-----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, HykYuZBOfyDhSmoBbPMpiRts0XXX11OU3d1EOSPh3vS9w+q2qVtzIOkSJgTLFgFI 4PmKxbkOidYDHyl6xMeDEQ== 0000913610-99-000007.txt : 19990402 0000913610-99-000007.hdr.sgml : 19990402 ACCESSION NUMBER: 0000913610-99-000007 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SANGSTAT MEDICAL CORP CENTRAL INDEX KEY: 0000913610 STANDARD INDUSTRIAL CLASSIFICATION: BIOLOGICAL PRODUCTS (NO DIAGNOSTIC SUBSTANCES) [2836] IRS NUMBER: 943076069 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22890 FILM NUMBER: 99582203 BUSINESS ADDRESS: STREET 1: 1505 ADAMS DR CITY: MENLO PARK STATE: CA ZIP: 94025 BUSINESS PHONE: 6503280300 MAIL ADDRESS: STREET 1: 1505 ADAMS DR CITY: MENLO PARK STATE: CA ZIP: 94025 10-K 1 FORM 10-K FOR PERIOD ENDING 12/31/98 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 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 0-22890 SANGSTAT MEDICAL CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 94-3076-069 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) 1505 ADAMS DRIVE MENLO PARK, CALIFORNIA 94025 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICE, ZIP CODE) Registrant's telephone number, including area code: (650) 328-0300 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock ($.001 par value) Preferred Share Purchase Rights 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 a 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. [ ] The aggregate market value of voting stock held by non-affiliates of the Registrant, as of March 18, 1999 was approximately $229,528,000 (based on the closing price for shares of the Registrant's Common Stock as reported by the NASDAQ National Market System of $18.25 on that date). Shares of Common Stock held by each officer, director, and holder of 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. On March 18, 1999 approximately 16,307,684 shares of the Registrant's Common Stock, $.001 par value, were outstanding. ========================================================================== PART I ITEM 1. BUSINESS Overview SangStat, The Transplant Company(R), is a specialty pharmaceutical company applying a disease management approach to improve the outcome of organ transplantation. The Company's devices, drugs and services form a family of products that address the needs of patients in each stage of transplant care from pre-transplant monitoring to lifetime post- transplant care. SangStat's product pipeline is a combination of proprietary and licensed-in products that are in various stages of research, development and marketing. The Company plans to capitalize on this pipeline by developing relationships with key providers and managed care organizations to better integrate the management of transplant recipients' care to improve the outcomes and lower costs. SangStat has a variety of monitoring and therapeutic products and product candidates to address the pre-transplant, acute care and chronic phases of transplantation. SangStat received U.S. Food and Drug Administration ("FDA") marketing approval for SangCya(TM) (Cyclosporine Oral Solution, USP [MODIFIED]) ("SANGCYA") in October 1998 and received marketing approval in the United Kingdom in January 1999. Cyclosporine, which to date has only been marketed by Novartis AG ("Novartis"), is the leading immunosuppressive drug used by transplant patients, with estimated worldwide sales of over $1.3 billion in 1998. SANGCYA is AB rated to Neoral oral solution which signifies that SANGCYA is therapeutically equivalent to, and interchangeable with, Neoral oral solution. SANGCYA will be marketed with the CYCLOTECH device, a hand- held liquid dispensing device once CYCLOTECH is commercially available. Thymoglobulin [Anti-thymocyte Globulin, (Rabbit)] ("THYMOGLOBULIN") has been marketed in Europe since 1985. THYMOGLOBULIN was approved for marketing in the United States by the FDA in December 1998 for acute renal rejection and launched by the Company in February 1999. SangStat is also conducting clinical trials for the following products and devices: SANG-2000, a capsule dosage form based on an oil-free cyclosporine formulation technology similar to SANGCYA; a generic AZATHIOPRINE product candidate for use as an adjunct therapy in chronic immunosuppression; ANTILFA, for prevention of Delayed Graft Function (DGF); ALLOTRAP 1258, a proprietary HLA peptide designed to promote graft acceptance; CELSIOR, a formulated solution for organ preservation; and CYCLOSTAT and CREASTAT for monitoring cyclosporine and serum creatinine concentrations, respectively. To further the Company's goal of providing comprehensive disease management, the Company has a division, THE TRANSPLANT PHARMACY, which provides mail order distribution of drugs and transplant patient management services. Organ Transplantation Organ transplantation can save or improve the lives of patients with organ failures for whom there are few alternative treatments. Transplantation involves surgically replacing the failed organ of a transplant recipient with a viable organ from a donor. Because the success of a transplant depends on the degree of compatibility between the organ donor and the recipient, a typical transplant candidate must wait on a national computerized waiting list until a compatible organ can be found. Currently, there are approximately 100,000 transplant candidates registered on waiting lists in approximately 500 transplant centers throughout North America and Europe. At any given time, approximately 70% of these patients are waiting for kidney transplants. The other patients are waiting for liver, heart, heart-lung, bowel or pancreas transplants. Each year approximately 50,000 new patients receive donated organs. In order to prevent rejection of implanted organs, recipients must begin a life-long regimen of immunosuppressive therapy immediately upon receiving a donated organ. There are more than 240,000 patients in North America and Europe that need daily immunosuppressive therapy to prevent graft rejection and graft loss. In addition to being a life-saving and life-enhancing procedure, transplantation can be cost-effective as well. For example, the cost over a 10-year period of a kidney transplant is generally less than the cost of dialysis. However, transplantation is still very costly, due in substantial part to the costs of lifetime immunosuppressive therapy and associated side effects as well as the costs of treating rejection and infection episodes. Therefore, products that limit the need for immunosuppression and reduce the frequency and severity of rejection and infection episodes could significantly improve the cost-effectiveness of transplantation. The Transplant Immune Response The function of the immune system is to protect the body from damage caused by invading microorganisms or other foreign matter, including donor organs. This defensive function is performed by the humoral (B- cell) and cell-mediated (T-cell) arms of the immune system. When challenged, the humoral and cell-mediated systems interact and generate a coordinated immune response to recognize, target and eliminate the pathogen or, in the case of transplantation, the donor organ, thereby resulting in graft rejection. Specifically, the donor organ antigens (HLA molecules) are recognized by the immune system of the graft recipient as being "non-self." The immune response to a transplant depends on the level of compatibility between donor and recipient HLA molecules. The HLA system consists of a complex array of molecules playing a key role in the normal immune response as well as in graft acceptance or rejection. Dr. Jean Dausset, a scientific advisor to SangStat, and Nobel Prize laureate for this pioneering discovery, originally discovered HLAs. Molecular differences between an organ donor's and a recipient's HLAs lead to the recognition of the donor's HLAs as non-self by the recipient's immune system. Graft rejection results when the recipient's immune system T- cell progenitors recognize the donor's HLAs as non-self, activate against the graft and proliferate into numerous cytotoxic T-cells. When these cytotoxic T-cells invade and attack the graft, rejection and loss of the organ often occur. In addition to T-cells, anti-HLA antibodies can play an active role in the anti-graft immune response. The presence of anti-HLA antibodies in the recipient's blood may indicate a high risk of accelerated rejection. Maximizing HLA compatibility by selecting, for a given recipient, the donor whose HLAs are as similar as possible to the recipient's HLAs and not recognized by antibodies preexisting in the recipient's blood, is key to reducing the risk of rejection. However, because it is extremely difficult to get a perfect HLA match except in identical twins, rejection episodes occur frequently. Current therapies used to reduce the occurrence of rejection episodes involve the chronic use of immunosuppressants, which impair the entire immune system of the recipient. Even with the use of immunosuppressants, graft rejection remains frequent, and their chronic use can lead to serious side effects, including life-threatening infections, kidney or liver toxicity and cancers. The Transplant Process A typical transplant patient progresses through three clinical phases: the pre-transplant phase; the acute phase (surgery and first year post- transplant); and the chronic phase (lifetime post-transplant). The Pre-Transplant Phase. A transplant candidate is registered on a national computerized waiting list, which ranks candidates according to the urgency of the need for a transplant and maintains the data necessary to determine if a compatible organ becomes available. A kidney transplant candidate usually waits months or even years for a compatible organ and continues to undergo dialysis several times per week to substitute for the failed kidneys. Typically, a blood sample is collected as frequently as monthly and evaluated to estimate the candidate's level of immune sensitization against a panel of HLA molecules representative of the population of prospective organ donors. This procedure, called Panel Reactive Antibody (PRA) testing utilizes microlymphocytotoxicity, a complex and subjective laboratory method developed in the 1960s. Traditional HLA compatibility testing lacks accuracy and standardization and therefore often results in poor matching of donors and recipients. The Acute Phase (Surgery and First Year Post-Transplant). Most organs are retrieved from trauma victims who are declared brain-dead but maintain cardiac function until their organs are removed. The harvested organs are stored in a preservation solution to prevent deterioration and then tissue typed to determine the level of HLA antigens. Each organ is cross-matched with approximately 100 potential recipients on the transplant waiting lists. Once the best candidate for each organ has been chosen, the organ is shipped in an organ preservation solution to the recipient's transplant center. The length of storage time allowed before transplant varies among organ types and can severely limit the distance an organ can be shipped. The quality of organ preservation is therefore an important factor contributing to the viability of the transplant. Transplant surgery has become a relatively safe and standardized procedure. After the transplant, the challenge for physicians is to prevent graft rejection by suppressing the activity of T-cells. Consequently, the success of the transplant is highly dependent on the immunosuppressive regimen that is initiated the day of transplantation and continued daily for the rest of the patient's life. In addition, organ recipients must be regularly monitored to measure the body's immune response and blood drug levels and to identify acute rejection episodes. Despite the use of immunosuppressants, during the first year following transplantation many transplant patients (estimates range from 15% in certain populations to more than 60% in others, depending on risk factors and therapy) undergo one or more graft rejection episodes. During a rejection episode, the body mounts an immune attack on the graft, resulting in impaired function of the transplanted organ. Because rejection, infection and drug toxicity produce similar symptoms, diagnosis of rejection may be difficult until it reaches an advanced stage and is confirmed by an invasive graft biopsy. The only way to stop the rejection process is by administering additional immunosuppressive therapy, such as high doses of steroids, and/or anti-T-cell monoclonal and/or polyclonal antibodies. In many cases, rejection can be arrested and organ damage reversed. However, at the end of the first year, about 20% to 50% of kidney transplant patients (and a higher percentage for other organs) have had rejection. This rejection may lead to graft loss in about 20% of kidney transplant patients (and a higher percentage for other organs). If the graft loss occurs early post-transplant (within the first few months following transplantation), surgery is typically required to remove the rejected kidney. Regardless of whether surgery is performed, the patient must return to chronic dialysis and possibly receive a second transplant, which has a lower probability of success than the first. Failure to reverse rejection of other organs often results in the death of the patient. The Chronic Phase (Lifetime Post-Transplant). The use of immunosuppressants, initiated during the acute phase, is continued daily throughout the patient's lifetime to minimize or prevent the loss of the graft by acute or chronic rejection. Conventional therapy typically combines several drugs, most commonly cyclosporine, azathioprine and steroids, or alternative combinations for certain patients using tacrolimus and/or mycophenolate mofetil. These drugs act nonspecifically and broadly impair the recipient's immune system in order to reduce the immune response against the graft. Cyclosporine is the leading immunosuppressive drug used in the post-transplant phase. In 1998, worldwide sales of Novartis' cyclosporines, Sandimmune and Neoral, were estimated at over $1.3 billion. Even with the use of immunosuppressants, patients have an approximate 5% to 20% risk of losing grafts per year during the first three years following transplantation, and less than 50% of patients have functioning grafts after approximately ten years. Products, Product Candidates and Services SangStat's portfolio of complementary drugs, monitoring products, product candidates and services are designed to prevent and treat graft rejection and monitor patients throughout the patient's lifetime. The following table summarizes SangStat's principal products, product candidates and services.
TRANSPLANT POTENTIAL CLINICAL PHASE PRODUCT/SERVICE USE STATUS(1) - -------------- ----------------- -------------------- ------------------------- Pre-Transplant PRA-STAT(R) Detects anti-HLA Marketed US and Europe Monitoring antibodies in candidates monthly Transplant Thymoglobulin(R) Treats acute Marketed worldwide Acute Care kidney rejection (FDA approval 12/98) episodes Lymphoglobuline Treats acute Marketed outside US kidney rejection episodes Allotrap 1258(2) Promotes graft Pre-clinical acceptance Celsior(TM) Preserves organs Cardiac clinical trials prior to completed. Filing transplantation anticipated first half 1999 Antilfa(TM) For prevention of Phase III Delayed Graft Function (DGF) Lifetime Post- SangCya(TM) Chronic Markted in US (US launch Transplant Cyclosporine Oral immunosuppression 11/98) Care Solution (prevent organ UK approval 1/99 rejection) Sang-2000 Chronic Bioequivalance trials Cyclosporine immunosuppression completed. Filing Capsules (prevent organ anticipated first half 1999 rejection) CycloTech(R) Dispensing/Dosing FDA 510(k) clearance device 8/98 (3) Cyclo-Stat(TM) Device for measuring Clinical trials cyclosporine levels in blood CreaStat(TM) Device for measuring Clinical trials creatinine levels in blood Azathioprine Chronic Bioequivalance trials immunosuppression completed. Filing (prevent organ anticipated first half 1999 rejection) The Transplant Mail order and 17 centers participating Pharmacy (R) patient management program
(1) "Phase I, II or III" indicates that the product candidate is in a certain stage of clinical trials. "Bioequivalence Trials" are clinical studies in healthy volunteers which assess pharmacokinetic parameters of the drug candidate against the reference drug to support an application for the approval of a generic drug without the need for safety and efficacy trials. "Marketed" means that commercial sales of the product have commenced. See "-Government Regulation." (2) ALLOTRAP 1258 is a second generation peptide to Allotrap 2702. Allotrap 1258 currently in pre-clinical development was found to be more potent than 2702 and the Company may decide to develop this peptide in lieu of Allotrap 2702. The result of the Phase II study in Europe showed that Allotrap 2702 was safe and well-tolerated in the study. (3) Not yet commercially available. CYCLOSPORINE PRODUCTS SANGCYA On October 31, 1998 the FDA granted marketing approval to SANGCYA for prevention of rejection in solid organ transplant recipients, and an AB rating versus Neoral(R) oral solution (a Novartis cyclosporine formulation). SANGCYA includes the same active ingredient, in the same concentration, in the same dosage form and is bioequivalent to Neoral but in a formulation proprietary to SangStat. The United States Patent and Trademark Office has issued two separate patents owned by SangStat, Patent No. 5,766,629 (June, 1998) and Patent No. 5,827,822 (October 1998), covering SangStat's proprietary cyclosporine formulation technology for developing multiple formulations and dosage forms of cyclosporine including SangCya. The AB rating signifies that SANGCYA is therapeutically equivalent to, and interchangeable with, Neoral oral solution. SANGCYA was launched in the United States in November 1998. It is marketed in the United States by the SangStat direct sales force. SANGCYA is the first therapeutically equivalent competitor of Neoral oral solution to be introduced in the U.S. cyclosporine marketplace. Cyclosporine, the leading immunosuppressive drug used to prevent graft rejection in transplantation, is marketed by Novartis in two different formulations, Sandimmune and Neoral. Neoral is the newer formulation of cyclosporine marketed by Novartis. Approximately 70% of the patients in the U.S. on Sandimmune(R), the older formulation of cyclosporine first introduced in 1983, have switched to Neoral, the newer, less expensive and more bioavailable formulation introduced in 1995. There are approximately 140,000 transplant recipients in the U.S. and 250,000 worldwide who require daily immunosuppressive therapy for life from the time of transplant surgery, and the majority of these individuals take cyclosporine. Global sales of cyclosporine were estimated at $1.3 billion in 1998, with oral solution sales representing approximately 10% of the total cyclosporine market. SANGCYA's indications are identical to Neoral's indications and include (i) the prophylaxis of organ rejection in kidney, liver and heart allogeneic transplants; (ii) the treatment of patients with severe, active rheumatoid arthritis where the disease has not adequately responded to methotrexate; and (iii) the treatment of adult, non- immunocompromised patients with severe (i.e. extensive and or disabling), recalcitrant, plaque psoriasis who have failed to respond to at least one systemic therapy (e.g.; PUVA, retinoids or methotrexate), or in patients for whom either systemic therapies are contraindicated, or cannot be tolerated. SANGCYA was granted marketing approval in the United Kingdom on January 28, 1999. SangStat plans to seek marketing approval in other countries of the European Union through the mutual recognition procedure. See - European Regulation - Approval of Therapeutic Products. SangStat expects to launch SANGCYA in the UK during the first half of 1999. The European market is roughly equivalent to the U.S. market in size and scope. There are approximately 20,000 new transplant recipients per year concentrated in just 250 transplant centers and over 100,000 transplant recipients in Europe who require daily lifelong immunosuppressive therapy from the time of transplant surgery. Estimated 1998 sales of cyclosporine exceeded $450 million in Europe and $70 million in the UK. CYCLOTECH In August 1998, SangStat received marketing clearance (510k) from the FDA for the CYCLOTECH device. CYCLOTECH is a hand-held liquid dispensing device intended for use by transplant recipients with SANGCYA Oral Solution. The CYCLOTECH device contains electronic event monitoring capabilities, recording medication dosing patterns that can be viewed by physicians via a proprietary software interface. This software enables physicians, via computer, to download recorded information from the CYCLOTECH device that includes a patient's detailed daily dosing history for up to a full year. The CYCLOTECH device and software will be supplied to transplant centers and utilized as part of a comprehensive disease management offering which includes SANGCYA Oral Solution. SangStat expects to launch CYCLOTECH in the U.S. in the second quarter of 1999 with full commercial availability in the U.S. in the second half of 1999. SangStat expects to launch CYCLOTECH in selected countries outside the U.S., including but not limited to, the United Kingdom and Australia. SANG-2000 In January 1999, SangStat announced the positive results of the SANG- 2000 bioequivalence pivotal trial versus Neoral(R) cyclosporine capsules. SANG-2000 cyclosporine is a capsule dosage form based on an oil-free cyclosporine formulation technology similar to SANGCYA and covered by United States Patent No. 5,766,629, which was issued in June, 1998. Based on these