TESTING. The Company has not completed the development of any products and there can be no assurance any products will be successfully developed. The Company has been in existence since 1986, and to date only six of its product candidates have entered clinical trials. The Company's potential immune-based therapies for HIV, autoimmune disease, cancer and gene therapy products currently under development will require significant additional research and development efforts and regulatory approvals prior to potential commercialization. To achieve profitable operations, the Company must successfully develop, manufacture, introduce and market products. There can be no assurance that any of the Company's potential products will prove to be safe and effective in clinical trials, that FDA or other regulatory approvals will be obtained or that such products will achieve market acceptance. The Company's potential HIV immune-based therapy, REMUNE, is in a Phase III clinical endpoint trial designed to provide evidence of efficacy based on clinical endpoints. There can be no assurance that the results of such clinical trial will demonstrate that REMUNE is safe and efficacious or, that even if the results of the clinical trial are considered successful by the Company, that the Food and Drug Administration ("FDA") will not require the Company to conduct additional large scale clinical trials with REMUNE before the FDA will consider approving REMUNE for commercial sale. Failure to successfully complete the Phase III clinical endpoint trial in a timely fashion and a failure to obtain FDA approval of REMUNE will materially and adversely affect the Company. There can be no assurance that the results of the Phase III trial will be consistent with Phase II results. In addition, REMUNE is being tested in a Phase II clinical trial in Thailand, in a pediatric Phase I clinical trial in the United States and in combination trials with approved HIV therapies in the United States and Spain. Failure of these trials to demonstrate the safety and effectiveness of REMUNE could have a material adverse effect on the regulatory approval process for this potential product. The Company's other potential immune-based therapies and gene therapy technologies are at a much earlier stage of development than REMUNE. The Company's gene therapy technology and certain of its technologies for the treatment of cancer have not yet been tested in humans and there can be no assurance that human testing of potential products based on such technologies will be permitted by regulatory authorities or, that even if human testing is permitted, that products based on such technologies will be developed and shown to be safe or efficacious. Potential immune-based therapies based on certain of the Company's autoimmune technology and certain of its cancer technologies are at an early stage of clinical testing and there can be no assurance that such products will be shown to be safe, efficacious or receive regulatory approval. There can be no assurance that the results of the Company's preclinical studies and clinical trials will be indicative of future clinical trial results. A commitment of substantial resources to conduct time-consuming research, preclinical studies and clinical trials, including the REMUNE Phase III clinical endpoint trial will be required if the Company is to develop any products. Delays in planned patient enrollment in the Company's current clinical trials or future clinical trials may result in increased costs, program delays or both. There can be no assurance that any of 20 the Company's potential products will prove to be safe and effective in clinical trials, that FDA or other regulatory approvals will be obtained or that such products will achieve market acceptance. Any products resulting from these programs are not expected to be successfully developed or commercially available for a number of years, if at all. There can be no assurance that unacceptable toxicities or side effects will not occur at any time in the course of human clinical trials or, if any products are successfully developed and approved for marketing, during commercial use of the Company's products. The appearance of any such unacceptable toxicities or side effects could interrupt, limit, delay or abort the development of any of the Company's products or, if previously approved, necessitate their withdrawal from the market. Furthermore, there can be no assurance that disease resistance will not limit the efficacy of potential products. ADDITIONAL FINANCING REQUIREMENTS AND ACCESS TO CAPITAL. The Company will need to raise additional funds to conduct research and development, preclinical studies and clinical trials necessary to bring its potential products to market and establish manufacturing and marketing capabilities. The Company anticipates that in 1998, the REMUNE clinical trials will cost approximately $10 million, and the manufacturing, research and all other expenses associated with the product will cost approximately an additional $15 million. The Company also anticipates that costs related to the development of REMUNE will continue to increase as the Company approaches possible commercialization. The anticipated costs with respect to REMUNE will depend on many factors, including the results of interim analyses of the data from the Phase III clinical endpoint trial, the availability of third party reimbursement for expanded access protocols for REMUNE, the potential for accelerated approval and certain other factors which will influence the Company's determination of the appropriate continued investment of the Company's financial resources in this program. The Company's future capital requirements will depend on many factors, including continued scientific progress in its research and development programs, the scope and results of preclinical studies and clinical trials, the time and costs involved in obtaining regulatory approvals, the costs involved in filing, prosecuting and enforcing patent claims, competing technological and market developments, the cost of manufacturing scale-up, effective commercialization activities and arrangements and other factors not within the Company's control. The Company intends to seek additional funding through public or private financings, arrangements with corporate collaborators or other sources. If funds are acquired through collaborations, the Company will likely be required to relinquish some or all rights to products that the Company may have otherwise developed itself. Adequate funds may not be available when needed or on terms acceptable to the Company. Insufficient funds may require the Company to scale back or eliminate some or all of its research and development programs or license to third parties products or technologies that the Company would otherwise seek to develop itself. The Company believes that its existing resources, including interest thereon will enable the Company to maintain its current and planned operations through 1998. PATENTS AND PROPRIETARY TECHNOLOGY. The Company has filed, or participated as licensee, in the filing of a number of patent applications in the United States and many international countries. The Company files applications as appropriate for patents covering its products and processes. The Company has been issued patents, or has licensed patents, covering certain aspects of its proposed immune-based therapies for HIV, autoimmune disease, cancer and gene therapy technologies. The Company's success may depend in part on its ability to obtain patent protection for its products and processes. The Company is aware that a group working with Connetics Corporation has received a United States patent related to autoimmune disease research that covers technology similar to that used by the Company There can be no assurance that the Company will be successful in these opposition proceedings. An unfavorable outcome could have an adverse impact on the Company's ability to consummate future corporate partnerships or market autoimmune disease products in Europe. There can be no assurance that the Company will be able to negotiate any necessary cross licenses, and if not successful, failure to do so could have a negative impact on the Company. There can be no assurance that the Company's patent applications will be issued as patents or that any of its issued patents, or any patent that may be issued in the future, will provide the Company with adequate protection for the covered products, processes or technology. The patent positions of biotechnology and pharmaceutical companies can be highly uncertain, and involve complex legal and factual questions. Therefore, the breadth of claims allowed in biotechnology and pharmaceutical patents cannot be predicted. The Company also relies upon unpatented trade secrets and know how, and no assurance can be given that others will not independently develop substantially equivalent trade secrets or know how. In addition, whether or not the Company's patents are issued, or issued with limited coverage, others may receive patents which contain claims applicable to the Company's product. There can be no assurance that any of the Company's patents, 21 or any patents issued to the Company in the future, will afford meaningful protection against competitors. Defending any such patent could be costly to the Company, and there can be no assurance that the patent would be held valid by a court of competent jurisdiction. The Company also relies on protecting its proprietary technology in part through confidentiality agreements with its corporate collaborators, employees, consultants and certain contractors. There can be no assurance that these agreements will not be breached, that the Company will have adequate remedies for any breach, or that the Company's trade secrets will not otherwise become known or independently discovered by its competitors. It is possible that the Company's products or processes will infringe, or will be found to infringe, patents not owned or controlled by the Company, such as the patent owned by Connetics Corporation. If any relevant claims of third-party patents are upheld as valid and enforceable, the Company could be prevented from practicing the subject matter claimed in such patents, or would be required to obtain licenses or redesign its products or processes to avoid infringement. There can be no assurance that such licenses would be available at all or on terms commercially reasonable to the Company or that the Company could redesign its products or processes to avoid infringement. Litigation may be necessary to defend against claims of infringement, to enforce patents issued to the Company or to protect trade secrets. Such litigation could result in substantial costs and diversion of management efforts regardless of the results of such litigation and an adverse result could subject the Company to significant liabilities to third parties, require disputed rights to be licensed or require the Company to cease using such technology. HISTORY OF OPERATING LOSSES. As of December 31, 1997, the Company had an accumulated deficit of $153.5 million. The Company has not generated revenues from the commercialization of any products and expects to incur substantial net operating losses over the next several years. There can be no assurance that the Company will be able to generate sufficient product revenue to become profitable at all or on a sustained basis. The Company expects to have quarter-to-quarter fluctuations in expenses, some of which could be significant, due to expanded research, development and clinical trial activities. LENGTHY APPROVAL PROCESS AND UNCERTAINTY OF GOVERNMENT REGULATORY REQUIREMENTS. Clinical testing, manufacture, promotion and sale of the Company's drug products are subject to extensive regulation by numerous governmental authorities in the United States, principally the FDA, and corresponding state and foreign regulatory agencies. The Company believes that REMUNE and most of its other potential immune-based therapies will be regulated by the FDA as biological drug products under current regulations of the FDA. Biological products must be shown to be safe, pure and potent (i.e., effective) and are subject to the same regulatory requirements as nonbiological products under the FDC Act, as amended by the FDA Modernization Act, except that a biological product licensed under the PHS Act is not required to have an approved NDA under the FDC Act. The FDA Modernization Act directed the FDA to take measures to minimize the differences in the review and approval of marketing applications for biological and nonbiological products. The FDA Modernization Act also made significant revisions to the statutory requirements with regard to the approval of new biological and nonbiological products. Among other things, the FDA Modernization Act established a new statutory program for the approval of fast track drugs, streamlined clinical research, and revised the content of product approval applications and the FDA review process. The FDA is required to issue regulations and guidelines in order to implement certain of these new requirements. Until the FDA implements these regulations and guidelines, it is impossible to predict the impact of the FDA Modernization Act on the review and approval of any marketing applications that the Company may submit to the FDA. The FDC Act, the PHS Act and other federal and state statutes and regulations govern or influence the testing, manufacture, safety, effectiveness, labeling, storage, recordkeeping, approval, advertising, distribution and promotion of biological prescription drug products. Noncompliance with applicable requirements can result in, among other things, fines, injunctions, seizure of products, total or partial suspension of product marketing, failure of the government to grant premarket approval, withdrawal of marketing approvals and criminal prosecution. The regulatory process for new therapeutic drug products, including the required preclinical studies and clinical testing, is lengthy and expensive and there can be no assurance that necessary FDA clearances will be obtained in a timely manner, if at all. There can be no assurance as to the length of the clinical trial period or the number of patients the FDA will require to be enrolled in the clinical trials in order to establish the safety and efficacy of the Company's products. The Company may encounter significant delays or excessive costs in its efforts to secure necessary approvals, and regulatory requirements are evolving and uncertain. Future United States or foreign legislative or administrative acts could also prevent or delay regulatory approval of the Company's products. There can be no assurance that the Company will be able to obtain the necessary approvals for clinical trials, 22 manufacturing or marketing of any of its products under development. Even if commercial regulatory approvals are obtained, they may include significant limitations on the indicated uses for which a product may be marketed. In addition, a marketed product is subject to continual FDA review. Later discovery of previously unknown problems or failure to comply with the applicable regulatory requirements may result in restrictions on the marketing of a product or withdrawal of the product from the market, as well as possible civil or criminal sanctions. The steps required before a biological drug product may be marketed in the United States generally include preclinical studies and the filing of an IND application with the FDA. Reports of results of preclinical studies and clinical trials for biological drug products are submitted to the FDA in the form of a Biologics Licensing Application ("BLA") for approval for marketing and commercial shipment. Submission of a BLA does not assure FDA approval for marketing. The BLA review process may take a number of years to complete, although reviews of applications for treatments of AIDS, cancer and other life-threatening diseases may be accelerated or expedited. Failure of the Company to receive FDA marketing approval for REMUNE or any of its other products under development on a timely basis could have a material adverse effect on the Company's business, financial condition and results of operations. In addition to obtaining approval for each biological drug product, an ELA usually must be filed and approved by the FDA. Among the other requirements for BLA approval is the requirement that prospective manufacturers conform to the FDA's GMP requirements specifically for biological drugs, as well as for other drugs. In complying with the FDA's GMP requirements, manufacturers must continue to expend time, money and effort in production, recordkeeping and quality control to assure that the product meets applicable specifications and other requirements. Failure to comply with the FDA's drug GMP requirements subjects the manufacturer to possible FDA regulatory action. There can be no assurance that the Company or its contract manufacturers, if any, will be able to maintain compliance with the FDA's drug GMP requirements on a continuing basis. Failure to maintain such compliance could have a material adverse effect on the Company's business, financial condition and results of operations. The Company believes its proprietary GeneDrug and cancer treatment therapies will likely be regulated as biological products. As with the Company's other potential products, the gene therapy and cancer products will be subject to extensive FDA regulation throughout the product development process, and there can be no assurance that any of these products will be successful at securing the requisite FDA marketing approval on a timely basis, if at all. The FDA Modernization Act also amended the FDC Act to permit expanded access to individuals and larger groups to unapproved new therapeutic and diagnostic products. Although the new law largely codifies existing FDA regulations in this area, it expands access to all investigational therapies under certain conditions. See "Business -- Government Regulation." Although the FDA has granted expanded access to REMUNE for those patients who are ineligible to enroll in the Phase III clinical endpoint trial, the FDA has to date not designated expanded access protocols for REMUNE as "treatment" protocols. Either expanded access or a treatment protocol designation might permit third party reimbursement of some of the costs associated with making REMUNE available to patients in such an expanded access context. There can be no assurance that the FDA will determine that REMUNE meets all of the FDA's criteria for use of an investigational drug for treatment use or that, even if the product is allowed for treatment use, that third party payers will provide reimbursement for any of the costs of treatment with REMUNE. The FDA also has issued regulations to accelerate the approval of or to expedite the review of new biological drug products for serious or life-threatening illnesses that provide meaningful therapeutic benefit to patients over existing treatments. Under the accelerated approval program, the FDA may grant marketing approval for a biological or nonbiological drug product earlier than would normally be the case. In addition to the accelerated approval process, the FDA has established procedures designed to expedite the development, evaluation and marketing of new therapies intended to treat persons with life-threatening and severely-debilitating illnesses, especially when no satisfactory alternative therapy exists. In addition, the FDA Modernization Act established a new statutory program for the approval of fast track drugs, including biological products. See "Business -- Government Regulation." There can be no assurance that the FDA will consider REMUNE or any other of the Company's products under development to be an appropriate candidate for accelerated approval, expedited review or fast track designation. To market any drug products outside of the United States, the Company is also subject to numerous and varying foreign regulatory requirements, implemented by foreign health authorities, governing the design and conduct of human clinical trials and marketing approval. The approval procedure varies among countries and can involve additional testing, and the time required to obtain approval may differ from that required to obtain FDA approval. 23 The foreign regulatory approval process includes all of the risks associated with obtaining FDA approval set forth above, and approval by the FDA does not ensure approval by the health authorities of any other country. See "Business -- Government Regulation." TECHNOLOGICAL CHANGE AND COMPETITION. The biotechnology industry continues to undergo rapid change and competition is intense in the fields of HIV, autoimmune disease, cancer and gene therapy, and such competition is expected to increase. The Company will compete with fully integrated pharmaceutical companies, small biotechnology companies, universities and research organizations. There can be no assurance that competitors have not or will not succeed in developing technologies and products that are more effective than any which have been or are being developed by the Company or which would render the Company's technology and products obsolete and noncompetitive. Many of the Company's competitors have substantially greater experience, financial and technical resources and production, marketing and development capabilities than the Company. Accordingly, certain of the Company's competitors may succeed in obtaining regulatory approval for products more rapidly or effectively than the Company. If the Company commences commercial sales of its products, it will also be competing with respect to manufacturing efficiency and sales and marketing capabilities, areas in which it currently has no experience. There can be no assurance that competitors will not develop and commercialize more effective or affordable products. DEPENDENCE ON THIRD PARTIES. The Company's strategy for the research, development and commercialization of its products requires entering into various arrangements with corporate collaborators, licensors, licensees and others, and the Company's commercial success is dependent upon these outside parties performing their respective contractual responsibilities, including the analysis of the data generated in the Company's clinical trials. The amount and timing of resources such third parties will devote to these activities may not be within the control of the Company. There can be no assurance that such parties will perform their obligations as expected and the failure of third parties to perform their obligations would have a material adverse effect on the Company. Although the Company has collaborative agreements with several universities and research institutions, the Company's agreement with Bayer is the only collaborative agreement that provides the Company with contract revenue. There can be no assurance that these collaborations will result in the development of any commercial products. Immune Response intends to seek additional collaborative arrangements to develop and commercialize certain of its products. There can be no assurance that the Company will be able to negotiate collaborative arrangements on favorable terms, or at all, in the future, or that its current or future collaborative arrangements will be successful. DEPENDENCE ON KEY PERSONNEL. Since its inception, Immune Response has relied on the technical and management skills of its experienced staff. The Company does not maintain key man life insurance on any of its personnel. The Company's success also depends in large part upon its ability to attract and retain highly qualified scientific and management personnel. The Company faces competition for such personnel from other companies, academic institutions, government entities and other organizations. There can be no assurance that the Company will be successful in hiring or retaining requisite personnel. LACK OF COMMERCIAL MANUFACTURING AND MARKETING EXPERIENCE. The Company has a manufacturing facility for REMUNE located in King of Prussia, Pennsylvania, and a pilot manufacturing facility in Carlsbad, California for its other products. The Company has not yet manufactured its product candidates in commercial quantities. No assurance can be given that the Company, on a timely basis, will be able to make the transition from manufacturing clinical trial quantities to commercial production quantities successfully or be able to arrange for contract manufacturing. The Company believes it will be able to manufacture REMUNE for initial commercialization, if the product obtains FDA approval, but it has not yet demonstrated the capability to manufacture REMUNE in commercial quantities, or its autoimmune disease, cancer and gene therapy treatments in large-scale clinical or commercial quantities. The Company has no experience in the sales, marketing and distribution of pharmaceutical products. There can be no assurance that the Company will be able to establish sales, marketing and distribution capabilities or make arrangements with its collaborators, licensees or others to perform such activities or that such efforts will be successful. There can be no assurance of market acceptance of the Company's products, if they are developed and approved for commercialization. The manufacture of the Company's products involves a number of steps and requires compliance with stringent quality control specifications imposed by the Company itself and by the FDA. Moreover, the Company's products can only be manufactured in a facility that has undergone a satisfactory inspection by the FDA. For these reasons, the Company would not be able quickly to replace its manufacturing capacity if it were unable to use its manufacturing facilities as a result of a fire, natural disaster (including an earthquake), equipment failure or other 24 difficulty, or if such facilities are deemed not in compliance with the FDA's drug GMP requirements and the non-compliance could not be rapidly rectified. The Company's inability or reduced capacity to manufacture its products would have a material adverse effect on the Company's business and results of operations. The Company may enter into arrangements with contract manufacturing companies to expand its own production capacity in order to meet requirements for its products, or to attempt to improve manufacturing efficiency. If the Company chooses to contract for manufacturing services and encounters delays or difficulties in establishing relationships with manufacturers to produce, package and distribute its finished products, clinical trials, market introduction and subsequent sales of such products would be adversely affected. Further, contract manufacturers must also operate in compliance with the FDA's drug GMP requirements; failure to do so could result in, among other things, the disruption of product supplies. Until recently, biologic product licenses could not be held by any company unless it performed significant manufacturing operations. The FDA recently amended its regulations in this regard, and the Company believes that under these new regulations it can now hold licenses for its biological products without performing significant manufacturing steps. Nonetheless, the Company's potential dependence upon third parties for the manufacture of its products may adversely affect the Company's profit margins and its ability to develop and deliver such products on a timely and competitive basis. UNCERTAINTY OF PRODUCT PRICING, REIMBURSEMENT AND RELATED MATTERS. The Company's ability to earn sufficient returns on its products will depend in part on the extent to which reimbursement for the costs of such products and related treatments will be available from government health administration authorities, private health coverage insurers, managed care organizations and other organizations. Third party payors are increasingly challenging the price of medical products and services. If purchasers or users of the Company's products are not able to obtain adequate reimbursement for the cost of using such products, they may forego or reduce such use. Significant uncertainty exists as to the reimbursement status of newly approved health care products, and there can be no assurance that adequate third party coverage will be available. Failure to obtain appropriate reimbursement would have a material adverse effect on the Company. PRODUCT LIABILITY EXPOSURE. The Company faces an inherent business risk of exposure to product liability and other claims in the event that the development or use of its technology or prospective products is alleged to have resulted in adverse effects. While the Company has taken, and will continue to take, what it believes are appropriate precautions, there can be no assurance that it will avoid significant liability exposure. Although the Company currently carries product liability insurance for clinical trials, there can be no assurance that the Company has sufficient coverage, or can obtain sufficient coverage, at a reasonable cost. An inability to obtain product liability insurance at acceptable cost or to otherwise protect against potential product liability claims could prevent or inhibit the commercialization of products developed by the Company. A product liability claim could have a material adverse effect on the Company's business, financial condition and results of operations. HAZARDOUS MATERIALS/ENVIRONMENTAL MATTERS. Although the Company does not currently manufacture commercial quantities of its product candidates, it produces limited quantities of such products for its clinical trials. The Company's research and development processes involve the controlled storage, use and disposal of hazardous materials, biological hazardous materials and radioactive compounds. The Company is subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of such materials and certain waste products. Although the Company believes that its safety procedures for handling and disposing of such materials comply with the standards prescribed by such laws and regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of such an accident, the Company could be held liable for any damages that result, and any such liability could exceed the resources of the Company. There can be no assurance that the Company will not be required to incur significant costs to comply with current or future environmental laws and regulations nor that the operations, business or assets of the Company will not be materially or adversely affected by current or future environmental laws or regulations. VOLATILITY OF STOCK PRICE AND ABSENCE OF DIVIDENDS. The market price of Immune Response's common stock, like that of the common stock of many other biopharmaceutical companies, has been and is likely to be highly volatile. Factors such as the results of preclinical studies and clinical trials by the Company, its collaborators or its competitors, other evidence of the safety or efficacy of products of the Company or its competitors, announcements of technological innovations or new products by the Company or its competitors, governmental regulatory actions, changes or announcements in reimbursement policies, developments with the Company's collaborators, developments concerning patent or other proprietary rights of the Company or its competitors (including litigation), concern as to the safety of the Company's products, period-to-period fluctuations in the Company's operating 25 results, changes in estimates of the Company's performance by securities analysts, market conditions for biopharmaceutical stocks in general and other factors not within the control of the Company could have a significant adverse impact on the market price of the common stock. The Company has never paid cash dividends on its common stock and does not anticipate paying any cash dividends in the foreseeable future. EFFECT OF CERTAIN ANTI-TAKEOVER PROVISIONS. The Company's Certificate of Incorporation and Bylaws include provisions that could discourage potential takeover attempts and make attempts by stockholders to change management more difficult. The approval of 66 2/3 percent of the Company's voting stock is required to approve certain transactions and to take certain stockholder actions, including the calling of special meetings of stockholders and the amendment of any of the anti-takeover provisions contained in the Company's Certificate of Incorporation. Further, pursuant to the terms of its stockholder rights plan, the Company has distributed a dividend of one right for each outstanding share of common stock. These rights will cause substantial dilution to the ownership of a person or group that attempts to acquire the Company on terms not approved by the Board of Directors and may have the effect of deterring hostile takeover attempts. EXECUTIVE OFFICERS The executive officers of the Company are as follows: DENNIS J. CARLO, PH.D., age 54, a co-founder of the Company, has been President and Chief Executive Officer since September 1994, and was Chief Operating Officer from April 1987 to September 1994 and Assistant Corporate Secretary and a Director since 1987. Dr. Carlo was Chief Scientific Officer from April 1987 to September 1995 and Executive Vice President from October 1987 to September 1994. From January 1982 to May 1987, Dr. Carlo was Vice President of Research and Development and Vice President of Therapeutic Manufacturing at Hybritech Incorporated, a biotechnology company that was acquired by Eli Lilly & Company ("Eli Lilly"), a pharmaceutical company, in 1986. From 1971 to 1981, Dr. Carlo held various positions at Merck & Co., Inc., including Director of Development and Basic Cellular Immunology and Director of Bacterial Vaccines and Immunology. Dr. Carlo is also a director of Vyrex Corporation. Dr. Carlo has authored or co-authored over 100 articles and abstracts in the field of immunology. Dr. Carlo received his Ph.D., M.S. and B.S. from Ohio State University. STEVEN P. RICHIERI, R.PH., age 43, has served as Chief Operating Officer since January 1998 and Senior Vice President, since October 1995, and was Vice President, Medical and Regulatory Affairs from May 1992 to October 1995, and Executive Director, Medical and Regulatory Affairs from October 1991 to May 1992. From 1984 to 1991, Mr. Richieri held various positions with Dura Pharmaceuticals, Inc. including Vice President, Regulatory and Technical Affairs. From 1981 to 1984, Mr. Richieri worked in Regulatory Affairs with Barnes Hind Inc., a subsidiary of Revlon, Inc. Prior to joining Barnes Hind Inc., Mr. Richieri worked as a Pharmacist in the medical community. Mr. Richieri received his M.B.A. from the University of San Diego and his B.S. from Rutgers College of Pharmacy. CHARLES J. CASHION, age 47, has been Senior Vice President, Finance and Administration since January 1998 and Chief Financial Officer of the Company since February 1989, Secretary of the Company since September 1989 and Treasurer of the Company since May 1991, and was Vice President, Finance from February 1989 to December 1997. From September 1987 to August 1989, Mr. Cashion was Executive Vice President and Secretary of Smith Laboratories and President and Chief Executive Officer of Sutter Corporation, a wholly owned subsidiary of Smith Laboratories. From 1980 to 1987, Mr. Cashion was Vice President, Chief Financial Officer and Treasurer of Smith Laboratories. Mr. Cashion previously held positions at Baxter International, Inc., and Motorola, Inc. Mr. Cashion received his M.B.A. and B.S. from Northern Illinois University. STEVEN W. BROSTOFF, PH.D., age 55, has been Chief Scientific Officer since October 1995 and Vice President, Research and Development for the Company since May 1992, and was Executive Director of Autoimmune Disease Research from July 1988 to May 1992. From 1973 to 1988, Dr. Brostoff held various positions within the Medical University of South Carolina including: Director, University Research Development; Director, Medical Scientist Training Program; Director, Program in Molecular and Cellular Biology and Pathobiology; Professorships in Microbiology and Immunology, and in Neurology; and served as Associate Dean of the Graduate School. During his tenure at the University, Dr. Brostoff also served as a Visiting Scientist at Oxford University in the United Kingdom. Prior to this, Dr. Brostoff held positions with Albert Einstein College of Medicine, Merck Institute for Therapeutic Research, the Salk Institute, and the Eleanor Roosevelt Institute for Cancer Research. Dr. Brostoff received his Ph.D. and B.S. from the Massachusetts Institute of Technology. 26 FRED C. JENSEN, D.V.M., age 72, has served as Vice President, Virology Research and Development since May 1992 and was Executive Director, Virology Research from March 1988 to May 1992. From 1983 to 1987, Dr. Jensen was the Senior Vice President of Cytotech, Inc. From 1973 to 1982, Dr. Jensen served as an Associate Member with Scripps Clinic and Research Foundation in various scientific disciplines including Immunopathology and Cellular and Development Immunology. Prior to joining Scripps, Dr. Jensen worked with Wistar Institute and Microbiological Associates. Dr. Jensen received his D.V.M. from the University of BRNO, School of Veterinary Medicine in Czechoslovakia after completion of undergraduate studies. PAULA B. ATKINS, age 44, has been Vice President, Administration of the Company since September 1992, and was Executive Director, Administration from June 1991 to September 1992, and Director, Administration from March 1988 to June 1991. From January 1985 to March 1988, Ms. Atkins was Director of Human Resources and Administration for Access Research Corporation. Ms. Atkins held positions previously with Foodmaker, Inc., a wholly owned subsidiary of Ralston Purina, and Scripps Clinic and Research Foundation. Ms. Atkins received her M.S. and B.A. from San Diego State University. 27 ITEM 2. PROPERTIES The Company leases a 50,000 square foot laboratory and headquarters facility located in Carlsbad, California. Under the terms of the lease, which expires on December 31, 2000, and has two five-year options to extend, current monthly rental on the facility is approximately $64,500. The Company also expects to begin leasing, in May 1998, a 31,200 square foot facility located adjacent to its headquarters facility in Carlsbad, California. The Company expects this facility to be used for additional laboratory and office space. Under the terms of the lease, which is expected to expire in March 2008, initial monthly rental on the facility will be approximately $18,400. The Company has also delivered to the lessor a Letter of Credit for $600,000 as an additional security deposit. The Company subleases a 51,000 square foot manufacturing facility located in King of Prussia, Pennsylvania. Under the terms of the sublease which expires on September 30, 2000, the monthly rental on the facility is approximately $28,450. The Company has an option to extend the sublease for up to six years, in three-year increments. The Company has also delivered to the sublessor a Letter of Credit for $203,200 as an additional security deposit. The Company owns 4.65 acres of undeveloped property adjacent to its headquarters facility in Carlsbad, California. This property may be used in the future as a manufacturing facility or for additional laboratory and office space. ITEM 3. LEGAL PROCEEDINGS Not applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable 28 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock is traded on the Nasdaq National Market ("NNM") under the symbol "IMNR." The following table sets forth the range of high and low sales prices for the Common stock on the NNM for the periods indicated since January 1, 1996.
