NOTE 7. COMMITMENTS AND CONTINGENCIES

Leases

The Company leases approximately 8,500 square feet of office space for its corporate headquarters in Pasadena, California. The lease will expire in September 2019. Rental costs are approximately $26,000 per month, increasing approximately 3% annually.

On January 8, 2016, the Company entered into a new lease for a Madison, Wisconsin research facility. The 10-year lease between with University Research Park, Inc. is for approximately 60,000 square feet of office and laboratory space located at 502 South Rosa Road, Madison, Wisconsin. This lease will replace the Company’s research facility lease, also with University Research Park, Inc. for property located at 465 Science Drive, Madison Wisconsin. The larger facility is designed to accommodate increased research and development space needed for the Company’s pipeline of current and future drug candidates.

The initial term of the lease commenced on January 1, 2016, with occupancy occurring October 2016. The lease payments and payments against a note payable for a tenant improvement allowance, which begin on October 1, 2016, will total approximately $15.2 million over the initial 10-year term. The Company also estimates payments for the Company’s pro rata share of certain real estate taxes, operating expenses and common area maintenance expenses to be approximately $0.6 million for the first year of the lease, and these payments will continue throughout the initial 10-year term. The Company has paid or accrued for approximately $7.0 million for leasehold improvements at September 30, 2016, net of tenant improvement allowances, and the work on the facility has been substantially completed in October 2016. The primary tenant improvement allowance of $2.1 million is accounted for as deferred rent and the secondary tenant improvement allowance of $2.7 million is accounted for as a note payable on the Company’s Consolidated Balance Sheet. Pursuant to the lease, within six months of the expiration of the initial 10-year term, the Company has the option to extend the lease for up to two additional five-year terms, with certain annual increases in base rent.

Additionally, on January 8, 2016 and in conjunction with signing the new lease agreement as discussed above, the Company entered into an amendment to the Company’s research facility lease for property located at 465 Science Drive, Madison, Wisconsin with University Research Park, Inc. to terminate the lease agreement for this property, effective on October 31, 2016.

Monthly rental expense under the previous facility which was in effect through September 30, 2016 was approximately $26,000. Other monthly rental expenses include common area maintenance and real estate taxes totaling approximately $20,000 per month. Utilities costs are approximately $18,000 per month. Total monthly costs are approximately $83,000 per month, including monthly payments recorded under a capital lease of approximately $19,000.

The Company leased additional research facility space in Middleton, Wisconsin, and this space is leased through December 2016. Monthly rental expense for the additional space is approximately $14,000. Other monthly rental expenses include common area maintenance and real estate taxes totaling approximately $4,000 per month.

Facility rent expense for the years ended September 30, 2016, 2015 and 2014 was $839,000, $744,000 and $554,000, respectively.

As of September 30, 2016, future minimum lease payments due in fiscal years under operating leases are as follows:

2017	$	1,559,259
2018		1,531,765
2019		1,435,409
2020		1,044,431
2021		1,070,496
2022 and thereafter		5,766,495
Total	$	12,407,855

Note Payable

As part of the Company’s lease for its new research facility in Madison, Wisconsin discussed above, the Company entered into a $2.7 million promissory note payable with its landlord to finance certain tenant improvements made to the new facility. The note will be amortized over the 10-year term of the lease, commencing on October 1, 2016. The note will bear interest at a rate of 7.1% and shall be payable in equal monthly installments of principal and interest.

As of September 30, 2016, future principal payments due in fiscal years under the note payable are as follows:

2017	$	194,310
2018		208,506
2019		223,820
2020		240,258
2021		257,903
2022 and thereafter		1,602,968
Total	$	2,727,765