results, SangStat intends to file for marketing clearance in the U.S. and Europe during the first half of 1999. SangStat's SANG-2000 pivotal pharmacokinetic trial was a single-dose, randomized, cross-over bioequivalence trial in 27 healthy human volunteers comparing SangStat's cyclosporine capsule with the reference drug, Neoral capsule. Subjects had blood samples taken at defined time points over a 36-hour period and the cyclosporine blood levels were analyzed using a standardized, validated cyclosporine assay. Under current FDA regulations and policy, SANG-2000 capsule may be approved without the need to duplicate the safety and efficacy trials if it is shown to be bioequivalent to Neoral capsule. Two different formulations of the same drug are considered bioequivalent if the drug's absorption rate, blood concentration and persistence in the bloodstream are demonstrated to be equivalent according to defined regulatory policy. Two key pharmacokinetic parameters, area under the blood concentration vs. time curve (AUC) and the maximum drug concentration (Cmax) are measured in human bioequivalence trials. These parameters are calculated from drug levels measured in the blood over a defined time period following dosing. Based on this trial, under current FDA policy, and subject to FDA review, SANG-2000 and Neoral capsules may be considered bioequivalent: the 90% confidence intervals (for the ratio of the log transformed parameters of SANG-2000 and Neoral capsules) were contained within the range of 80% to 125%, for AUC and Cmax. Statistical comparison of the key pharmacokinetic parameters for SANG-2000 and Neoral yield results which the Company believes demonstrate bioequivalence; however, the FDA has not yet reviewed any of these data. Successful development and commercialization of SANG-2000 is subject to numerous risks, including failure to obtain regulatory approvals and potential intellectual property claims of third parties, including those of Novartis and its contract manufacturers. In addition, if the Company is unable to demonstrate to the FDA that SANG-2000 is bioequivalent to the Neoral capsule, a currently approved Novartis formulation, the Company would be required to undertake additional development work and seek regulatory approval through the potentially longer NDA process if it wished to continue to pursue this product candidate. THYMOGLOBULIN/LYMPHOGLOBULINE THYMOGLOBULIN was granted approval for marketing by the FDA on December 30, 1998 for the treatment of acute rejection in kidney transplant recipients. THYMOGLOBULIN is a pasteurized anti-thymocyte rabbit immunoglobulin that induces immunosuppression as a result of T-cell depletion and immune modulation. THYMOGLOBULIN is made up of a variety of antibodies that recognize key receptors on T-cells, the cells of a transplant recipient's immune system that recognize and ultimately reject foreign objects such as a transplant. The exact mechanism is unknown, researchers believe THYMOGLOBULIN antibodies may inactivate and kill these T-cells, thus reversing the rejection process. SangStat launched THYMOGLOBULIN in the United States in February 1999. It is marketed by SangStat's direct sales force. In Europe, SangStat markets THYMOGLOBULIN under the trademark THYMOGLOBULINE through its wholly owned European affiliate IMTIX-SangStat. Acquired by SangStat in 1998, and operating now in Europe as IMTIX-SangStat, IMTIX was a division of the French pharmaceutical company Pasteur Merieux Connaught ("PMC"), a world leader in vaccines (Rhone Poulenc group) that had previously registered THYMOGLOBULINE in 51 European and other countries. THYMOGLOBULINE is a leader in Europe among anti-T cell antibodies and is indicated in Europe for prophylaxis and rejection in kidney, pancreas and liver transplants; treatment of rejection crises and acute Graft Versus Host Disease in allogeneic bone marrow transplantation; and aplastic anemia. In Canada, SangStat has filed a New Drug Submission (NDS) and is generating revenues through the distribution of THYMOGLOBULIN under that country's Emergency Drug Release (EDR) program, which permits the distribution of certain products before final regulatory approval. The Company announced in January 1998 the preliminary positive results of the first U.S. double blinded trial evaluating THYMOGLOBULIN vs. Atgam for induction therapy, at the time of transplant, to prevent acute graft rejection in kidney transplant patients. Atgam is an anti-thymocyte globulin (equine) marketed by Pharmacia and Upjohn. Based on the results of this induction trial, SangStat expects to conduct further studies with THYMOGLOBULIN for the prevention of organ transplant rejection, as part of its development program for this new indication in the United States. The Company is also conducting North American clinical trials with THYMOGOLBULIN for use in bone marrow transplantation. SangStat acquired LYMPHOGLOBULINE in 1998 as part of the IMTIX acquisition. LYMPHOGLOBULINE is a pasteurized anti-thymocyte equine immunoglobulin that induces immunosuppression as a result of T-cell depletion and immune modulation. LYMPHOGLOBULINE is marketed internationally by IMTIX-SangStat for the prophylaxis and rejection in organ transplantation. It is not available in the United States and the Company has no plans to seek approval in the United States for this product. AZATHIOPRINE Azathioprine is an immunosuppressant that inhibits the development of T- cells by interfering with the differentiation and proliferation of activated lymphocytes. It is used as an adjunct for the prevention of rejection in renal organ transplantation. The patent for azathioprine composition of matter has expired. Therapy is usually initiated shortly after transplantation and continued daily for the patient's lifetime. It is used in conjunction with cyclosporine and steroids in the standard "triple therapy" regimen used by the majority of U.S. transplant centers. It is currently marketed as Imuran by Glaxo Wellcome Ltd. and as generic azathioprine by Roxane Laboratories and Bedford Laboratories. United States sales of all azathioprine products in 1998 were estimated to be $45 million. SangStat has developed a generic AZATHIOPRINE for use in transplantation as an adjunct therapy in chronic immunosuppression and has completed its pharmacokinetic and human bioequivalency trials. The Company intends to seek market approval by filing an Abbreviated New Drug Application ("ANDA") with the FDA and to market the product as a branded therapeutic substitute for Imuran. ANTILFA ANTILFA (Odulimomab), the monoclonal antibody 25.3, is a mouse lgG1 with specificity to the chain of the human leukocyte function-associated molecule LFA-1. ANTILFA can be used to block the LFA-1 molecule, thus reducing the cell-cell interaction. An anti-LFA-1 (CD11a) mAb, which inhibits adhesion of leukocytes is a potential agent for the prevention of acute renal allograft rejection. SangStat is conducting Phase III clinical trials with ANTILFA for prevention of Delayed Graft Function. SangStat acquired ANTILFA as part of the IMTIX transaction with PMC. ALLOTRAP PEPTIDES The ALLOTRAP family of peptides is derived from the Company's proprietary sHLA technology and is designed to promote graft acceptance. SangStat believes that the ALLOTRAP family of peptides may enable the body to accept a graft as self without otherwise limiting the normal operation of the immune system, thus possibly reducing the need for chronic immunosuppressive therapy. The Company believes that if an ALLOTRAP peptide is exposed to the recipient's T-cell progenitors simultaneously with the donor's HLAs, the T-cell progenitors are deactivated. As a result, the T-cells are not activated against the donor's HLA and do not reject the graft. The results of an initial Phase II safety study in Europe showed that ALLOTRAP 2702 was safe and well-tolerated in the study. Toxicology studies have been completed in a second generation peptide, ALLOTRAP 1258. Pre-clinical development has indicated that this second generation peptide may be more potent than ALLOTRAP 2702. As a result, the Company may decide to pursue the development of ALLOTRAP 1258 rather than ALLOTRAP 2702. The Company is also pursuing licensing opportunities for ALLOTRAP 1258 in the autoimmune area. Although the Company believes it conducted its clinical trials taking into account both European and U.S. regulatory standards, there can be no assurance that such data will be accepted by the FDA. The Company expects to conduct several additional Phase II clinical studies to assess product efficacy and optimize dosage before potentially conducting large-scale Phase III trials. The use of ALLOTRAP peptides to promote graft acceptance in humans is novel and unproven and there can be no assurance that such peptides will prove to be safe or effective in humans for any clinical indication for any transplant type or at any dosage. PRA-STAT PRA-STAT is intended to improve HLA compatibility between organ donors and recipients by providing accurate, rapid, efficient and standardized testing. PRA-STAT is designed for Panel Reactive Antibody (PRA) testing to track the appearance and disappearance of anti-HLA antibodies in transplant candidates, and to analyze such antibodies. This guides the selection criteria of the prospective donor for each transplant candidate. PRA testing is often performed every month on patients waiting for transplants. PRA-STAT was introduced in March 1994. In July 1996, the Company completed an agreement with Baxter Healthcare Corporation ("Baxter") to reacquire marketing rights to PRA-STAT in order to market this monitoring product directly and to better establish its own product distribution capabilities. The terms of this reacquisition included the obligation to pay Baxter royalties on future sales of the reacquired product. CELSIOR The quality of organ preservation is an important factor contributing to the viability of the transplant. Most organs are retrieved from trauma victims who are declared brain-dead but maintain cardiac function until their organs are removed. The procured organs are stored in a preservation solution to prevent deterioration and tissue typed to determine the HLA antigens. Following this, each donor must be crossmatched with the patients on the transplant waiting lists, each organ being crossmatched with approximately 100 potential recipients. Once the best candidate for each organ has been chosen, the organs are shipped to the recipient's transplant center. The amount of storage time allowed before transplant varies between organ types and can severely limit the distance an organ can be shipped. SangStat licensed CELSIOR from PMC in 1993 and acquired all rights to CELSIOR in the PMC-IMTIX transaction. CELSIOR is a formulated solution to store and extend viability of organs between organ recovery and transplantation. CELSIOR is sold by IMTIX-SangStat internationally for organ preservation. In the U.S., SangStat intends to assess the effect of CELSIOR on organ viability and speed of post-transplant organ function recovery. After consultation with the FDA, the Company voluntarily withdrew its 510(k) in 1996 for a two-component CELSIOR product in favor of a one component product. The Company has completed a multicenter clinical trial for a redesigned, one-component, ready-to-use CELSIOR product candidate for cardiac transplantation and intends to submit a new 510(k) during the first half of 1999 for this indication. The Company plans to conduct a multicenter clinical trial for use of CELSIOR in lung transplantation. CYCLOSTAT and CREASTAT The efficacy and safety of a transplant depends on individual susceptibility to graft rejection and immunosuppressive therapy. Transplant recipients must visit a clinic to provide a blood sample for the determination of a cyclosporine level. Similarly, the monitoring of kidney graft function requires the regular determination of serum creatinine concentrations. SangStat is developing several monitoring products for at-home use, which will assist the physician in customizing drug therapy for each patient: CYCLOSTAT and CREASTAT. CYCLOSTAT and CREASTAT are at-home blood collection devices for the measurement of cyclosporine and creatinine levels in capillary blood samples obtained from a fingerstick. These user-friendly blood collection devices will allow more frequent monitoring of cyclosporine levels and kidney function and improve out-patient management. They are designed to provide a health care provider with a patient's cyclosporine blood level without requiring the patient to travel to a health care facility. These at-home tests offer convenience to both patient and health care providers; patients will not have to arrange to travel to a health care facility. Both products are in development. The Company plans to seek marketing clearance of these products from the FDA upon successful completion of clinical trials. THE TRANSPLANT PHARMACY To further the Company's goal to provide comprehensive disease management, in September 1996 SangStat established THE TRANSPLANT PHARMACY, a program designed to provide mail order distribution of drugs and other services for transplant patients. Its first site of operation opened in September 1996 at the University of Tennessee Bowld Hospital Organ Transplant Center in Memphis, Tennessee. As of December 31, 1998, there were seventeen participating transplant center sites actively referring patients in the U.S.. The Company has also established a central mail order facility in Menlo Park, California. This service encourages the promotion of medication compliance, measures clinical and economic outcomes, and provides feedback directly to clinicians. Patients electing to enroll are able to have all of their medications filled through the program's central pharmacy. THE TRANSPLANT PHARMACY also places a key individual, such as a pharmacist, in each transplant center to interact directly with physicians, nurses and patients. THE TRANSPLANT PHARMACY's program seeks to provide a singular and integrated approach to the management of transplantation, in which the Company's drugs, monitoring products, and services can be supplied to meet the needs of individual transplant centers and their patients. On November 11, 1998, the Office of the Inspector General ("OIG") of the Department of Health & Human Services issued an Advisory Opinion which stated that the placement by a pharmacy of a licensed pharmacist at a hospital transplant center might constitute prohibited remuneration under the anti-kickback statute section 1128B9B) of the Social Security Act. The Company did not request the Advisory Opinion. The OIG regulations state that such opinions only apply to the requesting parties and the fact pattern set forth in their request for an advisory opinion. The Company believes that the operation of The Transplant Pharmacy differs from the fact pattern set out in the Advisory Opinion and does not constitute prohibited remuneration. There can be no assurance that the OIG will agree with this analysis, in which case The Transplant Pharmacy's program may be modified so that it would no longer include an on-site pharmacist at transplant centers. Sales and Marketing The Company currently markets through its direct sales force those products for which it retains commercial rights and has obtained regulatory approval. The Company hired a new Vice President of Sales on February 1, 1999. As of March 18, 1999, the Company has 21 Transplant Account Managers ("TAMs"), supervised by three regional sales directors, who detail primarily to the approximately 250 transplant centers in the United States. A number of the TAMs have backgrounds in transplantation, either from detailing other transplant products or with clinical backgrounds as nurses or as transplant coordinators in transplant centers. There are also two national account directors who call on group purchasing organizations and managed care groups. The Company also uses a variety of marketing techniques to promote its products, including sampling, journal advertising, promotional material, specialty publications, rebate coupons, product guarantees, educational conferences and exposure of its products on the Internet. In Europe, the products are marketed through IMTIX-SangStat's existing sales force and marketing team, which includes approximately 30 people who have been selling THYMOGLOBULIN and LYMPHOGLOBULIN, among other products, for the past ten years. There are also approximately 250 transplant centers in Europe. For certain territories, however, the Company may also enter into co- promotion arrangements or other licensing arrangements with pharmaceutical, diagnostic or biotechnology companies. In 1997, SangStat entered into an exclusive agreement with Amgen for the registration, marketing and distribution of SANGCYA and SANG-2000 in certain Asian Pacific Rim territories. SangStat retains the exclusive commercial rights to SANGCYA and SANG-2000 for all other territories including North America and Europe. To the extent the Company enters into co-promotion or other licensing arrangements, any revenues received by the Company will be dependent on the efforts of third parties and there can be no assurance that such efforts will be successful. To the extent that the Company itself undertakes to market a substantial portion of its products, or is unable to enter into co-promotion agreements or to arrange for third party distribution of its products, additional expenditures, management resources and time will be required to develop a sales force. Warehousing and Distribution The Company utilizes an independent warehousing corporation to store and distribute SANGCYA and THYMOGLOBULIN from one central warehousing location in Kentucky. Upon the receipt of a purchase order through electronic data input, phone, mail or facsimile, the order is placed to the warehouse for shipment, usually within 24 hours, to the customer placing the order. The warehousing corporation is also responsible for invoicing and collections. Strategic Relationships/Licensing Arrangements The Company evaluates on an ongoing basis potential collaborative relationships with corporate and other partners where such relationships may complement and expand SangStat's research, development, sales and marketing capabilities. There can be no assurance that the Company will be interested in or able to negotiate any additional collaborative arrangements or that, if established, such relationships will be successful. Pasteur Merieux Connaught On September 30, 1998, the Company completed the acquisition of PMC's organ transplant business known as IMTIX. The resulting wholly owned subsidiary of the Company, named IMTIX-SangStat, is dedicated to the research, development, manufacture and marketing of pharmaceuticals for transplantation. The Company will pay PMC royalties on IMTIX-SangStat product sales that are variable and contingent upon the sales of such IMTIX-SangStat products. Currently the Company contracts with PMC for certain steps in the manufacturing process of THYMOGLOBULIN and LYMPHOGLOBULINE. Additionally, the Company leases from PMC the manufacturing facilities for these two products. These agreements with PMC expire on dates ranging from 2008 to 2013. See "Risk Factors - Risks Associated With the Manufacture of SANGCYA, SANG-2000 and THYMOGLOBULIN." Amgen, Inc. In December 1997, the Company signed an exclusive agreement with Amgen, Inc. ("Amgen") for the registration, marketing and distribution of SANGCYA and SANG-2000 in select territories in the Asia/Pacific rim. SangStat has retained the exclusive commercial rights to SANGCYA and SANG-2000 in all other territories including North America and Western Europe. Under the terms of the agreement, Amgen will have exclusive rights to market SANGCYA and SANG-2000, under SangStat's branded trademark, in Australia, New Zealand, China and Taiwan. The licensing agreement includes an initial payment to SangStat, other milestone payments based on key regulatory submissions and approvals, and royalties. Amgen made four payments to SangStat in 1998 based upon milestones set forth in the Agreement. Stanford University SangStat has a worldwide, exclusive license from Stanford University to make, sell or otherwise distribute products covered by patents and patent applications on certain HLA peptides, including some of the ALLOTRAP peptides. Stanford University has no obligation to conduct any further research with respect to such ALLOTRAP peptides. The exclusivity of SangStat's rights under the license agreement with Stanford University expire in October 2007. Additionally, under the terms of this agreement, SangStat must pay to Stanford University annual license fees and a royalty on products covered by the license agreement. Competition The drugs being developed by the Company compete with existing and new drugs being created by pharmaceutical, biopharmaceutical, and biotechnology companies and universities. Many of these entities have significantly greater research and development capabilities, as well as substantial marketing, manufacturing, financial and managerial resources and represent significant competition for the Company. The principal factors upon which the Company's products compete are product utility, therapeutic benefits, ease of use, effective marketing, distribution and price. The Company believes it competes favorably with respect to all of these factors. With respect to SANGCYA, SANG-2000, THYMOGLOBULIN, and AZATHIOPRINE, the Company will be competing against large companies that have significantly greater financial resources and established marketing and distribution channels for equivalent products. For example, Novartis currently controls virtually 100% of the worldwide cyclosporine markets and has significantly greater resources than SangStat. There