1996 HIGH LOW ---- ---- --- January 1 - March 31, 1996 $ 8.50 $ 4.75 April 1 - June 30, 1996 15.25 5.94 July 1 - September 30, 1996 11.38 7.13 October 1 - December 31, 1996 9.63 6.52 1997 ---- January 1 - March 31, 1997 $ 9.13 $ 6.06 April 1 - June 30, 1997 9.13 6.50 July 1 - September 30, 1997 14.25 7.38 October 1 - December 31, 1997 13.75 9.00
As of March 20, 1998, the Company's Common Stock was held by 969 stockholders of record. The Company has never paid cash dividends and does not anticipate paying any cash dividends in the foreseeable future. 29 ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---------------------------------------------------------------------- (In thousands, except per share data) STATEMENT OF OPERATIONS DATA: Contract research revenue $ 2,000 $ 1,000 $ 1,561 $ 6,035 $ 4,768 Licensed research revenue --- 6,000 --- 1,000 --- Research and development expenses 34,090 27,211 19,489 13,511 11,854 Net loss (33,557) (21,026) (19,936) (17,399) (15,738) Net loss per share - Basic (1.53) (1.19) (1.19) (1.05) (.95) Shares used in computing net loss per share 21,883 17,658 16,750 16,614 16,550 DECEMBER 31, ---------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---------------------------------------------------------------------- (in thousands) BALANCE SHEET DATA: Cash, cash equivalents, marketable securities and short-term investments $30,439 $47,787 $44,610 $59,328 $75,359 Working capital 28,939 45,684 43,586 59,226 75,691 Total assets 37,375 54,086 50,429 68,483 86,680 Stockholders' equity 35,102 51,304 48,441 67,086 84,915
30 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Immune Response is a biopharmaceutical company developing immune-based therapies to induce specific T cell responses for the treatment of HIV, autoimmune diseases and cancer. The Company is conducting clinical trials for its immune-based therapies for HIV, rheumatoid arthritis, psoriasis, multiple sclerosis, colon cancer and brain cancer and preclinical studies for prostate cancer. In addition, the Company is developing a targeted delivery technology for gene therapy which is designed to enable the intravenous injection of genes for delivery directly to the liver. The Company's gene therapy program is currently focused on diseases of the liver and is in preclinical studies for the treatment of hemophilia and hepatitis. The Company's strategy is to retain ownership of these proprietary technologies and to seek corporate collaborations or joint ventures for certain disease-specific applications. This discussion contains forward-looking statements concerning the Company's operating results and timing of anticipated expenditures. Such statements are subject to risks and uncertainties which could cause actual results to differ materially from those projected. Factors that could cause or contribute to such differences include those discussed under "Risk Factors," as well as those discussed elsewhere in this Form 10-K. The following should be read in conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere in this Form 10-K. These forward-looking statements speak only as of the date hereof. The Company undertakes no obligation to publicly release the result of any revisions to these forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. During 1997, the Company completed a $16.0 million private placement of units consisting of common stock and warrants to purchase common stock of the Company. These units were separately purchased at a price of $7.80 per unit by two directors of the Company, one of whom is the Company's President and Chief Executive Officer. The units sold in the private placement consisted of 2,051,281 shares of common stock plus warrants exercisable for 2,051,281 shares of common stock. The warrants, with an exercise price of $14.00 per share, are callable by the Company if the Company's common stock trades at $28.00 per share or greater for 45 consecutive days. The warrants expire on April 17, 2001. The shares and warrants are unregistered and are not transferable until April 1998. The Company has conducted a comprehensive review of its computer systems to identify the systems that could be affected by the "Year 2000" issue and has implemented a plan to resolve the issue. The Year 2000 problem is the result of computer programs being written using two digits rather than four digits to define the applicable year. Any of the Company's programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a major system failure or miscalculations. The Company presently believes that the Year 2000 problem will not pose significant operational problems for the Company's computer systems. The Company has not been profitable since inception and had an accumulated deficit of $153.5 million as of December 31, 1997. To date, the Company has not recorded any revenues from the sale of products. Revenues recorded through December 31, 1997 were earned in connection with contract research, licensing of technologies and investment income. The Company expects its operating losses to continue to increase over the next several years, as well as to have quarter-to-quarter fluctuations, some of which could be significant, due to expanded research, development and clinical trial activities. There can be no assurance that the Company will be able to generate sufficient product revenue to become profitable at all or on a sustained basis. RESULTS OF OPERATIONS License and contract research revenues of $2 million in 1997 and $7 million in 1996, were received from Bayer Corporation related to a research collaboration for a potential therapy for hemophilia which began in July 1996. Contract research revenues of $1.6 million in 1995 were primarily derived from a research and development agreement from the Company's former joint venture with Rhone-Poulenc Rorer Inc. ("Joint Venture"). Revenues derived from this agreement included reimbursement for research and development costs and certain administrative expenses. The Company has not received any revenue from the commercial sale of products and may not derive revenue from the sale of products for the foreseeable future. 31 Investment income was $2.4 million in 1997, $2.6 million in 1996 and $3.0 million in 1995. The fluctuation in investment income over the past three years was due to the Company's cash position during that period, as well as to the fluctuation in interest rates. The Company's research and development expenses have increased substantially over the past three years from $19.5 million in 1995, to $27.2 million in 1996, to $34.1 million in 1997. These increases were due primarily to the expansion of clinical testing and regulatory management of REMUNE, as well as increased staffing levels and purchases of laboratory materials and supplies related to the assumption of the manufacturing responsibility of REMUNE from the Joint Venture. The Company has also expanded its autoimmune disease research programs, including Phase II clinical trials with a rheumatoid arthritis treatment and a psoriasis treatment. In addition, research and development expenditures have increased related to research using GeneDrug delivery and cancer treatments. Research and development expenses are expected to continue to rise in the foreseeable future due to expanding preclinical and clinical testing of the Company's proposed treatments. The Company's costs incurred for the development of REMUNE during 1997, 1996 and 1995 were $23.7 million, $17.8 million and $11.3 million, respectively. Costs incurred for the development of potential products in the autoimmune disease program were $3.9 million, $4.3 million and $4.1 million for the years 1997, 1996 and 1995, respectively. The gene therapy program incurred costs in 1997, 1996 and 1995 of $4.9 million, $4.3 million and $3.7 million, respectively. The cancer program, which began in 1996, incurred costs of $1.6 million through December 31, 1997 and $756,000 during 1996. General and administrative expenses were $3.9 million in 1997, $3.4 million in 1996 and $3.7 million in 1995. General and administrative expenses increased in 1997 compared to 1996 primarily due to the Company evaluating corporate strategies. General and administrative expenses decreased in 1996 compared to 1995 primarily due to the additional costs incurred in 1995 related to the Company's acquisition of Rhone-Poulenc Rorer's interest in the Joint Venture. General and administrative expenses necessary to support corporate activities are expected to increase in 1998. LIQUIDITY AND CAPITAL RESOURCES As of December, 1997, the Company had working capital of $28.9 million, including $30.4 million of cash, cash equivalents, marketable securities and short-term investments. This compares with working capital as of December 31, 1996 of $45.7 million, including $47.8 million of cash, cash equivalents, marketable securities and short-term investments. Working capital decreased, despite the $16.0 million received from the private placement of common stock and warrants in 1997, as a result of normal costs of operations, in particular, due to the cost of the HIV clinical trials with REMUNE. The Company will need to raise additional funds to conduct research and development, preclinical studies and clinical trials necessary to bring its potential products to market and establish manufacturing and marketing capabilities. The Company anticipates that in 1998, the REMUNE clinical trials will cost approximately $10 million, and the manufacturing, research and all other expenses associated with the product will cost approximately an additional $15 million. The Company also anticipates that costs related to the development of REMUNE will continue to increase as the Company approaches possible commercialization. The anticipated costs with respect to REMUNE will depend on many factors, including the results of interim analyses of the data from the Phase III clinical endpoint trial, the potential for accelerated approval and certain other factors which will influence the Company's determination of the appropriate continued investment of the Company's financial resources in this program. The Company's future capital requirements will depend on many factors, including continued scientific progress in its research and development programs, the scope and results of preclinical studies and clinical trials, the time and costs involved in obtaining regulatory approvals, the costs involved in filing, prosecuting and enforcing patent claims, competing technological and market developments, the cost of manufacturing scale-up, effective commercialization activities and arrangements and other factors not within the Company's control. The Company intends to seek additional funding through public or private financings, arrangements with corporate collaborators or other sources. If funds are acquired through collaborations, the Company will likely be required to relinquish some or all rights to products that the Company may have otherwise developed itself. Adequate funds may not be available when needed or on terms acceptable to the Company. Insufficient funds may require the Company to scale back or eliminate some or all of its research and development programs or license to third parties products or technologies that the Company would otherwise seek to develop itself. The Company believes that its existing resources, including interest thereon, will enable the Company to maintain its current and planned operations through 1998. 32 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements and supplementary data of the Company required by this item are set forth at the pages indicated in Item 14(a)(1). ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable 33 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS The information required by this item (with respect to Directors) is incorporated by reference from the information under the captions "Election of Directors" and "Other Matters" contained in the Company's Proxy Statement to be filed with the Securities and Exchange ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference from the information under the caption "Compensation of Executive Officers and Directors" contained in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference from the information under the caption "Stock Ownership of Management and Certain Beneficial Owners" contained in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference from the information under the caption "Certain Transactions" contained in the Proxy Statement. 34 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - -------- ---------------------------------------------------------------- (a) (1) Financial Statements The consolidated financial statements required by this item are submitted in a separate section beginning on page F-1 of this report.
Consolidated Financial Statements of The Immune Response Corporation -------------------------------------------------------------------- Report of Independent Public Accountants F-1 Consolidated Balance Sheets at December 31, 1997 and 1996 F-2 Consolidated Statements of Operations for the three years ended December 31, 1997 F-3 Consolidated Statements of Stockholders' Equity for the three years ended December 31, 1997 F-4 Consolidated Statements of Cash Flows for the three years ended December 31, 1997 F-5 Notes to Consolidated Financial Statements F-6
(2) Financial Statement Schedules Schedules have been omitted because of the absence of conditions under which they are required or because the required information is included in the financial statements or the notes thereto. (3) Exhibits with each management contract or compensatory plan or arrangement required to be filed identified. See paragraph (c) below. (b) Reports on Form 8-K There were no reports on Form 8-K filed by the Company during the fourth quarter of the fiscal year ended December 31, 1997. (c) Exhibits 3(i)(6) Restated Certificate of Incorporation of The Immune Response Corporation. 3(ii)(6) Restated Bylaws of The Immune Response Corporation. 10.1(7) Amended and Restated 1989 Stock Plan of The Immune Response Corporation. 10.13(1) Assignment, dated May 27, 1988, by Jonas Salk and Dennis J. Carlo, assignors, to the Company. 10.14(1) Assignment, dated May 27, 1988 by Jonas Salk to the Company. 10.17(1) Lease, dated as of May 22, 1989, between the Company and BDN Carlsbad #1 Limited Partnership. 10.28(5)* Form of Indemnification Agreement entered into between the Company and its officers and directors. 10.36(2) First Amendment, dated February 19, 1990, to Lease between BDN Carlsbad #1 Limited Partnership and the Company. 10.37* Amended and Restated 1990 Directors' Stock Option Plan of The Immune Response Corporation. 10.42(3) Second and Third Amendments to the Lease, dated as of May 22, 1989, between the Company and BDN Carlsbad #1 Limited Partnership. 35 10.47(4) Rights Agreement, dated February 26, 1992, between the Company and First Interstate Bank, Ltd., as Rights Agent. 10.53* Form of The Immune Response Corporation Special Nonstatutory Stock Option Agreement. 10.55 Stock Purchase Agreement dated as of September 15, 1995, between The Immune Response Corporation and Trinity Medical Group Co., Ltd. 10.56 Sublease dated as of March 2, 1995, between Immunization Products Limited and Rhone-Poulenc Rorer Pharmaceuticals Inc. 10.57 Amendment No. 1 to sublease dated as of June 5, 1995, between Immunization Products Limited and Rhone-Poulenc Rorer Pharmaceuticals Inc. 10.58(8) Collaboration Agreement by and between The Immune Response Corporation and Bayer Corporation, dated as of July 8, 1996. 10.59(9) Unit Purchase Agreement, dated April 15, 1997, between The Immune Response Corporation and Kevin B. Kimberlin, including Common Stock Purchase Warrant, Promissory Note and Stock Pledge Agreement. 10.60(9) Unit Purchase Agreement, dated April 15, 1997, between The Immune Response Corporation and Dennis J. Carlo, Ph.D., including Common Stock Purchase Warrant, Promissory Note and Stock Pledge Agreement. 10.61(9) Amendment No. 1 to Rights Agreement (Exhibit 10.47), dated April 17, 1997, between The Immune Response Corporation and Harris Trust Company of California 10.62(10) Common Stock Purchase Warrant, dated June 26, 1997, between The Immune Response Corporation and Kevin B. Kimberlin. 10.63(10) Common Stock Purchase Warrant, dated June 26, 1997, between The Immune Response Corporation and Dennis J. Carlo, Ph.D. 10.64 Lease, dated December 15, 1997, between the Company and The Childs Family Investment Partnership, L.P. and The A.J. Gardner Family Trust, U/T/A 3/5/81. 21.1 Subsidiaries of the Registrant. 23.1 Consent of Independent Public Accountants. 24.1 Power of Attorney (see page 37). 27.1 Financial Data Schedule (1) Incorporated by reference to the exhibits of the same number to the Company's Registration Statement on Form S-1, No. 33-31057. (2) Incorporated by reference to the exhibits of the same number to the Company's Registration Statement on Form S-1, No. 33-34096. (3) Incorporated by reference to the exhibits of the same number to the Company's Report on Form 10-K for the Fiscal Year ended December 31, 1990 (Commission File No. 0-18006). (4) Incorporated by reference to Exhibit 5.1 to the Company's Report on Form 8-K filed March 4, 1992 (Commission File No 0-18006). (5) Incorporated by reference to the exhibits of the same number to the Company's Registration Statement on Form S-1, No. 33-31057. (6) Exhibits 3(i) and 3(ii) are incorporated by reference to Exhibits 4.1 and 4.2 respectively, to the Company's Registration Statement on Form S-8, No. 33-62940. (7) Incorporated by reference to the exhibit of the same number to the Company's Registration Statement on Form S-8, No. 33-80884. (8) Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K, as amended, dated July 8, 1996. Confidential treatment has been granted for certain portions of the Exhibit. (9) Incorporated by reference to the Exhibits of the same number filed with the Company's March 31, 1997 Form 10-Q. (10) Incorporated by reference to the Exhibits of the same number filed with the Company's June 30, 1997 Form 10-Q. * Indicates management contract or compensatory plan or arrangement. 36 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. THE IMMUNE RESPONSE CORPORATION By: /s/ DENNIS J. CARLO ---------------------------------- Dennis J. Carlo, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Dennis J. Carlo and Charles J. Cashion his attorneys-in-fact, each with full power of substitution, for him in any and all capacities, to sign any amendments to this Report and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorneys-in-fact, or their substitute or substitutes, may do or cause to be done by virtue hereof. /s/ James B. Glavin Chairman of the March 23, 1998 - ----------------------------- Board of Directors James B. Glavin /s/ Dennis J. Carlo President, March 23, 1998 - ----------------------------- Chief Executive Officer, Dennis J. Carlo and Director /s/ Charles J. Cashion Senior Vice President, March 23, 1998 - ----------------------------- Finance and Administration, Charles J. Cashion Chief Financial Officer Secretary and Treasurer /s/ Kevin B. Kimberlin Director March 23, 1998 - ----------------------------- Kevin B. Kimberlin /s/ Gilbert S. Omenn Director March 23, 1998 - ----------------------------- Gilbert S. Omenn /s/ Melvin Perelman Director March 23, 1998 - ----------------------------- Melvin Perelman 37 /s/ John Simon Director March 23, 1998 - ----------------------------- John Simon /s/ William M. Sullivan Director March 23, 1998 - ----------------------------- William M. Sullivan /s/ Philip M. Young Director March 23, 1998 - ----------------------------- Philip M. Young 38 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS The Board of Directors and Stockholders of The Immune Response Corporation: We have audited the accompanying consolidated balance sheets of The Immune Response Corporation (a Delaware corporation) and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of The Immune Response Corporation and subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP San Diego, California January 19, 1998 F1 THE IMMUNE RESPONSE CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
December 31, -------------------------- 1997 1996 ------------ ----------- ASSETS Current assets: Cash and cash equivalents $ 4,872 $ 3,786 Marketable securities-available-for-sale 25,567 42,736 Short-term investment -- 1,265 Other current assets 773 680 ------------ ----------- Total current assets 31,212 48,467 Property and equipment, net 5,810 5,570 Deposits and other assets 353 49 ------------ ----------- $ 37,375 $ 54,086 ------------ ----------- ------------ ----------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,356 $ 1,871 Accrued expenses 562 497 Deferred rent obligation 355 414 ------------ ----------- Total current liabilities 2,273 2,782 Commitments (Note 3) Stockholders' equity: Preferred stock, 5,000,000 shares authorized: none issued -- -- Common stock, $.0025 par value, 40,000,000 shares authorized, 22,815,054 and 20,229,719 shares issued and outstanding at December 31, 1997 and 1996, respectively 57 51 Warrants 2,144 -- Additional paid-in capital 186,374 171,056 Unrealized gain on marketable securities 27 140 Accumulated deficit (153,500) (119,943) ------------ ----------- Total stockholders' equity 35,102 51,304 ------------ ----------- $ 37,375 $ 54,086 ------------ ----------- ------------ -----------
See accompanying notes. F2 THE IMMUNE RESPONSE CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)
Year ended December 31, --------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Revenues: Contract research revenue $ 2,000 $ 1,000 $ 1,561 Licensed research revenue -- 6,000 -- ----------- ----------- ----------- 2,000 7,000 1,561 Expenses: Research and development 34,090 27,211 19,489 General and administrative 3,904 3,420 3,684 ----------- ----------- ----------- 37,994 30,631 23,173 Other revenue and expense: Investment income 2,437 2,605 2,960 Equity in operations of joint venture -- -- (1,284) ----------- ----------- ----------- 2,437 2,605 1,676 ----------- ----------- ----------- Net loss $ (33,557) (21,026) $ (19,936) ----------- ----------- ----------- ----------- ----------- ----------- Net loss per share - Basic $ (1.53) $ (1.19) $ (1.19) ----------- ----------- ----------- ----------- ----------- ----------- Weighted average number of shares outstanding 21,883,235 17,658,383 16,750,460 ----------- ----------- ----------- ----------- ----------- -----------
See accompanying notes. F3 THE IMMUNE RESPONSE CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands)
Unrealized Gain Common Stock Additional (Loss) on Total -------------- Paid-in Marketable Accumulated Stockholders' Shares Amount Warrants Capital Securities Deficit Equity ------ ------ -------- ---------- ---------- ----------- ------------ Balance at December 31, 1994 16,740 $ 42 $ --- $ 146,634 $ (610) $ (78,981) $ 67,085 Issuance of common stock from exercise of options 49 --- --- 136 --- --- 136 Change in unrealized gain (loss) on marketable securities --- --- --- --- 1,155 --- 1,155 Net loss --- --- --- --- --- (19,936) (19,936) ------ ------ -------- ---------- ---------- ----------- ------------ Balance at December 31, 1995 16,789 42 --- 146,770 545 (98,917) 48,440 Issuance of common stock in private stock transactions 568 1 --- 7,999 --- --- 8,000 Issuance of common stock from public offering, net of issuance costs of $1,189,000 2,530 7 --- 15,250 --- --- 15,257 Issuance of common stock from exercise of options 343 1 --- 1,037 --- --- 1,038 Change in unrealized gain (loss) on marketable securities --- --- --- --- (405) --- (405) Net loss --- --- --- --- --- (21,026) (21,026) ------ ------ -------- ---------- ---------- ----------- ------------ Balance at December 31, 1996 20,230 51 --- 171,056 140 (119,943) 51,304 Issuance of common stock and warrants in private transaction, net of issuance costs of $360,000 (Note 4) 2,051 5 2,144 13,491 --- --- 15,640 Issuance of common stock from exercise of options 534 1 --- 1,827 --- --- 1,828 Change in unrealized gain (loss) on marketable securities --- --- --- --- (113) --- (113) Net loss --- --- --- --- --- (33,557) (33,557) ------ ------ -------- ---------- ---------- ----------- ------------ Balance at December 31, 1997 22,815 $ 57 $ 2,144 $ 186,374 $ 27 $ (153,500) $ 35,102 ------ ------ -------- ---------- ---------- ----------- ------------ ------ ------ -------- ---------- ---------- ----------- ------------ See accompanying notes.