Litigation

The Company and certain of its officers and directors were named as defendants in a putative consolidated class action in the United States District Court for the Central District of California regarding certain public statements in connection with the Company’s hepatitis B drug research. The consolidated class action, initially filed as Wang v. Arrowhead Research Corp., et al., No. 2:14-cv-07890 (C.D. Cal., filed Oct. 10, 2014), and Eskinazi v. Arrowhead Research Corp., et al., No. 2:14-cv-07911 (C.D. Cal., filed Oct. 13, 2014), asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and sought damages in an unspecified amount. Additionally, three putative stockholder derivative actions captioned Weisman v. Anzalone et al., No. 2:14-cv-08982 (C.D. Cal., filed Nov. 20, 2014), Bernstein (Backus) v. Anzalone, et al., No. 2:14-cv-09247 (C.D. Cal., filed Dec. 2, 2014); and Johnson v. Anzalone, et al., No. 2:15-cv-00446 (C.D. Cal., filed Jan. 22, 2015), were filed in the United States District Court for the Central District of California, alleging breach of fiduciary duty by the Company’s Board of Directors in connection with the facts underlying the securities claims. An additional consolidated derivative action asserting similar claims is pending in Los Angeles County Superior Court, initially filed as Bacchus v. Anzalone, et al., (L.A. Super., filed Mar. 5, 2015); and Jackson v. Anzalone, et al. (L.A. Super., filed Mar. 16, 2015). Each of these suits seeks damages in unspecified amounts and some seek various forms of injunctive relief. On October 7, 2016, the federal district court dismissed the consolidated class action with prejudice. On October 10, 2016 the plaintiffs appealed the consolidated class action to the United States Court of Appeals for the Ninth Circuit. The Weisman and Johnson derivative actions have been dismissed without prejudice. The Bernstein derivative action remains pending. The Company believes it has meritorious defenses and intends to vigorously defend itself in each of these matters. The Company makes provisions for liabilities when it is both probable that a liability has been incurred and the amount can be reasonably estimated. No such liability has been recorded related to these matters. The Company does not expect these matters to have a material effect on its Consolidated Financial Statements. With regard to legal fees, such as attorney fees related to these matters or any other legal matters, the Company’s recognizes such costs as incurred.

The Company and two of its former executives were named as defendants in a complaint filed on November 11, 2014 and captioned William Marsh Rice University vs. Unidym, Inc. and Arrowhead Research Corporation, No. 2014-66088, in the United States District Court for the Southern District of Texas relating to alleged breaches of a license agreement between Rice University and the Company’s former subsidiary, Unidym, Inc. The Company and the plaintiff settled the matter under an agreement in which the Company paid a confidential settlement amount and the plaintiff permanently dismissed its claims. The amount of the settlement was recorded during the three months ended March 31, 2016 and did not have a material effect on the Company’s Consolidated Financial Statements.

The Company and certain executive officers were named as defendants in related putative securities class actions filed on November 15, 2016 and December 2, 2016 in the Central District of California and respectively captioned Meller v. Arrowhead Pharmaceuticals, Inc., et al., No. 2:16-cv-08505, and Siegel v. Arrowhead Pharmaceuticals, Inc., et al., No. 2:16-cv-8954. The plaintiff brings claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 regarding certain public statements in connection with the Company’s drug research programs and seek damages in an unspecified amount. The Company believes it has meritorious defenses and intends to vigorously defend itself in these matters. The Company makes provisions for liabilities when it is both probable that a liability has been incurred and the amount can be reasonably estimated. No such liability has been recorded related to these matters. The Company cannot predict the ultimate outcome of this matter and cannot accurately estimate any potential liability the Company may incur or the impact of the results of this matter on the Company. With regard to legal fees, such as attorney fees related to these matters or any other legal matters, the Company’s recognizes such costs as incurred.

Purchase Commitments

In the normal course of business, we enter into various purchase commitments for the manufacture of drug components, for toxicology studies, and for clinical studies. As of September 30, 2016, these future commitments were estimated at approximately $10.4 million, of which approximately $10.4 million is expected to be incurred in fiscal 2017, and $0 is expected to be incurred beyond fiscal 2017. The reduction in amount and timing of these commitments is due to the Company’s discontinuation of its clinical trials for ARC-520, ARC-AAT and ARC-521.

Technology License Commitments

The Company has licensed from third parties the rights to use certain technologies for its research and development activities, as well as in any products the Company may develop using these licensed technologies. These agreements and other similar agreements often require milestone and royalty payments. Milestone payments, for example, may be required as the research and development process progresses through various stages of development, such as when clinical candidates enter or progress through clinical trials, upon NDA and upon certain sales level milestones. These milestone payments could amount to the mid to upper double-digit millions of dollars. During the year ended September 30, 2016, 2015, and 2014, we reached milestones amounting to $3.0 million, $1.0 million and $1.0 million, respectively, based on progress achieved on our clinical candidates. In certain agreements, the Company may be required to make mid to high single-digit percentage royalty payments based on a percentage of the sales of the relevant products.