can be no assurance that the Company will be able to compete successfully against Novartis. The generic drug industry is characterized by intense price competition and the Company anticipates that it will face this and other forms of competition. There can be no assurance that developments by others will not render the Company's products or technologies obsolete or noncompetitive or that the Company will be able to keep pace with technological developments. Many of the competitors have developed or are in the process of developing technologies that are, or in the future may be, the basis for competitive products. Some of these products may have an entirely different approach or means of accomplishing the desired therapeutic effect than products being developed by the Company and may be more effective and less costly. In addition, many of these competitors have significantly greater experience than the Company in undertaking preclinical testing and human clinical trials of pharmaceutical products and obtaining regulatory approvals of such products. Accordingly, the Company's competitors may succeed in commercializing products more rapidly than the Company. The Company believes that other companies are developing cyclosporine formulations that may be marketed as generic equivalents. Were these competitors to develop their products more rapidly and complete the regulatory process sooner, it could have a material adverse effect on the Company's business, financial condition, cash flows and results of operations. Treatments for the problems associated with transplantation that the Company's products seek to address are currently available. For example, Sandimmune and Neoral, marketed by Novartis, compete with SANGCYA and SANG-2000. Orthoclone OKT3, marketed by Johnson & Johnson and ATGAM, marketed by Pharmacia & Upjohn Inc., Simulect, marketed by Novartis, and Zenapax, marketed by F. Hoffmann La-Roche Ltd., are competitive with THYMOGLOBULIN. Prograf marketed by Fujisawa Pharmaceutical Co. Ltd, CellCept, marketed by F. Hoffmann La-Roche Ltd. and Imuran, marketed by Glaxo Wellcome Ltd. are or would be competitive with SANGCYA, SANG-2000 and AZATHIOPRINE. All of such products are commercially available for use as immunosuppressive drugs and are widely prescribed. In addition, One Lambda Inc., Pel Freez, Biotest Diagnostics Corp., and Genetic Therapy, Inc. market products for pre-transplant HLA monitoring and Abbott Laboratories markets a cyclosporine level post-transplant monitoring device, all of which are widely used. Additional therapeutics and monitoring products are available or are under development by these and other parties including, but not limited to: American Home Products Corp. (rapamycin), Bristol Myers Squibb (CTLA4), and DuPont Merck (ViaSpan), and other companies including, but not limited to Abbott (cyclosporine), MedImmune Inc., BioTransplant, Inc., and Ivax Corp. In addition, THE TRANSPLANT PHARMACY also competes with other drug distribution companies, such as Chronimed Inc., MedCo, and Stadtlander Drug Company. To the extent these companies' therapeutics, monitoring products and services address the problems associated with transplantation on which the Company has focused, they may represent significant competition. Patents and Proprietary Technology The Company's policy is to seek patent protection and to enforce its intellectual property rights. The Company has three issued patents in the United States which cover its cyclosporine formulation technology, for developing multiple formulations and dosage forms of cyclosporine. The Company has ten issued patents which cover several different test formats for sHLA-based and allied assays, including PRA-STAT. The Company's patents expire on various dates beginning in the year 2008 and ending in the year 2017. SangStat has patent applications pending in the United States in the pretransplant and post-transplant monitoring, cyclosporine, and xenotransplantation areas. The Company has also filed patent applications with respect to several product candidates in many other countries, including Japan, Canada and the countries regulated by the European Patent Office. There can be no assurance that SangStat can manufacture, or have manufactured, formulate or commercialize SANGCYA and SANG-2000 without infringing patent or other proprietary rights of Novartis or other third parties. The Company has recently been sued by Novartis for patent infringement. See "Risk Factors-Litigation with Novartis." Some of the Company's family of ALLOTRAP peptides are being developed under an exclusive, worldwide, license from Stanford University. Although Stanford has filed patent applications with respect to such technology, no assurance can be given that the patent application or any of its claims will be allowed, valid, or enforceable or that the Company's products will not infringe on other patents. Patent applications in the United States are maintained in secrecy until patents issue. Since publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries by several months, SangStat cannot be certain that it was the first to discover compositions covered by its pending patent applications or the first to file patent applications on such compositions. There can be no assurance that the Company's pending patent applications will result in issued patents or that any of its issued patents will afford protection against a competitor. There can be no assurance that any patent issued to, or licensed by, the Company will provide protection that has commercial significance. The Company's patents involve specific claims and thus do not provide broad coverage. There can be no assurance that the Company's patent applications or any claims of these patent applications will be allowed, valid or enforceable, that any patents or any claims of these patents will provide the Company with competitive advantages for its products or that they will not be successfully challenged or circumvented by the Company's competitors. The Company also relies on trade secrets and proprietary know-how which it seeks to protect, in part, by confidentiality agreements with its employees and consultants. There can be no assurance that these agreements will not be breached, that the Company would have adequate remedies for any breach or that the Company's trade secrets will not otherwise become known or independently developed by competitors. The Company has registered or applied for registration of the names of most of its products under development or commercialized for research and development use. However, there can be no assurance that any trademark registration will be granted or not challenged by competitors. Manufacturing In 1998, the Company leased a manufacturing facility in Lyon, France as part of the IMTIX transaction for the manufacture of THYMOGLOBULIN. The Company's wholly-owned subsidiary, IMTIX-SangStat, manufactures THYMOGLOBULIN. There can be no assurance that IMTIX-SangStat will continue to meet FDA, or other regulatory agency's, standards governing Good Manufacturing Practices ("GMP"). The Company currently relies on PMC to perform certain services for the Company in the manufacturing process. See "Risk Factors-Risks Associated with the Manufacture of SANGCYA, SANG-2000 and THYMOGLOBULIN." The Company lacks facilities to manufacture any of its other drugs or drug candidates in accordance with current GMP prescribed by the FDA. The Company generally relies on third parties to manufacture compounds other than THYMOGLOBULIN for commercial sales and clinical trials, including SANGCYA, CYCLOTECH, SANG-2000, ALLOTRAP 1258, AZATHIOPRINE and CELSIOR and has contracted for commercial production of these compounds. The Company depends on such third parties to perform their obligations effectively and on a timely basis. There can be no assurance that such parties will perform and any such failure may delay clinical development or submission of products for regulatory approval, or otherwise impair the Company's competitive position which could have a material adverse effect on the Company's business, financial condition, cash flows and results of operations. In addition, the manufacturing of drug candidates involves a number of technical steps and requires meeting stringent quality control specifications imposed by government regulatory bodies and by the Company itself. Additionally, such products can only be manufactured in facilities approved by the applicable regulatory authorities. Because of these and other factors, the Company may not be able to quickly and efficiently replace its manufacturing capacity in the event that its manufacturers are unable to manufacture their products at one or more of their facilities. If these manufacturers were affected for any reason, the Company's ability to ship its products could be impaired, which could have a material adverse effect on the Company's business, financial condition, cash flows and results of operations. For certain of its products and potential products, the Company will need to develop further its production technologies for use on a larger scale in order to conduct human clinical trials and produce such potential products for commercial sale at an acceptable cost. The Company intends to rely on its third-party manufacturers to meet FDA required GMP. However, the Company is ultimately responsible for any failure of such manufacturers to meet such requirements. The Company has contracted for commercial scale production of cyclosporine bulk material for SANGCYA and SANG-2000 with Gensia Sicor as well as with a second FDA approved manufacturer. In addition, the Company has contracted for the production of its finished formulated SANGCYA and SANG-2000 with Eli Lilly and Company. The Company has also contracted for manufacture of azathioprine bulk material with an FDA approved manufacturer and with a separate FDA approved manufacturer for production of its finished formulated AZATHIOPRINE product candidate. There can be no assurance that such third parties will perform satisfactorily and any such failure may delay clinical trial development or the submission of the product for regulatory approval, impair the Company's ability to deliver products on a timely basis, or otherwise impair the Company's competitive position, which could have a material adverse effect on the Company's business, financial condition and results of operations. See "Risks Associated with the Manufacture of SANGCYA, SANG-2000 and THYMOGLOBULIN." Cyclosporine is particularly difficult to manufacture since it must be extracted from whole cells and carefully purified. There can be no assurance that SANGCYA and SANG-2000 can be manufactured in commercial quantities at an economical cost. There can be no assurance that SangStat can manufacture, or have manufactured, formulate or commercialize SANGCYA or SANG-2000 without infringing patent or other proprietary rights of Novartis or other third parties, due in part to the large number and scope of these patents and the difficulty of solubilizing cyclosporine into a formulated drug product. Although Novartis' composition of matter patent for cyclosporine expired in September 1995 in the United States, Novartis' patents relating to formulations are expected to continue to present significant barriers to entry to potential competitors. See "Risk Factors-Litigation with Novartis." The Company is currently purchasing ALLOTRAP peptides for its clinical trials under a supply agreement with UCB, S.A. ("UCB"). The Company believes that UCB adheres to established GMP production methods and complies with the Company's quality control and quality assurance standards. More than 10 lots of clinical amounts of ALLOTRAP peptides have been manufactured by UCB to date. The Company expects to purchase ALLOTRAP peptides from UCB for commercial sale. However, there can be no assurance that UCB will be able to scale up its manufacturing to support the commercial sale of ALLOTRAP peptides or that supply of ALLOTRAP peptides to the Company will be uninterrupted. With respect to its monitoring products including PRA-STAT, the Company has contracted for third party manufacturing and which the Company believes operates in compliance with GMP. However, there can be no assurance that this third party would pass a regulatory inspection from the FDA or other agencies. The raw materials required for the majority of the Company's products and product candidates are currently available from several suppliers in quantities sufficient to conduct the Company's research, development and clinical development activities. However, there can be no assurance that the raw materials necessary for the manufacture of the Company's products and product candidates will be available in sufficient quantities or at a reasonable cost. Complications or delays in obtaining raw materials or in product manufacturing could delay the submission of products for regulatory approval, product launch and the initiation of new development programs, which could materially impair the Company's business, financial condition, cash flows and results of operations. See "Risk Factors- Limited Manufacturing Capability." Government Regulation SangStat's research and development activities, preclinical studies and clinical trials, and ultimately the manufacturing, marketing and labeling of its products, are subject to extensive regulation by the FDA and other regulatory authorities in the United States and other countries. The United States Federal Food, Drug, and Cosmetic Act (the "Act") and the regulations promulgated thereunder and other federal and state statutes and regulations govern, among other things, the testing, manufacture, safety, efficacy, labeling, storage, record keeping, approval, advertising, promotion, import and export of the Company's products. Preclinical study and clinical trial requirements and the regulatory approval process typically take years and require the expenditure of substantial resources. Additional government regulation may be established that could prevent or delay regulatory approval of the Company's product candidates. Delays or rejections in obtaining regulatory approvals would adversely affect the Company's ability to commercialize any product candidates the Company develops and the Company's ability to receive product revenues or royalties. If regulatory approval of a product candidate is granted, the approval may include significant limitations on the indicated uses for which the product may be marketed. The FDA and other regulatory authorities require that the safety and efficacy of certain of the Company's product candidates be supported through adequate and well-controlled clinical trials. If the results of pivotal clinical trials submitted by the Company in applications for approval do not establish the safety and efficacy of the Company's product candidates to the satisfaction of the FDA and other regulatory authorities, the Company will not receive the approvals necessary to market its product candidates, which would have a material adverse effect on the Company's business, financial condition, cash flows and results of operations. FDA Regulation-Approval of Therapeutic Products The Company's therapeutic products are regulated as drugs and, in the case of THYMOGLOBULIN, as biological products. The steps ordinarily required before a drug or biological product may be marketed in the United States include (a) preclinical and clinical studies, (b) the submission to the FDA of an Investigational New Drug application ("IND"), which must become effective before human clinical trials may commence, (c) adequate and well-controlled human clinical trials to establish the safety and efficacy of the drug, (d) the submission to the FDA of New Drug Application ("NDA"), or Biological License Application ("BLA"), if applicable, and (e) FDA approval of the application, including approval of all product labeling. Preclinical tests include laboratory evaluation of product chemistry, formulation and stability, as well as animal studies to assess the potential safety and efficacy of each product. Preclinical safety tests must be conducted by laboratories that comply with FDA regulations regarding Good Laboratory Practice. The results of the preclinical tests are submitted to the FDA as part of an IND and are reviewed by the FDA before the commencement of human clinical trials. Unless the FDA objects to an IND, the IND will become effective 30 days following its receipt by the FDA. There can be no assurance that submission of an IND will result in FDA authorization to commence clinical trials or that the lack of an objection means that the FDA will ultimately approve an application for marketing approval. Clinical trials involve the administration of the investigational product to humans under the supervision of a qualified principal investigator. Clinical trials must be conducted in accordance with Good Clinical Practices ("GCP") under protocols submitted to the FDA as part of the IND. Also, each clinical trial must be approved and conducted under the auspices of an Institutional Review Board ("IRB") and with patient informed consent. The IRB will consider, among other things, ethical factors, the safety of human subjects and the possible liability of the institution conducting the clinical trials. Clinical trials are typically conducted in three sequential phases, but the phases may overlap. Phase I clinical trials involve the initial introduction of the drug into healthy human volunteers. In Phase I clinical trials, the drug is tested for safety (adverse effects), dosage tolerance, metabolism, distribution, excretion and pharmacodynamics (clinical Pharmacology). Phase II clinical trials are conducted in a target patient population to gather evidence about the pharmacokinetics, safety and biological or clinical efficacy of the drug for specific indications; to determine dosage tolerance and optimal dosage; and to identify possible adverse effects and safety risks. When a compound has shown evidence of efficacy and an acceptable safety profile in Phase II evaluations, Phase III clinical trials are undertaken to evaluate clinical efficacy and to test for safety in an expanded patient population. There can be no assurance that any of the Company's clinical trials will be completed successfully or within any specified time period. The Company or the FDA may suspend clinical trials at any time, if either entity concludes that clinical subjects are being exposed to an unacceptable health risk, or for other reasons. There can be no assurance that, after the results of the Phase III clinical trials have been announced, the FDA will not disagree with the design of the Phase III clinical trial protocols. In addition, the FDA inspects and reviews clinical trial sites, informed consent forms, data from the clinical trial sites, including case report forms and record keeping procedures, and the performance of the protocols by clinical trial personnel to determine compliance with good clinical practice. The FDA also examines whether there was bias in the conduct of clinical trials. The conduct of clinical trials is complex and difficult, especially in Phase III. There can be no assurance that the design or the performance of the Phase III clinical trial protocols will be successful. The results of preclinical studies and clinical trials, if successful, are submitted in an application to seek the FDA approval to market the drug or biological product for a specified use. The testing and approval process requires substantial time and effort, and there can be no assurance that any approval will be granted for any product or that approval will be granted according to any schedule. The FDA may refuse to approve an application if it believes that applicable regulatory criteria are not satisfied. The FDA may also require additional testing for safety and efficacy of the drug. Moreover, if regulatory approval of a drug product is granted, the approval will be limited to specific indications. There can be no assurance that any of the Company's product candidates will receive regulatory approvals for marketing, or if approved, that approval will be for the indications requested by the Company. The FDA has implemented an accelerated review process for drugs that treat serious or life threatening diseases and conditions. Such approval is subject to the additional requirement that, following product launch, a Company continues to study the drug to verify and describe its clinical benefit. Under these FDA Accelerated Approval Procedures, the FDA may withdraw approval if the Company fails to show due diligence in conducting post-marketing clinical trials or if these clinical trials fail to demonstrate clinical benefit to the FDA's satisfaction. When appropriate, the Company intends to pursue opportunities for accelerated review of its products. The Company cannot predict the ultimate opportunities for accelerated review of its products. The Company cannot predict the ultimate effect of the accelerated review process on the timing or likelihood of FDA review of any of its product candidates. For certain drugs that are generic versions of previously approved products, there is an abbreviated FDA approval process. A sponsor may submit an Abbreviated Application for: (1) a drug product that is the "same" as the drug product listed in the approved drug product list published by the FDA (the "listed drug") with respect to active ingredient(s), route of administration, dosage form, strength and conditions of use recommended in the labeling; (2) a drug product that differs with regard to certain changes from a listed drug if the FDA has approved a petition from a prospective applicant permitting the submission of an Abbreviated Application for the changed product; and (3) a drug that is a duplicate