F4 THE IMMUNE RESPONSE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Year ended December 31, --------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Operating activities: Net loss $ (33,557) $ (21,026) $ (19,936) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation and amortization 1,266 848 1,038 Equity in operations of joint venture --- --- 1,284 Other --- --- 374 Deferred rent expense (59) (30) (1) Changes in operating assets and liabilities: Research contract receivable from a related party --- --- (1,199) Other current assets (93) 284 332 Accounts payable (515) 713 651 Accrued expenses 64 111 73 ----------- ----------- ----------- Net cash used by operating activities (32,894) (19,100) (17,386) Investing activities: Purchase/sale of marketable securities, net 18,322 6 15,543 Purchase of short-term investment --- (1,265) --- Purchase of property and equipment (2,526) (1,613) (442) Net proceeds from sale of equipment --- --- 1,948 Sale of land 1,020 --- --- Other assets (304) --- 4 ----------- ----------- ----------- Net cash provided from (used by) investing activities 16,512 (2,872) 17,053 Financing activities: Net proceeds from sale of common stock through public offering --- 15,256 --- Proceeds from other sales of common stock --- 8,000 --- Net proceeds from sale of common stock and warrants through private offering 15,640 --- --- Net proceeds from exercise of stock options 1,829 1,038 136 Payment on debt and capital lease obligations --- --- (132) ----------- ----------- ----------- Net cash provided from financing activities 17,469 24,294 4 ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents 1,087 2,322 (329) Cash and cash equivalents at beginning of year 3,785 1,463 1,792 ----------- ----------- ----------- Cash and cash equivalents at end of year $ 4,872 $ 3,785 $ 1,463 ----------- ----------- ----------- ----------- ----------- ----------- Supplemental disclosure of noncash investing and financing activities: Equipment received from liquidation of joint venture $ --- $ --- $ 2,009 ----------- ----------- ----------- ----------- ----------- -----------
See accompanying notes. F5 THE IMMUNE RESPONSE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION The Immune Response Corporation (the "Company"), a Delaware corporation, is a biopharmaceutical company with proprietary technologies in four core areas: Human Immunodeficiency Virus ("HIV"), autoimmune disease, gene therapy and cancer. The Company is conducting clinical trials for potential immune-based therapies for HIV, rheumatoid arthritis, psoriasis, multiple sclerosis, brain and colon cancers. The Company has potential gene therapies in preclinical studies for hemophilia and hepatitis. The Company intends to retain ownership of its core technologies and to license selected applications. The Company's products are in various stages of development. Prior to generating product revenues, the Company must complete the development of its products, including several years of human clinical testing, and receive regulatory approvals prior to selling these products in the human health care market. No assurance can be given that the Company's products will be successfully developed, regulatory approvals will be granted, or patient and physician acceptance of these products will be achieved. The Company faces additional risks associated with biopharmaceutical companies whose products are in various stages of development. These risks include, among others, the Company's need for additional financing to complete its research and development programs and commercialize its technologies. There is no assurance such financing will be available to the Company when required or that such financing would be available under favorable terms. The Company believes that patents and other proprietary rights are important to its business. The Company's policy is to file patent applications to protect technology, inventions and improvements to its inventions that are considered important to the development of its business. The patent positions of pharmaceutical and biotechnology firms, including the Company, are uncertain and involve complex legal and factual questions for which important legal principles are largely unresolved. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. NET LOSS PER SHARE Net loss per share is computed using the weighted average number of common shares outstanding during the period. Common equivalent shares are excluded as the effect would be antidilutive. NEW ACCOUNTING STANDARDS In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("FAS") No. 128, "Earnings per Share." The Company adopted these new rules effective December 15, 1997. The adoption of this new standard did not have an impact upon current or previously reported earnings per share. In December 1997, the Company adopted SFAS No. 129, "Disclosure of Information about Capital Structure." This Statement establishes standards for disclosing information about an entity's capital structure. This Statement is effective for financial statements for periods ending after December 15, 1997. The adoption of SFAS No. 129, in fiscal 1997, did not have an effect on the Company's results of operations or financial position. During July 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." This Statement establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. The objective of the Statement is to report a measure of all changes in equity of an enterprise that result from transactions and other economic events of the period other than transactions with owners ("comprehensive income"). Comprehensive income is the total of net income and all other nonowner changes in equity. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997, with earlier application permitted. The Company does not anticipate that the adoption of the accounting and disclosure provisions of SFAS No. 130 will have an impact on the Company's financial statements and results of operations. F6 THE IMMUNE RESPONSE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 CONCENTRATION OF CREDIT RISK The Company invests its excess cash in U.S. Government securities and money market accounts. The Company has established guidelines relative to diversification and maturities that maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates. PROPERTY AND EQUIPMENT Property and equipment is stated at cost and is depreciated or amortized over the estimated useful lives of the assets (five to seven years) or the lease term using the straight-line method. Property and equipment consists of the following:
DECEMBER 31, ----------------------- (IN THOUSANDS) 1997 1996 ---------- ---------- Furniture and fixtures $ 1,246 $ 1,078 Equipment 1,393 1,064 Leasehold improvements 7,034 6,344 Land 1,339 -- -------- -------- 11,012 8,486 Less accumulated depreciation and amortization (5,202) (3,936) -------- -------- 5,810 4,550 Land held for sale -- 1,020 -------- -------- $ 5,810 $ 5,570 -------- -------- -------- --------
INCOME TAXES All income tax amounts have been computed in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Under this statement, the liability method is used to account for deferred income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax base of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences reverse. 2. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES Cash and cash equivalents consist of cash and time deposits with original maturities of less than three months. Short-term investments are stated at market. Marketable securities consist of treasury securities with maturities of more than three months. The Company has classified all of its marketable securities as available-for-sale securities. The following table summarizes available-for-sale securities:
AVAILABLE-FOR-SALE SECURITIES GROSS GROSS (IN THOUSANDS) UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES FAIR VALUE --------- --------- --------- --------- DECEMBER 31, 1997 U.S. Government Securities $ 25,540 $ 99 $ 72 $ 25,567 --------- --------- --------- --------- --------- --------- --------- --------- DECEMBER 31, 1996 U.S. Government Securities $ 42,596 $ 198 $ 58 $ 42,736 --------- --------- --------- --------- --------- --------- --------- ---------
The net realized losses on sales of available-for-sale securities totaled $16,000 for the year ended December 31, 1997. F7 THE IMMUNE RESPONSE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 The amortized cost and estimated fair value of available-for-sale securities at December 31, 1997, by contractual maturity, are shown below:
ESTIMATED COST FAIR VALUE --------- --------- Due in one year or less $ 17,957 $ 17,961 Due after one year through three years 7,583 7,606 --------- --------- $ 25,540 $ 25,567 --------- --------- --------- ---------
3. COMMITMENTS The Company leases its offices, research facility and certain office and laboratory equipment under operating lease agreements. The equipment lease agreements require monthly payments through September 1998. The office and research facility lease agreement, which commenced in January 1991, is for a term of ten years, with two five-year options to extend. In connection with this lease, the Company received certain deferred payment terms and the minimum annual rent is subject to certain annual increases. Rent is being expensed on a straight-line basis over the term of the lease. Deferred rent reflected in the accompanying balance sheet represents the difference between rent expense accrued and amounts actually paid under the terms of the lease. At December 31, 1997, future minimum rental payments due under the Company's noncancellable operating leases are as follows:
YEAR ENDING DECEMBER 31, -------------- (in thousands) 1998 $2,859 1999 2,242 2000 1,488 2001 241 2002 249 Thereafter 1,429 -------- $ 8,508 -------- --------
Included in the 1998 balance is $600,000 to purchase a certificate of deposit to be used as collateral for a letter of credit that will be delivered to the landlord of a facility the Company expects to begin leasing in April 1998. Total rent expense for the years ended December 31, 1997, 1996 and 1995 was $2.4 million, $3.2 million, and $2.5 million, respectively. 4. STOCKHOLDERS' EQUITY STOCK TRANSACTIONS During 1997, the Company completed a $16.0 million private placement of units consisting of common stock and warrants to purchase common stock of the Company. These units were purchased at a price of $7.80 per unit by a director of the Company, and the Company's and President and Chief Executive Officer. The units sold in the private placement consisted of 2,051,281 shares of common stock plus warrants exercisable for 2,051,281 shares of common stock. The warrants, with an exercise price of $14.00 per share, are callable by the Company if the Company's common stock trades at $28.00 per share or greater for 45 consecutive days. The warrants expire on April 17, 2001. The shares and warrants are unregistered and are not transferable until April 1998. In April 1996, the Company received $5 million from Trinity Medical Group Co., Ltd. of Bangkok, Thailand for the purchase of the Company's common stock at $15 per share. Trinity has also agreed to make additional equity investments of up to $10 million based on the achievement of certain regulatory and commercial milestones and governmental approvals. F8 THE IMMUNE RESPONSE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 STOCK TRANSACTIONS - CONTINUED In October 1996, the Company entered into an agreement with Viru-Tech Limited to develop and distribute REMUNE in South America and Central America. Under the agreement, Viru-Tech Limited purchased $3 million of the Company's common stock. Also in October 1996, the Company issued 2,530,000 shares, at $6.50 per share, in an underwritten public offering. Net proceeds from this offering were $15.3 million. STOCK OPTIONS The Company has established various stock option plans to grant options to purchase common stock to employees and non-employee directors of the Company and certain other individuals. The plans authorize the Company to issue or grant qualified and non-qualified options to purchase up to 6,150,000 shares of its common stock. Under the terms of the 1989 Stock Plan, options may be granted at not less than 100% and 85% of fair market value as of the date of grant for qualified and non-qualified options, respectively. To date, all options have been issued at 100% of fair market value. These options primarily become exercisable over a four year period from the date of grant. During April 1995, the Company offered holders of stock options issued under the 1989 Stock Plan, with the exception of members of the Board of Directors, the opportunity to exchange an issued stock option for a new stock option on a one-for-one basis on April 19, 1995. The new stock option price per share of $3.25 exceeded the market value of the Company's stock on that day. The stock options will continue the vesting schedule of the exchanged stock options. Of the 2,305,885 eligible stock options, 2,213,581 were exchanged for new options. The 1990 Directors' Stock Option Plan provides for the Company to issue or grant non-qualified options to purchase up to 650,000 common shares to its non-employee directors. Under the terms of the plan, options will be granted at the fair market value as of the date of grant. These options become exercisable in four equal annual installments on each of the first four anniversaries of the date of grant. Additionally, the 1990 Directors' Stock Option Plan provides that upon each date of the Company's Annual Meeting of the Stockholders, non-employee directors are eligible to receive a grant of 6,250 shares at the fair market value on date of grant, with a one-year vesting schedule. Activity with respect to the various stock plans is summarized as follows:
STOCK WEIGHTED OPTIONS AVERAGE (IN THOUSANDS) OUTSTANDING PRICE ----------- ----------- Balance at December 31, 1994 3,198 $11.45 Granted 637 3.38 Exercised (48) 2.82 Cancelled (186) 13.39 ----------- Balance at December 31, 1995 3,602 3.91 Granted 902 7.29 Exercised (342) 3.03 Cancelled (111) 4.69 ----------- Balance at December 31, 1996 4,050 4.71 Granted 578 8.34 Exercised (534) 3.42 Cancelled (91) 6.75 ----------- Balance at December 31, 1997 4,003 5.36 ----------- -----------
The weighted avereage remaining useful life of the outstanding stock options at December 31, 1997 is approximately six years. At December 31, 1997, 6,887,558 shares of common stock were reserved for the exercise of stock options. F9 THE IMMUNE RESPONSE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 The Company has adopted the disclosure-only provisions of FAS 123. Accordingly, no compensation cost has been recognized for the stock option plans. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date for awards in 1997 consistent with the provisions of FAS 123, the Company's net loss and loss per share would have been increased to the pro forma amounts indicated below:
(in thousands, except per share data) 1997 1996 1995 -------- -------- -------- Net loss - as reported $33,557 $ 21,026 $ 19,936 Net loss - pro forma $45,290 $ 30,078 $ 25,480 Net loss per share - as reported $ 1.53 $ 1.19 $ 1.19 Net loss per share - pro forma $ 2.07 $ 1.70 $ 1.52
The fair value of each option grant was estimated on the date of grant using the Black Scholes option-pricing model with the following weighted average assumptions used for grants in 1997: risk free interest rate of 5.72%, expected option life of 5 years, expected volatility of .8288 and a dividend rate of zero. Because FAS 123 has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. PREFERRED STOCK The Company is authorized to issue up to 5 million shares of preferred stock. No shares of preferred stock were outstanding at December 31, 1996 or 1997. STOCKHOLDER RIGHTS PLAN The Company has a Stockholder Rights Plan that provides for the distribution of a preferred stock purchase right (a "Right") as a dividend for each share of the Company's common stock of record held at the close of business on March 12, 1992, as well as all future stock issuances. Under certain conditions involving an acquisition by any person or group of 15% or more of the common stock, the Rights permit the holders (other than the 15% holder) to purchase the Company's common stock at a 50% discount upon payment of an exercise price of $150 per Right. In addition, in the event of certain business combinations, the Rights permit the purchase of the common stock of an acquiror at a 50% discount. Under certain conditions, the Rights may be redeemed by the Board of Directors in whole, but not in part, at a price of $.01 per Right. The Rights have no voting privileges and are attached to and automatically trade with the Company's common stock. The Rights expire February 26, 2002. 5. LICENSE AGREEMENT In July 1996, Immune Response entered into an agreement with Bayer Corporation ("Bayer"), the United States affiliate of Bayer AG of Leverkusen, Germany, to develop gene therapy products for the treatment of hemophilia A, a hereditary blood clotting disorder. Bayer made an initial license payment of $6 million upon signing this agreement. Bayer also purchased $4 million of Immune Response Common Stock in the Company's public stock offering completed in October 1996. In addition, during the term of the agreement, the Company will receive research funding from Bayer for Immune Response's hemophilia A program and may receive milestone payments and royalties on future sales, if a product is developed and commercialized. Under the agreement, Bayer is responsible for all medical and regulatory activities associated with developing any potential hemophilia A products, and will also be responsible for commerical-scale manufacturing and commercialization of any such product developed. The agreement provides Bayer with a worldwide license to the Company's GeneDrug-TM- technology for the delivery of the Factor VIII gene and the option to enter into negotiations with the Company to use this technology to treat other blood coagulation disorders. F10 THE IMMUNE RESPONSE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 6. INVESTMENT IN JOINT VENTURE Immunization Products Limited (the "Joint Venture"), a joint venture between the Company and Rhone-Poulenc Rorer Inc., was formed to develop, manufacture and market certain products related to the diagnosis and treatment of human immunodeficiency virus infection. In March 1995, the Company regained all manufacturing, marketing and distribution rights for REMUNE from Rhone-Poulenc Rorer Inc. The Company also assumed control and responsibility for the Joint Venture's manufacturing facility. The Company agreed to pay Rhone-Poulenc Rorer Inc. up to $3 million in royalties on future commercial sales of REMUNE, or upon certain transactions involving licensing rights to REMUNE to a future corporate partner. 7. INCOME TAXES At December 31, 1997, the Company had federal and California tax net operating loss carryforwards of approximately $124.4 million and $19.4 million, respectively. The difference between the federal and California tax loss carryforwards is primarily attributable to capitalized research and development expenses for California and the 50% limitation of California loss carryforwards. The federal tax loss carryforwards will begin expiring in 2002, unless previously utilized, while the California tax loss carryforwards began to expire in 1995. The Company also has federal and California research and development tax credit carryforwards of $6 million and $2.1 million, respectively, which begin expiring in 2002 unless previously utilized. Pursuant to Internal Revenue Code Sections 382 and 383, annual use of the Company's net operating loss and credit carryforwards will be limited because of a cumulative change in ownership of more than 50% which occurred during 1992. However, the Company does not believe such change will have a material impact upon the utilization of these carryforwards. Included in the federal loss carryforwards are approximately $4.4 million of acquired net operating loss carryforwards that can only be used to the extent of the separate taxable income of the acquired company. The components of the Company's deferred tax assets as of December 31, 1997 and 1996 are as follows:
DECEMBER 31, ------------------------ (IN THOUSANDS) 1996 1997 --------- --------- Net operating loss carryforwards $ 32,776 $ 43,460 Unused research and development credits 5,100 8,100 Capitalized research and development 3,200 5,026 Other 803 1,054 --------- --------- 41,879 57,640 Valuation allowance (41,879) (57,640) --------- --------- $ -- $ -- --------- --------- --------- ---------
Approximately $4.2 million of the valuation allowance at December 31, 1997 relates to benefits of stock options which, when recognized, will be allocated directly to stockholders' equity. F11 THE IMMUNE RESPONSE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1997 8. QUARTERLY RESULTS (UNAUDITED) The following unaudited quarterly financial information includes, in management's opinion, all normal and recurring adjustments necessary to fairly state the Company's consolidated results of operations and related information for the periods presented. Net loss per share has been computed using the weighted average shares outstanding during each quarter.
1ST 2ND 3RD 4TH QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 Contract research revenue $ 1,000 $ -- $ 1,000 $ -- Operating expenses (9,592) (10,602) (8,458) (9,342) -------- -------- -------- -------- Loss from operations (8,592) (10,602) (7,458) (9,342) Other income (expense) 609 669 591 568 -------- -------- -------- -------- Net loss $ (7,983) $ (9,933) $ (6,867) $ (8,774) -------- -------- -------- -------- -------- -------- -------- -------- Net loss per share $ (0.39) $ (0.45) $ (0.31) $ (0.38) -------- -------- -------- -------- -------- -------- -------- -------- 1996 Contract research revenue $ -- $ -- $ 1,000 $ -- Licensed research revenue -- -- 6,000 -- Operating expenses (6,245) (8,310) (7,719) (8,357) -------- -------- -------- -------- Loss from operations (6,245) (8,310) (719) (8,357) Other income (expense) 744 579 585 697 -------- -------- -------- -------- Net loss $ (5,501) $ (7,731) $ (134) $ (7,660) -------- -------- -------- -------- -------- -------- -------- -------- Net loss per share $ (0.33) $ (0.45) $ (0.01) $ (0.40) -------- -------- -------- -------- -------- -------- -------- --------
F12 EX-10.64 2 EXHIBIT 10.64 AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION STANDARD INDUSTRIAL COMMERCIAL SINGLE-TENANT LEASE - NET (DO NOT USE THIS FORM FOR MULTI-TENANT BUILDINGS) 1. BASIC PROVISIONS ("BASIC PROVISIONS") 1.1 PARTIES: This Lease ("Lease"), dated for reference purposes only, December 15, 1997, is made by and between The Childs Family Investment Partnership, L.P. and The A.J. Gardner Family Trust, U/T/A 3/5/81 ("Lessor"), and The Immune Response Corporation, a Delaware Corporation ("Lessee"), (collectively the "Parties," or individually a "Party"). 1.2 PREMISES: That certain real property, including all improvements therein or to be provided by Lessor under the terms of this lease, and commonly known as 5931 Darwin Court, Carlsbad, California 92008, located in the County of San Diego, State of California and generally described as (describe briefly the nature of the property and, if applicable, the "Project", if the property is located within a Project) An approximately 31,200 square foot concrete tilt up freestanding building and appurtances located in the Carlsbad Research Center. (See Addendum) ("Premises"). (See also Paragraph 2) 1.3 TERM: Ten (10) years and Zero (0) months ("Original Term") commencing See Addendum ("Commencement Date") and ending one hundred twenty (120) months thereafter ("Expiration Date"). (See also Paragraph 3) 1.4 EARLY POSSESSION: See Addendum ("Early Possession Date"). (See also Paragraphs 3.2 and 3.3) 1.5 BASE RENT: $18,408.00 (See Addendum) per month ("Base Rent"), payable in advance on the first (1st) day of each month commencing on the Commencement date. (See also Paragraph 4) /X/ If this box is checked, there are provisions in this Lease for the Base Rent to be adjusted. 1.6 BASE RENT PAID UPON EXECUTION: $18,408.00 (Eighteen Thousand Four Hundred Eight and no/100ths Dollars) as Base Rent for the period beginning with the first month following the Commencement Date. 1.7 SECURITY DEPOSIT: $24,024.00 ("Security Deposit"). (See also Paragraph 5) 1.8 AGREED USE: See Addendum. (See also Paragraph 6) 1.9 INSURING PARTY. Lessor is the "Insuring Party" unless otherwise stated herein. (See also Paragraph 8) 1.10 REAL ESTATE BROKERS: (See also Paragraph 15) (a) REPRESENTATION: The following real estate brokers (collectively, the "Brokers") and brokerage relationships exist in this transaction (check applicable boxes): /X/ David Onosko, CB Commercial Real Estate Group, Inc. represents Lessor exclusively ("Lessor's Broker"); /X/ William Driscoll, CB Commercial Real Estate Group, Inc. represents Lessee exclusively ("Lessee's Broker"); or / / ____________________ represents both Lessor and Lessee ("Dual Agency"). (b) PAYMENT TO BROKERS: Upon execution and delivery of this Lease by both Parties, Lessor shall pay to the Broker the fee agreed to in their separate written agreement (or if there is no such agreement, the sum of _____% of the total Base Rent for the brokerage services rendered by said Broker). 1.11 GUARANTOR. The obligations of the Lessee under this Lease are to be guaranteed by N/A ("Guarantor"). (See also Paragraph 37) 1.12 ADDENDA AND EXHIBITS. Attached hereto is an Addendum or Addenda consisting of 15 Pgs through ____ and Exhibits 1.2, 5, 6.2, 50 and 56, all of which constitute a part of this Lease. PAGE 1 2. PREMISES. 2.1 LETTING. Lessor hereby leases to Lessee, and Lessee hereby leases from Lessor, the Premises. for the term, at the rental, and upon all of the terms, covenants and conditions set forth in this Lease. Unless otherwise provided herein, any statement of size set forth in this Lease, or that may have been used in calculating rental. is an approximation which the Parties agree is reasonable and the rental based thereon is not subject to revision whether or not the actual size is more or less. 2.2 CONDITION. Lessor shall deliver the Premises to Lessee broom clean and free of debris on the Commencement Date or the Early Possession Date, whichever first occurs ("Start Date"), and, so long as the required service contracts described in Paragraph 7.1(b) below are obtained by Lessee within thirty (30) days following the Start Date, warrants that the existing electrical, plumbing, fire sprinkler, lighting, heating, ventilating and air conditioning systems ("HVAC"), loading doors, if any, and all other such elements in the Premises, other than those constructed by Lessee, shall be in good operating condition on said date and that the structural elements of the roof, bearing walls and foundation of any buildings on the Premises (the "Building") shall be free of material defects. If a non-compliance with said warranty exists as of the Start Date, Lessor shall, as Lessor's sole obligation with respect to such matter, except as otherwise provided in this Lease, promptly after receipt of written notice from Lessee setting forth with specificity the nature and extent of such non-compliance, rectify same at Lessor's expense. If, after the Start Date, Lessee does not give Lessor written notice of any non-compliance with this warranty within (i) one year* as to the surface of the roof and the structural portions of the roof, foundations and bearing walls, (ii) six (6) months as to the HVAC systems, (iii) thirty (30) days as to the remaining systems and other elements of the Building, correction of such non-compliance shall be the obligation of Lessee at Lessee's sole cost and expense. *as to patent defects and three (3) years as to latent defects 2.3 COMPLIANCE. Lessor warrants that the improvements on the Premises comply with all applicable laws, covenants or restrictions of record, building codes, regulations and ordinances ("Applicable Requirements") in effect on the Start Date. Said warranty does not apply to the use to which Lessee will put the Premises or to any Alterations or Utility Installations (as defined in Paragraph 7.3(a)) made or to be made by Lessee. NOTE: Lessee is responsible for determining whether or not the zoning is appropriate for Lessees intended use, and acknowledges that past uses of the Premises may no longer be allowed If the Premises do not comply with said warranty, Lessor shall, except as otherwise provided, promptly after receipt of written notice from Lessee setting forth with specificity the nature and extent of such noncompliance, rectify the same at Lessors expense. If Lessee does not give Lessor written notice of a non-compliance with this warranty within six (6) months following the Start Date, correction of that non-compliance shall be the obligation of Lessee at Lessee's sole cost and expense. If the Applicable Requirements are hereafter changed (as opposed to being in existence at the Start Date, which is addressed in Paragraph 6.2(e) below) so as to require during the term of this Lease the construction of an addition to or an alteration of the Building, the remediation of any Hazardous Substance. or the reinforcement or other physical modification of the Building ("Capital Expenditure"), Lessor and Lessee shall allocate the cost of such work as follows: (a) Subject to Paragraph 2.3(c) below, if such Capital Expenditures are required as a result of the specific and unique use of the Premises by Lessee as compared with uses by tenants in general, Lessee shall be fully responsible for the cost thereof, provided, however that if such, Capital Expenditure is required during the last two (2) years of this Lease and the cost thereof exceeds six (6) months' Base Rent, Lessee may instead terminate this Lease unless Lessor notifies Lessee, in writing, within ten (10) days after receipt of Lessee's termination notice that Lessor has elected to pay the difference between the actual cost thereof and the amount equal to six (6) months' Base Rent. If Lessee elects termination., Lessee shall immediately cease the use of the Premises which requires such Capital Expenditure and deliver to Lessor written notice specifying a termination date at least ninety (90) days thereafter. Such termination date shall, however, in no event be earlier than the last day that Lessee could legally utilize the Premises without commencing such Capital Expenditure. (b) If such Capital Expenditure is not the result of the specific and unique use of the Premises by Lessee (such as, governmentally mandated seismic modifications), then Lessor and Lessee shall allocate the obligation to pay for such costs pursuant to the provisions of Paragraph 7.1 (c): provided, however, that if such Capital Expenditure is required during the last two years of this Lease or if Lessor reasonably determines that it is not economically feasible to pay its share thereof, Lessor shall have the option to terminate this Lease upon ninety (90) days prior written notice to Lessee unless Lessee notifies Lessor, in writing, within ten (10) days after receipt of Lessor's termination notice that Lessee will pay for such Capital Expenditure. If Lessor does not elect to terminate, and fails to tender its share of any such Capital PAGE 2 Expenditure, Lessee may advance such funds and deduct same, with Interest, from Rent until Lessor's share of such costs have been fully paid. If Lessee is unable to finance Lessor's share, or if the balance of the Rent due and payable for the remainder of this Lease is not sufficient to fully reimburse Lessee on an offset basis, Lessee shall have the right to terminate this Lease upon thirty (30) days written notice to Lessor. (c) Notwithstanding the above, the provisions concerning Capital Expenditures are intended to apply only to non-voluntary, unexpected, and new Applicable Requirements. If the Capital Expenditures are instead triggered by Lessee as a result of an actual or proposed in use, change in intensity of use, or modification to the Premises then, and in that event, Lessee shall be fully responsible for the cost thereof, and Lessee shall not have any right to terminate this Lease. 2.4 ACKNOWLEDGEMENTS. Lessee acknowledges that: (a) it has been advised by Lessor and/or Brokers to satisfy itself with respect to the condition of the Premises (including but not limited to the electrical, HVAC and fire sprinkler systems, security, environmental aspects, and compliance with Applicable Requirements), and their suitability for Lessee's intended use, (b) Lessee has made such investigation as it deems necessary with reference to such matters and assumes all responsibility therefor as the same relate to its occupancy of the Premises, and (c) neither Lessor, Lessor's agents, nor any Broker has made any oral or written representations or warranties with respect to said matters other than as set forth in this Lease. In addition, Lessor acknowledges that: (a) Broker has made no representations, promises or warranties concerning Lessee's ability to honor the Lease or suitability to occupy the Premises, and (b) it is Lessor's sole responsibility to investigate the financial capability and/or suitability of all proposed tenants. 2.5 LESSEE AS PRIOR OWNER/OCCUPANT. The warranties made by Lessor in Paragraph 2 shall be of no force or effect if immediately Prior to the Start Date Lessee was the owner or occupant of the Premises. In such event, Lessee shall be responsible for any necessary corrective work. 3. TERM. 3.1 TERM. The Commencement Date, Expiration Date and Original Term of this Lease are as specified in Paragraph 1.3. 3.2 EARLY POSSESSION. If Lessee totally or partially occupies the Premises prior to the Commencement Date, the obligation to pay Base Rent shall be abated for the period of such early possession. All other terms of this Lease (including but not limited to the obligations to pay Real Property Taxes and insurance premiums and to maintain the Premises) shall, however, be in effect during such period. Any such early possession shall not affect the Expiration Date. 3.3 DELAY IN POSSESSION. Lessor agrees to use its best commercially reasonable efforts to deliver possession of the Premises to Lessee by December 31, 1997. If, despite said efforts, Lessor is unable to deliver possession as agreed, Lessor shall not be subject to any liability therefor, nor shall such failure affect the validity of this Lease. Lessee shall not, however, be obligated to pay Rent or perform its other obligations until it receives possession of the Premises. If possession is not delivered within sixty (60) days after the Commencement Date, Lessee may, at its option, by notice in writing within ten (10) days after the end of such sixty (60) day period, cancel this Lease, in which event the Parties shall be discharged from all obligations hereunder. If such written notice is not received by Lessor within said ten (10) day period, Lessee's right to cancel shall terminate. Except as otherwise provided, if possession is not tendered to Lessee *by December 31, 1997 the April 1, 1998 date in 1.3 shall be extended by the number of days beyond December 31, 1997 that the Lessor delivered possession, but minus any days of delay caused by the acts or omissions of Lessee. If possession of the Premises is not delivered within four (4) months after December 31, 1997, this Lease shall terminate unless other agreements are reached between Lessor and Lessee, in writing. 3.4 LESSEE COMPLIANCE. Lessor shall not be required to tender possession of the Premises to Lessee until Lessee complies with its obligation to provide evidence of insurance (Paragraph 8.5). Pending delivery of such evidence, Lessee shall be required to perform all of its obligations under this Lease from and after the Start Date, including the payment of Rent, notwithstanding Lessor's election to withhold possession pending receipt of such evidence of insurance. Further, if Lessee is required to perform any other conditions prior to or concurrent with the Start Date, the Start Date shall occur but Lessor may elect to withhold possession until such conditions are satisfied. PAGE 3 4. RENT. 4.1 RENT DEFINED. All monetary obligations of Lessee to Lessor under the terms of this Lease (except for the Security Deposit) are deemed to be rent ("Rent"). 4.2 PAYMENT. Lessee shall cause payment of Rent to be received by Lessor in lawful money of the United States, without offset or deduction, on or before the day on which it is due. Rent for any period during the term hereof which is for less than one (1) full calendar month shall be prorated based upon the actual number of days of said month. Payment of Rent shall be made to Lessor at its address stated herein or to such other persons or place as Lessor may from time to time designate in writing. Acceptance of a payment which is less than the amount then due shall not be a waiver of Lessor's rights to the balance of such Rent, regardless of Lessor's endorsement of any check so stating. Rent shall be payable to LANDCO and mailed to 432 So. Bentley Avenue, Los Angeles, California 90049-3513. 5. SECURITY DEPOSIT. Lessee shall deposit with Lessor upon execution hereof the Security Deposit as security for Lessee's faithful performance of its obligations under this Lease. If Lessee fails to pay Rent, or otherwise Defaults under this Lease, Lessor may use, apply or retain all or any portion of said Security Deposit for the payment of any amount due Lessor or to reimburse or compensate Lessor for any liability, expense, loss or damage which Lessor may suffer or incur by reason thereof. If Lessor uses or applies all or any portion of said Security Deposit, Lessee shall within ten (10) days after written request therefor deposit monies with Lessor sufficient to restore said Security Deposit to the full amount required by this Lease. If the Base Rent increases during the term of this Lease, Lessee shall, upon written request from Lessor, deposit additional moneys with Lessor so that the total amount of the Security Deposit shall at ail times bear the same proportion to the increased Base Rent as the initial Security Deposit bore to the initial Base Rent. Should the Agreed Use be amended to accommodate a material change in the business of Lessee or to accommodate a sublessee or assignee, Lessor shall have the right to increase the Security Deposit to the extent necessary, in Lessors reasonable judgment, to account for any increased wear and tear that the Premises may suffer as a result thereof. If a change in control of Lessee occurs during this Lease and following such change the financial condition of Lessee is, in Lessor's reasonable judgment, significantly reduced, Lessee shall deposit such additional monies with Lessor as shall be sufficient to cause the Security Deposit to be at a commercially reasonable level based on said change in financial condition. Lessor shall not be required to keep the Security Deposit separate from its general accounts. Within fourteen (14) days after the expiration or termination of this Lease, if Lessor elects to apply the Security Deposit only to unpaid Rent, and otherwise within thirty (30) days after the Premises have been vacated pursuant to Paragraph 7.4(c) below, Lessor shall return that portion of the Security Deposit not used or applied by Lessor. No part of the Security Deposit shall be considered to be held in trust, to bear interest or to be prepayment for any monies to be paid by Lessee under this Lease. 6. USE. 6.1 USE. Lessee shall use and occupy the Premises only for the Agreed Use, or any other legal use which is reasonably comparable thereto, and for no other purpose, Lessee shall not use or permit the use of the Premises in a manner that is unlawful, creates damage, waste or a nuisance, or that disturbs owners and/or occupants of, or causes damage to neighboring properties. Lessor shall not unreasonably withhold or delay its consent to any written request for a modification of the Agreed Use, so long as the same will not impair the structural integrity of the improvements on the Premises or the mechanical or electrical systems therein, is not significantly more burdensome to the Premises. If Lessor elects to withhold consent, Lessor shall within five (5) business days after such request give written notification of same, which notice shall include an explanation of Lessor's objections to the change in use. 6.2 HAZARDOUS SUBSTANCES. (See Addendum) (a) REPORTABLE USES REQUIRE CONSENT. The term "Hazardous Substance" as used in this Lease shall mean any product, substance, or waste whose presence, use, manufacture, disposal, transportation, or release, either by itself or in combination with other materials expected to be on the Premises, is either: (i) potentially injurious to the public health, safety or welfare, the environment or the Premises, (ii) regulated or monitored by any governmental authority, or (iii) a basis for potential liability of Lessor to any governmental agency or third party under any applicable statute or common law theory. Hazardous Substances shall include, but not be limited to, hydrocarbons, petroleum, gasoline, and/or crude oil or any products, by-products or fractions thereof, Lessee shall not engage in any activity in or on the Premises which constitutes a Reportable Use of Hazardous Substances without the express prior written consent of Lessor and timely compliance (at Lessee's expense) with all Applicable Requirements. "Reportable Use" shall mean (i) the installation or use PAGE 4 of any above or below ground storage tank, (ii) the generation, possession, storage, use, transportation, or disposal of a Hazardous Substance that requires a permit from, or with respect to which a report, notice, registration or business plan is required to be filed with, any governmental authority, and/or (ml the presence at the Premises of a Hazardous Substance with respect to which any Applicable Requirements requires that a notice be given to persons entering or occupying the Premises or neighboring properties. Notwithstanding the foregoing, Lessee may use any ordinary and customary materials reasonably required to be used in the normal course of the Agreed Use, so long as such use is in compliance with all Applicable Requirements, is not a Reportable Use, and does not expose the Premises or neighboring property to any meaningful risk of contamination or damage or expose Lessor to any liability therefor. In addition, Lessor may condition its consent to any Reportable Use upon receiving such additional assurances as Lessor reasonably deems necessary to protect itself, the public, the Premises and/or the environment against damage, contamination, injury and/or liability, including, but not limited to, the installation (and removal on or before Lease expiration or termination) of protective modifications (such as concrete encasements) and/or increasing the Security Deposit. (b) DUTY TO INFORM LESSOR. If Lessee knows, or has reasonable cause to believe, that a Hazardous Substance has come to be located in, on, under or about the Premises, other than as previously consented to by Lessor, Lessee shall immediately give written notice of Such fact to Lessor, and provide Lessor with a copy of any report, notice, claim or other documentation which it has concerning the presence of such Hazardous Substance. (c) LESSEE REMEDIATION. Lessee shall not cause or permit any Hazardous Substance to be spilled or released in, on, under, or about the Premises (including through the plumbing or sanitary sewer system) and shall promptly, at Lessee's expense, take all investigatory and/or remedial action reasonably recommended, whether or not formally ordered or required, for the cleanup of any contamination of, and for the maintenance, security and/or monitoring of the Premises or neighboring properties, that was caused or materially contributed to by Lessee, or pertaining to or involving any Hazardous Substance brought onto the Premises during the term of this Lease, by or for Lessee, or any third party. (d) LESSEE INDEMNIFICATION. Lessee shall indemnify, defend and hold Lessor, its agents, employees, lenders and ground lessor, if any, harmless from and against any and all loss of rents and/or damages, liabilities, judgments, claims, expenses, penalties, and attorneys' and consultants' fees arising out of or involving any Hazardous Substance brought onto the Premises by or for Lessee, or any third party (provided, however, that Lessee shall have no liability under this Lease with respect to underground migration of any Hazardous Substance under the Premises from adjacent properties.* Lessee's obligations shall include, but not be limited to, the effects of any contamination or injury to person, property or the environment created or suffered by Lessee, and the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease. No termination, cancellation or release agreement entered into by Lessor and Lessee shall release Lessee from its obligations under this Lease with respect to Hazardous Substances, unless specifically so agreed by Lessor in writing at the time of such agreement. * unless migration is from an affiliated company (e) LESSOR INDEMNIFICATION. Lessor and its successors and assigns shall indemnify, defend, reimburse and hold Lessee, its employees and lenders, harmless from and against any and all environmental damages, including the cost of remediation, which existed as a result of Hazardous Substances on the Premises prior to the Start Date or which are caused by the gross negligence or willful misconduct of Lessor, its agents or employees. Lessor's obligations, as and when required by the Applicable Requirements, shall include, but not be limited to, the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease. (f) INVESTIGATIONS AND REMEDIATIONS. Lessor shall retain the responsibility and pay for any investigations or remediation measures required by governmental entities having jurisdiction with respect to the existence of Hazardous Substances on the Premises prior to the Start Date, unless such remediation measure is required as a result of Lessee's use (including "Alterations", as defined in paragraph 7.3(a) below) of the Premises, in which event Lessee shall be responsible for such payment. Lessee shall cooperate fully in any such activities at the request of Lessor, including allowing Lessor and Lessor's agents to have reasonable access to the Premises at reasonable times in order to carry out Lessor's investigative and remedial responsibilities. (g) LANDLORD TERMINATION OPTION. If a Hazardous Substance Condition occurs during the term of this Lease, unless Lessee is legally responsible therefor (in which case Lessee shall make the investigation and remediation thereof required by the Applicable Requirements and this Lease shall continue in full force and effect, but subject to PAGE 5 Lessor's rights under Paragraph 6.2(d) and Paragraph 13), Lessor may, at Lessor's option, either (i) investigate and remediate such Hazardous Substance Condition, if required, as soon as reasonably possible at Lessor's expense, in which event this Lease shall continue in full force and effect, or (ii) if the estimated cost to remediate such condition exceeds twelve (12) times the then monthly Base Rent or $100,000, whichever is greater, give written notice to Lessee, within thirty (30) days after receipt by Lessor of knowledge of the occurrence of such Hazardous Substance Condition, of Lessor's desire to terminate this Lease as of the date sixty (60) days following the date of such notice. In the event Lessor elects to give a termination notice, Lessee may, within ten (10) days thereafter, give written notice to Lessor of Lessee's commitment to pay the amount by which the cost of the remediation of such Hazardous Substance Condition exceeds an amount equal to twelve (12) times the then monthly Base Rent or $100,000, whichever is greater. Lessee shall provide Lessor with said funds or satisfactory assurance thereof within thirty (30) days following such commitment. In such event, this Lease shall continue in full force and effect, and Lessor shall proceed to make such remediation as soon as reasonably possible after the required funds are available. If Lessee does not give such notice and provide the required funds or assurance thereof within the time provided, this Lease shall terminate as of the date specified in Lessor's notice of termination. 6.3 LESSEE'S COMPLIANCE WITH APPLICABLE REQUIREMENTS. Except as otherwise provided in this Lease, Lessee shall, at Lessee's sole expense, fully, diligently and in a timely manner, materially comply with all Applicable Requirements, the requirements of any applicable fire insurance underwriter or rating bureau, and the recommendations of Lessor's engineers and/or consultants which relate in any manner to the Premises, without regard to whether said requirements are now in effect or become effective after the Start Date. Lessee shall, within ten (10) days after receipt of Lessor's written request, provide Lessor with copies of all permits and other documents, and other information evidencing Lessee's compliance with any Applicable Requirements specified by Lessor, and shall immediately upon receipt, notify Lessor in writing (with copies of any documents involved) of any threatened or actual claim, notice, citation, warning, complaint or report pertaining to or involving the failure of Lessee or the Premises to comply with any Applicable Requirements. 6.4 INSPECTION; COMPLIANCE. Lessor and Lessor's "Lender" (as defined in Paragraph 30 below) and consultants shall have the right to enter into Premises at any time, in the case of an emergency, and otherwise at reasonable times, for the purpose of inspecting the condition of the Premises and for verifying compliance by Lessee with this Lease. The cost of any such inspections shall be paid by Lessor, unless a violation of Applicable Requirements, or a contamination is found to exist or be imminent, or the inspection is requested or ordered by a governmental authority. In such case, Lessee shall upon request reimburse Lessor for the cost of such inspections, so long as such inspection is reasonably related to the violation or contamination. 7. MAINTENANCE; REPAIRS, UTILITY INSTALLATIONS; TRADE FIXTURES AND ALTERATIONS. 7.1 LESSEE'S OBLIGATIONS. (a) IN GENERAL. Subject to the provisions of Paragraph 2.2 (Condition), 2.3 (Compliance), 6.3 (Lessee's Compliance with Applicable Requirements), 7.2 (Lessor's Obligations), 9 (Damage or Destruction), and 14 (Condemnation), Lessee shall, at Lessee's sole expense, keep the Premises, Utility Installations, and Alterations in good order, condition and repair (whether or not the portion of the Premises requiring repairs, or the means of repairing the same, are reasonably or readily accessible to Lessee, and whether or not the need for such repairs occurs as a result of Lessee's use, any prior use, the elements or the age of such portion of the Premises), including, but not limited to, all equipment or facilities, such as plumbing, heating, ventilating, air-conditioning, electrical, lighting facilities, boilers, pressure vessels, fire protection system, fixtures, walls (interior and exterior), foundations, ceilings, roofs, floors, windows, doors, plate glass, skylights, landscaping, driveways, parking lots, fences, retaining walls, signs, sidewalks and parkways located in, on, or adjacent to the Premises. Lessee, in keeping the Premises in good order, condition and repair, shall exercise and perform good maintenance practices, specifically including the Procurement and maintenance of the service contracts required by Paragraph 7.1(b) below. Lessee's obligations shall include restorations, replacements or renewals when necessary to keep the Premises and all improvements thereon or a part thereof in good order, condition and state of repair, Lessee shall, during the term of this Lease, keep the exterior appearance of the Building in a first-class condition consistent with the exterior appearance of other similar facilities of comparable age and size in the vicinity, including, when necessary, the exterior repairing of the Building. PAGE 6 (b) SERVICE CONTRACTS. Lessee shall, at Lessee's sole expense, procure and maintain contracts, with copies to Lessor, in customary form and substance for, and with contractors specializing and experienced in the maintenance of the following equipment and improvements, if any, if and when installed on the Premises: (i) HVAC equipment, (ii) boiler, and pressure vessels, (iii) fire extinguishing systems, including fire alarm and/or smoke detection, (iv) landscaping and irrigation systems, (v) roof covering and drains, (vi) driveways and parking lots, (vii) clarifiers (viii) basic utility feed to the perimeter of the Building, and (ix) any other equipment, if reasonably required by Lessor. Lessee may use its own qualified personnel with Lessor's approval which shall not be unreasonably withheld. (c) REPLACEMENT. Subject to Lessees indemnification of Lessor as set forth in Paragraph 8.7 below, and without relieving Lessee of liability resulting from Lessee's failure to exercise and perform good maintenance Practices, if the Basic Elements described in Paragraph 7.1(b) cannot be repaired other than at a cost which is in excess of 50% of the cost of replacing such Basic Elements, then such Basic Elements shall be replaced by Lessor, and the cost thereof shall be prorated between the Parties and Lessee shall only be obligated to pay, each month during the remainder of the term of this Lease, on the date on which Base Rent is clue, an amount equal to the product of multiplying the cost of such replacement by a fraction, the numerator of which is one, and the denominator of which is the number of months of the useful life of such replacement as such useful life is specified pursuant to Federal income tax regulations or guidelines for depreciation thereof (including interest on the unamortized balance as is then commercially reasonable in the judgment of Lessor's accountants), with Lessee reserving the right to prepay its obligation at any time. 7.2 LESSOR'S OBLIGATIONS. Subject to the provisions of Paragraphs 2.2 (Condition), 2.3 (Compliance), 9 (Damage or Destruction) and 14 (Condemnation), it is intended by the Parties hereto that Lessor have no obligation, in any manner whatsoever, to repair and maintain the Premises, or the equipment therein, all of which obligations are intended to be that of the Lessee. It is the intention of the Parties that the terms of this Lease govern the respective obligations of the Parties as to maintenance and repair of the Premises, and they expressly waive the benefit of any statute now or hereafter in effect to the extent it is inconsistent with the terms of this Lease. 7.3 UTILITY INSTALLATIONS; TRADE FIXTURES; ALTERATIONS. (See Addendum) (a) DEFINITIONS; CONSENT REQUIRED. The term "Utility Installations" refers to all floor and window coverings, air lines, power panels, electrical distribution, security and fire protection systems, communication systems, lighting fixtures, HVAC equipment, plumbing, and fencing in or on the Premises. The term "Alterations" shall mean any modification of the improvements, other than Utility Installations or Trade Fixtures, whether by addition or deletion, "Lessee Owned Alterations and/or Utility Installations" are defined as Alterations and/or Utility Installations made by Lessee that are not yet owned by Lessor pursuant to Paragraph 7.4(a). Lessee shall not make any Alterations or Utility Installations to the Premises without Lessor's prior written consent. Lessee may, however, make non-structural Utility Installations to the interior of the Premises (excluding the roof) without such consent but upon notice to Lessor, as long as they are not visible from the outside, do not involve puncturing, relocating or removing the roof or any existing walls, and the cumulative cost thereof during this Lease as extended does not exceed $50,000 in the aggregate or $10,000 in any one year. (b) CONSENT. Any Alterations or Utility Installations that Lessee shall desire to make and which require the consent of the Lessor shall be presented to Lessor in written form with detailed plans. Consent shall be deemed conditioned upon Lessee's: (i) acquiring all applicable governmental permits, (ii) furnishing Lessor with copies of both the permits and the plans and specifications prior to commencement of the work, and (iii) compliance with all conditions of said permits and other Applicable Requirements in a prompt and expeditious manner. Any Alterations or Utility Installations shall be performed in a workmanlike manner with good and sufficient materials. Lessee shall promptly upon completion furnish Lessor with as-built plans and specifications. For work which costs an amount equal to the greater of one month's Base Rent, or $10,000. Lessor may condition its consent upon Lessee providing a lien and completion pond in an amount equal to one and one-half times the estimated cost of such Alteration or Utility Installation and/or upon Lessee's posting an additional Security Deposit with Lessor. (c) INDEMNIFICATION. Lessee shall pay, when due, all claims for labor or materials furnished or alleged to have been furnished to or for Lessee at or for use on the Premises, which claims are or may be secured by any mechanic's or materialmen's lien against the Premises or any interest therein. Lessee shall give Lessor not less than ten (10) days' notice prior to the commencement of any work in, on or about the Premises, and Lessor shall have the right to post PAGE 7 notices of non-responsibility. If Lessee shall contest the validity of any such lien, claim or demand, then Lessee shall, at its sole expense defend and protect itself, Lessor and the Premises against the same and shall pay and satisfy any such adverse judgment that may be rendered thereon before the enforcement thereof. If Lessor shall require, Lessee shall furnish a surety bond in an amount equal to one and one-half times the amount of such contested lien, claim or demand, indemnifying Lessor against liability for the same. If Lessor elects to participate in any such action, Lessee shall pay Lessor's attorneys fees and costs. 7.4 OWNERSHIP; REMOVAL; SURRENDER; AND RESTORATION. (a) OWNERSHIP. Subject to Lessor's right to require removal or elect ownership as hereinafter provided, all Alterations and Utility Installations made by Lessee shall be the property of Lessee, but considered a part of the Premises. Lessor may, at any time, elect in writing to be the owner of all or any specified part of the Lessee Owned Alterations and Utility Installations. Unless otherwise instructed per Paragraph 7.4(b) hereof, all Lessee Owned Alterations and Utility Installations shall, at the expiration or termination of this Lease, become the property of Lessor and be surrendered by Lessee with the Premises. (b) REMOVAL. By delivery to Lessee of written notice from Lessor not earlier than ninety (90) and not later than thirty (30) days prior to the end of the term of this Lease, Lessor may require that any or all Lessee Owned Alterations or Utility Installations be removed by the expiration or termination of this Lease. Lessor may require the removal at any time of all or any part of any Lessee Owned Alterations or Utility Installations made without the required consent. (c) SURRENDER/RESTORATION. Lessee shall surrender the Premises by the Expiration Date or any earlier termination date, with all of the improvements, parts and surfaces thereof broom clean and free of debris, and in good operating order, condition and state of repair, ordinary wear and tear excepted. "Ordinary wear and tear" shall not include any damage or deterioration that would have been prevented by good maintenance practice. Lessee shall repair any damage occasioned by the installation, maintenance or removal of Trade Fixtures, Lessee Owned Alterations and/or Utility Installations, furnishings, and equipment as well as the removal of any storage tank installed by or for Lessee, and the removal, replacement, or remediation of any soil, material or groundwater contaminated by Lessee. Trade Fixtures shall remain the property of Lessee and shall be removed by Lessee. The failure by Lessee to timely vacate the Premises pursuant to this Paragraph 7.4(c) without the express written consent of Lessor shall constitute a holdover under the provisions of Paragraph 26 below. 8. INSURANCE; INDEMNITY. 8.1 PAYMENT FOR INSURANCE. Lessee shall pay for all insurance required under Paragraph 8 except to the extent of the cost attributable to liability insurance carried by Lessor under Paragraph 8.2(b) in excess of $2,000,000 per occurrence. Premiums for policy periods commencing prior to or extending beyond the Lease term shall be prorated to correspond to the Lease term. Payment shall be made by Lessee to Lessor on a monthly basis along with other estimated Triple Net Expenses. 8.2 LIABILITY INSURANCE. (a) CARRIED BY LESSEE. Lessee shall obtain and keep in force a Commercial General Liability Policy of Insurance protecting Lessee and Lessor against claims for bodily injury, personal injury and property damage based upon or arising out of the ownership, use, occupancy or Maintenance of the Premises and all areas appurtenant thereto. Such insurance shall be on an occurrence basis providing single limit coverage in an amount not less than $2,000,000 per occurrence with an "Additional Insured-Managers or Lessors of Premises Endorsement" and contain the "Amendment of the Pollution Exclusion Endorsement" for damage caused by heat, smoke or fumes from a hostile fire. The Policy shall not contain any intra-insured exclusions as between insured persons or organizations, but shall include coverage for liability assumed under this Lease as an "insured contract" for the performance of Lessee's indemnity obligations under this Lease. The limits of said insurance shall not, however, limit the liability of Lessee nor relieve Lessee of any obligation hereunder. All insurance carried by Lessee shall be primary to and not contributory with any similar insurance carried by Lessor, whose insurance shall be considered excess insurance only. PAGE 8 (b) CARRIED BY LESSOR. Lessor may maintain liability insurance as described in Paragraph 8.2(a), in addition to, and not in lieu of, the insurance required to be maintained by Lessee. Lessee shall not be named as an additional insured therein. 8.3 PROPERTY INSURANCE - BUILDING, IMPROVEMENTS AND RENTAL VALUE. (a) BUILDING AND IMPROVEMENTS. The Insuring Party shall obtain and keep in force a policy or policies in the name of Lessor, with loss payable to Lessor, any groundlessor, and to any Lender(s) insuring loss or damage to the Premises. The amount of such insurance shall be equal to the full replacement cost of the Premises, as the same shall exist from time to time, or the amount required by any Lenders, but in no event more than the commercially reasonable and available insurable value thereof. If Lessor is the Insuring Party, however, Lessee Owned Alterations and Utility installations, Trade Fixtures, and Lessee's personal property shall be insured by Lessee under Paragraph 8.4 rather than by Lessor, it the coverage is available and commercially appropriate, such policy or policies shall insure against all risks of direct physical loss or damage* (except the perils of flood ), including coverage for debris removal and the enforcement of any Applicable Requirements requiring the upgrading, demolition, reconstruction or replacement of any portion of the Premises as the result of a covered loss. Said policy or policies shall also contain an agreed valuation provision in lieu of any coinsurance clause, waiver of subrogation, and inflation guard protection causing an increase in the annual property insurance coverage amount by a factor of not less than the adjusted U.S. Department of Labor Consumer Price Index for All Urban Consumers for the city nearest to where the Premises are located. If such insurance coverage has a deductible clause, the deductible amount shall not exceed $1,000 per occurrence, and Lessee shall be liable for such deductible amount in the event of an Insured Loss. *including earthquake (b) RENTAL VALUE. The Insuring Party shall obtain and keep in force a policy or policies in the name of Lessor with loss payable to Lessor and any Lender, insuring the loss of the full Rent for one (1) year. Said insurance shall provide that in the event the Lease is terminated by reason of an insured loss, the period of indemnity for such coverage shall be extended beyond the date of the completion of repairs or replacement of the Premises, to provide for one full year's loss of Rent from the date of any such loss. Said insurance shall contain an agreed valuation provision in lieu of any coinsurance clause, and the amount of coverage shall be adjusted annually to reflect the projected Rent otherwise payable by Lessee, for the next twelve (12) month period. Lessee shall be liable for any deductible amount in the event of such loss. (c) ADJACENT PREMISES. If the Premises are part of a larger building, or of a group of buildings owned by Lessor which are adjacent to the Premises, the Lessee shall pay for any increase in the premiums for the property insurance of such building or buildings if said increase is caused by Lessee's acts, omissions, use or occupancy of the Premises. 8.4 LESSEE'S PROPERTY/BUSINESS INTERRUPTION INSURANCE. (a) PROPERTY DAMAGE. Lessee shall obtain and maintain insurance coverage on all of Lessee's personal property, Trade Fixtures, and Lessee Owned Alterations and Utility Installations. Such insurance shall be full replacement cost coverage with a deductible of not to exceed $1,000 per occurrence. The proceeds from any such insurance shall be used by Lessee for the replacement of personal property, Trade Fixtures and Lessee Owned Alterations and Utility Installations. Lessee shall provide Lessor with written evidence that such insurance is in force. (b) BUSINESS INTERRUPTION. Lessee shall obtain and maintain loss of income and extra expense insurance in amounts as will reimburse Lessee for direct or indirect loss of earnings attributable to all perils commonly insured against by prudent lessees in the business of Lessee or attributable to prevention of access to the Premises as a result of such perils. (c) NO REPRESENTATION OF ADEQUATE COVERAGE. Lessor makes no representation that the limits or forms of coverage of insurance specified herein are adequate to cover Lessee's property, business operations or obligations under this Lease. PAGE 9 8.5 INSURANCE POLICIES. Insurance required herein shall be by companies duly licensed or admitted to transact business in the state where the Premises are located, and maintaining during the policy term a "General Policyholders Rating" of at least B+, V, as set forth in the most current issue of "Best's Insurance Guide", or such other rating as may be required by a Lender. Lessee shall not do or permit to be done anything which invalidates the required insurance policies. Lessee shall, prior to the Start Date, deliver to Lessor certified copies of policies of such insurance or certificates evidencing the existence and amounts of the required insurance. No such policy shall be cancelable or subject to modification except after thirty (30) days prior written notice to Lessor. Lessee shall, at least thirty (30) days prior to the expiration of such policies, furnish Lessor with evidence of renewals or "insurance binders" evidencing renewal thereof, or Lessor may order such insurance and charge the cost thereof to Lessee, which amount shall be payable by Lessee to Lessor upon demand. Such policies shall be for a term of at least one year, or the length of the remaining term of this Lease, whichever is less. If either Party shall fail to procure and maintain the insurance required to be carried by it, the other Party may, but shall not be required to, procure and maintain the same. 8.6 WAIVER OF SUBROGATION. Without affecting any other rights or remedies, Lessee and Lessor each hereby release and relieve the other, and waive their entire right to recover damages against the other, for loss of or damage to its property arising out of or incident to the perils required to be insured against herein. The effect of such releases and waivers is not limited by the amount of insurance carried or required, or by any deductibles applicable hereto. The Parties agree to have their respective property damage insurance carriers waive any right to subrogation that such companies may have against Lessor or Lessee, as the case may be, so long as the insurance is not invalidated thereby. 