of, or meets the monograph for, an approved antibiotic drug. While the Company believes that SANG-2000 and AZATHIOPRINE will qualify for this abbreviated format, there can be no assurance that the FDA will not require additional information or that these products will be approved for marketing. An Abbreviated Application need not contain the clinical and preclinical data supporting the safety and effectiveness of the product. The applicant must instead demonstrate that the product is bioequivalent to the listed drug. FDA regulations define bioequivalence as the absence of a significant difference in the rate and the extent to which the active ingredient moiety becomes available at the site of drug action when administered at the same molar dose under similar conditions in an appropriately designed study. If the approved generic drug is both bioequivalent and pharmaceutically equivalent to the listed drug, the agency may assign a code to the product in an FDA publication that will represent a determination by the agency that the product is therapeutically equivalent to the listed drug. This designation will be considered by third parties in determining whether the generic drug will be utilized as an alternative to the listed drug. There can be no assurance that the Company will receive an "AB" rating on SANG-2000 or AZATHIOPRINE, which would permit automatic substitution of SANG-2000 for Neoral Capsules and AZATHIOPRINE for Imuran. FDA Regulation-Approval of Monitoring Products The Company's monitoring products are regulated as medical devices by the FDA and as such require regulatory clearance prior to commercial distribution. New medical devices are generally introduced to the market based on a premarket notification or "510(k)" submission to the FDA in which the sponsor establishes that the proposed device is "substantially equivalent" to a legally marketed Class I or Class II medical device or to a Class III medical device for which the FDA has not required premarket approval. The claim of substantial equivalence will generally have to be supported by various types of data and materials including, in some instances, preclinical and/or clinical test results. Following submission of the 510(k), the sponsor may not place the device into U.S. commercial distribution until a substantial equivalence order is issued by the FDA. The order may be sent within 90 days of submission but could take significantly longer. The order may declare the FDA's determination that the device is "substantially equivalent" to another legally marketed device and allow the proposed device to be marketed in the United States. The FDA may, however, determine that the proposed device is not substantially equivalent, or may require further information, such as additional test data, before the FDA is able to make a determination regarding substantial equivalence. Such determination or request for additional information could delay the Company's market introduction of its products by several quarters or more and could have a material adverse effect on the Company's business, financial condition and results of operations. There is no assurance that a 510(k) marketing clearance will be granted for these products. Additional regulatory barriers may be encountered by not meeting performance requirements of American Society of Histocompatability and Immunogenetics ("ASHI") and the labeling requirements of Clinical Laboratory Improvements Amendment ("CLIA"). If the sponsor of a 510(k) cannot obtain an FDA order declaring substantial equivalence, the sponsor will have to submit a premarket approval application ("PMA"). A PMA will generally have to be supported by extensive data, including preclinical and clinical trial data, to prove the safety and efficacy of the device. Although, by statute, the FDA has 180 days to review a PMA once it has been accepted for filing. PMA reviews more often involve a significantly longer time period, usually 12 to 24 months or longer from the date of filing. There also can be no assurance that the data collected by the sponsor would support a PMA marketing approval. The sponsor may be required to obtain an Investigational Device Exemption ("IDE") before it commences clinical testing to support a 510(k) submission or PMA. Each clinical trial must be approved and conducted under the auspices of an IRB and with patient informed consent. The IRB will consider, among other things, ethical factors, the safety of human subjects, and the possible liability of the institution conducting the clinical trials. For some products, the sponsor must also submit the protocol to the FDA. The sponsor of the IDE may be able to distribute limited amounts of these products for research use only if certain FDA requirements are met. Some of these requirements may also apply to distribution for clinical investigational use only. The FDA monitors and oversees the use and distribution of all "research use only" and "investigational use only" devices. There can be no assurances that the FDA will determine that the Company's product candidates are substantially equivalent to other legally marketed devices. The FDA may require the submission of a PMA, which would delay the Company's market introduction of its products and could have a material adverse effect on the Company's business, financial condition and results of operations. The testing and approval process will require substantial time and effort, and there can be no assurance that any approval will be granted for any product or that approval will be granted according to any schedule. The FDA may refuse to approve a PMA if it believes that applicable regulatory criteria are not satisfied. The FDA may also require additional testing for safety and efficacy of the device. Moreover, if the PMA is approved, the approval will be limited to specific indications or uses. There can be no assurance that any of the Company's product candidates will receive regulatory approvals for commercial distribution, or if approved that approval will be for the indications requested by the Company. Prior to any approval of the Company's products for marketing, all manufacturing facilities must pass the FDA preapproval inspections. FDA Regulation-Post-Approval Requirements Even if regulatory approvals for the Company's product candidates are obtained, the Company, its products and the facilities manufacturing the Company's products are subject to continual review and periodic inspection. Each U.S. drug and device manufacturing establishment must be registered with the FDA. Domestic manufacturing establishments are subject to biennial inspections by the FDA and must comply with the FDA's GMP regulations. To supply device products for use in the United States, foreign manufacturing establishments must comply with the FDA's GMP regulations and are subject to periodic inspection by the FDA or by regulatory authorities in those countries under reciprocal agreements with the FDA. In complying with GMP regulations, manufacturers must expend funds, time and effort in the area of production and quality control to ensure full technical compliance. The FDA stringently applies regulatory standards for manufacturing. Labeling and promotional activities are regulated by the FDA and, in certain instances, by the Federal Trade Commission. The Company must also report certain adverse events involving its drugs and devices to the agency under regulations issued by the FDA. The FDA can impose other post-marketing controls on the Company and its products, and has expanded authority in this regard for certain products, such as devices approved under PMAs. Failure to comply with applicable regulatory requirements, can result in, among other things, warning letters, fines, injunctions, civil penalties recall or seizure of products, total or partial suspension of production, refusal of the government to grant approvals, premarket clearance or pre-market approval, withdrawal of approvals and criminal prosecution of the Company and employees. European Regulations The Company's activities in Europe are regulated by both the law of the European Union ("EU") and by the national law of the EU Member States. There are a number of EU Regulations and Directives in force governing the authorization and the marketing of medicinal products. The purpose of such Regulations and Directives is to harmonize the legal framework regulating medicinal products in the EU. In the event of a conflict between EU legislation and national law, EU legislation takes precedence over national law. Once adopted, Regulations apply immediately in Member States, Directives must be implemented into national law by Member States. Failure to implement Directives by national governments either properly or in a timely fashion still leaves significant areas of regulation to national law. Efforts to harmonize regulation of medicines within the EU began in 1965 with the adoption of Directive 65/65 which required Member States to establish premarket approval requirements and prescribed the criteria for approval. Since then, the EU has issued a series of measures aimed at making regulation of medicinal products more uniform. European Regulations-Approval of Therapeutic Products In addition to Regulations and Directives, the EU has formulated non- binding guidelines (the "Guidelines") which set out detailed EU requirements relating to the quality, safety and efficacy of medicinal products. Such Guidelines have been formulated by the European Commission in consultation with the Committee for Proprietary Medicinal Products ("CPMP"). Although these Guidelines are not legally binding, failure to comply with them makes it less likely that product research work submitted in support of an application for marketing authorizations will be acceptable to the competent authorities throughout the EU. In European countries which are not EU Member States, national laws apply which are frequently divergent from the EU framework. The following paragraphs relate only to regulation in EU Member States. When adequate preclinical data are available, an application normally will be made either to the relevant national regulatory authority and/or to an ethics committee for approval to carry out a clinical trial with the unlicensed medicinal product. While marketing authorizations must be supported by clinical trials of a type and extent set out in the Directives and Guidelines, the actual approval process for commencement of clinical trials is not currently harmonized by EU law and varies from state to state. Clinical trials are typically conducted in three sequential phases which may overlap. In Phase I, the product is tested in humans to determine certain parameters relating to safety, potential adverse effects and/or pharmacokinetics. Phase II involves studies in a target patient population to collect additional pharmacokinetic clinical data demonstrating safety and, subsequently, to determine the preliminary biological or clinical efficacy and optional dosage of the product. Phase III trials are then undertaken to collect further data to demonstrate quality, safety and efficacy within an expanded target patient population. The various European regulatory authorities may require multiple Phase III trials to support the quality, safety and efficacy of the product. This process may take three to six or more years to complete. When appropriate clinical trial data supporting quality, safety and efficacy are available, an application for a marketing authorization may be submitted. In 1993, legislation was adopted which established a very new and amended system for the registration of medicinal products in the EU. The main purpose of this system is to prevent the existence of essentially separate national approval systems which have been a major obstacle to harmonization. One of the most significant features of this new system is the establishment of a new European Agency for the Evaluation of Medicinal Products ("EMEA"). Under the new system, marketing authorizations, broadly speaking, may be submitted at either a centralized, a decentralized or a national level. The centralized procedure is administered by the EMEA; this procedure is mandatory for the approval of biotechnology and high technology products and available at the applicant's option for other products. The centralized procedure provides for the first time in the EU for the grant of a single marketing authorization which is valid in all EU Member States. As of January 1995, a mutual recognition procedure is available at the request of the applicant for all medicinal products which are not subject to the centralized procedure under the so-called "decentralized procedure". The decentralized procedure became mandatory as of January 1, 1998. The decentralized procedure creates a new system for mutual recognition of national approval decisions, makes changes in existing procedures for national approvals and establishes procedures for co- ordinated EU action on product suspensions and withdrawals. Under this procedure, the holder of a national marketing authorization for which mutual recognition is sought may submit an application to one or more Member States, certify that the dossier is identical to that on which the first approval was based or explain any differences and certify that identical dossiers are being submitted to all Member States from which recognition is sought. Within 90 days of receiving the application and assessment report, each Member State must decide whether to recognize the approval. The procedure encourages Member States to work with applicants and other regulatory authorities to resolve disputes concerning mutual recognition. If such disputes cannot be resolved within the 90-day period provided for review, the application will be subject to a binding arbitration procedure. The Company will choose the appropriate route of European regulatory filing to accomplish the most rapid regulatory approvals. However, there can be no assurance that the chosen regulatory strategy will secure regulatory approvals or approvals of the Company's chosen products indications. Under all procedures approval of an application must be refused if, after review, it appears that the quality, safety or efficacy of a medicinal product has not been adequately demonstrated by the applicant. In practice, requirements for specific post-marketing surveillance, or Phase IV studies, are increasingly imposed as de facto conditions of the grant of a marketing authorization. In some Member States, before a product is marketed, it is also necessary to obtain approval for the price to be charged for the product. However, this is not the position in the United Kingdom, for example, where the initial price is set by the Company (subject to the constraints of the Pharmaceutical Price Regulation System, which controls the profitability of a Company's business with the National Health Service). The European Commission is presently reviewing various matters relating to the pricing of medicinal products within the EU. Currently EU regulation does not harmonize the pricing measures Member States may enact, but only seeks to guarantee the transparency of these measures. The Company believes it is unlikely the EU will regulate in the area of health care financing. The Company believes that determination of prices and reimbursement of health care products is therefore likely to remain a prerogative to the Member States for the foreseeable future. There can be no assurance that Member States will not adopt new cost containment policies that will limit marketing opportunities in the EU. The passage of a product through the approval system is likely to take a considerable period of time. However, it is hoped that the new authorization system will limit the length of time the review process will take. Generally under the scheme the review process is intended to take a maximum of 210 days after the receipt of a valid application. It should also be noted that each national regulatory authority has the power to suspend or revoke a marketing authorization any time if it is no longer satisfied as to the product's safety, quality and efficacy. Increasing harmonization of decision-making by national authorities through the CPMP and/or a new European agency, and the existence of a mechanism by which any EU distribution could compel a Member State to act in accordance with a CPMP opinion, should result in more efficiency and future market authorization process. EU law requires that companies manufacturing products must hold a manufacturer's authorization and must comply with EU requirements as to GMP. These standards are enforced by inspection. Primary responsibility for ensuring that manufacturing procedures conform to marketing authorizations and good manufacturing practice requirements will rest with the authorities in the Member States where the product is manufactured or first imported into the EU. A procedure for abridged applications for generic products also exists in the EU. The general effect of the abridged application procedure is to give scope for the emergence of generic competition once patent protection has expired and the original product has been on the market for at least six years or ten years. Independent of any patent protection, under the abridged procedure, new products benefit in principle from a basic six-year period of protection (commencing with the data of first authorization in the EU) from abridged applications for a marketing authorization. Abridged applications can be made principally for medicinal products which are essentially similar to medicinal products which have been authorized for either six or ten years. Under the abridged application procedure, the applicant is not required to provide the results of pharmacological and toxicological tests or the results of clinical trials. For such abridged applications, all data concerning manufacturing, quality and bioavailability are required. The applicant submitting the abridged application generally must provide evidence or information that the drug product subject to this application is essentially similar to that of the listed drug product: (1) it has the same qualitative and quantitative composition with respect to the active ingredient; (2) the dosage form; and (3) similarity in bioavailability between the new drug product and the reference listed drug. This period of protection is extended to ten years in respect of products derived from certain biotechnological processes or other high-technology medicinal products viewed by the competent authorities as representing a significant innovation. Further, each Member State may have a discretion to extend the basic six-year period of protection to a ten-year period, to all products marketed in its territory. Most Member States have exercised such discretion. This protection does not prevent another Company from making a full application supported by all necessary pharmacological, toxicological and clinical data within the period of protection. The application of the rules of marketing exclusivity to various product situations remains uncertain, and divergent views are taken by some of the EU regulatory authorities on the availability of the period of protection where new products are different from existing products only in terms of, for instance, strength or dosage form. European Regulations-Monitoring Products The Commission of the European Communities proposed a draft of new directives to govern approvals of in vitro diagnostic medical devices in late 1995, amending the existing Directive. Future approvals of the Company's monitoring products may therefore be dependent on meeting the conditions of the proposed Directive. When the Company's monitoring products meet the essential requirements of the Directive, such monitoring products will have CE markings of conformity. Environmental Regulation In connection with its research and development activities and its manufacturing materials and products, the Company is subject to federal, state and local laws, rules, regulations and policies governing the use, generation, manufacture, storage, air emission, effluent discharge, handling and disposal of certain materials, biological specimens, and wastes. Although the Company believes that it has complied with these laws, regulations and policies in all material respects and has not been required to take any action to correct any noncompliance, there can be no assurance that the Company will not be required to incur significant costs to comply with environmental and health and safety regulations in the future. The Company's research and development involves the controlled use of hazardous materials, including but not limited to certain hazardous chemicals and infectious biological specimens. Although the Company believes that its safety procedures for handling and disposing of such materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be 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. Third Party Reimbursement The operating results of the Company will depend in part on the availability of adequate reimbursement for the Company's products from third-party payors, such as government entities, private health insurers and managed care organizations. Third-party payors increasingly are seeking to negotiate the pricing of medical services and products. In some cases, third-party payors will pay or reimburse a user or supplier of a prescription drug product only a portion of the purchase price of the product. In the case of the Company's prescription products, payment or reimbursement by third-party payors of only a portion of the cost of such products could make such products less attractive, from a cost perspective, to users, suppliers and prescribing physicians. There can be no assurance that reimbursement, if available, will be adequate. If