8.7 INDEMNITY. Except for Lessor's gross negligence or willful misconduct, Lessee shall indemnity, protect, defend and hold harmless the Premises, Lessor and its agents, Lessor's master or ground lessor, partners and Lenders, from and against any and all claims, loss of rents and/or damages, liens, judgments, penalties, attorneys' and consultants' fees, expenses and/or liabilities arising out of, involving, or in connection with, the use and/or occupancy of the Premises by Lessee. If any action or proceeding is brought against Lessor by reason of any of the foregoing matters, Lessee shall upon notice defend the same at Lessee's expense by counsel reasonably satisfactory to Lessor and Lessor shall cooperate with Lessee in such defense, Lessor need not have first paid any such claim in order to be defended or indemnified. 8.8 EXEMPTION OF LESSOR FROM LIABILITY. Lessor shall not be liable for injury or damage to the person or goods, wares, merchandise or other property of Lessee. Lessee's employees, contractors, invitees, customers, or any other person in or about the Premises, whether such damage or injury is caused by or results from fire, steam, electricity, gas, water or rain, or from the breakage, leakage, obstruction or other defects of pipes, fire sprinklers, wires, appliances, plumbing, HVAC or lighting fixtures, or from any other cause, whether the said injury or damage results from conditions arising upon the Premises or upon other portions of the Building of which the Premises are a part, or from other sources or places. Lessor shall not be liable for any damages arising from any act or neglect of any other tenant of Lessor, Notwithstanding Lessor's negligence or breach of this Lease, Lessor shall under no circumstances be liable for injury to Lessee's business or for any loss of income or profit therefrom. 9. DAMAGE OR DESTRUCTION. 9.1 DEFINITIONS. (a) "PREMISES PARTIAL DAMAGE" shall mean damage or destruction to the improvements on the Premises, other than Lessee Owned Alterations and Utility Installations, which can reasonably be repaired in six (6) months or less from the date of the damage or destruction. Lessor snail notify Lessee in writing within thirty (30) days from the date of the damage or destruction as to whether or not the damage is Partial or Total. (b) "PREMISES TOTAL DESTRUCTION" shall mean damage or destruction to the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixtures, which cannot reasonably be repaired in six (6) months or less from the date of the damage or destruction, Lessor shall notify Lessee in writing within thirty (30) days from the date of the damage or destruction as to whether or not the damage is Partial or Total. (c) "INSURED LOSS" shall mean damage or destruction to improvements on the Premises, other than Lessee Owned Alterations and Utility installations and Trade Fixtures, which was caused by an event required to be covered by the insurance described in Paragraph 8.3(a), irrespective of any deductible amounts or coverage limits involved. PAGE 10 (d) "REPLACEMENT COST" shall mean the cost to repair or rebuild the improvements owned by Lessor at the time of the occurrence to their condition existing immediately prior thereto, including demolition, debris removal and upgrading required by the operation of Applicable Requirements, and without deduction for depreciation. (e) "HAZARDOUS SUBSTANCE CONDITION" shall mean the occurrence or discovery of a condition involving the presence of, or a contamination by, a Hazardous Substance as defined in Paragraph 6.2(a), in, on, or under the Premises. 9.2 PARTIAL DAMAGE - INSURED LOSS. If a Premises Partial Damage that is an insured Loss occurs, then Lessor shall, at Lessor's expense, repair such damage (but not Lessee's Trade Fixtures or Lessee Owned Alterations and Utility installations) as soon as reasonably possible and this Lease shall continue in full force and effect: provided, however, that Lessee shall, at Lessor's election, make the repair of any damage or destruction the total cost to repair of which is $10,000 or less, and, in such event, Lessor shall make any applicable insurance proceeds available to Lessee on a reasonable basis for that purpose. Notwithstanding the foregoing, if the required insurance was not in force or the insurance proceeds are not sufficient to effect such repair, the Insuring Party shall promptly contribute the shortage in proceeds (except as to the deductible which is Lessee's responsibility) as and when required to complete said repairs. In the event, however, such shortage was due to the fact that, by reason of the unique nature of the improvements, full replacement cost insurance coverage was not commercially reasonable and available, Lessor shall have no obligation to pay for the shortage in insurance proceeds or to fully restore the unique aspects of the Premises unless Lessee provides Lessor with the funds to cover same, or adequate assurance thereof, within ten (10) days following receipt of written notice of such shortage and request therefor, it Lessor receives said funds or adequate assurance thereof within said ten (10) day period, the party responsible for making the repairs shall complete them as soon as reasonably possible and this Lease shall remain in full force and effect, if such funds or assurance are not received, Lessor may nevertheless elect by written notice to Lessee within ten (10) days thereafter to: (i) make such restoration and repair as is commercially reasonable with Lessor paying any shortage in proceeds, in which case this Lease shall remain in full force and effect, or have this Lease terminate thirty (30) days thereafter. Lessee shall not be entitled to reimbursement of any funds contributed by Lessee to repair any such damage or destruction. Premises Partial Damage due to flood or earthquake shall be subject to Paragraph 9.3, notwithstanding that there may be some insurance coverage, but the net proceeds of any such insurance shall be made available for the repairs if made by either Party. 9.3 PARTIAL DAMAGE - UNINSURED LOSS. If a Premises Partial Damage that is not an Insured Loss occurs, unless caused by a negligent or willful act of Lessee (in which event Lessee shall make the repairs at Lessee's expense), Lessor may either: (i) repair such damage as soon as reasonably possible at Lessor's expense, in which event this Lease shall continue in full force and effect, or (6) terminate this Lease by giving written notice to Lessee within thirty (30) days after receipt by Lessor of knowledge of the occurrence of such damage. Such termination shall be effective sixty (60) days following the date of such notice. In the event Lessor elects to terminate this Lease, Lessee shall have the right within ten (10) days after receipt of the termination notice to give written notice to Lessor of Lessee's commitment to pay for the repair of such damage without reimbursement from Lessor. Lessee shall provide Lessor with said funds or satisfactory assurance thereof within thirty (30) days after making such commitment. In such event this Lease shall continue in full force and effect, and Lessor shall proceed to make such repairs as soon as reasonably possible after the required funds are available, If Lessee does not make the required commitment, this Lease shall terminate as of the date specified in the termination notice. 9.4 TOTAL DESTRUCTION. Notwithstanding any other provision hereof, if a Premises Total Destruction occurs, this Lease shall terminate sixty (60) days following such Destruction. It the damage or destruction was caused by the gross negligence or willful misconduct of Lessee. Lessor shall have the right to recover Lessor's damages from Lessee, except as provided in Paragraph 8.6. 9.5 DAMAGE NEAR END OF TERM. If at any time during the last six (6) months of this Lease there is damage for which the cost to repair exceeds one (1) month's Base Rent, whether or not an Insured Loss, Lessor may terminate this Lease effective sixty (60) days following the date of occurrence of such damage by giving a written termination notice to Lessee within thirty (30) days after the date of occurrence of such damage. Notwithstanding the foregoing, if Lessee at that time has an exercisable option to extend this Lease or to purchase the Premises, then Lessee may preserve this Lease by, (a) exercising such option and (b) providing Lessor with any shortage in insurance proceeds (or adequate assurance thereof) needed to make the repairs on or before the earlier of (i) the date which is ten days after Lessee's receipt of Lessor's written notice purporting to terminate this Lease, or (ii) the day prior to the date upon which such option expires. If Lessee duly PAGE 11 exercises such option during such period and provides Lessor with funds (or adequate assurance thereof) to cover any shortage in insurance proceeds, Lessor shall, at Lessors commercially reasonable expense, repair such damage as soon as reasonably possible and this Lease shall continue in full force and effect. If Lessee fails to exercise such option and provide such funds or assurance during such period, then this Lease shall terminate on the date specified in the termination notice and Lessee's option shall be extinguished. 9.6 ABATEMENT OF RENT; LESSEE'S REMEDIES. (a) ABATEMENT. In the event of Premises Partial Damage or Premises Total Destruction or a Hazardous Substance Condition for which Lessee is not responsible under this Lease, the Rent payable by Lessee for the period required for the repair, remediation or restoration of such damage snail be abated in proportion to the degree to which Lessee's use of the Premises is impaired, but not to exceed the proceeds received from the Rental Value insurance. All other obligations of Lessee hereunder shall be performed by Lessee, and Lessor shall have no liability for any such damage, destruction, remediation, repair or restoration except as provided herein. (b) REMEDIES. If Lessor shall be obligated to repair or restore the Premises and does not commence, in a substantial and meaningful way, such repair or restoration within ninety (90) days after such obligation shall accrue, Lessee may, at any time prior to the commencement of such repair or restoration, give written notice to Lessor and to any Lenders of which Lessee has actual notice, of Lessee's election to terminate this Lease on a date not less than sixty (60) days following the giving of such notice. If Lessee gives such notice and such repair or restoration is not commenced within thirty (30) days thereafter, this Lease shall terminate as of the date specified in said notice. If the repair or restoration is commenced within said thirty (30) days, this Lease shall continue in full force and effect, "Commence" shall mean either the unconditional authorization of the preparation of the required plans, or the beginning of the actual work on the Premises, whichever first occurs. 9.7 TERMINATION-ADVANCE PAYMENTS. Upon termination of this Lease pursuant to Paragraph 6.2(g) or Paragraph 9, an equitable adjustment shall be made concerning advance Base Rent and any other advance payments made by Lessee to Lessor, Lessor shall, in addition, return to Lessee so much of Lessee's Security Deposit as has not been, or is not then required to be, used by Lessor. 9.8 WAIVE STATUTES. Lessor and Lessee agree that the terms of this Lease shall govern the effect of any damage to or destruction of the Premises with respect to the termination of this Lease and hereby waive the provisions of any present or future statute to the extent inconsistent herewith. 10. REAL PROPERTY TAXES. 10.1 DEFINITION OF "REAL PROPERTY TAXES." As used herein, the term "Real Property Taxes" shall include any form of assessment: real estate, general, special, ordinary or extraordinary, or rental levy or tax (other than inheritance, personal income or estate taxes); improvement bond; and/or license fee imposed upon or levied against any legal or equitable interest of Lessor in the Premises, Lessor's right to other income therefrom, and/or Lessor's business of leasing, by any authority having the direct or indirect power to tax and where the funds are generated with reference to the Building address and where the proceeds so generated are to be applied by the city, county or other local taxing authority of a jurisdiction within which the Premises are located. The term "Real Property Taxes" shall also include any tax, fee, levy, assessment or charge, or any increase therein, imposed by reason of events occurring during the term of this Lease, including but not limited to, a change in the ownership of the Premises. Not withstanding the foregoing, Lessee shall not be responsible for any increase in Real Property Taxes during the first five (5) years following the Start Date. 10.2 (a) PAYMENT OF TAXES. Lessee shall pay the Real Property Taxes applicable to the Premises during the term of this Lease on a monthly basis along with other estimated Triple Net charges paid to Lessor. Subject to Paragraph 10.2(b), all such payments shall be made at least ten (10) days prior to any delinquency date. Lessee shall promptly furnish Lessor with satisfactory evidence that such taxes have been paid. If any such taxes shall cover any period of time prior to or after the expiration or termination of this Lease, Lessee's share of such taxes shall be prorated to cover only that portion of the tax bill applicable to the period that this Lease is in effect, and Lessor shall reimburse Lessee for any overpayment, if PAGE 12 Lessee shall fail to pay any required Real Property Taxes. Lessor shall have the right to pay the same, and Lessee shall reimburse Lessor therefor upon demand. (b) ADVANCE PAYMENT. In the event Lessee incurs a late charge on any Rent payment, Lessor may, at Lessor's option, estimate 'he current Real Property Taxes, and require that such taxes be paid in advance to Lessor by Lessee, either: (i) in a lump sum amount equal to the installment due, at least twenty (20) days prior to the applicable delinquency date, or (ii) monthly in advance with the payment of the Base event. If Lessor elects to require payment monthly in advance, the monthly payment shall be an amount equal to the amount of the estimated installment of taxes divided by the number of months remaining before the month in which said installment becomes delinquent. When the actual amount of the applicable tax bill is known, the amount of such equal monthly advance payments shall be adjusted as required to provide the funds needed to pay the applicable taxes. If the amount collected by Lessor is insufficient to pay such Real Property Taxes when due, Lessee shall pay Lessor, upon demand, such additional sums as are necessary to pay such obligations. All moneys paid to Lessor under this Paragraph may be intermingled with other moneys of Lessor and shall not bear interest. In the event of a Breach by Lessee in the performance of its obligations under this Lease, then any balance of funds paid to Lessor under the provisions of this Paragraph may at the option of Lessor, be treated as an additional Security Deposit. 10.3 JOINT ASSESSMENT. If the Premises are not separately assessed, Lessee's liability shall be an equitable proportion of the Real Property Taxes for all of the land and improvements included within the tax parcel assessed, such proportion to be conclusively determined by Lessor from the respective valuations assigned in the assessor's work sheets or such other information as may be reasonably available. 10.4 PERSONAL PROPERTY TAXES. Lessee shall pay, prior to delinquency, all taxes assessed against and levied upon Lessee Owned Alterations, Utility Installations, Trade Fixtures, furnishings, equipment and all personal property of Lessee. When possible, Lessee shall cause such property to be assessed and billed separately from the real property of Lessor. It any of Lessee's said personal property shall be assessed with Lessors real property, Lessee shall pay Lessor the taxes attributable to Lessee's property within ten (10) days after receipt of a written statement. 11. UTILITIES. Lessee shall pay for all water, gas, heat, light, power, telephone, trash disposal and other utilities and services supplied to the Premises, together with any taxes thereon. If any such services are not separately metered to Lessee, Lessee shall pay a reasonable proportion, to be determined by Lessor, of all charges jointly metered. 12. ASSIGNMENT AND SUBLETTING. 12.1 LESSOR'S CONSENT REQUIRED. SEE ADDENDUM (d) An assignment or subletting without consent shall, at Lessor's option, be a Default curable after notice per Paragraph 13.1(c), or a noncurable Breach without the necessity of any notice and grace period. If Lessor elects to treat such unapproved assignment or subletting as a noncurable Breach. Lessor may either: (i) terminate this Lease, or PAGE 13 (ii) upon thirty (30) days written notice, increase the monthly Base Rent to one hundred ten percent (110%) of the Base Rent then in effect. Further, in the event of such Breach and rental adjustment, (i) the purchase price of any option to purchase the Premises held by Lessee shall be subject to similar adjustment to one hundred ten percent (110%) of the price previously in effect, and (ii) all fixed and non-fixed rental adjustments scheduled during the remainder of the Lease term shall be increased to One Hundred Ten Percent (1 10%) of the scheduled adjusted rent. (e) Lessee's remedy for any breach of Paragraph 12.1 by Lessor shall be limited to compensatory damages and/or injunctive relief. 12.2 TERMS AND CONDITIONS APPLICABLE TO ASSIGNMENT AND SUBLETTING. (a) Regardless of Lessor's consent, any assignment or subletting shall not: (i) be effective without the express written assumption by such assignee or sublessee of the obligations of Lessee under this Lease, (ii) release Lessee of any obligations hereunder, or (iii) alter the primary liability of Lessee for the payment of Rent or for the performance of any other obligations to be performed by Lessee. (b) Lessor may accept Rent or performance of Lessee's obligations from any person other than Lessee pending approval or disapproval of an assignment. Neither a delay in the approval or disapproval of such assignment nor the acceptance of Rent or performance shall constitute a waiver or estoppel of Lessor's right to exercise its remedies for Lessee's Default or Breach. (c) Lessor's consent to any assignment or subletting shall not constitute a consent to any subsequent assignment or subletting. (d) In the event of any Default or Breach by Lessee, Lessor may proceed directly against Lessee, any Guarantors or anyone else responsible for the performance of Lessee's obligations under this Lease, including any assignee or sublessee, without first exhausting Lessor's remedies against any other person or entity responsible therefore to Lessor, or any security held by Lessor. (e) Each request for consent to an assignment or subletting shall be in writing, accompanied by information relevant to Lessor's determination as to the financial and operational responsibility and appropriateness of the proposed assignee or sublessee, including but not limited to the intended use and/or required modification of the Premises, if any, together with a fee of $1,000 or ten percent (1 0%) of the current monthly Base Rent applicable to the portion of the Premises which is the subject of the proposed assignment or sublease, whichever is greater, as consideration for Lessor's considering and processing said request. Lessee agrees to provide Lessor with such other or additional information and/or documentation as may be reasonably requested. (f) Any assignee of, or sublessee under, this Lease shall, by reason of accepting such assignment or entering into such sublease, be deemed to have assumed and agreed to conform and comply with each and every term, covenant, condition and obligation herein to be observed or performed by Lessee during the term of said assignment or sublease, other than such obligations as are contrary to or inconsistent with provisions of an assignment or sublease to which Lessor has specifically consented to in writing. 12.3 ADDITIONAL TERMS AND CONDITIONS APPLICABLE TO SUBLETTING. The following terms and conditions shall apply to any subletting by Lessee of all or any part of the Premises and shall be deemed included in all subleases under this Lease whether or not expressly incorporated therein: (a) Lessee hereby assigns and transfers to Lessor all of Lessee's interest in all Rent payable on any sublease, and Lessor may collect such Rent and apply same toward Lessee's obligations under this Lease, provided, however, that until a Breach shall occur in the performance of Lessee's obligations, Lessee may collect said Rent. Lessor shall not, by reason of the foregoing or any assignment of such sublease, nor by reason of the collection of Rent, be deemed liable to the sublessee for any failure of Lessee to perform and comply with any of Lessee's obligations to such sublessee. Lessee hereby irrevocably authorizes and directs any such sublessee, upon receipt of a written notice from Lessor stating that a Breach exists in the performance of Lessee's obligations under this Lease, to pay to Lessor all Rent due and to become due under the sublease. Sublessee shall rely upon any such notice from Lessor and shall pay all Rents to PAGE 14 Lessor without any obligation or right to inquire as to whether such Breach exists, notwithstanding any claim from Lessee to the contrary. (b) In the event of a Breach by Lessee. Lessor may, at its option, require sublessee to attorn to Lessor, in which event Lessor shall undertake the obligations of the sublessor under such sublease from the time of the exercise of said option to the expiration of such sublease; provided, however, Lessor shall not be liable for any prepaid rents or security deposit paid by such sublessee to such sublessor or for any prior Defaults or Breaches of such sublessor. (c) Any matter requiring the consent of the sublessor under a sublease shall also require the consent of Lessor. (d) No sublessee shall further assign or sublet all or any part of the Premises without Lessor's prior written consent. (e) Lessor shall deliver a copy of any notice of Default or Breach by Lessee to the sublessee, who shall have the right to cure the Default of Lessee within the grace period, if any, specified in such notice. The sublessee shall have a right of reimbursement and offset from and against Lessee for any such Defaults cured by the sublessee. 13. DEFAULT; BREACH, REMEDIES. 13.1 DEFAULT; BREACH. A "Default" is defined as a failure by the Lessee to comply with or perform any of the terms, covenants, conditions or rules under this Lease. A "Breach" is defined as the occurrence of one or more of the following Defaults, and the failure of Lessee to cure such Default within any applicable grace period: (a) The abandonment of the Premises: or the vacating of the Premises without providing a commercially reasonable level of security, or where the coverage of the property insurance described in Paragraph 8.3 is jeopardized as a result thereof, or without providing reasonable assurances to minimize potential vandalism. (b) The failure of Lessee to make any payment of Rent or any Security Deposit required to be made by Lessee hereunder, whether to Lessor or to a third party, when due, to provide reasonable evidence of insurance or surety bond, or to fulfill any obligation under this Lease which endangers or threatens life or property, where such failure continues for a period of three (3) business days following written notice to Lessee. (c) The failure by Lessee to provide (i) reasonable written evidence of compliance with Applicable Requirements, (ii) the service contracts, (iii) the rescission of an unauthorized assignment or subletting, (iv) a Tenancy Statement, (v) a requested subordination, (vi) evidence concerning any guaranty and/or Guarantor, (vii) any document requested under Paragraph 42 (easements), or (viii) any other documentation or information which Lessor may reasonably require of Lessee under the terms of this Lease, where any such failure continues for a period of ten (1 0) days following written notice to Lessee. (d) A Default by Lessee as to the terms, covenants, conditions or provisions of this Lease, or of the rules adopted under Paragraph 40 hereof, other than those described in subparagraphs 13.1(a), (b) or (c), above, where such Default continues for a period of thirty (30) days after written notice; provided, however, that if the nature of Lessee's Default is such that more than thirty (30) days are reasonably required for its cure, then it shall not be deemed to be a Breach if Lessee commences such cure within said thirty (30) day period and thereafter diligently prosecutes such cure to completion. (e) The occurrence of any of the following events: (i) the making of any general arrangement or assignment for the benefit of creditors; (ii) becoming a "debtor" as defined in 11 U.S.C. Section 101 or any successor statute thereto (unless, in the case of a petition filed against Lessee, the same is dismissed within sixty (60) days); (iii) the appointment of a trustee or receiver to take possession of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where possession is not restored to Lessee within thirty (30) days; or (iv) the attachment, execution or other judicial seizure of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where such seizure is not discharged within thirty (30) days; provided, however, in the event that any provision of this subparagraph (e) is contrary to any applicable law, such provision shall be of no force or effect, and not affect the validity of the remaining provisions. PAGE 15 (f) The discovery that any financial statement of Lessee or of any Guarantor given to Lessor was materially false. (g) If the performance of Lessee's obligations under this Lease is guaranteed: (i) the death of a Guarantor, (6) the termination of a Guarantor's liability with respect to this Lease other than in accordance with the terms of such guaranty, (iii) a Guarantor's becoming insolvent or the subject of a bankruptcy filing, (iv) a Guarantor's refusal to honor the guaranty, or (v) a Guarantor's breach of its guaranty obligation on an anticipatory basis, and Lessee's failure, within sixty (60) days following written notice of any such event, to provide written alternative assurance or security, which, when coupled with the then existing resources of Lessee, equals or exceeds the combined financial resources of Lessee and the Guarantors that existed at the time of execution of this Lease. 13.2 REMEDIES. If Lessee fails to perform any of its affirmative duties or obligations, within ten (10) days after written notice (or in case of an emergency, without notice), Lessor may, at its option, perform such duty or obligation on Lessee's behalf, including but not limited to the obtaining of reasonably required bonds, insurance policies, or governmental licenses, permits or approvals. The costs and expenses of any such performance by Lessor shall be due and payable by Lessee upon receipt of invoice therefor. If any check given to Lessor by Lessee shall not be honored by the bank upon which it is drawn, Lessor, at its option, may require all future payments to be made by Lessee to be by cashiers check. In the event of a Breach, Lessor may, with or without further notice or demand, and without limiting Lessor in the exercise of any right or remedy which Lessor may have by reason of such Breach: (a) Terminate Lessee's right to possession of the Premises by any lawful means, in which case this Lease shall terminate and Lessee shall immediately surrender possession to Lessor. In such event Lessor shall be entitled to recover from Lessee: (i) the unpaid Rent which had been earned at the time of termination; (ii) the worth at the time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that the Lessee proves could have been reasonably avoided: (iii) the worth at the time of award of the amount by which the unpaid rent for the balance of the term after the time of award exceeds the amount of such rental loss that the Lessee proves could be reasonably avoided; and (iv) any other amount necessary to compensate Lessor for all the detriment proximately caused by the Lessee's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, including but not limited to the cost of recovering possession of the Premises, expenses of reletting, including necessary renovation and alteration of the Premises, reasonable attorneys' fees, and that portion of any leasing commission paid by Lessor in connection with this Lease applicable to the unexpired term of this Lease. The worth at the time of award of the amount referred to in provision (iii) of the immediately preceding sentence shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of the District within which the Premises are located at the time of award plus one percent (1%). Efforts by Lessor to mitigate damages caused by Lessee's Breach of this Lease shall not waive Lessor's right to recover damages under Paragraph 12. If termination of this Lease is obtained through the provisional remedy of unlawful detainer, Lessor shall have the right to recover in such proceeding any unpaid Rent and damages as are recoverable therein, or Lessor may reserve the right to recover all or any part thereof in a separate suit. If a notice and grace period required under Paragraph 13.1 was not previously given, a notice to pay rent or quit, or to perform or quit given to Lessee under the unlawful detainer statute shall also constitute the notice required by Paragraph 13.1. In such case, the applicable grace period required by Paragraph 13.1 and the unlawful detainer statute shall run concurrently, and the failure of Lessee to cure the Default within the greater of the two such grace periods shall constitute both an unlawful detainer and a Breach of this Lease entitling Lessor to the remedies provided for in this Lease and/or by said statute. (b) Continue the Lease and Lessee's right to possession and recover the Rent as it becomes due, in which event Lessee may sublet or assign, subject only to reasonable limitations. Acts of maintenance, efforts to relet, and/or the appointment of a receiver to protect the Lessor's interests, shall not constitute a termination of the Lessee's right to possession. (c) Pursue any other remedy now or hereafter available under the laws or judicial decisions of the state wherein the Premises are located. The expiration or termination of this Lease and/or the termination of Lessee's right to possession shall not relieve Lessee from liability under any indemnity provisions of this Lease as to matters occurring or accruing during the term hereof or by reason of Lessee's occupancy of the Premises. PAGE 16 13.3 INDUCEMENT RECAPTURE. Any agreement for free or abated rent or other charges, or for the giving or paying by Lessor to or for Lessee of any cash or other bonus, inducement or consideration for Lessee's entering into this Lease, all of which concessions are hereinafter referred to as "Inducement Provisions," shall be deemed conditioned upon Lessee's full and faithful performance of all of the terms, covenants and conditions of this Lease. Upon Breach of this Lease by Lessee, any such Inducement Provision shall automatically be deemed deleted from this Lease and of no further force or effect, and any rent, other charge, bonus, inducement or consideration theretofore abated, given or paid by Lessor under such an Inducement Provision shall be immediately due and payable by Lessee to Lessor, notwithstanding any subsequent cure of said Breach by Lessee. The acceptance by Lessor of rent or the cure of the Breach which initiated the operation of this paragraph shall not be deemed a waiver by Lessor of the provisions of this paragraph unless specifically so stated in writing by Lessor at the time of such acceptance. 13.4 LATE CHARGES. Lessee hereby acknowledges that late payment by Lessee of Rent will cause Lessor to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges, and late charges which may be imposed upon Lessor by any Lender. Accordingly, if any Rent shall not be received by Lessor within five (5) days after such amount shall be due, then, without any requirement for notice to Lessee, Lessee shall pay to Lessor a one-time late charge equal to ten percent (10%) of each such overdue amount. The parties hereby agree that such late charge represents a fair and reasonable estimate of the costs Lessor will incur by reason of such late payment. Acceptance of such late charge by Lessor shall in no event constitute a waiver of Lessee's Default or Breach with respect to such overdue amount, nor prevent the exercise of any of the other rights and remedies granted hereunder. In the event that a late charge is payable hereunder, whether or not collected, for three (3) consecutive installments of Base Rent, then notwithstanding any provision of this Lease to the contrary, Base Rent shall, at Lessor's option, become due and payable quarterly in advance. 13.5 INTEREST. Any monetary payment due Lessor hereunder, other than late charges, not received by Lessor, when due as to scheduled payments (such as Base Rent) or within thirty (30) days following the date on which it was due for non-scheduled payment, shall bear interest from the date when due, as to scheduled payments, or the thirty-first (31st) day after it was due as to non-scheduled payments. The interest ("Interest") charged shall be equal to the prime rate reported in the Wall Street Journal as published closest prior to the date when due plus four percent (4%), but shall not exceed the maximum rate allowed by law. Interest is payable in addition to the potential late charge provided for in Paragraph 13.4. 13.6 BREACH BY LESSOR. (a) NOTICE OF BREACH. Lessor shall not be deemed in breach of this Lease unless Lessor fails within a reasonable time to perform an obligation required to be performed by Lessor. For purposes of this Paragraph, a reasonable time shall in no event be less than thirty (30) days after receipt by Lessor, and any Lender whose name and address shall have been furnished Lessee in writing for such purpose, of written notice specifying wherein such obligation of Lessor has not been performed; provided, however, that if the nature of Lessor's obligation is such that more than thirty (30) days are reasonably required for its performance, then Lessor shall not be in breach if performance is commenced within such thirty (30) day period and thereafter diligently pursued to completion. (b) PERFORMANCE BY LESSEE ON BEHALF OF LESSOR. In the event that neither Lessor nor Lender cures said breach within thirty (30) days after receipt of said notice, or if having commenced said cure they do not diligently pursue it to completion, then Lessee may elect to cure said breach at Lessee's expense and offset from Rent an amount equal to the greater of one month's Base Rent or the Security Deposit, and to pay an excess of such expense under protest, reserving Lessee's right to reimbursement from Lessor, Lessee shall document the cost of said cure and supply said documentation to Lessor. 14. CONDEMNATION. If the Premises or any portion thereof are taken under the power of eminent domain or sold under the threat of the exercise of said power (collectively "Condemnation"), this Lease shall terminate as to the part taken as of the date the condemning authority takes title or possession, whichever first occurs. If more than ten percent (10%) of any building portion of the premises, or more than twenty-five percent (25%) of the land area portion of the premises not occupied by any building, is taken by Condemnation, Lessee may, at Lessee's option, to be exercised in writing within ten (10) days after Lessor shall have given Lessee written notice of such taking (or in the absence of such notice, within ten (10) days after the condemning authority shall have taken possession) terminate this Lease as of the date the condemning authority takes such possession. It Lessee does not terminate this Lease in accordance with the foregoing, this Lease shall PAGE 17 remain in full force and effect as to the portion of the Premises remaining, except that the Base Rent shall be reduced in proportion to the reduction in utility of the Premises caused by such Condemnation. Condemnation awards and/or payments shall be the property of Lessor, whether such award shall be made as compensation for diminution in value of the leasehold, the value of the part taken, or for severance damages; provided, however, that Lessee shall be entitled to any compensation for Lessee's relocation expenses, loss of business goodwill and/or Trade Fixtures, without regard to whether or not this Lease is terminated pursuant to the provisions of this Paragraph. All Alterations and Utility Installations made to the Premises by Lessee, for purposes of Condemnation only, shall be considered the property of the Lessee and Lessee shall be entitled to any and ail compensation which is payable therefor. In the event that this Lease is not terminated by reason of the Condemnation, Lessor shall repair any damage to the Premises caused by such Condemnation. 15. BROKERS' FEE. 15.3 REPRESENTATIONS AND INDEMNITIES OF BROKER RELATIONSHIPS. Lessee and Lessor each represent and warrant to the other that it has had no dealings with any person, firm, broker or finder (other than the Brokers, if any) in connection with this Lease, and that no one other than said named Brokers is entitled to any commission or finder's fee in connection herewith, Lessee and Lessor do each hereby agree to indemnify, protect, defend and hold the other harmless from and against liability for compensation or charges which may be claimed by any such unnamed broker, finder or other similar party by reason of any dealings or actions of the indemnifying Party, including any costs, expenses, attorneys' fees reasonably incurred with respect thereto. 16. TENANCY STATEMENT/ESTOPPEL CERTIFICATES. (a) Each Party (as "Responding Party") shall within ten (10) days after written notice from the other Party (the "Requesting Party") execute, acknowledge and deliver to the Requesting Party a statement in writing in form similar to the then most current "Estoppel Certificate" form published by the American Industrial Real Estate Association, plus such additional information, confirmation and/or statements as may be reasonably requested by the Requesting Party. (b) If the Responding Party shall fail to execute or deliver the Estoppel Certificate within such ten day period, the Requesting Party may execute an Estoppel Certificate stating that: (i) the Lease is in full force and effect without modification except as may be represented by the Requesting Party, (ii) there are no uncured defaults in the Requesting Party's performance, and (iii) it Lessor is the Requesting Party, not more than one month's rent has been paid in advance, Prospective purchasers and encumbrancers may rely upon the Requesting Party's Estoppel Certificate, and the Responding Party shall be estopped from denying the truth of the facts contained in said Certificate. (c) If Lessor desires to finance, refinance, or sell the Premises, or any part thereof, Lessee and all Guarantors shall deliver to any potential lender or purchaser designated by Lessor such financial statements as may be reasonably required by such tender or purchaser, including but not limited to Lessee's financial statements for the past three (3) years. All such financial statements shall be received by Lessor and such lender or purchaser in confidence and shall be used only for the purposes herein set forth. PAGE 18 17. DEFINITION OF LESSOR. The term "Lessor" as used herein shall mean the owner or owners at the time in question of the fee title to the Premises, or, if this is a sublease, of the Lessee's interest in the prior lease. In the event of a transfer of Lessor's title or interest in the Premises or this Lease. Lessor shall deliver to the transferee or assignee (in cash or by credit) any unused Security Deposit held by Lessor. Upon such transfer or assignment and delivery of the Security Deposit, as aforesaid, the prior Lessor shall be relieved of all liability with respect to the obligations and/or covenants under this Lease thereafter to be performed by the Lessor. Subject to the foregoing, the obligations and/or covenants in this Lease to be performed by the Lessor shall be binding only upon the Lessor as hereinabove defined. Notwithstanding the above, and subject to the provisions of Paragraph 20 below, the original Lessor under this Lease, and all subsequent holders of the Lessors interest in this Lease shall remain liable and responsible with regard to the potential duties and liabilities of Lessor pertaining to Hazardous Substances as outlined in Paragraph 6 above. 18. SEVERABILITY. The invalidity of any provision of this Lease, as determined by a court of competent jurisdiction, shall in no way affect the validity of any other provision hereof. 19. DAYS. Unless otherwise specifically indicated to the contrary, the word "days" as used in this Lease shall mean and refer to calendar days. 20. LIMITATION ON LIABILITY. Subject to the provisions of Paragraph 17 above, the obligations of Lessor under this Lease shall not constitute personal obligations of Lessor, the individual partners of Lessor or its or their individual partners, directors, officers or shareholders, and Lessee shall look to the Premises, and to no other assets of Lessor, for the satisfaction of any liability of Lessor with respect to this Lease, and shall not seek recourse against the individual partners of Lessor, or its or their individual partners, directors, officers or shareholders, or any of their personal assets for such satisfaction. 21. TIME OF ESSENCE. Time is of the essence with respect to the performance of all obligations to be performed or observed by the Parties under this Lease. 22. NO PRIOR OR OTHER AGREEMENTS: BROKER DISCLAIMER. This Lease contains all agreements between the Parties with respect to any matter mentioned herein, and no other prior or contemporaneous agreement or understanding shall be effective. Lessor and Lessee each represents and warrants to the Brokers that it has made, and is relying solely upon, its own investigation as to the nature, quality, character and financial responsibility of the other Party to this Lease and as to the nature, quality and character of the Premises. Brokers have no responsibility with respect thereto or with respect to any default or breach hereof by either Party. The liability (including court costs and Attorneys' fees), of any Broker with respect to negotiation, execution, delivery or performance by either Lessor or Lessee under this Lease or any amendment or modification hereto shall be limited to an amount up to the tee received by such Broker pursuant to this Lease: provided, however, that the foregoing limitation on each Broker's liability shall not be applicable to any gross negligence or willful misconduct of such Broker. 23. NOTICES. 23.1 NOTICE REQUIREMENTS. All notices required or permitted by this Lease shall be in writing and may be delivered in person (by hand or by courier) or may be sent by regular, certified or registered mail or U.S. Postal Service Express Mail, with postage prepaid, or by facsimile transmission, and shall be deemed sufficiently given it served in a manner specified in this Paragraph 23. The addresses noted adjacent to a Party's signature on this Lease shall be that Party's address for delivery or mailing of notices. Either Party may by written notice to the other specify a different address for notice, except that upon Lessees taking possession of the Premises, the Premises shall constitute Lessee's address for notice. A copy of all notices to Lessor shall be concurrently transmitted to such party or parties at such addresses as Lessor may from time to time hereafter designate in writing. 23.2 DATE OF NOTICE. Any notice sent by registered or certified mail, return receipt requested, shall be deemed given on the date of delivery shown on the receipt card, or if no delivery date is shown, the postmark thereon. If sent by regular mail the notice shall be deemed given forty-eight (48) hours after the same is addressed as required herein and mailed with postage prepaid. Notices delivered by United States Express Mail or overnight courier that guarantee next day delivery shall be deemed given twenty-four (24) hours after delivery of the same to the Postal Service or courier. Notices transmitted by facsimile transmission or similar means shall be deemed delivered upon telephone confirmation of receipt, PAGE 19 provided a copy is also delivered via delivery or mail. If notice is received on a Saturday, Sunday or legal holiday, it shall be deemed received on the next business day. 24. WAIVERS. No waiver by Lessor of the Default or Breach of any term, covenant or condition hereof by Lessee, shall be deemed a waiver of any other term, covenant or condition hereof, or of any subsequent Default or Breach by Lessee of the same or of any other term, covenant or condition hereof. Lessor's consent to, or approval of, any act shall not be deemed to render unnecessary the obtaining of Lessor's consent to, or approval of, any subsequent or similar act by Lessee, or be construed as the basis of an estoppel to enforce the provision or provisions of this Lease requiring such consent. The acceptance of Rent by Lessor shall not be a waiver of any Default or Breach by Lessee. Any payment by Lessee may be accepted by Lessor on account of moneys or damages due Lessor, notwithstanding any qualifying statements or conditions made by Lessee in connection therewith, which such statements and/or conditions shall be of no force or effect whatsoever unless specifically agreed to in writing by Lessor at or before the time of deposit of such payment. 25. RECORDING. Either Lessor or Lessee shall, upon request of the other, execute, acknowledge and deliver to the other a short form memorandum of this Lease for recording purposes. The Party requesting recordation shall be responsible for payment of any fees applicable thereto. 26. NO RIGHT TO HOLDOVER. Lessee has no right to retain possession of the Premises or any part thereof beyond the expiration or termination of this Lease. In the event that Lessee holds over, then the Base Rent shall be increased to one hundred fifty percent (150%) of the Base Rent applicable during the month immediately preceding the expiration or termination. Nothing contained herein shall be construed as consent by Lessor to any holding over by Lessee. 27. CUMULATIVE REMEDIES. No remedy or election hereunder shall be deemed exclusive but shall, wherever possible, be cumulative with all other remedies at law or in equity. 28. COVENANTS AND CONDITIONS; CONSTRUCTION OF AGREEMENT. All provisions of this Lease to be observed or performed by Lessee are both covenants and conditions. In construing this Lease, all headings and titles are for the convenience of the parties only and shall not be considered a part of this Lease. Whenever required by the context, the singular shall include the plural and vice versa. This Lease shall not be construed as if prepared by one of the parties, but rather according to its fair meaning as a whole, as if both parties had prepared it. 29. BINDING EFFECT; CHOICE OF LAW. This Lease shall be binding upon the parties, their personal representatives, successors and assigns and be governed by the laws of the State in which the Premises are located. Any litigation between the Parties hereto concerning this Lease shall be initiated in the county in which the Premises are located. 30. SUBORDINATION; ATTORNMENT; NON-DISTURBANCE. 30.1 SUBORDINATION. This Lease and any Option granted hereby shall be subject and subordinate to any ground lease, mortgage, deed of trust, or other hypothecation or security device (collectively, "Security Device"), now or hereafter placed upon the Premises, to any and all advances made on the security thereof, and to all renewals, modifications, and extensions thereof. Lessee agrees that the holders of any such Security Devices (in this Lease together referred to as "Lessor's Lender") shall have no liability or obligation to perform any of the obligations of Lessor under this Lease. Any Lender may elect to have this Lease and/or any Option granted hereby superior to the lien of its Security Device by giving written notice thereof to Lessee, whereupon this Lease and such Options shall be deemed prior to such Security Device, notwithstanding the relative dates of the documentation or recordation thereof. 30.2 ATTORNMENT. Subject to the non-disturbance provisions of Paragraph 30.3, Lessee agrees to attorn to a Lender or any other party who acquires ownership of the Premises by reason of a foreclosure of a Security Device, and that in the event of such foreclosure, such new owner shall not: (i) be liable for any act or omission of any prior lessor or with respect to events occurring prior to acquisition of ownership: (ii) be subject to any offsets or defenses which Lessee might have against any prior lessor, or (iii) be bound by prepayment of more than one (1) month's rent. 30.3 NON-DISTURBANCE. With respect to Security Devices entered into by Lessor after the execution of this Lease, Lessee's subordination of this Lease shall be subject to receiving a commercially reasonable non-disturbance agreement (a "Non-Disturbance Agreement") from the Lender which Non-Disturbance Agreement provides that Lessee's possession of PAGE 20 the Premises, and this Lease, including any options to extend the term hereof, will not be disturbed so long as Lessee is not in Breach hereof and attorns to the record owner of the Premises. Further, within sixty (60) days after the execution of this Lease. Lessor shall use its commercially reasonable efforts to obtain a Non-Disturbance Agreement from the holder of any pre-existing Security Device which is secured by the Premises. In the event that Lessor is unable to provide the Non-Disturbance Agreement within said sixty (60) days, then Lessee may, at Lessee's action, directly contact Lessors lender and attempt to negotiate for the execution and delivery of a Non-Disturbance Agreement. 30.4 SELF-EXECUTING. The agreements contained in this Paragraph 30 shall be effective without the execution of any further documents: provided, however, that, upon written request from Lessor or a Lender in connection with a sale, financing or refinancing of the Premises, Lessee and Lessor shall execute such further writings as may be reasonably required to separately document any subordination, attornment and/or Non-Disturbance Agreement provided for herein. 31. ATTORNEYS' FEES. It any Party brings an action or proceeding involving the Premises to enforce the terms hereof or to declare rights hereunder, the Prevailing Party (as hereafter defined) in any such proceeding, action, or appeal thereon, shall be entitled to reasonable attorneys' fees. Such fees may be awarded in the same suit or recovered in a separate suit, whether or not such action or proceeding is pursued to decision or judgment. The term, "Prevailing Party" shall include, without limitation, a Party who substantially obtains or defeats the relief sought, as the case may be, whether by compromise, settlement, judgment, or the abandonment by the other Party of its claim or defense. The attorneys' fees award shall not be computed in accordance with any court fee schedule, but shall be such as to fully reimburse all attorneys' fees reasonably incurred, in addition, Lessor shall be entitled to attorneys' fees, costs and expenses incurred in the preparation and service of notices of Default and consultations in connection therewith, whether or not a legal action is subsequently commenced in connection with such Default or resulting Breach. 32. LESSOR'S ACCESS; SHOWING PREMISES: REPAIRS. Lessor and Lessor's agents shall have the right to enter the Premises at any time in the case of an emergency, and otherwise at reasonable times for the purpose at showing the same to prospective purchasers, lenders, or lessees, and making such alterations, repairs, improvements or additions to the Premises as Lessor may deem necessary. All such activities shall be without abatement of rent or liability to Lessee. Lessor may at any time place on the Premises any ordinary "For Sale" signs and Lessor may during the last six (6) months of the term hereof place on the Premises any ordinary "For Lease" signs. Lessee may at any time place on or about the Premises any ordinary "For Sublease" sign. 33. AUCTIONS. Lessee shall not conduct, nor permit to be conducted, any auction upon the Premises without Lessors prior written consent. Lessor shall not be obligated to exercise any standard of reasonableness in determining whether to permit an auction. 34. SIGNS. Except for ordinary "For Sublease" signs, Lessee shall not place any sign upon the Premises without Lessor's prior written consent. All signs must comply with all Applicable Requirements. 35. TERMINATION; MERGER. Unless specifically stated otherwise in writing by Lessor, the voluntary or other surrender of this Lease by Lessee, the mutual termination or cancellation hereof, or a termination hereof by Lessor for Breach by Lessee, shall automatically terminate any sublease or lesser estate in the Premises; provided, however, that Lessor may elect to continue any one or all existing subtenancies, Lessor's failure within ten (110) days following any such event to elect to the contrary by written notice to the holder of any such lesser interest, shall constitute Lessor's election to have such event constitute the termination of such interest. 36. CONSENTS. Except as otherwise provided herein, wherever in this Lease the consent of a Party is required to an act by or for the other Party, such consent shall not be unreasonably withheld or delayed, Lessor's actual reasonable costs and expenses (including but not limited to architects', attorneys', engineers' and other consultants' fees) incurred in the consideration of, or response to, a request by Lessee for any Lessor consent, including but not limited to consents to an assignment, a subletting or the presence or use of a Hazardous Substance, shall be paid by Lessee upon receipt at an invoice and supporting documentation therefor. Lessor's consent to any act, assignment or subletting shall not constitute an acknowledgment that no Default or Breach by Lessee of this Lease exists, nor shall such consent be deemed a waiver of any then existing Default or Breach, except as may be otherwise specifically stated in writing by Lessor at the time of such consent. The failure to specify herein any particular condition to Lessor's consent shall not preclude the imposition by Lessor at the time of consent of such further or other conditions as are then reasonable with reference to the particular matter for which consent is being given. In the event that either Party disagrees with any determination made by the other PAGE 21 hereunder and reasonably requests the reasons for such determination, the determining party shall furnish its reasons in writing and in reasonable detail within ten (10) business days following such request. 37. GUARANTOR. 37.1 EXECUTION. The Guarantors, if any, shall each execute a guaranty in the form most recently published by the American Industrial Real Estate Association, and each such Guarantor shall have the same obligations as Lessee under this Lease. 37.2 DEFAULT. It shall constitute a Default of the Lessee if any Guarantor fails or refuses, upon request to provide: (a) evidence of the execution of the guaranty, including the authority of the party signing on Guarantor's behalf to obligate Guarantor, and in the case of a corporate Guarantor, a certified copy of a resolution of its board of directors authorizing the making of such guaranty, (b) current financial statements, (c) a Tenancy Statement, or (d) written confirmation that the guaranty is still in effect. 38. QUIET POSSESSION. Subject to payment by Lessee of the Rent and performance of all of the covenants, conditions and provisions on Lessee's part to be observed and performed under this Lease, Lessee shall have quiet possession and quiet enjoyment of the Premises during the term hereof. 39. OPTIONS. 39.1 DEFINITION. "Option" shall mean: (a) the right to extend the term of or renew this Lease or to extend or renew any lease that Lessee has on other property of Lessor; (b) the right of first refusal or first offer to lease either the Premises or other property of Lessor; (c) the right to purchase or the right of first refusal to purchase the Premises or other property of Lessor. 39.2 OPTIONS PERSONAL TO ORIGINAL LESSEE. Each Option granted to Lessee in this Lease is personal to the original Lessee, and cannot be assigned or exercised by anyone other than said original Lessee and only while the original Lessee is in full possession of the Premises and, if requested by Lessor, with Lessee certifying that Lessee has no intention of thereafter assigning or subletting. 39.3 MULTIPLE OPTIONS. In the event that Lessee has any multiple Options to extend or renew this Lease, a later Option cannot be exercised unless the prior Options have been validly exercised. 39.4 EFFECT OF DEFAULT ON OPTIONS. (a) Lessee shall have no right to exercise an Option: (i) during the period commencing with the giving of any notice of Default and continuing until said Default is cured, (ii) during the period of time any Rent is unpaid (without regard to whether notice thereof is given Lessee), (iii) during the time Lessee is in Breach of this Lease, or (iv) in the event that Lessee has been given three (3) or more notices of separate Default, whether or not the Defaults are cured, during the twelve (12) month period immediately preceding the exercise of the Option. (b) The period of time within which an Option may be exercised shall not be extended or enlarged by reason of Lessees inability to exercise an Option because of the provisions of Paragraph 39.4(a). (c) An Option shall terminate and be of no further force or effect, notwithstanding Lessee's due and timely exercise of the Option, if, after such exercise and prior to the commencement of the extended term, (i) Lessee fails to pay Rent for a period of thirty (30) days after such Rent becomes due (without any necessity of Lessor to give notice thereof), (ii) Lessor gives to Lessee three (3) or more notices of separate Default during any twelve (12) month period, whether or not the Defaults are cured, or (iii) if Lessee commits a Breach of this Lease. 40. MULTIPLE BUILDINGS. If the Premises are a part of a group of buildings controlled by Lessor, Lessee agrees that it will observe all reasonable rules and regulations which Lessor may make from time to time for the management, safety, and care of said properties, including the care and cleanliness of the grounds and including the parking, loading and unloading of vehicles, and that Lessee will pay its fair share of common expenses incurred in connection therewith. PAGE 22 41. SECURITY MEASURES. Lessee hereby acknowledges that the rental payable to Lessor hereunder does not include the cost of guard service or other security measures, and that Lessor shall have no obligation whatsoever to provide same, Lessee assumes all responsibility for the protection of the Premises, Lessee, its agents and invitees and their properly from the acts of third parties. 42. RESERVATIONS. Lessor reserves to itself the right, from time to time, to grant, without the consent or joinder of Lessee, such easements, rights and dedications that Lessor deems necessary, and to cause the recordation of parcel maps and restrictions, so long as such easements, rights, dedications, maps and restrictions do not unreasonably interfere with the use of the Premises by Lessee. Lessee agrees to sign any documents reasonably requested by Lessor to effectuate any such easement rights, dedication, map or restrictions. 43. PERFORMANCE UNDER PROTEST. If at any time a dispute shall arise as to any amount or sum of money to be paid by one Party to the other under the provisions hereof, the Party against whom the obligation to pay the money is asserted shall have the right to make payment "under protest and such payment shall not be regarded as a voluntary payment and there shall survive the right on the Part of said Party to institute suit for recovery of such sum. If it shall be adjudged that there was no legal obligation on the part of said Party to Pay such sum or any part thereof, said Party shall be entitled to recover such sum or so much thereof as it was not legally required to pay. 44. AUTHORITY. If either Party hereto is a corporation, trust, limited liability company, partnership, or similar entity, each individual executing this Lease on behalf of such entity represents and warrants that he or she is duly authorized to execute and deliver this Lease on its behalf. Each party shall, within thirty (30) days after request, deliver to the other party satisfactory evidence of such authority. 45. CONFLICT. Any conflict between the printed provisions of this Lease and the typewritten or handwritten provisions shall be controlled by the typewritten or handwritten provisions. 46. OFFER. Preparation of this Lease by either Party or their agent and submission of same to the other Party shall not be deemed an offer to lease to the other Party. This Lease is not intended to be binding until executed and delivered by all Parties hereto. 47. AMENDMENTS. This Lease may be modified only in writing, signed by the Parties in interest at the time of the modification. As long as they do not materially change Lessee's obligations hereunder. Lessee agrees to make such reasonable non-monetary modifications to this Lease as may be reasonably required by a Lender in connection with the obtaining of normal financing or refinancing of the Premises. 48. MULTIPLE PARTIES. If more than one person or entity is named herein as either Lessor or Lessee, such multiple Parties shall have joint and several responsibility to comply with the terms of this Lease. 49. MEDIATION AND ARBITRATION OF DISPUTES. An Addendum requiring the Mediation and/or the Arbitration of all disputes between the Parties and/or Brokers arising out of this Lease : is 9 is not attached to this Lease. LESSOR AND LESSEE HAVE CAREFULLY READ AND REVIEWED THIS LEASE AND EACH TERM AND PROVISION CONTAINED HEREIN, AND BY THE EXECUTION OF THIS LEASE SHOW THEIR INFORMED AND VOLUNTARY CONSENT THERETO, THE PARTIES HEREBY AGREE THAT AT THE TIME THIS LEASE IS EXECUTED, THE TERMS OF THIS LEASE ARE COMMERCIALLY REASONABLE AND EFFECTUATE THE INTENT AND PURPOSE OF LESSOR AND LESSEE WITH RESPECT TO THE PREMISES. PAGE 23 - ------------------------------------------------------------------------------- ATTENTION: NO REPRESENTATION OR RECOMMENDATION IS MADE BY THE AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION OR BY ANY BROKER AS TO THE LEGAL SUFFICIENCY, LEGAL EFFECT, OR TAX CONSEQUENCES OF THIS LEASE OR THE TRANSACTION TO WHICH IT RELATES, THE PARTIES ARE URGED TO: 1. SEEK ADVICE OF COUNSEL AS TO THE LEGAL AND TAX CONSEQUENCES OF THIS LEASE. 2. RETAIN APPROPRIATE CONSULTANTS TO REVIEW AND INVESTIGATE THE CONDITION OF THE PREMISES, SAID INVESTIGATION SHOULD INCLUDE BUT NOT BE LIMITED TO: THE POSSIBLE PRESENCE OF HAZARDOUS SUBSTANCES, THE ZONING OF THE PREMISES, THE STRUCTURAL INTEGRITY, THE CONDITION OF THE ROOF AND OPERATING SYSTEMS, AND THE SUITABILITY OF THE PREMISES FOR LESSEE'S INTENDED USE. WARNING: IF THE PREMISES IS LOCATED IN A STATE OTHER THAN CALIFORNIA, CERTAIN PROVISIONS OF THE LEASE MAY NEED TO BE REVISED TO COMPLY WITH THE LAWS OF THE STATE IN WHICH THE PREMISES IS LOCATED. - ------------------------------------------------------------------------------- PAGE 24 The parties hereto have executed this Lease at the place and on the dates specified above their respective signatures. Executed at: Executed at: ------------------------- ---------------------------- on: on: ---------------------------------- ------------------------------------- By LESSOR: By LESSEE: THE CHILDS FAMILY INVESTMENT THE IMMUNE RESPONSE CORPORATION, PARTNERSHIP, L.P. AND THE A.J. GARDNER A DELAWARE CORPORATION FAMILY TRUST, U/T/A 3/5/81 By: /s/ ROLAND A. CHILDS By: /s/ PAULA BAXTER ATKINS ---------------------------------- ------------------------------------- Name Printed: ROLAND A. CHILDS Name Printed: DENNIS J. CARLO, PH.D. ------------------------ --------------------------- Title: Title: PRESIDENT CHIEF EXECUTIVE OFFICER ------------------------------- ---------------------------------- By: /s/ ALLAN J. GARDNER By: ---------------------------------- ------------------------------------- Name Printed: ALLAN J. GARDNER Name Printed: ------------------------ --------------------------- Title: Title: ------------------------------- ---------------------------------- Address: C/O LANDCO, 432 SOUTH Address: ----------------------------- -------------------------------- BENTLEY AVENUE, LOS ANGELES, - ------------------------------------- ---------------------------------------- CA 90049-3513 - ------------------------------------- ---------------------------------------- Telephone: (310) 476-3209 Telephone: ( ) -------------------------- ------------------------------ Facsimile: (310) 476-0111 Facsimile: ( ) --------------------------- ------------------------------ Federal ID No. Federal ID No. ----------------------- -------------------------- BROKER: BROKER: - ------------------------------------- ---------------------------------------- Executed at: Executed at: ------------------------- ---------------------------- on: on: ---------------------------------- ------------------------------------- By: By: ---------------------------------- ------------------------------------- Name Printed: Name Printed: ------------------------ --------------------------- Title: Title: ------------------------------- ---------------------------------- Address: Address: ----------------------------- -------------------------------- - ------------------------------------- --------------------------------------- Telephone: ( ) Telephone: ( ) -------------------------- ----------------------------- Facsimile: ( ) Facsimile: ( ) --------------------------- ----------------------------- Federal ID No. Federal ID No. ----------------------- -------------------------- PAGE 25 ADDENDUM TO LEASE This Addendum to Lease ("Addendum") is made by and between The Childs Family Partnership, L.P. and The A. J. Gardner Family Trust u/t/a 3/5/81, general partners doing business as "Darwin Court" but holding title as tenants-in-common (collectively, "Lessor") and The Immune Response Corporation, a Delaware corporation ("Lessee") and shall supplement that certain Standard Industrial/Commercial Single-Tenant Lease Net between Lessor and Lessee dated as of December 15, 1997 and Exhibits thereto (collectively, the "Lease"). Where appropriate the numbering used in the Addendum shall refer to the same numbered paragraphs in the Lease. Notwithstanding anything contained in the Lease to the contrary, the provisions set forth below will be deemed to be part of the Lease and if there is any inconsistency between this Addendum and the Lease, the terms of this Addendum shall supersede and control. All references in the Lease and in this Addendum shall be construed to mean the Lease and the Exhibits thereto, as amended and supplemented by this Addendum. All defined terms used in this Addendum, unless specifically defined in this Addendum, shall have the same meaning as such terms have in the Lease. References to "Paragraph" shall refer to the pre-printed Lease form and references to "Section" shall refer to this Addendum. 