adequate reimbursement levels are not provided by government entities or other third-party payors for the Company's products, the Company's business, financial condition and results of operations would be materially adversely affected. A number of legislative and regulatory proposals aimed at changing the United States' health care system have been proposed in recent years. While the Company cannot predict whether any such proposals will be adopted, or the effect that any such proposal may have on its business, such proposals, if enacted, could have a material adverse effect on the Company's business, financial condition and results of operations. Product Liability Insurance The Company faces an inherent risk of exposure to product liability claims in the event that the use of its products is alleged to have resulted in adverse effects. Such risk exists even with respect to those products that are manufactured in licensed and regulated facilities or that otherwise received regulatory approval for commercial sale. There can be no assurance that the Company will not be subject to significant product liability claims. The Company currently has product liability insurance in the amount of $10.0 million per claim and $10.0 million in the aggregate on a claims-made basis. Many of the Company's customers require the Company to maintain product liability insurance coverage as a condition to their conducting business with the Company. As the loss of such insurance coverage could result in a loss of such customers, the Company intends to take all reasonable steps necessary to maintain such insurance coverage. There can be no assurance that insurance coverage will be available in the future on commercially reasonable terms, or at all, or that such insurance will be adequate to cover potential product liability claims, or that the loss of insurance coverage or the assertion of a product liability claim or claims would not materially adversely affect the Company's business, financial condition and results of operations. Scientific, Medical, Pharmacy, Regulatory and Business and Medical Ethics Advisory Boards The Company's Scientific, Medical, Pharmacy, Regulatory, Business and Medical Ethics Advisory Boards consist of individuals with recognized expertise in immunology, transplantation or regulatory affairs. The Scientific, Medical, Pharmacy, Regulatory, and Business and Medical Ethics Advisory Boards' members advise the Company about present and long-term scientific planning, research and development. Members meet individually or as a group with the management of the Company from time to time. Each member of the Scientific, Medical, Pharmacy and Regulatory Advisory Boards has entered into a consulting agreement with the Company. The following persons are members of one or more of the Company's Scientific, Medical, Pharmacy. Regulatory, Business and Medical Ethics Advisory Boards: Rita Alloway, Pharm.D., is an Associate Professor in the Department of Clinical Pharmacy at the University of Tennessee, Memphis, Tennessee. Dr. Alloway is a Board Certified Pharmacotherapy Specialist practicing at the UT William F. Bowld Hospital. Her current research is focused on individualizing and optimizing immune suppressive regimes for the transplant recipient. Dr. Alloway is the Past President of the Mid South College of Clinical Pharmacy. Gilbert J. Burckart, Pharm. D., is a member of the Pharmacy faculty at the University of Pittsburgh and established the Clinical Pharmacokinetics Laboratory with Dr. Raman Venkataramanan. In conjunction with Dr. Thomas Starzl and other members of the Pittsburgh Transplantation Institute, Dr. Burckart has studied drug disposition in organ transplant patients since that time, and he is the Principal Investigator of an NIH grant in this area that is now entering its ninth year. Dr. Burckart also has a joint appointment as a Professor of Pediatrics in the School of Medicine. Dean S. Collier, Pharm.D., is Assistant Professor, Department of Pharmacy Practice, University of Nebraska Medical Center. He conducts research with various immunotherapeutics and has published several articles on this subject. He received his Pharm.D. from the University of Iowa and completed an Immunotherapy Fellowship at the University of Nebraska. Jean Dausset, M.D., received a Nobel Prize in Medicine in 1980 for work that led to the discovery of HLA. In 1984, he founded and is currently serving as President of the Human Polymorphism Study Center (CEPH) which is currently engaged in research directed toward mapping the human genome. Professor Dausset is a member of the French Academy of Sciences, a foreign member of the American Academy of Arts and Sciences and of the National Academy of Sciences. Robert E. Dupuis, Pharm.D., BCPS, is a Clinical Associate Professor at the School of Pharmacy, and Assistant Director of Toxicology in the Department of Laboratory Medicine, University of North Carolina at Chapel Hill. He is a board-certified Pharmacology Specialist and received his Pharm.D. from State University of New York at Buffalo. Roy First, M.D., is a Professor of Internal Medicine at the University of Cincinnati Medical Center, and Director of the Section of Transplantation in the Division of Nephrology and Hypertension. He is a Past President of the American Society of Transplant Physicians (ASTP), and is current Chairman of the Ad Hoc Committee for Organ Donation of the United Network for Organ Sharing (UNOS). Dr. First obtained his medical degree at the University of Witwatersrand in Johannesburg, South Africa in 1966. A. Osama Gaber, M.D., is Associate Professor, Department of Surgery, University of Tennessee and President of the Medical Staff at UT William F. Bowld Hospital. He was President of the Tennessee Transplant Society and is Co-Chair SEOPF Pancreas Transplant Committee. Ronald D. Guttmann, M.D., FRCPC, is Director of the McGill Center for Clinical Immunobiology and Transplantation, and a Professor of Medicine at the McGill University Faculty of Medicine, Montreal, Quebec, Canada. Dr. Guttmann was previously affiliated with the Peter Bent Brigham Hospital and Harvard Medical School. Amy M. Haddad, Ph.D., is a Professor at the Center for Health Policy & Ethics and School of Pharmacy & Allied Health Professions, Creighton University, Omaha Nebraska. Dennis F. Heinrichs, B.S.N., M.B.A., is the President/Chief Operating Officer, LifeLink Foundation, Inc. Curtis D. Holt, Pharm.D., is the Transplant Pharmacist Specialist, UCLA-Cedars Medical Centers and Assistant Clinical Professor or Surgery, UCLA School of Medicine, Division of Liver and Pancreas Transplantation. He is also the Director of Clinical Research, Dumont-UCLA Liver Transplant Program. Cheryl Jacobs, LICSW, is the clinical transplant social worker at the University of Minnesota (Fairview University Medical Center) since 1991. Her primary focus is on kidney transplant recipients and living organ donors. N. David Kennedy, Pharm.D., MPA, FASCP, is Manager of Medical Affairs, Plasma Operations for the American Red Cross. He is recognized as an expert on plasma derivatives and many topics associated with blood products, including being a nationally known speaker on Creutzfeldt-Jakob Disease. Sherry LaForest, Pharm.D., is a clinical pharmacist at Methodist Hospital in Indianapolis. She was previously Assistant Professor of Pharmacy Practice at Temple University, as well as Clinical Pharmacy Specialist for the Heart Failure and Transplant teams at Temple University Hospital. She is active in the American College of Clinical Pharmacy and a member of the International Society of Heart and Lung Transplantation. Kathleen D. Lake, Pharm.D., BCPS, is the Director of Clinical Research and Transplant Therapeutics, Divisions of Nephrology & Surgery and Senior Associate Research Scientist at the University of Michigan Medical School in Ann Arbor. She received her B.S. and Pharm.D. degrees from the University of Minnesota and is a Board Certified Pharmacotherapy Specialist. Dr. Lake has been involved in the area of transplantation since 1985 and specializes in the pharmacotherapy of transplant patients. Dr. Lake has been a member of the Board of Regents of the American College of Pharmacy for the past eight years, is Editor of the Transplant Pharmacy Newsletter, is a member of the Working Group of Transplant Cardiologists, and has recently been appointed to the Scientific Studies Committee of the American Society of Transplant Physicians. Richard M. Lewis, M.D., is currently Professor of Urology and director of Renal Transplantation at Loyola University Medical Center. He is a member of American Society of Transplant Physicians, the American Urological Association (AUA), the Society for Renovascular Surgery and Renal Transplantation (AUA). Suzanne Valerie McDiarmid, M.B., Ch. B., is an Associate Professor of Pediatrics and Surgery, University of California Los Angeles and Director, Pediatric Liver Transplant Program, UCLA-Cedars-Sinai Medical Center. She is a member of several professional organizations including the American Society of Transplant Physicians, the International Liver Transplant Society and the American Association for the Study of Liver Disease as well as being named a Fellow of the American Academy of Pediatrics. Marsha Morien, serves as Director, Transplantation Services, Nebraska Health System. She is a member of the Board of Directors for Hickman- Kenyon Systems, Inc., a software firm that develops and markets databases for transplantation and other protocol driven clinical care. Barbara Oliver, is a transplant recipient (renal) and a member of Board of Directors, Transplant Recipients International Organization, Inc. (TRIO), chairing their Commications Committee and is the president of the Kentuckiana/Louisville Chapter. Douglas James Norman, M.D., is a Professor of Medicine and the Director if The Medical Transplantation Program, Oregon Health Sciences University. He is a member of the American Society of Transplant Physicians, the Pacific Northwest Transplant Society, the National Kidney Foundation, and the Western Association of Physicians. Shi-Hui Pan, Pharm.D., a Transplant Pharmacy Specialist at the Comprehensive Liver Disease and Treatment Center, St. Vincent Medical Center, Los Angeles, California. Prior to this, she was a Transplant Pharmacy Specialist for kidney, heart, lung and liver transplant programs at Cedars-Sinai Medical Center, Los Angeles, California, for six years. She received her transplant fellowship training, Pharm.D. and M.S. from the University of Minnesota, College of Pharmacy. Roger Ratouis, Ph.D., is a consultant for regulatory affairs. From 1959 to 1990, Dr. Ratouis was employed by Roussel Uclaf where he held various positions, first in research, then in pharmaceutical development, before heading the Regulatory Affairs and Planning Department in the Health Care Division. William G. Reiss, Pharm.D., BCPS, is an Assistant Professor of Pharmacy, University of Maryland at Baltimore. He is primarily involved in the clinical management of solid organ transplant and conducts research in the area clinical pharmacokinetics. He is a board-certified Pharmacology Specialist and received his Pharm.D. from State University of New York at Buffalo. Employees As of December 31, 1998, the Company employed 241 people worldwide. None of the Company's current employees is represented by a labor union or is the subject of a collective bargaining agreement. The Company believes that it maintains good relations with its employees. ITEM 2. PROPERTIES The Company headquarters are located in Menlo Park, California. Floor space in Menlo Park is approximately 27,600 square feet, including offices, laboratory space, manufacturing space, storage area and specialized areas for pilot production and preclinical testing. The Menlo Park facilities serve as the principal sites for preclinical research, clinical trial management, process development, monitoring product manufacturing, quality assurance and quality control, and regulatory affairs. The leases for these building spaces expire in June 1999 and may be renewed for subsequent years. The Company currently has no plans to renew such leases. In addition, the Company leases approximately 4,500 square feet in Menlo Park for its central mail order pharmacy. The Company has entered into a sublease commencing June 1999 for approximately 44,000 square feet in Fremont, California, including offices, laboratory space, storage area and specialized areas for pilot production and preclinical testing. The Company intends to relocate its headquarters from Menlo Park, California to Fremont, California in approximately June 1999. The lease for the Fremont building space will expire in 2005 and may be renewed for subsequent years. The Company also leases approximately 23,000 square feet from PMC in Lyon, France for marketing, sales, adminstration and manufacturing of THYMOGLOBULIN. These leases expire in 2013. The Company leases approximately 2,000 square feet in Missassauga, Ontario, Canada. The lease for this facility expires in August 1999, and the Company has the option to renew its lease for subsequent five-year periods. This site is used as headquarters for marketing and sales activities of SangStat Canada, Ltd. The Company believes that its current facilities are suitable and adequate to meet its needs for the foreseeable future and anticipates that it will be able to expand its facilities to nearby locations as the need develops. ITEM 3. LEGAL PROCEEDINGS Novartis vs. SangStat On February 11, 1999, Novartis Pharmaceuticals Corporation filed a lawsuit (case number 99-065) in Federal District Court for the District of Delaware against the Company alleging infringement of United States patent #5,389,382, a cyclosporine technology patented by Novartis A.G. The Novartis patent does not cover Neoral but rather a separate delivery system not used in the Neoral formulation. Novartis seeks the following relief: (i) a finding that SangStat willfully infringed the patent; (ii) to permanently enjoin SangStat from infringing the Novartis patent; (iii) treble damages; and (iv) reasonably attorneys' fees , costs and expenses. SangStat's answer is due April 5, 1999 and discovery will not begin until after the answer is filed. SangStat believes that the lawsuit is without merit and that it does not infringe the Novartis patent. SangStat intends to defend itself vigorously against this claim. Although the Company is optimistic that this dispute will ultimately be resolved favorably to the Company, the course of litigation is inherently uncertain and there can be no assurance of a favorable outcome. As a result of the Novartis suit, SangStat could be enjoined from selling SANGCYA for a significant period of time or ultimately be prevented from selling SANGCYA. Should this happen, the Company does not believe it would be able to obtain a license from Novartis on acceptable terms because the Company believes cyclosporine is an important product for Novartis and that Novartis would not want to diminish its profits from this product by licensing it on acceptable terms to the Company. Failure to obtain any such required license could prevent the Company from selling SANGCYA entirely, which would have a material adverse effect on the Company's future results of operations. The litigation, whether or not resolved favorably to the Company, is likely to be expensive, lengthy and time consuming, will divert management's attention and could have a material adverse effect on the Company's business, financial condition, cash flows and results of operations. SANG-2000 is not covered by this lawsuit and the Company does not believe that this lawsuit will have an impact on the regulatory approval of Sang-2000. See "Risk Factors-Litigation with Novartis." Novartis vs. FDA Novartis Pharmaceuticals Corporation sued the FDA on February 11, 1999 in the United States District Court for the District of Columbia (case number 1:99CV-00323) alleging that the FDA did not follow its own regulations in approving SANGCYA in October 1998. The lawsuit against the FDA appears to be based on arguments similar to those used in the failed citizen' petition in which Novartis alleged that because Neoral and SANGCYA, both oral solutions, are based on different formulation technologies, they should be classified as different dosage forms. Novartis asks that the court rescind the AB rating that was given to SANGCYA. Loss of the "AB" rating would prevent SANGCYA from being automatically substitutable for Neoral oral solution, which would impede the marketing of SANGCYA. The Company believes that the lawsuit is without merit and that the FDA will prevail in this matter. Although the Company is optimistic that this dispute will ultimately be resolved favorably to the Company, the course of litigation is inherently uncertain and there can be no assurance of a favorable outcome. Novartis' requested relief, if granted, could have a significant negative economic impact on SangStat. In order to defend its interests vigorously, SangStat filed a Motion for Leave to Intervene in this lawsuit on February 23, 1999. The Court has not yet ruled on this motion. See "Risk Factors-Litigation with Novartis." ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock commenced trading publicly on the Nasdaq National Market on December 14, 1993 and is traded under the symbol SANG. The following table sets forth for the periods indicated the high and low daily closing prices for the Common Stock: HIGH LOW -------- -------- FISCAL YEAR ENDED DECEMBER 31, 1997 First Quarter........................... 30.250 26.500 Second Quarter.......................... 27.375 13.750 Third Quarter........................... 30.625 21.500 Fourth Quarter.......................... 40.500 28.000 FISCAL YEAR ENDED DECEMBER 31, 1998 First Quarter........................... 38.719 23.562 Second Quarter.......................... 34.812 24.312 Third Quarter........................... 31.969 16.566 Fourth Quarter.......................... 30.532 16.500 On March 18, 1999 the closing sale price of the Common Stock as reported on the Nasdaq National Market was $18.25 per share. As of March 18, 1999 there were approximately 130 holders of record of the Common Stock. DIVIDEND POLICY The Company has not declared or paid any cash dividends since its inception. The Company currently intends to retain all earnings, if any, for use in the expansion of its business and therefore does not anticipate paying any dividends in the foreseeable future. The Company has not declared or paid any cash dividends since its inception. The Company currently intends to retain all earnings, if any, for use in the expansion of its business and therefore does not anticipate paying any dividends in the foreseeable future. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data set forth below with respect to the Company's statements of operations for each of the three years in the period ended December 31, 1998, and with respect to the balance sheets as of December 31, 1998 and 1997, are derived from the Consolidated Financial Statements of the Company which are included elsewhere in this Annual Report on Form 10-K. The statement of operations data for the years ended December 31, 1995 and 1994 and the balance sheet data as of December 31, 1996, 1995 and 1994, are derived from audited consolidated financial statements not included herein. The data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements of the Company and the Notes thereto included elsewhere in this Annual Report on Form 10-K.
YEAR ENDED DECEMBER 31, ----------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (in thousands, except per share data) CONSOLIDATED STATEMENTS OF OPERATIONS DATA: Revenues: Net product sales................ $18,586 $3,777 $2,399 $2,698 $674 Collaborative agreement.......... 1,092 750 -- 1,125 3,000 --------- --------- --------- --------- --------- Total revenues.............. 19,678 4,527 2,399 3,823 3,674 --------- --------- --------- --------- --------- Operating expenses: Cost of sales and manufacturing.. 12,532 3,736 2,846 2,753 1,503 Research and development......... 17,688 16,210 8,330 6,647 4,845 Selling, general and administrative................. 27,149 11,067 6,120 3,773 3,157 Acquired in-process research and development................ 3,218 -- -- -- -- Amortization of intangible assets 351 -- -- -- -- --------- --------- --------- --------- --------- Total operating expenses.... 60,938 31,013 17,296 13,173 9,505 --------- --------- --------- --------- --------- Loss from operations.................. (41,260) (26,486) (14,897) (9,350) (5,831) Other income (expense) - net.......... 3,053 5,506 2,123 672 284 --------- --------- --------- --------- --------- Net loss before income taxes($38,207) ($20,980) ($12,774) ($8,678) ($5,547) Income taxes.......................... 257 -- -- -- -- --------- --------- --------- --------- --------- Net loss....................($38,464) ($20,980) ($12,774) ($8,678) ($5,547) Net loss per common share(1).......... ($2.39) ($1.36) ($1.03) ($0.92) ($0.79) ========= ========= ========= ========= ========= Shares used in per share computations(1)..................... 16,080 15,376 12,405 9,385 7,049
YEAR ENDED DECEMBER 31, ----------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (in thousands) CONSOLIDATED BALANCE SHEET DATA: Cash, cash equivalents and short-term investments......................... $29,660 $92,036 $41,321 $9,222 $12,378 Working capital....................... $46,828 93,812 40,724 8,451 11,367 Total assets.......................... 107,327 104,354 44,750 11,560 14,450 Long-term obligations, excluding current portion..................... 16,402 1,557 1,100 1,091 1,153 Accumulated deficit...................(100,270) (61,806) (40,826) (28,052) (19,374) Total stockholders' equity............ 59,587 97,470 40,955 8,281 11,328
- ------------------------------- (1) For a description of the computation of net loss per share see Note 1 of Notes to Consolidated Financial Statements. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with "Selected Consolidated Financial Data" and the Company's Consolidated Financial Statements and Notes thereto included elsewhere in this Annual Report on Form 10-K. Except for the historical information contained herein, the discussion in this Annual Report on Form 10-K contains certain forward-looking statements that involve risks and uncertainties, such as statements of the Company's plans, objectives, expectations and intentions. The cautionary statements made in this Annual Report on Form 10-K should be read as being applicable to all related forward-looking statements wherever they appear in this Annual Report on Form 10-K. The Company's actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include those discussed in "Risk Factors," as well as those discussed elsewhere herein. SangStat is a specialty pharmaceutical company, applying a disease management approach to improve the outcome of organ transplantation. The Company has a total of 12 monitoring and therapeutic product and product candidates to address the pre-transplant, acute care and chronic phases of transplantation. During 1998, the Company launched one of its lead products, prepared for the launch of its second lead product, conducted additional clinical studies, built a sales and marketing sales team and developed THE TRANSPLANT PHARMACY(TM). The Company's accumulated deficit from inception through December 31, 1998 was $100,270,000. The Company's operating loss has increased each year since inception and losses are expected to continue in the near future as a result of a number of factors including the uncertainty in the timing and the amount of revenue to be earned upon product sales, expenses required for product development, clinical trials and marketing and sales activities. In addition, the Company's business is subject to significant risks, including but not limited to, the success of its research and development efforts, litigation by third parties regarding intellectual property, in particular, litigation with Novartis regarding SANGCYA, obtaining and enforcing patents important to the Company's business, the lengthy and expensive regulatory approval process, reliance on third parties to manufacture products or product candidates, competition from other products and uncertainties associated with health care reform measures. Even if the Company's products appear promising at various stages of development, they may not reach the market for a number of reasons. Such reasons include, but are not limited to, the possibilities that the product candidates will be found to be ineffective or unsafe, be difficult to manufacture on a large scale, be uneconomical to market, be precluded from commercialization by proprietary rights of third parties or be unacceptable to providers, payors or patients. Additional expenses, delays and losses of opportunities that may arise out of these and other risks could have a material adverse impact on the Company's business, financial condition, cash flows and results of operations. Results of Operations Acquisition. On September 30, 1998, the Company completed the acquisition of Pasteur Merieux Connaught's (PMC) organ transplant business known as IMTIX. The acquisition was accounted for using the purchase method of accounting. The resulting wholly owned subsidiary of the Company, named IMTIX-SangStat, is dedicated to the research, development, manufacture and marketing of pharmaceuticals for transplantation. The aggregate purchase price of approximately $31 million consisted of $10 million paid upon closing and a non-interest bearing note of $21 million payable over five years as follows: $3 million in 1999, $3 million in 2000, $6 million in 2001, $5 million in 2002 and $4 million in 2003. The note payable is discounted at a rate of 9.25% and is included in Notes payable. In addition, the Company will pay PMC certain royalties on IMTIX-SangStat product sales. The aggregate purchase price and approximately $2.5 million of acquisition costs were allocated to the net tangible assets acquired based on their fair value on the date of acquisition, identifiable intangible assets and purchased in-process research and development. The purchased in-process research and development of approximately $3.2 million was charged to the Company's operations in the third quarter of 1998 and represents the value of products that had not yet reached technological feasibility and no alternative future use. The estimated value for the in-process technology was determined using the income approach which discounted to present value the cash flows expected to be derived from the in-process products. The projections were based on historical trends and future expectations of the acquired company's revenue and expenses to be generated from the in-process products. The discount rate used reflected the risk associated with development of the in-process products. The Company currently intends to continue the development of the acquired in-process products and has not yet determined if it will be successful in its efforts to complete as the safety and efficacy of these products has not yet been determined. The determination of the products' safety and efficacy is expected to be completed in 1999 with estimated costs to complete the clinical studies less than $500,000. Depending on the outcome of the ongoing clinical studies, further studies may be required to fully assess the feasibility of the acquired in-process products. Approximately $14.2 million of the purchase price was allocated to various specified intangible assets and is being amortized over their estimated useful lives ranging from five to fourteen years. Amortization for the year -ended December 31, 1998 was $351,000. Total revenues. Net product sales for the year ended December 31, 1998 were $18,586,000, representing an increase of $14,809,000 or 392% from 1997. The increase was due primarily to an increase in sales of THE TRANSPLANT PHARMACY and sales of therapeutic products in Europe as a result of the acquisition of IMTIX. Net product sales for the year ended December 31, 1997 were $3,777,000, an increase of $1,378,000 or 57% from 1996. The increase primarily reflected a 36% increase in sales of Monitoring Products and an 894% increase in sales of THE TRANSPLANT PHARMACY. Revenue from collaborative agreements was $1,093,000 in 1998, an increase of $343,000 or 46% from 1997. The Company received milestone payments of $1,000,000 in 1998 from Amgen under the collaborative distribution agreement for SANGCYA and SANG-2000 in certain territories outside the United States; in 1997, the Company received an initial payment of $750,000 from Amgen under that same collaborative distribution agreement Cost of sales and manufacturing. Cost of sales and manufacturing expenses were $12,532,000 for the year ended December 31, 1998, an increase of $8,796,000 or 235% from 1997. The increase was substantially due to additional costs associated with increased sales of Therapeutic Products and THE TRANSPLANT PHARMACY. For the year ended December 31, 1997, cost of sales and manufacturing expenses were $3,736,000, an increase of $890,000 or 31% over the prior year. The increase reflected declines of 4% and 1% in costs of sales for Monitoring Products and THYMOGLOBULIN, respectively, offset by the increased sales volume of THE TRANSPLANT PHARMACY. Research and development. Research and development expenses were $17,688,000 for the year ended December 31, 1998, representing an increase of $1,478,000 or 9% over 1997. The increase is primarily due to spending for THYMOGLOBULIN, AZATHIOPRINE and XENOJECT(TM) and the addition of IMTIX research & development spending in the fourth quarter of 1998. For the year ended December 31, 1997, research and development expenses were $16,210,000 reflecting an increase of $7,880,000 or 95% from the prior year. The increase primarily reflected continued expansion of clinical and regulatory activities for SANGCYA , SANG-2000 and THYMOGLOBULIN. SangCya(TM), oral solution, the Company's first cyclosporine product candidate, was approved by the U.S. Food and Drug Administration (FDA) on October 31, 1998, as a bioequivalent formulation to Neoral(R) for the prevention of rejection in organ transplant recipients. SangCya was launched in the U.S. in the fourth quarter of 1998 and has also been filed in Europe under the mutual recognition process. Selling, general and administrative. Selling, general and administrative expenses were $27,149,000 for the year ended December 31, 1998, reflecting an increase of $16,081,000 or 145% over 1997. The increase is principally due to the Company's expansion of its commercial infrastructure and launch and pre-launch activities to help support the U.S. launches of the Company's first two therapeutic products, SANGCYA and THYMOGLOBULIN, the growth of The Transplant Pharmacy and the addition of IMTIX expenses in the fourth quarter of 1998. For the year ended December 31, 1997, selling, general and administrative expenses were $11,068,000, an increase of $4,948,000 or 81% over the prior year. The increase reflected the Company's expansion of its marketing and sales staff for its therapeutic products, SANGCYA and THYMOGLOBULIN and continued growth of THE TRANSPLANT PHARMACY. Interest income - net. Interest income was $3,611,000 for the year ended December 31, 1998, which represented a decrease of $2,106,000 from the prior year. The decrease reflects the decrease in the average cash balance available for investment as a result of the Company's use of cash for operating activities. For the year ended December 31, 1997, interest income was $5,717,000, an increase of $3,456,000 over 1996, which was primarily due to the increase in average cash balances available for investment as a result of the sale of equity securities during 1996 and 1997. Interest expense for the year ended December 31, 1998 was $558,000, an increase of $348,000 over the same period in 1997. Interest expense for the year ended December 31, 1997 was $210,000, an increase of $72,000 over the same period in 1996. Income taxes. For the year ended December 31, 1998, the Company recorded a provision of $257,000 for European income taxes based upon income earned from IMTIX in the fourth quarter. A tax provision was not recorded in 1997 or 1996. Net loss. Net loss for the year ended December 31, 1998 was $38,464,000 compared to a loss of $20,980,000 in 1997 and a loss of $12,774,000 in 1996. These increases primarily reflect increases in research and development, including clinical trials and regulatory affairs, and selling, general and administrative expenses. Liquidity and Capital Resources From inception through December 31, 1998, the Company has financed its operations substantially from proceeds of approximately $137,977,000 from public offerings of its Common Stock and $21,236,000 from private placements of equity securities. During the years ended December 31, 1998, 1997 and 1996, the Company's net cash used in operating activities was approximately $40,952,000, $22,352,000 and $12,526,000 respectively. The increase in net cash used in operating activities in each year above is substantially due to the increased amount of net loss incurred in each year. As of December 31, 1998, the Company had cash, cash equivalents and short-term investments of $29,660,000 and total assets of $107,327,000. Net cash used in investing activities totaled $23,416,000 and $17,048,000 during the years ended December 31, 1997 and 1996, respectively, and resulted substantially from the Company's net purchases of short-term investments. For the year ended December 31, 1998, net cash provided by investing activities was $6,489,000, which was primarily the result of the maturity of short-term investments, offset by cash used for the purchase of IMTIX. Net cash provided by financing activities totaled $29,000, $76,615,000 and $44,811,000 during the years ended December 31, 1998, 1997 and 1996, respectively. Such amounts were substantially comprised of proceeds received from the sale of Common Stock during the respective periods offset in part by net repayments of notes payable and capital lease obligations. Although the Company has no current contractual obligations relating to capital expenditures, it anticipates that capital expenditures, primarily for its United States operations, will aggregate approximately $2.6 million during 1999. The Company utilizes various computer software packages in the conduct of its business activities. The Company has conducted a preliminary assessment of its internal information technology systems to identify the systems that could be affected by the Year 2000 issue. Based on this preliminary assessment, the Company currently has no reason to believe that its internal information technology systems are not Year 2000 compliant. The Company intends to continue to assess the Year 2000 compliance of its internal information technology systems. To date, the Company has not made any material expenditures related to the Year 2000 compliance of its internal information technology systems and the Company does not currently anticipate spending any material amounts for Year 2000 remediation. There can be no assurance that Year 2000 errors or defects will not be discovered in the Company's internal information technology systems. In the event Year 2000 errors or defects are discovered in the Company's internal information technology systems and the Company is not able to remedy such errors or defect in a timely manner or the cost to remedy such errors or defects is significant, there would be a material adverse effect on the Company's business, results of operations or financial condition. The Company has not yet fully assessed the extent of its exposure, or investigated the plans of its suppliers and vendors to address their exposures to these year 2000 problems, and thus the Company may be adversely impacted should these organizations not successfully address this issue. At December 31, 1998, the Company had Federal, state and foreign net operating loss ("NOL") carryforwards of approximately $93,699,000, $24,821,000 and $1,502,000, respectively, available to reduce future taxable income. In addition, the Company had available research and experimentation credit carryforwards of approximately $1,490,000 and $803,000 for federal and state tax purposes. The Company's ability to realize the benefits of the NOL and credit carryforwards is dependent upon the generation of sufficient taxable income in the respective taxing jurisdiction prior to their expiration. There can be no assurance that the Company will be able to generate sufficient taxable income to avail itself of such benefits. Furthermore, utilization of the net operating loses and credits may be subject to an annual limitation due to ownership change limitations provided by the Internal Revenue Code of 1986 and similar state provisions. The annual limitation may result in the expiration of net operating loses and credits before utilization. The Company anticipates the need, within the next twelve months, to raise additional funds through additional financings, including private or public equity and/or debt offerings and collaborative research and development arrangements with corporate partners. There can be no assurance that adequate funds will be raised on favorable terms, if at all, or that discussions with potential collaborative partners will result in any agreements. The Company's future capital requirements will depend on many factors, including its research and development programs, the scope and results of clinical trials, the time and costs involved in obtaining regulatory approvals, the costs involved in obtaining and enforcing patents or any litigation by third parties regarding intellectual property, the status of competitive products, the establishment of manufacturing capacity or third-party manufacturing arrangements, the establishment of sales and marketing capabilities, the establishment of collaborative relationships with other parties, and the costs of manufacturing scale-up and working capital requirements for inventory and financing of accounts receivable. If adequate funds are not available, the Company may be required to delay, scale back or eliminate one or more of its development programs or obtain funds through arrangements with collaborative partners or others that may require the Company to relinquish rights to certain technologies, product candidates or products that the Company would not otherwise relinquish. SangCya Approved in UK On February 4, 1999, the Company announced that the United Kingdom granted, under their national regulatory procedure, marketing approval to SangCya(TM) Oral Solution (cyclosporine) for prevention of rejection in solid organ transplant recipients as well as other immunosuppressant indications. Based on this approval, SangStat intends to seek additional European Member State approvals through the Mutual Recognition Procedure. This application was submitted to the UK Medicines Control Agency on February 12, 1998 with the aim of benefiting from the European Community Mutual Recognition Procedure for obtaining regulatory approval in multiple Member States. This procedure involves the filing of the submission in only one Member State (e.g. UK), which upon grant of marketing authorization, then serves as the Reference Member State for the other Concerned Member States. In accordance with the EC legislation, once this procedure is initiated, these Concerned Member States are required to mutually recognize the initial authorization and summary of Product Characteristics within 90 days. This is expected to result in SangCya approval in most European countries during the second half of 1999. The European market is roughly equivalent to the U.S. market in size and scope. There are approximately 20,000 new transplant recipients per year concentrated in just 250 transplant centers and over 100,000 transplant recipients in Europe who require daily lifelong immunosuppressive therapy from the time of transplant surgery. Estimated 1998 sales of cyclosporine exceeded $450 million in Europe and $70 million in the UK. Recently Issued Accounting Pronouncements In the first quarter of 1998, the Company adopted Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income, which requires an enterprise to report, by major components and as a single total, the change in its net assets during the period from non-owner sources. In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, which establishes annual and interim reporting standards for an enterprise's business segments and related disclosures about its products, services, geographic areas and major customers. The adoption of this statement in 1998 did not impact the Company's consolidated financial position, results of operations or cash flows. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This Statement requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS 133 will be effective for the Company's year ending December 31, 2000. Management believes that this Statement will not have a significant impact on the Company. Risk Factors History of Operating Losses; Future Profitability Uncertain. SangStat was incorporated in 1988 and has experienced significant operating losses since that date. As of December 31, 1998, the Company's accumulated deficit was $100,270,000. The Company's operating expenses have increased from approximately $17.3 million to $31.0 million to $60.9 million over the last three fiscal years. Total revenues increased from approximately $2.4 million to $4.5 million to $19.7 million while net losses from operations increased from approximately $14.9 million to $26.5 million to $41.3 million over the last three fiscal years. There can be no assurance that the Company will ever achieve significant revenues from product sales or profitable operations. To date, the Company's product revenues have been substantially dependent on sales of certain organ transplantation products, including a limited number of monitoring products, international sales of THYMOGLOBULIN and LYMPHOGLOBULINE, and limited initial sales in North America of THYMOGLOBULIN and SANGCYA. Future Growth Dependent on Sales of Key Products. The Company expects to derive a majority of its future revenues from sales of SANGCYA, SANG-2000 and THYMOGLOBULIN. SANGCYA and THYMOGLOBLIN were launched in November 1998 and February 1999, respectively and the Company expects to file for regulatory approval for SANG-2000 in the first half. Accordingly, any factor adversely affecting the sale of these key products, individually or collectively, would have a material adverse effect on the Company's business, financial condition and results of operations. Sales of these key products could be adversely affected by competitive changes, regulatory matters, manufacturing or supply interruptions, number of contracts with managed care providers and group purchasing organization, factors affecting production, marketing or pricing actions, changes in the prescribing practices of transplant physicians, reimbursement practices of third party payors, product liability claims or other factors. In particular, with respect to SANGCYA and SANG-2000, sales may be affected by perceptions of both patients and physicians regarding use of a generic version of a critical, life-saving therapeutic, the availability and acceptance of the CYCLOTECH device to be used in connection with SANGCYA, and intense competitive pressure from Novartis as well as the Novartis litigation. See "-Uncertainty of Market Acceptance; "-Substantial Competition;" and "-Litigation with Novartis." Litigation with Novartis. On February 11, 1999, Novartis Pharmaceuticals Corporation filed a lawsuit (case number 99-065) in Federal District Court for the District of Delaware against the Company alleging infringement of United States patent #5,389,382, a cyclosporine technology patented by Novartis A.G. The Novartis patent does not cover Neoral but rather a separate delivery system not used in the Neoral formulation. Novartis seeks the following relief: (i) a finding that SangStat willfully infringed the patent; (ii) to permanently enjoin SangStat from infringing the Novartis patent; (iii) treble damages; and (iv) reasonably attorneys' fees , costs and expenses. SangStat's answer is due April 5, 1999 and discovery will not begin until after the answer is filed. SangStat believes that the lawsuit is without merit and that it does not infringe the Novartis patent. SangStat intends to defend itself vigorously against this claim. Although the Company is optimistic that this dispute will ultimately be resolved favorably to the Company, the course of litigation is inherently uncertain and there can be no assurance of a favorable outcome. As a result of the Novartis suit, SangStat could be enjoined from selling SANGCYA for a significant period of time or ultimately be prevented from selling SANGCYA. Should this happen, the Company does not believe it would be able to obtain a license from Novartis on acceptable terms because the Company believes cyclosporine is an important product for Novartis and that Novartis would not want to diminish its profits from this product by licensing it on acceptable terms to the Company. Failure to obtain any such required license could prevent the Company from selling SANGCYA entirely, which would have a material adverse effect on the Company's future results of operations. The litigation, whether or not resolved favorably to the Company, is likely to be expensive, lengthy and time consuming, will divert management's attention and could have a material adverse effect on the Company's business, financial condition, cash flows and results of operations. SANG-2000 is not covered by this lawsuit and the Company does not believe that this lawsuit will have an impact on the regulatory approval of Sang-2000. Novartis Pharmaceuticals Corporation sued the FDA on February 11, 1999 in the United States District Court for the District of Columbia (case number 1:99CV-00323) alleging that the FDA did not follow its own regulations in approving SANGCYA in October 1998. The lawsuit against the FDA appears to be based on arguments similar to those used in the failed citizen's petition in which Novartis alleged that because Neoral and SANGCYA, both oral solutions, are based on different formulation technologies, they should be classified as different dosage forms. Novartis asks that the court rescind the AB rating that was given to SANGCYA. Loss of the "AB" rating would prevent SANGCYA from being automatically substitutable for Neoral oral solution, which would impede the marketing of SANGCYA. The Company believes that the lawsuit is without merit and that the FDA will prevail in this matter. Although the Company is optimistic that this dispute will ultimately be resolved favorably to the Company, the course of litigation is inherently uncertain and there can be no assurance of a favorable outcome. Novartis' requested relief, if granted, could have a significant negative economic impact on SangStat. In order to defend its interests vigorously, SangStat filed a Motion for Leave to Intervene in this lawsuit on February 23, 1999. The Court has not yet ruled on this motion. Fluctuations in Operating Results. The Company's operating losses have increased each year since inception and losses may be expected to continue in the near future as a result of a number of factors including the uncertainty in the timing and the amount of revenue earned upon product sales and achievement of research and development milestones, funding under collaborative research agreements and expenses required for product development, clinical trials and marketing and sales activities. The Company's operating results may fluctuate significantly depending on other factors, including the introduction of new products by the Company's competition, regulatory actions, market acceptance of the Company's products, adoption of new technologies, manufacturing capabilities, legal actions and third-party reimbursement policies. No Assurance of Successful Product Development. To achieve profitable operations, the Company, alone or with others, must successfully develop, obtain regulatory approval for, manufacture, introduce and market its products and product candidates. There can be no assurance that the Company's product development efforts will be successfully completed, that required regulatory approvals will be obtained, or that any products if developed and introduced will be successfully marketed. The Company's product candidates will require extensive development, testing and investment, as well as regulatory approval prior to commercialization. Cost overruns due to unanticipated regulatory delays or demands, unexpected adverse side effects or insufficient therapeutic efficacy would prevent or substantially slow down the development effort and ultimately would have a material adverse effect on the Company. Furthermore, there can be no assurance that the Company's research and development efforts will be successful and that any given product will be approved by appropriate regulatory authorities or that any product candidate under development will be safe, effective or capable of being manufactured in commercial quantities at an economical cost, will not infringe the proprietary rights of others or will achieve market acceptance. THYMOGLOBULIN was approved for sale in the U.S. in December 1998. SANGCYA was approved for sale in the U.S. in October 1998 and in the U.K. in January 1999. The Company has also filed an NDS for marketing approval of THYMOGLOBULIN in Canada. The Company's other principal pharmaceutical product candidates, including the Company's capsule formulation of cyclosporine (SANG-2000), the Company's formulation of AZATHIOPRINE, ANTILFA, and ALLOTRAP 1258, have not been approved for commercial sale in any country. SangStat has developed a generic AZATHIOPRINE for use in transplantation as an adjunct therapy in chronic immunosuppression and has completed its pharmacokinetic and human bioequivalency trials. The Company intends to seek market approval by filing an ANDA with the FDA. In 1996, the Company voluntarily withdrew its 510(k) for a two-component CELSIOR product and has completed a multi-center clinical trial for a redesigned one-component, ready-to-use CELSIOR product candidate. The results of an initial Phase II safety study in Europe showed that ALLOTRAP 2702 was safe and well-tolerated in the study. Toxicology studies have been completed in a second generation peptide, ALLOTRAP 1258. Pre-clinical development has indicated that this second generation peptide may be more potent than ALLOTRAP 2702. As a result, the Company may decide to pursue the development of ALLOTRAP 1258 rather than ALLOTRAP 2702. The Company has designed the ALLOTRAP clinical trials to comply with regulatory standards in France as well as in the United States, so that it may use the data to support its NDA to the FDA. There can be no assurance that such data will be accepted by the FDA. The use of ALLOTRAP peptides to promote graft acceptance in humans is novel and unproven and there can be no assurance that such peptides will prove to be safe or effective in humans for any clinical indication, including for any transplant type or at any dosage. The Company has no clinical evidence in humans that ALLOTRAP peptides will be effective in promoting graft acceptance or safety in transplant patients and there can be no assurance that ALLOTRAP or any other product candidates based on ALLOTRAP peptides will receive marketing approval or become viable commercial products. Certain of the Company's monitoring product candidates are in development and have not been approved for commercial sale. There can be no assurance that these product candidates will be successfully developed, receive regulatory approval or be marketed on a profitable basis. See "Business-Products and Product Candidates." Risks Associated With the Manufacture of SANGCYA, SANG-2000 and THYMOGLOBULIN. Cyclosporine is particularly difficult to manufacture and there can be no assurance that SANGCYA or SANG-2000 can be manufactured in commercial quantities at an economical cost. The Company has contracted for commercial scale production of cyclosporine bulk material (i.e. the active ingredient of cyclosporine) for SANGCYA and SANG-2000 from both Gensia Sicor and a second FDA approved supplier. Gensia Sicor received approval in July 1997 of an ANDA from the FDA for the manufacture of bulk cyclosporine drug substance. SangStat's second supplier of bulk cyclosporine drug substance has also been approved by the FDA. The Company has also separately subcontracted the manufacture of SANGCYA and SANG-2000 product with Eli Lilly. There can be no assurance that such third parties will perform satisfactorily and any such failure may delay regulatory approval, product launch, impair the Company's ability to deliver products on a timely basis, or otherwise impair the Company's competitive position, which would have a material adverse effect on the Company's business, financial condition, cash flows and results of operations. THYMOGLOBULIN is also difficult to manufacture and there can be no assurance that SangStat will be able to manufacture commercial quantities at an economical cost. The Company recently acquired the IMTIX division of PMC, including certain manufacturing capabilities with respect to THYMOGLOBULIN. From time to time, prior to the acquisition, certain batches of THYMOGLOBULIN did not meet manufacturing specifications, resulting in a shortage of THYMOGLOBULIN product for commercial sale. Since the acquisition, all batches of THYMOGLOBULIN have met manufacturing specifications. Even after the acquisition, the Company still relies on PMC for certain important manufacturing services, including, but not limited to, quality assurance and quality control, as well as lyophilization. There can be no assurance that PMC will continue to provide these critical manufacturing services to the Company in an effective manner or without interruption. There can be no assurance that the Company will not experience manufacturing difficulties with respect to THYMOGLOBULIN in the future. Uncertainty of Market Acceptance. Whether or not regulatory approvals are obtained, uncertainty exists as to whether the Company's products will be accepted by the market. In particular, there can be no assurance that the Company's product candidates would obtain significant market share. Factors that may affect the willingness of patients, physicians, pharmacists and third-party payors to convert to SangStat products, if approved, include price, perception of bioequivalence, perceived clinical benefits and risks, ease of use, other product features and brand loyalty. In addition, other factors may limit the market acceptance of products developed by the Company, including the timing of regulatory approval and market entry relative to competitive products, the availability of alternative therapies, the price of the Company's products relative to alternative therapies, the availability of third-party reimbursement and the extent of marketing efforts by the Company or third-party distributors or agents retained by the Company. There can be no assurance that patients, physicians, pharmacists, or third-party payors will accept the Company's products. In particular, with respect to SANGCYA and SANG-2000, if product approval is obtained, there can be no assurance that the Company will be successful in taking significant market share away from Novartis. Volatility of Common Stock Price. The market prices for securities of pharmaceutical and biotechnology companies, including the Company, have historically been highly volatile. The market has from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. Factors such as fluctuations in the Company's operating results, announcements of new therapeutic products by the Company or its competitors, announcements regarding collaborative agreements, governmental regulation, clinical trial results, developments in patent or other proprietary rights, litigation, public concern as to the safety of drugs developed by the Company or others, comments made by securities analysts and general market conditions may have a significant effect on the market price of the Company's Common Stock. In particular, the realization of any of the risks described on this 10-K could have a significant and adverse impact on the market price. Ability to Manage Growth. The Company has recently experienced a period of expansion of its operations that has placed a strain upon its management system and resources. The Company's ability to compete effectively and to manage future growth, if any, will require the Company to continue to improve its financial and management controls, reporting systems and procedures on a timely basis and expand, train and manage an increasing number of employees. The Company's failure to do so would have a material adverse effect on the Company's business, financial condition and results of operations. Uncertainty Regarding Patents and Proprietary Rights. The Company's success depends in part on its ability to obtain and enforce patent protection for its products and to preserve its trade secrets. The Company holds patents and pending patent applications in the United States and abroad. The Company's patents involve specific claims and thus do not provide broad coverage. There can be no assurance that the Company's patent applications or any claims of these patent applications will be allowed, or found to be valid or enforceable, that any patents or any claims of these patents will provide the Company with competitive advantages for its products or that such issued patents and any patents issued under pending patent applications will not be successfully challenged or circumvented by the Company's competitors. The Company has not conducted extensive patent and prior art searches with respect to many of its product candidates and technologies, and there can be no assurance that third-party patents or patent applications do not exist or could not be filed in the United States, Europe or other countries which would have an adverse effect on the Company's ability to market its products. There can be no assurance that any claims in the Company's patent applications would be allowed, or found to be valid or enforceable, or that any of the Company's products would not infringe on others' patents or proprietary rights in the United States or abroad. The ALLOTRAP peptide family is being developed under an exclusive, worldwide license from Stanford University. Although Stanford has filed patent applications with respect to such technology, there can be no assurance that, other than the patent application that has issued, any of the claims of such patent applications will be allowed, or found to be valid or enforceable and as to the issued patent, that the claims will be found to be valid or enforceable. There can be no assurance that SangStat can manufacture, or have manufactured, formulate or commercialize SANGCYA and SANG-2000 without infringing patent or other proprietary rights of Novartis or other third parties. The Company has recently been sued by Novartis for patent infringement. See "-Litigation with Novartis." Patent applications in the United States are maintained in secrecy until patents issue. Since publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries by several months, SangStat cannot be certain that it was the first to discover compositions covered by its pending patent applications or the first to file patent applications on such compositions. There can be no assurance that the Company's pending patent applications will result in issued patents or that any of its issued patents will afford protection against a competitor. The Company also relies on trade secrets and proprietary know-how which it seeks to protect, in part, by confidentiality agreements with its employees and consultants. There can be no assurance that these agreements will not be breached, that the Company would have adequate remedies for any breach or that the Company's trade secrets will not otherwise become known or independently developed by competitors. The Company has registered or applied for registration of the names of most of its products under development or commercialized for research and development use. However, there can be no assurance that any trademark registration will be granted or not challenged by competitors. See "Business-Patents and Proprietary Technology." Substantial Competition. The drugs being developed by the Company compete with existing and new drugs being created by pharmaceutical, biopharmaceutical, biotechnology and diagnostics companies and universities. Many of these entities have significantly greater research and development capabilities, as well as substantial marketing, manufacturing, financial and managerial resources and represent significant competition for the Company. The principal factors upon which the Company's products compete are product utility, therapeutic benefits, ease of use, effectiveness marketing, distribution and price. With respect to THYMOGLOBULIN, SANGCYA, SANG-2000, and AZATHIOPRINE, the Company will be competing against large companies that have significantly greater financial resources and established marketing and distribution channels for competing products. For example, Novartis currently controls virtually 100% of the worldwide cyclosporine markets and has significantly greater resources than the Company. There can be no assurance that the Company will be able to compete successfully against Novartis. To date, the Company has a limited number of contracts with managed care providers and group purchasing organizations. The Company's future sales will be dependent on the Company's ability to enter into contracts with these entities. The drug industry is characterized by intense price competition and the Company anticipates that it will face this and other forms of competition. There can be no assurance that developments by others will not render the Company's products or technologies obsolete or noncompetitive or that the Company will be able to keep pace with technological developments. Many of the competitors have developed or are in the process of developing technologies that are, or in the future may be, the basis for competitive products. Some of these products may have an entirely different approach or means of accomplishing the desired therapeutic effect than products being developed by the Company and may be more effective and less costly. In addition, many of these competitors have significantly greater experience than the Company in undertaking preclinical testing and human clinical trials of pharmaceutical products and obtaining regulatory approvals of such products. Accordingly, the Company's competitors may succeed in commercializing products more rapidly than the Company. For example, the Company believes that the degree of market penetration of SANG-2000 is dependent in part on whether the Company is the first company to market a bioequivalent formulation of cyclosporine. The Company believes that other companies may be developing cyclosporine formulations that may be marketed as generic equivalents. Were these competitors to develop their products more rapidly and complete the regulatory process sooner, it could have a material adverse effect on the Company's business, financial condition, cash flows and results of operations. Treatments for the problems associated with transplantation that the Company's products seek to address are currently available. For example, Sandimmune and Neoral, marketed by Novartis, compete with SANGCYA and SANG-2000. Orthoclone OKT3, marketed by Johnson & Johnson and ATGAM, marketed by Pharmacia & Upjohn Inc., Simulect, marketed by Novartis, and Zenapax, marketed by Roche Ltd., would be competitive with THYMOGLOBULIN. Prograf marketed by Fujisawa Pharmaceutical Co. Ltd, CellCept, marketed by Roche Ltd. and Imuran, marketed by Glaxo Wellcome Ltd. would be competitive with SANGCYA, SANG-2000 and AZATHIOPRINE. All of such products are commercially available for use as immunosuppressive drugs and are widely prescribed. In addition, One Lambda Inc., Pel Freez, Biotest Diagnostics Corp., and Genetic Therapy, Inc. market products for pre-transplant HLA monitoring and Abbott Laboratories markets a cyclosporine level post-transplant monitoring device, all of which are widely used. Additional therapeutics and monitoring products are available or are under development by these and other parties including, but not limited to: American Home Products Corp. (rapamycin), Bristol Myers Squibb (CTLA4), and DuPont Merck (ViaSpan), and other companies including, but not limited to Abbott (cyclosporine), MedImmune Inc., BioTransplant, Inc., and Ivax Corp. All of the aforementioned competitive and other drugs are commercially available for use as immunosuppressive drugs and are widely prescribed. To the extent these therapeutics, monitoring products or novel transplant procedures address the problems associated with transplantation on which the Company has focused, they may represent significant competition. See "Business- Competition." Limited Manufacturing Capability. In 1998, the Company leased a manufacturing facility in Lyon, France as part of the IMTIX