1.1 PARTIES. The phrase ", general partners doing business as "Darwin Court" but holding title as tenants-in-common" is inserted after the names of the entities comprising Lessor. 1.2 PREMISES. Lessor at its expense shall construct a Building Shell of approximately 31,200 square feet. The phrase "Building Shell" means the Building improvements and related site improvements as shown on those certain plans and specifications (collectively, "Lessor's Plans") prepared by Smith Consulting Architects ("Lessor's Architect"), dated on the various sheets between April 3, 1997 and April 18, 1997 an entire set of which has been delivered to Lessee by Lessor's contractor, Riggins Construction & Management, Inc. as listed on the attached Schedule 1.2. Lessee has the right to expand the second floor office space at its cost in which case the total leasable area will be correspondingly increased. Lessor shall not amend or modify Lessor's Plans in any material respect without the prior consent of Lessee. Lessor represents and warrants that no part of the Building Shell will contain asbestos, asbestos-containing material or other Hazardous Substances (collectively "ACHM"). If Lessor does employ ACHM, the ACHM will be promptly removed in a manner required by the appropriate government agency and in accordance with Applicable Requirements. Lessor will be fully responsible for making all alterations and repairs to the Premises and the Building Shell at its cost required to remove any and all ACHM discovered at any time to have existed in the Premises or Building Shell as of the Start Date, or resulting from or necessitated by the failure by Lessor and/or Lessor's contractor to comply with Applicable Requirements regarding ACHM, or from Lessor's and/or Lessor's contractor's utilization of Hazardous Substances as defined by Applicable Requirements at the time the Lease is executed, in violation of such Applicable Requirements or which could pose a health risk to occupants of the Premises. 1.3 TERM. The Commencement Date shall be the earliest of the completion of Lessee's completion of Lessee's Tenant Improvements (as defined in Addendum Section 50.1 below) or April 1, 1998. Lessor will confirm in writing the exact Commencement Date and Lease expiration date both of which will be acknowledged in writing by Lessee upon Lessee's confirmation of the accuracy thereof. For purposes of this Section 1.3, completion of Lessee's Tenant Improvements shall be deemed to have occurred on the date on which (i) Lessee's architect, with no undue delay, issues a certificate to Lessee stating that all Tenant Improvements have, in all material respects, been completed in accordance with drawings approved by Lessee therefor and are operable, (ii) all Utility Installations which are identified as part of Lessee's Tenant Improvements are operational at the Premises, (iii) adequate access to the Premises for Lessee's uses under the -1- Lease has been completed, and (iv) the government agency having appropriate jurisdiction thereover issues a "right to occupy" designation (or such similar designation) in the inspection record for Lessee's Tenant Improvements. 1.4 EARLY POSSESSION. Early Possession will start when the Lessor has completed the Building Shell in accordance with Lessor's Plans and shall end at the earliest of Lessee's completion of the Tenant Improvements as described in Section 1.3 above or April 1, 1998. In the event of the imposition of a water moratorium by local governmental agencies with authority thereover such that establishment of exterior landscaping to be installed by Lessor would be adversely affected, Lessor may delay completion of such landscaping without affecting the Start Date otherwise applicable, provided such landscaping is completed as soon as practicable thereafter, and in all events not later than the Commencement Date. 1.5 BASE RENT. Base Rent is calculated on the basis of $.59 per square foot of the Premises per month on a "triple net" basis. The Base Rent shall be subject to adjustment during the ninety (90) day period following the Commencement Date by $.59/ft. if Lessor's Architect determines the Building is more or less than 31,200 sq. ft. based on Building "as-builts" filed with the City of Carlsbad. All square footage measurements shall be from the roof "drip line" and in accordance with the Building Owners and Managers Association International standards for industrial/commercial projects (the "BOMA Standard"). Lessor's Architect shall complete such calculations within said 90-day period at Lessor's expense. Lessee shall have the right, exercisable within ninety (90) days after the later of (a) the date Lessor gives Lessee written notice of the final calculation of the Premises and the Building as contemplated above, or (b) the date Lessee commences business operations from the Premises (or, when appropriate, any additional space leased by Lessee pursuant to the Lease), to remeasure the Premises and the Building within such ninety (90) day period. In the event that subsequent remeasurement of the Premises and/or the Building by Lessee, within the time period specified above, indicates that the square footage measurement prepared by Lessor produces a square footage number in excess of or lower than the square footage number which would have resulted had the BOMA Standard been properly utilized, any payments due to Lessor from Lessee based upon the amount of square feet contained in the Premises shall be proportionally, retroactively and prospectively reduced or increased, as appropriate, to reflect the actual number of square feet as properly remeasured under the BOMA Standard. If Lessor disagrees with Lessee's remeasurement and if a dispute occurs regarding the final accuracy of the measurement of the Premises and the Building in accordance with the BOMA Standard, such dispute will be resolved pursuant to binding arbitration pursuant to this Addendum. Operating Expenses (defined below) other than the Administration Fee (defined below) shall commence on the Start Date. Base Rent and the Administration Fee shall not commence prior to the Commencement Date; PROVIDED, HOWEVER, to the extent Lessee commences business operations on, and utilizes therefor, any portion of the Premises from and after the Start Date, Lessee shall be responsible for payment of Base Rent and the Administration Fee prorated with respect to the portion of the Premises so used. In no event shall use of the Premises for Lessee's construction activities prior to the Commencement Date be deemed to constitute a use of the Premises for Lessee's business operations. 1.8 AGREED USE. Lessee will use the Premises for general medical, office use and biopharmaceutical use, research and development, product production, manufacture and distribution and any other like use in keeping with the class and character of the building and permitted uses within the Carlsbad Research Center. 1.9 INSURING PARTY. Lessee may opt to be the Insuring Party for all leasehold improvements which are for biopharmaceutical uses as opposed to industrial/office uses upon thirty (30) days prior written notice to Lessor. Lessee shall also have the option of insuring the Building Shell in the event Lessee can obtain the insurance coverages required under the Lease with respect thereto at a premium cost of at least ten percent (10%) less than the premium cost obtained by Lessor provided Lessee's carriers for such insurance are substantially comparable in all material respects to Lessor's. Notwithstanding the foregoing, Lessor may opt to remain the -2- Insuring Party and retain its insurance carrier if it pays the amounts in excess of such ten percent (10%) premium differential at its sole cost and expense. 2.2 CONDITION. Lessor's delivery of the Premises shall include the Building Shell fully completed in accordance with the Plans and ready for Lessee's construction of its Tenant Improvements. There shall be no requirement that service contracts under Paragraph 7.1(b) of the Lease be obtained by Lessee as a condition to Lessor's warranty regarding the HVAC as the HVAC systems are the responsibility of Lessee as part of the Tenant Improvements (defined below). Written notices to be given to Lessor regarding non-compliance with the warranties given under Paragraph 2.2 of the Lease shall be given with reasonable promptness by Lessee following discovery of the condition giving rise to such notice and the period during which such notices may be given is modified to one (1) year as to all systems and elements of the Building which are part of the Building Shell, however, Lessee shall have the benefit of any longer warranty periods otherwise accruing to Lessor from contractors and suppliers providing services or materials to Lessor as part of the Building Shell construction. The acknowledgements set forth in Paragraph 2.4 of the Lease shall not affect this Section. 2.3 COMPLIANCE. Lessor shall be responsible for the compliance of the Building Shell with all Applicable Requirements in effect as of the Start Date throughout the Term of the Lease and shall effect such compliance promptly following notice from any party, including Lessee, thereof at any time during the Term or any extensions thereof. Lessee shall not be required to comply with the six month notification period stated in Paragraph 2.3 with respect to such non-compliance. All costs incurred by Lessor to comply with Applicable Requirements in effect on the Start Date shall be born by Lessor solely and shall not be part of the Base Rent or otherwise payable by Lessee. The acknowledgements set forth in Paragraph 2.4 of the Lease shall not affect this Section. 2.4 ACKNOWLEDGEMENTS. All references to Brokers are hereby deleted from Paragraph 2.4. 2.5 LESSEE AS PRIOR OWNER/OCCUPANT. Paragraph 2.5 of the Lease is hereby deleted. 3.3 DELAY IN POSSESSION. In the event possession of the Premises is not delivered by Lessor to Lessee by April 1, 1998, Lessee shall have the right to terminate the Lease. 3.4 LESSEE COMPLIANCE. The last sentence of Paragraph 3.4 is hereby deleted. 5. SECURITY DEPOSIT. In the event Lessor utilizes the Security Deposit as permitted under the Lease, Lessee shall have thirty (30) days after request therefore to replenish the amount of the Security Deposit with the required amount under the Lease. Lessee shall have no obligation to increase the amount of the Security Deposit, for any reason, so long as the L/C (as defined below) is in place. Any application by Lessor of the Security Deposit shall cure the default to which such portion of the Security Deposit is applied, to the extent thereof. As additional security for monetary defaults, Lessee shall deliver to Lessor no later than the Start Date an irrevocable Letter of Credit for $600,000 from Union Bank of California or other comparable financial institution having substantially the same net worth, substantially in the form attached as Schedule 5 (excluding any terms which are found to be commercially unreasonable by the issuer thereof), or otherwise on terms and conditions mutually acceptable to Lessor, Lessee and such issuer ("L/C"). If Lessee fails to timely deliver the L/C, and such failure continues for a period of thirty (30) days following the Start Date, Lessor shall have the right to immediately terminate the Lease by giving Lessee written notice of such election, and such termination shall be effective immediately upon Lessor's delivery of such notice. Lessee shall also have the option of maintaining the L/C amount as a cash deposit with Lessor as contemplated under Section 5.2(i) below. 5.1 Lessor shall not resort to the L/C without first exhausting the proceeds of the monetary portion of the Security Deposit. Fifteen (15) days before each anniversary of the issuance of the L/C, Lessee shall obtain a -3- commitment of renewal and if the L/C is not renewed within ten (10) days, the failure to renew will permit Lessor to draw down the L/C in full and maintain it in lieu of the L/C as contemplated under Section 5.2(i) below. 5.2 Notwithstanding any other provision of the Lease and so long as no uncured material Breach exists, Lessor agrees to release the L/C under any one of the following independent conditions: (i) Lessee substitutes cash with Lessor which Lessor agrees to keep in interest bearing accounts in the name of Lessor with Lessee entitled to an offset against rental obligations for the amount of interest income earned (the financial institutions with which such deposit, or portions thereof, is maintained, and the rate of interest accruing thereon, shall be reasonably acceptable to Lessee), or (ii) Lessee reports net income of at least $50,000,000 for three years in a row, or (iii) Lessee's audited Balance Sheet indicates a Net Worth of at least $100,000,000. 6.2 HAZARDOUS SUBSTANCES. The word "potentially" is hereby deleted from Paragraph 6.2(a)(i). Paragraph 6.2(b) is hereby modified to provide that such notice from Lessee to Lessor regarding the presence of Hazardous Substances with respect to the Premises shall only be required if such presence of Hazardous Substances is in violation of Applicable Requirements. Paragraph 6.2(c) is modified to require that Lessee shall not be responsible for any Hazardous Substances brought on to the Premises by Lessor, its employees, agents or representatives. Paragraph 6.2(d) is modified to provide that Lessee shall not be required to indemnify Lessor or its employees, agents or representatives against such party's own actions, negligence or omissions. Without limiting Lessee's obligations under this section regarding reporting requirements with respect to Hazardous Substances, Lessee shall, within ten (10) business days following Lessee's first use of a Hazardous Substance required to be reported thereon, complete and deliver to applicable government authorities a Hazardous Materials Questionnaire in the form as set forth in Schedule 6.2 annexed to this Addendum, with a copy to Lessor. 6.3 LESSEE'S COMPLIANCE WITH APPLICABLE REQUIREMENTS. Lessee shall be entitled to satisfy its requirements regarding evidencing its compliance with Applicable Requirements by providing Lessor with copies of permits filed with applicable government authorities by Lessee on an annual basis other than building permits, copies of which shall be provided to Lessor by Lessee as soon as practicable following Lessee's receipt of same. Lessee shall only be required to comply with reasonable recommendations of Lessor's engineers and/or consultants. 7.1 LESSEE'S OBLIGATIONS. Lessor shall assign all warranties and guarantees in connection with the Building Shell and the Premises for work completed by or on behalf of Lessor, to Lessee and shall extend all reasonable assistance to Lessee in the enforcement thereof. Lessor shall also provide a list of all subcontractors and vendors supplying services or materials in connection with the construction and completion of the Building Shell and the Premises to Lessee promptly following the Commencement Date. 7.3 ALTERATIONS; TRADE FIXTURES. Lessee is granted the right to make non-structural alterations and improvements to the Premises costing less than $100,000 per year without any consent required of Lessor, as long as (a) Lessee pays for the entire cost of such alterations and improvements, (b) Lessee agrees to remove said alterations and improvements upon the expiration or termination of the Lease, if requested by Lessor, and (c) such alterations and improvements will not adversely affect the structural integrity of the Premises and/or the Building. Any time Lessee proposes to make such alterations and/or improvements for which Lessor has a right of approval hereunder, Lessee shall provide Lessor with ten (10) business days' notice of such proposed alterations and/or improvements, together with the plans and specifications therefor and a list of all vendors and -4- subcontractors supplying services or materials with respect to such alterations, and Lessor shall grant its approval within such ten (10) day period, unless Lessor reasonably determines that such alterations and/or improvements would adversely affect the structural integrity of the Premises and/or the Building or would adversely affect the exterior appearance of the Building. Lessee shall not be required to provide any completion bonds with respect to alterations installed by Lessee. Lessee shall provide "as-builts" for all alterations. Notwithstanding anything to the contrary in the Lease, all articles of personal property and all Trade Fixtures, machinery and equipment, furniture and movable partitions owned by Lessee or installed by or on behalf of Lessee in the Premises shall remain the property of Lessee, and may be removed by Lessee at any time during the Term of the Lease as long as Lessee is not in Breach hereunder with any applicable cure period having expired. If Lessee fails to remove all of its effects from the Premises upon the expiration or earlier termination of the Lease for any cause whatsoever, Lessor may, at its option, any time after five (5) days' written notice to Lessee of its intention to remove such effects, remove same in any manner that Lessor shall choose and store such effects without liability to Lessee for loss thereof, and Lessee shall pay Lessor upon demand any and all reasonable expenses incurred in connection with such removal, including court costs, attorneys' fees, and reasonable storage charges incurred while such effects were in Lessor's possession. The term "Trade Fixtures" shall mean Lessee's machinery and equipment that has been installed without penetrating the roof membrane and can be removed without doing material damage to the Premises (unless repaired by Lessee) whether or not the item is plugged into an electrical outlet or hot wired. 7.4(b) REMOVAL. Lessee shall receive not less than one hundred twenty (120) days prior written notice from Lessor to remove alterations required by Lessor to be removed due to the expiration of the Lease Term, such removal to be completed within said 120-day period or as soon as practicable thereafter with due and diligent effort. Such 120-day notice from Lessor may be given at any time during the period commencing on the date which is six (6) months prior to the expiration of the Term of the Lease and ending on the date which is six (6) months after the expiration of the Term of the Lease. 8.1 PAYMENT FOR INSURANCE. To the extent Lessor is the Insuring Party, payments for premiums shall be made by Lessee to Lessor annually not less than fifteen (15) business days following Lessee's receipt of notification from Lessor of such premium amount based on the actual due date for Lessor's annual payment of such premiums. 8.3(a) PROPERTY INSURANCE-BUILDING AND IMPROVEMENTS. Notwithstanding language to the contrary, deductibles for policies of insurance required to be maintained hereunder may be $25,000 per occurrence. 8.3(b) RENTAL VALUE. Rental Value insurance required to be maintained under the Lease shall not extend beyond the date of completion of repairs or replacements with respect to any such loss giving rise to a claim thereunder, or beyond the date of any termination of the Lease. 8.3(c) ADJACENT PREMISES. Paragraph 8.3(c) is hereby deleted. 8.4 LESSEE'S PROPERTY/BUSINESS INTERRUPTION INSURANCE. Paragraph 8.4 is hereby deleted from the Lease. 8.5 INSURANCE POLICIES. Lessor shall not do or permit to be done anything which invalidates required insurance policies under the Lease. 8.8 EXEMPTION OF LESSOR FROM LIABILITY. Lessor shall not be exempted from liability for Lessor's (or anyone acting through or on behalf of Lessor) intentional misconduct. -5- 9.2 PARTIAL DAMAGE - INSURED LOSS. The reference to a total cost of repair of $10,000 shall be replaced with a reference to $100,000. Lessee shall have the right to effect any repairs to the Premises which Lessor elects not to effect. To the extent any amounts contributed by Lessee to repair damage or destruction are in excess of the actual cost thereof, or cost savings are realized with respect thereto, the full amount of such excess proceeds or cost savings shall be paid to Lessee. 9.4 TOTAL DESTRUCTION. Lessee shall not be liable for payment of any rent under the Lease after the date of Lease termination (subject to any abatement occurring from the date of Premises Total Destruction). 9.5 DAMAGE NEAR END OF TERM. Lessee shall be entitled to a reciprocal right to terminate the Lease in the event of such damage. Lessee is also granted the following additional rights to terminate. A. Notwithstanding anything in the Lease to the contrary, and except as expressly set forth in Subsection (B) below, in the event that Lessee is notified or becomes aware of the occurrence of the following: (i) damage or destruction to the Premises, and/or the Building or any part thereof so as to interfere substantially with Lessee's use of the Premises, Premises parking, and/or the Building; (ii) a taking by eminent domain or exercise of other governmental authority of the Premises, and/or the Building or any part thereof so as to interfere substantially with Lessee's use of the Premises, Premises parking, and/or the Building; or (iii) any discovery of Hazardous Substances in, on or around the Premises, the Building and/or the Building site not placed in, on or around the Premises, the Building and/or the site by Lessee, that, considering the nature and amount of the substances involved, interferes with Lessee's use of the Premises or which presents a health risk to any occupants of the Premises (each of the items set forth in provision (A)(i), (ii) and (iii) being referred to herein as a "Trigger Event"); and Lessee cannot, within nine (9) months ("Non-Use Period") of the occurrence of the Trigger Event, be given reasonable use of, and access to, a fully repaired, restored, safe and healthful Premises, Premises parking and Building (except for minor "punch-list" items which will be repaired promptly thereafter), and the utilities and services pertaining to the Premises, the Premises parking and the Building, all suitable for the efficient conduct of Lessee's business therefrom, then Lessee may elect to exercise a right to terminate the Lease upon thirty (30) days' written notice sent to Lessor upon the expiration of the Non-Use Period. B. In the event of any Trigger Event occurring during the last year of the Lease Term or, if an applicable renewal option has been exercised, during the last year of any renewal term, should the Non-Use Period continue for ninety (90) days, Lessee may elect to exercise a right to terminate the Lease upon thirty (30) days' written notice sent to Lessor at any time following the expiration of the Non-Use Period. 9.6 ABATEMENT OF RENT; LESSEE'S REMEDIES. Paragraph 9.6 of the Lease is hereby deleted and replaced with the following: In the event that Lessee is prevented from using, and does not use, the Premises or any portion thereof, for five (5) consecutive business days or ten (10) business days in any twelve (12) month period (the "Eligibility Period") as a result of (a) any damage or destruction to the Premises, the Premises parking and/or the Building (other than due to Premises Total -6- Destruction when abatement of Lessee's rent shall commence as of the date of such destruction, (b) any repair, maintenance or alteration performed by Lessor after the Commencement Date and required or permitted by the Lease, which substantially interferes with Lessee's use of the Premises, the Premises parking and/or the Building, (c) any failure by Lessor to provide Lessee with services or access to the Premises, the Premises parking and/or the Building, (d) because of an eminent domain proceeding, or (e) because of the presence of Hazardous Substances in, on or around the Premises, the Building or the Site which could pose a health risk to occupants of the Premises, then Lessee's Base Rent shall be abated or reduced, as the case may be, after expiration of the Eligibility Period for such time that Lessee continues to be so prevented from using, and does not use, the Premises or a portion thereof, in the proportion that the rentable area of the portion of the Premises that Lessee is prevented from using, and does not use, bears to the total rentable area of the Premises. However, in the event that any portion of the Premises comprising seventy-five percent (75%) of the rentable area of the Premises is rendered unusable as described hereinabove, then for such time after expiration of the Eligibility Period during which such portion of the Premises is so rendered unusable, the Base Rent for the entire Premises shall be abated; provided, however, if Lessee reoccupies and conducts its business from any portion of the Premises during such period, the rent allocable to such reoccupied portion, based on the proportion that the rentable area of such reoccupied portion of the Premises bears to the total rentable area of the Premises, shall be payable by Lessee from the date such business operations commence. If Lessee's right to abatement occurs because of an eminent domain taking and/or because of damage or destruction to the Premises, the Premises parking, the Building, or Lessee's property, provided rental value insurance proceeds are available to Lessor therefor, Lessee's abatement period shall continue until Lessee has been given sufficient time and sufficient access to the Premises, the Premises parking facility and/or the Building, to rebuild such portion it is required to rebuild, to install its property, furniture, fixtures, and equipment to the extent the same shall have been removed and/or damaged as a result of such damage or destruction and/or eminent domain taking and to move in over one (1) weekend. To the extent Lessee is entitled to abatement without regard to the Eligibility Period, because of an event covered by Lease Articles 9 or 14, then the Eligibility Period shall not be applicable. 10.1 DEFINITION OF "REAL PROPERTY TAXES". Real Property Taxes shall not include any tax based on any net income of Lessor with respect to the Building for state or federal income tax purposes and shall not include any tax penalties incurred as a result of Lessor's negligence or failure to file any tax or informational returns when due. 10.2 PAYMENT OF TAXES. Paragraph 10.2 is hereby deleted. Lessee shall pay all Real Property Taxes to Lessor who shall pay such amounts directly to the taxing authorities prior to delinquency thereof. Such payment shall be made only at such time as payment of Real Property Taxes is actually due to the taxing authorities to prevent imposition of penalties for delinquent payment. Real Property Taxes shall also include reimbursement to Lessor for its prepayment of amounts assessed against the Premises under City of Carlsbad Community Facilities District #1, provided such reimbursement is made in such amounts and at such times as such assessment would have been payable by Lessor in the ordinary course absent such prepayment. 10.3 JOINT ASSESSMENT. Paragraph 10.3 of the Lease is hereby deleted. 10.4 PERSONAL PROPERTY TAXES. All of Paragraph 10.4 of the Lease except for the first sentence thereof is hereby deleted. -7- 12.1 ASSIGNMENT AND SUBLETTING. Lessor's Consent required. All of Paragraph 12.1 of the Lease is hereby deleted and replaced with the following: Lessee shall not voluntarily or by operation of law assign, transfer, mortgage or encumber (collectively, "assign or assignment") or sublet all or any part of Lessee's interest in this Lease or in the Premises without Lessor's prior written consent. Notwithstanding the foregoing, Lessee may assign the Lease or may sublet the Premises or any part thereof without Lessor's consent to any subsidiary, parent, affiliate or control corporation or to any corporation which acquires all of Lessee's assets or with which it may merge providing Lessee remains liable and the use does not substantially change. Notwithstanding any other provision in Paragraph 12 of the Lease, Lessor's consent to a sublease shall not be required and Lessor shall not have the right to adjust the rental so long as all of the following conditions are and remain satisfied: (a) the sublease is for a portion of the Premises constituting less than fifty percent (50%) of the total rentable square feet of the Premises; (b) Lessee continues to occupy the remaining portions of the Premises; (c) the sublessee does not employ on the Premises Hazardous Substances in violation of Applicable Requirements and its use is not otherwise in violation of the Lease; and (d) Lessee is not otherwise in Breach of this Lease. For any other assignment or subletting, Lessor agrees it will not unreasonably withhold, condition or delay its consent to any such assignment or subletting. Rental amounts in excess of the Base Rent payable to Lessor by Lessee under the Lease (the "Excess Rental") on account of such assignment or subletting will be shared between the Lessor and Lessee. Lessor shall be entitled to that portion of the Excess Rental arising by virtue of the value of the Premises as a warehouse (offices, distribution of electrical, bathrooms etc.) and Lessee shall be entitled to that portion of the Excess Rental arising by virtue of the improvements installed by Lessee having a biopharmaceutical use and character as opposed to an industrial/office use and character; PROVIDED, HOWEVER, Excess Rental shall be calculated net of all expenses incurred by Lessee in any assignment or subleasing of the Premises, including, without limitation, any amounts paid to Lessor by Lessee during periods where the assigned or subleased portion of the Premises was vacant; any improvement allowance or other economic concession paid by Lessee to any sublessee or assignee; broker's commissions; attorneys' fees; lease take-over payments; costs of advertising the space for sublease or assignment; and any other costs actually paid in assigning or subletting the Premises. Lessor shall not be paid any Excess Rental amounts until Lessee has recovered all such costs incurred in connection with such subleasing or assignment. 12.2(e) The amount which Lessor may receive for consideration of any request for assignment or subletting shall not exceed $500 in any instance. 12.3(c) Paragraph 12.3(c) is hereby modified to provide that for any action by a sublessee with respect to the Premises that would trigger a requirement for Lessor's consent under the Lease if such action were taken by Lessee under the Lease, such subtenant shall be required to seek Lessor's consent to such action. 12.3(e) The last sentence of Paragraph 12.3(e) is hereby deleted. 13.1(b) Paragraph 13.1(b) is hereby deleted and replaced with the following: The failure to pay any installment of base rent, or any other monetary payment required to be made by Lessee under the Lease, when due and payable hereunder, upon the date when payment is due, such failure continuing for a period of five (5) business days after written notice of such failure; or -8- 13.1(c) Paragraph 13.1(c) is hereby modified to replace the reference to "ten (10) days" with a reference to "thirty (30) days." 13.1(f) Paragraph 13.1(f) is hereby deleted and replaced with the following: "All notices to be given pursuant to this Section 13.1 shall be in addition to, and not in lieu of, the notice requirements of California Code of Civil Procedure Section 1161." 13.1(g) Paragraph 13.1(g) is hereby deleted from the Lease. 13.4 LATE CHARGES. The late charge of 10% is deleted and replaced with a late charge of six percent (6%). 13.5 INTEREST. The reference to 4% for purposes of calculating Interest on the Lease is deleted and replaced with two percent (2%). 15. BROKERS' FEES. Lessor shall be responsible for payment of all fees owed to the Brokers with respect to the Lease. 16.2 Lessee shall have no obligation to deliver any financial statements to Lessor so long as Lessee is required to report to the United States Securities and Exchange Commission with respect to its financial status and such filings are publicly available. 26. NO RIGHT TO HOLDOVER. The amount of 150% as an increase in the Base Rent for a holdover by Lessee shall not apply if Lessee has notified Lessor not less than three (3) months prior to the expiration of the Term of the Lease that Lessee intends to hold over in the Premises, subject to Lessor's written consent, not to be unreasonably withheld, conditioned or delayed, in which event such holdover by Lessee shall be on all the terms and provisions of the Lease, at a Base Rent adjusted pursuant to Section 55 below. The duration of such holdover shall be specified by Lessee at the time notice of such holdover is given to Lessor and shall not exceed three (3) months. 30.2 ATTORNMENT. As a condition to any requirement of attornment hereunder, the beneficiary of a Security Device shall have elected that this Lease shall be prior and superior to such Security Device prior to any event of foreclosure thereunder. 31. ATTORNEYS' FEES. The provisions of Paragraph 31 of the Lease shall apply to arbitration. 32. LESSOR'S ACCESS. Lessor shall only enter the Premises to the extent reasonably required by Lessor and not "as Lessor may deem necessary." 37. GUARANTOR. Paragraph 37 is hereby deleted from the Lease. 39.2 OPTIONS PERSONAL TO ORIGINAL LESSEE. Notwithstanding the provisions of Paragraph 39.2, Lessee may assign its Options under the Lease to any permitted assignee under the Lease provided Lessee remains liable for full performance of the Lease by such assignee. 40. MULTIPLE BUILDINGS. Paragraph 40 is hereby deleted from the Lease. 50. TENANT IMPROVEMENTS. Lessee at its sole cost shall be responsible for the Tenant Improvements including space plans, building plans, and for all costs of construction including, but not by way of limitation, permit fees for its Tenant Improvements. Office improvements shall be constructed of a quality comparable to the quality existing at 5935 Darwin Court or otherwise reasonably acceptable to Lessor and consist of a -9- minimum of 5,100 square feet on the second floor and 5,100 square feet directly below on the first floor. A minimum of 5,100 square feet of such office improvements shall be completed within twelve (12) months of the Commencement Date, with the remainder to be completed not later than eighteen (18) months from the Commencement Date. Lessee's plans for construction of the Tenant Improvements ("Lessee's Plans") and its general contractor for such construction shall be subject to the Lessor's prior approval to be given not later than ten (10) business days after submittal to Lessor, with Lessor's approval not to be unreasonably withheld, conditioned or delayed. In the event Lessor disapproves Lessee's Plans, Lessor shall specify the reasons for such disapproval and Lessee shall have ten (10) business days to revise and re-submit Lessee's Plans for Lessor's approval. Lessor shall respond thereto within five (5) business days and if the revised Lessee's Plans are again disapproved by Lessor, the foregoing procedure shall be re-instituted until Lessor's approval is obtained. Lessee warrants that the Tenant Improvements will comply with all Applicable Requirements in effect at the time of such construction. Lessee shall construct as part of the Tenant Improvements, screening of the HVAC units on the roof of the Building in accordance with the requirements of the covenants, conditions and restrictions ("CC&Rs") applicable to the project of which the Building is a part. Lessee acknowledges that Lessor has notified those individuals responsible for administering the CC&Rs that such screening will be completed in accordance with the attached Schedule 50. Unless Lessee is successful in obtaining such individual's consent to a deviation from the screening requirements set forth in the attached Schedule 50, Lessee shall complete such screening to the satisfaction of such individuals in accordance with the attached Schedule 50. 50.1 The phrase "Tenant Improvements" means all interior and exterior (including HVAC systems) improvements which will not be part of the Building Shell constructed by Lessor and shall include but not by way of limitation (a) partitions, walls, doors, (b) all surface finishes, including wall coverings, paint, floor coverings, suspended ceilings and other similar items, (c) duct work, heat pumps, vents filters, diffusers, terminal boxes and accessories for completion of heating, ventilation and air conditioning systems within the Premises, (d) electrical distribution systems (including panels, subpanels, wires and outlets), lighting fixtures, outlets, switches and other electrical work to be installed in the Premises, (e) plumbing lines, fixtures and accessories, and all fire and life safety control systems such as fire walls and fire alarms ( including piping, wiring and accessories) to be located in the Premises , (f) improvements required for compliance with Title 24, and other governmental agencies, and (g) all the construction specific for Lessee's biopharmaceutical needs, to the extent the foregoing are included in the Plans. Lessee represents and warrants that no part of its Tenant Improvements will contain ACHM in violation of Applicable Requirements in effect at the time of such construction. If Lessee does employ ACHM, the ACHM will be promptly removed in a manner required by the appropriate government agency in accordance with Applicable Requirements. Lessee shall be fully responsible for making all alterations and repairs to the Tenant Improvements at its cost to remove any and all ACHM resulting from or necessitated by the failure of Lessee and/or Lessee's contractor to comply with Applicable Requirements regarding ACHM's in effect at the time of such construction, or from Lessee's and/or Lessee's contractor's utilization of Hazardous Substances as defined by Applicable Requirements, in violation of such Applicable Requirements or which could pose a health risk to occupants of the Premises. 51 OPERATING EXPENSES. In addition to payment of the Base Rent, Lessee shall, from and after the Start Date, be responsible for payment of all "Operating Expenses." The term "Operating Expenses" means all direct expenses and costs attributable to Lessee's use, occupancy and operation of the Premises which are customary in a "triple net" lease. Other than payments of Real Property Taxes, the Administration Fee and premiums for insurance policies maintained by Lessor as the Insuring Party, all Operating Expenses shall be paid directly by Lessee to the appropriate third party provider of services, utilities or items of operating expense prior to -10- delinquency. Lessor shall promptly forward to Lessee any and all invoices received by Lessor with respect to Operating Expenses, and in all events in sufficient time to permit timely payment thereof by Lessee. Operating Expenses shall also include a fee payable to Lessor (the "Administration Fee") for the due and punctual performance of all administrative responsibilities of Lessor under the Lease. The Administration Fee shall be payable concurrently with Base Rent in an amount equal to two percent (2%) of the monthly Base Rent then payable with respect to the Premises. In the event of any abatement of rent permitted Lessee pursuant to the provisions of the Lease, the Administration Fee shall also be abated in the same proportion as the Base Rent. 52. SERVICES. At the time of completion of the Building Shell, Lessor and its contractors shall, at no cost to Lessee, provide "as-builts" for the Building Shell and shall conduct a thorough inspection of the Building's systems in order to certify that the equipment and systems are in full working order. At the same time, Lessor will supply a written certification of the results of its mechanical contractor's inspection. Lessee will be given all certifications that Lessor receives from its contractors, subcontractors and vendors for construction of the Building Shell. 53. NON-DISTURBANCE. Lessor warrants and represents that in the event Lessor introduces any lien or mortgage holder to the Premises, then Lessor will obtain nondisturbance agreements in a form reasonably acceptable to Lessee from any and all of such mortgage or lien holders, ground lessors, etc., which agreements shall provide that as long as Lessee is not in default of the Lease beyond any applicable grace period, Lessee's occupancy of the Premises shall not be disturbed, its rights under the Lease will continue to be recognized and all of the Lessor's future obligations under the Lease will continue to be performed. 54. REAL ESTATE LICENSES. California law requires that Lessee be informed that Roland A. Childs, a general partner of the Childs Family Investment Partnership, L.P. and Allan J. Gardner, a trustee of the A. J. Gardner Family Trust are each State of California Real Estate Licensees. 55. RENT ADJUSTMENTS. The monthly rent for each month of the adjustment periods specified below shall be increased using the cost of living adjustment. (a) On the month of the first anniversary of the Commencement Date and each twelve months thereafter, the monthly rent payable under paragraph 1.5 ("Base Rent") of the Lease shall be adjusted by the change, if any, from the Base Month specified below, in the Consumer Price Index of the Bureau of Labor Statistics of the US Department of Labor for CPI U (All Urban Consumers), for Los Angeles-Anaheim-Riverside, All Items (19821984=100), herein referred to as "CPI." (b) The monthly rent payable in accordance with subparagraph (a) of this Section 55 shall be calculated as follows: the Base Rent set forth in Paragraph 1.5 of the Lease, shall be multiplied by a fraction the numerator of which shall be the CPI of the calendar month 2 (two) months prior to the month specified in (a) during which the adjustment is to take effect, and the denominator of which shall be the CPI of the calendar month which is two (2) months prior to the month containing the Commencement Date. The sum so calculated shall constitute the new monthly rent hereunder, but in no event, shall any such new monthly rent be less than the rent payable for the month immediately preceding the date for rent adjustment nor shall it be less than three (3) percent or more than six (6) percent during the first five (5) years unless the CPI exceeds twelve (12) percent in which case the overage over twelve (12) percent will be added to the maximum six (6) percent as additional rent. Thereafter, during the remainder of the initial term and any extension if one or both of the two options to extend are exercised, the Base Rent will be adjusted utilizing the same CPI in the same manner with an annual minimum of three (3) percent increase and a maximum seven (7) percent increase unless the CPI exceeds thirteen (13) percent in which case the overage over thirteen (13) percent will be added to the maximum seven (7) percent as additional rent. -11- 56. OPTIONS TO EXTEND. Lessor hereby grants to Lessee two (2) options (each, an "Option") to extend the Term of this Lease for an additional sixty (60) month period for each Option, commencing when the prior term expires upon each and all of the following terms and conditions: (i) Lessee gives to Lessor and Lessor actually receives (which receipt may be independently confirmed by Lessee) on a date which is prior to the date that the option period would commence (if exercised) by at least six (6) and not more than nine (9) months, a written notice in accordance with the Lease of the exercise of the options to extend this Lease for said additional terms, time being of the essence. If said notification of the exercise of said Options are not so given and received, the Options shall automatically expire; said Options may only be exercised consecutively; (ii) The provisions of Paragraph 39, including the provision relating to default of Lessee set forth in Paragraph 39.4 of this Lease are conditions of the Options; (iii) All of the terms and conditions of this Lease except where specifically modified by these Options shall apply; (iv) The monthly Base Rent for each month of the applicable Option period shall be calculated as follows, using the methods indicated below: MARKET RENTAL VALUE ADJUSTMENTS (MRV) (a) On the 10th anniversary of the Commencement Date if the first Option to extend is timely exercised and again five (5) years later if the second Option to extend is timely exercised, Base Rent shall be adjusted to the "Market Rental Value" of the Premises as follows: 1. Four months prior to the Market Rental Value (MRV) Adjustment Dates described above, Lessor and Lessee shall meet to establish an agreed upon new MRV for comparable space in the Carlsbad Research Center for the specified term. In determining MRV, the comparable space will be limited to an industrial building with offices, electrical distribution and other typical warehouse space such as but not limited to bath rooms but specifically excluding the peculiar attributes required by a biopharmaceutical firm such as refrigeration, and required plumbing and piping. If agreement cannot be reached, then: (i) Lessor and Lessee shall immediately appoint a mutually acceptable appraiser or broker to establish the new MRV within the next thirty (30) days. Any associated costs will be split equally between the parties, or (ii) Both Lessor and Lessee shall each immediately select and pay the appraiser or broker of their choice to establish a MRV within the next thirty (30) days. If, for any reason, either one of the appraisals is not completed within the next thirty (30) days, as stipulated, then the appraisal that is completed at that time shall automatically become the new MRV. If both appraisals are completed and the two appraisers/brokers cannot agree on a reasonable average MRV then they shall immediately select a third mutually acceptable appraiser/broker to establish a third MRV within the next thirty (30) days. The average of the two appraisals closest in value shall then become the new MRV. The costs of the third appraisal will be split equally between the parties. 2. If Lessee does not add additional mezzanine to the existing 5,100 sq. ft., the minimum MRV will be One and Five One-Hundredths Dollars ($1.05) per ft. for the eleventh (11th) year and One and Twenty-One One-Hundredths Dollars ($1.21) for the sixteenth (16th) year. If Lessee adds additional mezzanine during the Term of the Lease, the minimum MRV will be computed in the same manner as the -12- stated minimums were determined, the example of which is shown on the attached Schedule 56. In any event, the new MRV shall not be less than the Base Rent payable for the month immediately preceding the date for rent adjustment. (b) Upon the establishment of each new MRV: 1. The monthly Base Rent so calculated for each Term as specified in subsection (a) above will become the new "Base Rent" for the purpose of calculating any further CPI adjustments as specified in Section 55 above; and 2. the first month of each Market Rental Value term as specified in subsection (a) above shall become the new "Base Month" for the purpose of calculating any further Cost of Living Adjustments as specified in Paragraph 55. 57. ARBITRATION. This Addendum provision contains the sole and exclusive method, means and procedure to resolve any and all disputes or disagreements, including whether any particular matter constitutes, or with the passage of time would constitute, a Default or Breach under the Lease. The parties hereby irrevocably waive any and all rights to the contrary and shall at all times conduct themselves in strict, full, complete and timely accordance with the provisions of this Addendum provision. Any and all attempts to circumvent the provisions of this Addendum provision shall be absolutely null and void and of no force or effect whatsoever. As to any matter submitted to arbitration to determine whether it would, with the passage of time, constitute a Default or Breach, such passage of time shall not commence to run until any such affirmative determination, so long as it is simultaneously determined that the challenge of such matter as a potential Default or Breach was made in good faith, except with respect to the payment of money. With respect to the payment of money, such passage of time shall not commence to run only if the party which is obligated to make the payment does in fact make the payment to the other party. Such payment can be made "under protest," which shall occur when such payment is accompanied by a good-faith notice stating why the party has elected to make a payment under protest. This Section shall not prevent Lessor's recourse to the L/C or to cash held in lieu thereof for Breaches under the Lease, however, if Lessee disputes the existence of such Breach any draw down of the L/C or cash held in lieu thereof, as the case may be, shall be deemed made "under protest" pending resolution of such dispute hereunder. Such protest will be deemed waived unless the subject matter identified in the protest is submitted to arbitration as set forth in the following: (a) ARBITRATION PANEL. Within ninety (90) days after delivery of written notice ("Notice of Dispute") of the existence and nature of any dispute given by any party to the other party, and unless otherwise provided herein in any specific instance, the parties shall each: (i) appoint one (1) lawyer actively engaged in the licensed and full-time practice of law, specializing in real estate, in the County of San Diego for a continuous period immediately preceding the date of delivery ("Dispute Date") of the Notice of Dispute of not less than ten (10) years, but who has at no time ever represented or acted on behalf of any of the parties, and (ii) deliver written notice of the identity of such lawyer and a copy of his or her written acceptance of such appointment and acknowledgment of and agreement to be bound by the time constraints and other provisions of this Addendum provision ("Acceptance") to the other parties hereto. The party who selects the lawyer may not consult with such lawyer, directly or indirectly, to determine the lawyer's position on the issue which is the subject of the dispute. In the event that any party fails to so act, such arbitrator shall be appointed pursuant to the same procedure that is followed when agreement cannot be reached as to the third arbitrator. Within ten (10) days after such appointment and notice, such lawyers shall appoint a third lawyer (together with the first two (2) lawyers, "Arbitration Panel") of the same qualification and background and shall deliver written notice of the identity of such lawyer and a copy of his or her written Acceptance of such appointment to each of the parties. In the event that agreement cannot be reached on the appointment of a third lawyer within such period, such appointment and notification shall be made as quickly as possible by any court of competent jurisdiction, -13- by any licensing authority, agency or organization having jurisdiction over such lawyers, by any professional association of lawyers in existence for not less than ten (10) years at the time of such dispute or disagreement and the geographical membership boundaries of which extend to the County of San Diego or by any arbitration association or organization in existence for not less than ten (10) years at the time of such dispute or disagreement and the geographical boundaries of which extend to the County of San Diego, as determined by the party giving such Notice of Dispute and simultaneously confirmed in writing delivered by such party to the other party. Any such court, authority, agency, association or organization shall be entitled either to directly select such third lawyer or to designate in writing, delivered to each of the parties, an individual who shall do so. In the event of any subsequent vacancies or inabilities to perform among the Arbitration Panel, the lawyer or lawyers involved shall be replaced in accordance with the provisions of this Addendum provision as if such replacement was an initial appointment to be made under this Addendum provision within the time constraints set forth in this Addendum provision, measured from the date of notice of such vacancy or inability, to the person or persons required to make such appointment, with all the attendant consequences of failure to act timely if such appointed person is a party hereto. (b) DUTY. Consistent with the provisions of this Addendum provision, the members of the Arbitration Panel shall utilize their utmost skill and shall apply themselves diligently so as to hear and decide, by majority vote, the outcome and resolution of any dispute or disagreement submitted to the Arbitration Panel as promptly as possible, but in any event on or before the expiration of thirty (30) days after the appointment of the members of the Arbitration Panel. None of the members of the Arbitration Panel shall have any liability whatsoever for any acts or omissions performed or omitted in good faith pursuant to the provisions of this Addendum provision. (c) AUTHORITY. The Arbitration Panel shall (i) enforce and interpret the rights and obligations set forth in the Lease to the extent not prohibited by law, (ii) fix and establish any and all rules as it shall consider appropriate in its sole and absolute discretion to govern the proceedings before it, including any and all rules of discovery, procedure and/or evidence, and (iii) make and issue any and all orders, final or otherwise, and any and all awards, as a court of competent jurisdiction sitting at law or in equity could make and issue, and as it shall consider appropriate in its sole and absolute discretion, including the awarding of monetary damages (but shall not award consequential damages to either party and shall not award punitive damages except in situations involving knowing fraud or egregious conduct condoned by, or performed by, the person who, in essence, occupies the position which is the equivalent of the chief executive officer of the party against whom damages are to be awarded), the awarding of reasonable attorneys' fees and costs to the prevailing party as determined by the Arbitration Panel and the issuance of injunctive relief. If the party against whom the award is issued complies with the award, within the time period established by the Arbitration Panel, then no Default or Breach will be deemed to have occurred, unless the Default or Breach pertained to the non-payment of money by Lessee or Lessor, and Lessee or Lessor failed to make such payment under protest. (d) APPEAL. The decision of the Arbitration Panel shall be final and binding, may be confirmed and entered by any court of competent jurisdiction at the request of any party and may not be appealed to any court of competent jurisdiction or otherwise except upon a claim of fraud on the part of the Arbitration Panel, or on the basis of a mistake as to the applicable law. The Arbitration Panel shall retain jurisdiction over any dispute until its award has been implemented, and judgment on any such award may be entered in any court having appropriate jurisdiction. -14- (e) COMPENSATION. Each member of the Arbitration Panel (i) shall be compensated for any and all services rendered under this Addendum provision at a rate of compensation not to exceed the sum of (a) Two Hundred Fifty Dollars ($250.00) per hour and (b) the sum of Ten Dollars ($10.00) per hour multiplied by the number of full years of the expired Term under the Lease, plus reimbursement for any and all expenses incurred in connection with the rendering of such services, payable in full promptly upon conclusion of the proceedings before the Arbitration Panel. Such compensation and reimbursement shall be borne by the nonprevailing party as determined by the Arbitration Panel in its sole and absolute discretion. _________________ _________________ Lessor's Initials Lessee's Initials 58. ACCESS; PARKING. Lessee shall have full and uninterrupted access to the Premises twenty-four (24) hours per day, seven (7) days per week, every day of the year. All parking allocated to the Building under Applicable Requirements shall be for Lessee's sole and exclusive use at no additional cost or rent during the entire Lease Term or any extensions thereof. Lessee's parking privileges shall be available to Lessee twenty-four (24) hours per day, seven (7) days per week, every day of the year. 59. ENTRY BY LESSOR. Notwithstanding anything to the contrary set forth in the Lease to the contrary, Lessor and/or those acting on Lessor's behalf may only enter the Premises upon not less than two (2) business days prior notice to Lessee acknowledged by Lessee, except in cases of emergency, in which case only telephone notice shall be required. In any event, any such entry shall be accomplished as expeditiously as reasonably possible, in a manner so as to cause as little interference to Lessee as reasonably possible and in accordance with Lessee's security requirements. Lessor shall be accompanied by an employee of Lessee at all times. Lessee may designate certain areas of the Premises as "Secured Areas" should Lessee require such areas for the purpose of securing certain valuable property or confidential information or operations. Lessor may not enter such Secured Areas except in the case of emergency or in the event of a permitted Lessor inspection, in which case Lessor shall provide Lessee with five (5) business days' prior written notice of the specific date and time of such Lessor inspection and be accompanied by an employee of Lessee on all such inspections. 60. WHEN PAYMENT IS DUE. Other than payment of Base Rent, whenever in the Lease a payment is required to be made by one party to the other, but a specific date for payment is not set forth or a specific number of days within which payment is to be made is not set forth, or the words "immediately," "promptly" and/or "on demand," or their equivalent, are used to specify when such payment is due, then such payment shall be due thirty (30) days after the party which is entitled to such payment sends written notice to the other party demanding such payment. 61. LESSOR BANKRUPTCY PROCEEDING. In the event that the obligations of Lessor under the Lease are not performed during the pendency of a bankruptcy or insolvency proceeding involving the Lessor as the debtor, or following the rejection of this Lease in accordance with Section 365 of the United States Bankruptcy Code, then notwithstanding any provision of this Lease to the contrary, Lessee shall have the right to set off against rents next due and owing under this Lease (a) any and all damages caused by such non-performance of Lessor's obligations under the Lease by Lessor, debtor-in-possession, or the bankruptcy trustee, and (b) any and all damages caused by the non-performance of Lessor's obligations under the Lease following any rejection of the Lease in accordance with Section 365 of the United States Bankruptcy Code. 62. CONSENT/DUTY TO ACT REASONABLY. Regardless of any reference to the words "sole" or "absolute" (but except for matters which (a) would have an adverse effect on the structural integrity of the Building Shell, (b) could have an adverse effect on the Building HVAC systems, or (c) could have an effect on the exterior appearance of the Building, whereupon in each such case Lessor's duty is to act in good faith and in compliance with the Lease), any time the consent of Lessor or Lessee is required, such consent shall not be unreasonably -16- withheld, conditioned or delayed. Whenever the Lease grants Lessor or Lessee the right to take action, exercise discretion, establish rules and regulations or make allocations or other determinations (other than decisions to exercise expansion, contraction, cancellation, termination or renewal options), Lessor and Lessee shall act reasonably and in good faith and take no action which might result in the frustration of the reasonable expectations of a sophisticated lessee or lessor concerning the benefits to be enjoyed under the Lease. 63. COVENANTS AND AGREEMENTS. The failure of Lessor or Lessee to insist in any instance on the strict keeping, observance or performance of any covenant or agreement contained in the Lease, or the exercise of any election contained in the Lease, shall not be construed as a waiver or relinquishment for the future of such covenant or agreement, but the same shall continue and remain in full force and effect. 64. DAYS. All references in the Lease to "days" involving less than "ten (10) days" shall mean business days, and all references to "notice" shall mean written notice. 65. JOINT AND SEVERAL OBLIGATIONS. The obligations of Lessor under the Lease shall be joint and several obligations of the entities comprising Lessor. 66. DEFINITION OF APPLICABLE REQUIREMENTS. The use of the term "Applicable Requirements" in the Lease and this Addendum shall mean those laws, statutes, codes, ordinances, regulations, covenants and restrictions applicable to the matter to which such Applicable Requirements are stated to apply in the Lease and this Addendum. -16- SCHEDULE 1.2 LIST OF LESSOR'S PLANS [OMITTED] -17- SCHEDULE 5 FORM OF LETTER OF CREDIT [OMITTED] -18- SCHEDULE 6.2 FORM OF HAZARDOUS MATERIALS QUESTIONAIRE [OMITTED] -19- SCHEDULE 50 PROPOSED ROOF SCREENING REQUIREMENTS [4 PAGES OF GRAPHICS OF SCREENING OMITTED] -20- SCHEDULE 56 MARKET RENTAL VALUE CALCULATION [OMITTED] -21- AMENDMENT NO. 1 TO LEASE This AMENDMENT NO. 1 TO LEASE ("Amendment") is made as of January 31, 1998 by and between The Childs Family Investment Partnership, L.P. and The A. J. Gardner Family Trust u/t/a 3/5/81, general partners doing business as "Darwin Court" but holding title as tenants-in-common (collectively, "Lessor") and The Immune Response Corporation, a Delaware corporation ("Lessee") and shall amend and supplement that certain Standard Industrial/Commercial Single-Tenant Lease Net between Lessor and Lessee dated as of December 15, 1997, together with the Exhibits and a certain Addendum to Lease attached thereto (collectively, the "Lease"). All defined terms used in this Amendment, unless specifically defined in this Amendment, shall have the same meaning as such terms have in the Lease. NOW THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereby agree as follows: 1. AMENDMENTS TO LEASE. The following amendments to the Lease shall become effective upon full execution of this Amendment: 1.1 EARLY POSSESSION. Early Possession shall be deemed to have occurred on February 1, 1998 (the "Early Possession Date"). Notwithstanding such Early Possession, Lessee shall have no liability for claims or liabilities that arise out of any items of construction comprising any portion of the Building Shell to the extent such items were not completed as required under this Lease by Lessor as of the Early Possession Date. Early Possession by Lessee of such incomplete items shall not occur until such items are completed by Lessor in accordance with the requirements of the Lease. 1.2 COMMENCEMENT DATE. The Commencement Date of the Lease shall be the first to occur of: (i) Lessee's completion of the Tenant Improvements in accordance with the requirements of the Lease; and (ii) May 1, 1998. 2. EFFECT OF AMENDMENT; COUNTERPARTS. All references in the Lease and in this Amendment shall be construed to mean the Lease, as amended and supplemented by this Amendment. In the event of a conflict between the provisions of the Lease and this Amendment, this Amendment shall control. This Amendment may be executed in multiple counterparts, each of which shall be deemed an original, but all of which, together, shall constitute one and the same Amendment. IN WITNESS WHEREOF, the parties have executed this Amendment No.1 to Lease as of the date first set forth above. LESSOR LESSEE The Childs Family The Immune Response Corporation Investment Partnership, L.P. By: /s/ ROLAND A. CHILDS By: /s/ PAULA ATKINS -------------------------- ------------------------------- Roland A. Childs Name: Paula Atkins Its: General Partner ---------------------------- Title: Vice-President ---------------------------- /s/ ALLAN J. GARDNER - --------------------------- Allan J. Gardner, Trustee of the A.J. Gardner Family Trust, Under Declaration of Trust Dated March 5, 1981 -1- EX-21.1 3 EXHIBIT 21.1 Exhibit 21.1 SUBSIDIARIES OF THE REGISTRANT I.R.C. Inc., a Delaware corporation EX-23.1 4 EXHIBIT 23.1 Exhibit 23.1 CONSENT OF ARTHUR ANDERSEN, LLP, INDEPENDENT AUDITORS As independent public accountants, we hereby consent to the incorporation of our report in this Form 10-K into The Immune Response Corporation's previously filed Registration Statements on Form S-8 pertaining to the 1989 Stock Plan, the Amended and Restated 1990 Directors' Stock Plan and the Special Nonstatutory Stock Option Agreement of The Immune Response Corporation. Arthur Andersen, LLP San Diego, California March 24, 1998 EX-27.1 5 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON PAGES F2 AND F3 OF THE COMPANY'S FORM 10-K FOR THE YEAR-TO-DATE, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 3-MOS DEC-31-1997 OCT-01-1997 DEC-31-1997 4,872 25,567 0 0 0 31,212 11,012 5,202 37,375 2,273 0 0 0 57 35,045 37,375 0 4,437 0 37,994 0 0 0 (33,557) 0 (33,557) 0 0 0 (33,557) (1.53) (1.53)
-----END PRIVACY-ENHANCED MESSAGE-----