transaction for the manufacture of THYMOGLOBULIN. The Company's wholly-owned subsidiary, IMTIX-SangStat, manufactures THYMOGLOBULIN. There can be no assurance that IMTIX-SangStat will continue to meet FDA standards governing Good Manufacturing Practices ("GMP"). The Company currently relies on PMC to perform certain services for the Company in the manufacturing process. See "--Risks Related to the Manufacture of SANGCYA, SANG-2000, and THYMOGLOBULIN." The Company lacks facilities to manufacture any of its other drugs or drug candidates in accordance with current GMP prescribed by the FDA. The Company generally relies on third parties to manufacture compounds other than THYMOGLOBULIN and devices for commercial sales and clinical trials, including SANGCYA, PRA-STAT, CYCLOTECH, SANG-2000, ALLOTRAP 1258, AZATHIOPRINE and CELSIOR and has contracted for commercial production of these compounds and devices. There can be no assurance that manufacturers will meet FDA standards governing GMP or other regulatory guidelines, that any BLA's required for manufacturing will be filed, reviewed and approved, or that any third-party manufacturer will pass a preapproval inspection. The Company is currently purchasing ALLOTRAP 1258 for clinical trials from UCB Bioproducts S.A. ("UCB") located in Belgium, and intends to contract with UCB for commercial production. The Company has contracted for commercial scale production of cyclosporine bulk material for SANGCYA and SANG-2000 with Gensia Sicor as well as with a second FDA approved manufacturer. In addition, the Company has contracted for the production of its finished formulated SANGCYA and SANG-2000 with Eli Lilly and Company. The Company has also contracted for manufacture of azathioprine bulk material with an FDA approved manufacturer and with a separate FDA approved manufacturer for production of its finished formulated AZATHIOPRINE product candidate. There can be no assurance that the Company will be able to enter into secondary commercial scale manufacturing contracts or that any other third-party arrangements can be established on a timely or commercially reasonable basis, or at all. The Company will depend on all such third parties to perform their obligations effectively and on a timely basis. There can be no assurance that such parties will perform and any failures by third parties may delay clinical development or submission of products for regulatory approval, or otherwise impair the Company's competitive position which could have a material adverse effect on the Company's business, financial condition, cash flows and results of operations. In addition, the manufacturing of drug candidates involves a number of technical steps and requires meeting stringent quality control specifications imposed by government regulatory bodies and by the Company itself. Additionally, such products can only be manufactured in facilities approved by the applicable regulatory authorities. Because of these and other factors, the Company may not be able to replace its manufacturing capacity quickly or efficiently in the event that its manufacturers are unable to manufacture their products at one or more of their facilities. For certain of its potential products, the Company will need to develop its production technologies further for use on a larger scale in order to conduct human clinical trials and produce such products for commercial scale at an acceptable cost. The Transplant Pharmacy. Establishing THE TRANSPLANT PHARMACY as a viable distribution system entails a number of risks including the Company's ability to enter into agreements with transplant centers to utilize THE TRANSPLANT PHARMACY's services, compliance with state regulations regarding pharmacy licensing and compliance with federal and state laws regulating payments for referrals for health care services. On November 11, 1998, the Office of the Inspector General (OIG) of the Department of Health & Human Services issued an Advisory Opinion which stated that the placement by a pharmacy of a licensed pharmacist at a hospital transplant center might constitute prohibited remuneration under the anti-kickback statute section 1128B9B) of the Social Security Act. The Company did not request the Advisory Opinion and the Advisory Opinion only applies to the requesting party. The Company believes that the operation of The Transplant Pharmacy differs from the fact pattern set out in the Advisory Opinion and does not constitute prohibited remuneration. There can be no assurance that the OIG will agree with this analysis, in which case The Transplant Pharmacy's program may be modified so that it would no longer include an on-site pharmacist at transplant centers. There can be no assurance that the Company will be successful in establishing THE TRANSPLANT PHARMACY as a viable distribution method for the Company's products and services. See "Business-Products, Product Candidates and Services." No Assurance of FDA, Canadian or European Regulatory Approval; Government Regulation. The Company's research, preclinical development, clinical trials, manufacturing, marketing and distribution of its products in the United States and other countries are subject to extensive regulation by numerous governmental authorities including, but not limited to, the FDA. In order to obtain regulatory approval of a drug product, the Company must demonstrate to the satisfaction of the applicable regulatory agency, among other things, that such product is safe and effective for its intended uses and that the manufacturing facilities are in compliance with GMP requirements. The Company must also demonstrate the approvability of a BLA for its biological products. The approval of the Company's generic product candidates is dependent on demonstrating bioequivalence with reference products in addition to assurance of compliance with GMP regulations. In order to market its monitoring products, which are considered to be medical devices, the Company or its licensees will be required either to receive 510(k) marketing clearance or Premarket Approval Application ("PMA") approvals from the FDA for such products among other regulatory requirements. To obtain a 510(k) marketing clearance, the Company must show that a monitoring product is "substantially equivalent" to a legally marketed product not requiring FDA approval. In addition, the Company must demonstrate that it is capable of manufacturing the product to the relevant standards. To obtain PMA approval, the Company must submit extensive data, including pre-clinical and clinical trial data to prove the safety and efficacy of the device. Additionally, the Company is currently distributing several monitoring products for research or investigational use. Although the Company believes it is complying with FDA regulations regarding such distribution, there can be no assurance that the FDA will not determine that the Company is violating FDA regulations with respect to the distribution of these products. The process of obtaining FDA and other required regulatory approvals is lengthy and will require the expenditure of substantial resources, and there can be no assurance that the Company will be able to obtain the necessary approvals. Moreover, if and when such approval is obtained, the marketing, distribution and manufacture of the Company's products would remain subject to extensive regulatory requirements administered by the FDA and other regulatory bodies. Failure to comply with applicable regulatory requirements can result in, among other things, warning letters, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, refusal of the government to grant pre-market clearance or pre-market approval, withdrawal of approvals and criminal prosecution of the Company and employees. Additionally, the Company intends to pursue commercialization of its products in European countries. Both the Company's pre-transplant and post-transplant monitoring products should be subject to regulation as in vitro medical devices for which regulations are being presently formulated under harmonized European Directives. This new Directive is likely to impose additional requirements on the pre-transplant donor/recipient matching products and the post-transplant monitoring products. This legislation may include, among other things, requirements with respect to the design, safety and performance of the products as well as impose premarket approval procedures such as product type certification and quality systems certification of manufacturing. The Company's therapeutic products are subject to foreign regulatory requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement, which vary from country to country. The process of obtaining foreign regulatory approvals can be lengthy and require the expenditure of substantial resources, and there can be no assurance that the Company will be able to obtain the necessary approvals or the approvals for the proposed indications. See "Business-Government Regulation." Dependence on Collaborative Relationships. The Company has in the past relied on collaborative relationships to finance certain of its research and development programs. The Company may enter into collaborative relationships with corporate and other partners to develop and commercialize certain of its potential products. There can be no assurance that the Company will be able to negotiate acceptable collaborative arrangements in the future, that such collaborations will be available to the Company on acceptable terms or that any such relationships, if established, will be scientifically or commercially successful. See "Business-Strategic Relationships." Dependence upon Key Personnel. The Company's ability to develop its business depends in part upon its attracting and retaining qualified management and scientific personnel. As the number of qualified personnel is limited, competition for such personnel is intense. There can be no assurance that the Company will be able to continue to attract or retain such people. The loss of key personnel or the failure to recruit additional key personnel could significantly impede attainment of the Company's objectives and have a material adverse effect on the Company's financial condition and results of operations. The Company's planned activities will require the addition of new personnel, including management, and the development of additional expertise by existing management personnel, in areas such as research, product development, preclinical testing, clinical trial management, regulatory affairs, finance, manufacturing, pharmacy affairs and marketing and sales. The inability to acquire such services or to develop such expertise could have a material adverse effect on the Company's business, financial condition and results of operations. Uncertainty of Pharmaceutical Pricing and Reimbursement. The Company's ability to commercialize its products may depend in part on the extent to which reimbursement for the cost of such products and related treatment will be available from government health administration authorities, private health coverage insurers and other organizations. Significant uncertainty exists as to the pricing, availability of distribution channels and reimbursement status of newly approved healthcare products and there can be no assurance that adequate third party coverage will be available for the Company to maintain price levels sufficient for realization of an appropriate return on its investment in product development. In certain foreign markets, pricing or profitability of healthcare products is subject to government control. In the United States, there have been, and the Company expects that there will continue to be, a number of federal and state proposals to implement similar governmental control. In addition, an increasing emphasis on managed care in the United States has and will continue to increase the pressure on pharmaceutical pricing. While the Company cannot predict whether any such legislative or regulatory proposals will be adopted or the effect such proposals or managed care efforts may have on its business, the announcement of such proposals or efforts could have a material adverse effect on the Company's ability to raise capital, and the adoption of such proposals or efforts could have a material adverse effect on the Company's business, financial condition and results of operations. Further, to the extent that such proposals or efforts have a material adverse effect on other pharmaceutical companies that are prospective corporate partners for the Company, the Company's ability to establish corporate collaborations may be adversely affected. In addition, third-party payors are increasingly challenging the prices charged for medical products and services. If the Company succeeds in bringing one or more products to the market, there can be no assurance that these products will be considered cost effective or that reimbursement to the consumer will be available or will be sufficient to allow the Company to sell its products on a competitive basis. See "Business-Products, Product Candidates and Services." Product Liability Exposure; Limited Insurance Coverage. The Company faces an inherent business risk of exposure to product liability claims in the event that the use of products manufactured by the Company results in adverse effects during research, clinical development or commercial use. While the Company will attempt to take appropriate precautions, there can be no assurance that it will avoid significant product liability exposure. The Company's product liability insurance coverage is currently limited to $10,000,000 which may not be adequate insurance coverage to cover potential liability exposures. Moreover, there can be no assurance adequate insurance coverage will be available at acceptable cost, if at all, or that a product liability claim would not materially adversely affect the business, financial condition, cash flows and results of operations of the Company. Hazardous Materials. In connection with its research and development activities and operations, the Company is subject to federal, state and local laws, rules, regulations and policies governing the use, generation, manufacture, storage, air emission, effluent discharge, handling and disposal of certain materials, biological specimens and wastes. There can be no assurance that the Company will not incur significant costs to comply with environmental and health and safety regulations. The Company's research and development involves the controlled use of hazardous materials, including but not limited to certain hazardous chemicals and infectious biological specimens. Although the Company believes that its safety procedures for handling and disposing of such materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be 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. See "Business-Government Regulation." Effect of Certain Provisions: Anti-takeover Effects of Certificate of Incorporation, Bylaws, Stockholder Rights Plan and Delaware Law. Certain provisions of the Company's Certificate of Incorporation and Bylaws could delay or make more difficult a merger, tender offer or proxy contest involving the Company, which could adversely affect the market price of the Company's Common Stock. The Company's Board of Directors has the authority to issue up to 5,000,000 shares of Preferred Stock and to determine the price, rights preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The issuance of Preferred Stock could have the effect of making it more difficult for a third party to acquire a majority of the outstanding voting stock of the Company. Further, the Company has adopted a stockholder rights plan. The plan allows for the issuance of a dividend to stockholders of rights to acquire shares of the Company or, under certain circumstances, an acquiring corporation, at less than half their fair market value. The plan could have the effect of delaying, deferring or preventing a change in control of the Company. In addition, the Company is subject to the antitakeover provisions of Section 203 of the Delaware General Corporation Law, which will prohibit the Company from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. The application of Section 203 also could have the effect of delaying or preventing a change of control of the Company. Year 2000 Issue The Company utilizes various computer software packages in the conduct of its business activities. The Company has conducted a preliminary assessment of its internal information technology systems to identify the systems that could be affected by the Year 2000 issue. Based on this preliminary assessment, the Company currently has no reason to believe that its critical internal information technology systems are not Year 2000 compliant. The Company intends to continue to assess the Year 2000 compliance of its internal information technology systems. To date, the Company has not made any material expenditures related to the Year 2000 compliance of its internal information technology systems and the Company does not currently anticipate spending any material amounts for Year 2000 remediation. Total cost of completing Year 2000 compliance is estimated to be less than $100,000. There can be no assurance that Year 2000 errors or defects will not be discovered in the Company's internal information technology systems. In the event Year 2000 errors or defects are discovered in the Company's internal information technology systems and the Company is not able to remedy such errors or defect in a timely manner or the cost to remedy such errors or defects is significant, there would be a material adverse effect on the Company's business, results of operations or financial condition. The Company has not yet fully assessed the extent of its exposure, or fully investigated the plans of its suppliers and vendors to address their exposures to these year 2000 problems, and thus the Company may be adversely impacted should these organizations not successfully address this issue. Completion of this work is targeted for June 30, 1999. When all assessments have been completed, the Company will develop a contingency plan for any areas in which a Year 2000 exposure exists. ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk Market Risk Disclosures. The following discussion about the Company's market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. The Company is exposed to market risk related to changes in interest rates and equity security price risk. Interest Rate Sensitivity. The Company maintains a short-term investment portfolio consisting mainly of government and corporate bonds purchased with an average maturity of less than two years. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10 percent from levels at December 31, 1998, the fair value of the portfolio would decline by an immaterial amount. The Company generally has the ability to hold fixed income investments until maturity and therefore does not expect operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on its securities portfolio. Equity Price Risk. The Company holds a small portfolio of marketable-equity traded securities that are subject to market price volatility. Equity price fluctuations of plus or minus 15 percent would not have a material impact on the Company. All of the potential changes noted above are based on sensitivity analyses performed on the Company's financial positions at December 31, 1998. Actual results may differ materially. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Reference is made to item 14(a)(1) and 14(a)(2) of this Annual Report on Form 10-K. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III The information required by Items 10 through 13 of Part III is incorporated by reference from the registrant's Proxy Statement, under the captions "Nomination and Election of Directors," "Beneficial Stock Ownership," "Compensation of Executive Officers" and "Compensation Committee Interlocks and Insider Participation in Insider Participation and Certain Transactions", which Proxy Statement will be mailed to stockholders in connection with the registrant's annual meeting of stockholders which is expected to be held in May 1999. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as a part of this Annual Report on Form 10-K: 1. Financial Statements. Independent Auditors' Report Consolidated Balance Sheets - December 31, 1998 and 1997 Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996 Consolidated Statements of Comprehensive Income for the years ended December 31, 1998, 1997 and 1996 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements for the years ended December 31, 1998, 1997 and 1996 2. Financial Statement Schedule. Schedule II - Valuation and Qualifying Accounts and Reserves All other schedules are omitted because they are not required, are not applicable or the information is included in the consolidated financial statements and notes thereto. 3. Exhibits. Reference is made to Item 14(c) of this Annual Report on Form 10-K. (b) Reports on Form 8-K. Form 8-K filed on October 15, 1998 as amended on December 14, 1998 (c) Exhibits. 2.1 (7) Agreement and Plan of Merger dated as of July 24, 1995 between SangStat Delaware, Inc., and SangStat Medical Corporation, a California corporation, as filed with the Delaware Secretary of State on August 11, 1995. 2.2 (9) Master Agreement between SangStat Medical Corporation and Pasteur Merieux Serums & Vaccins, S.A. dated June 10, 1998, including Exhibit 8 thereto. 3.2 (7) Certificate of Incorporation of SangStat Delaware, Inc. 3.4 (6) Certificate of Designation for the Series A Junior Participating Preferred Stock, filed with the Delaware Secretary of State on August 16, 1995. 3.5 (7) Amended and Restated Bylaws of the Registrant. 4.5 (3) Specimen Common Stock Certificate of Registrant. 10.1 (1)(3)Collaborative Agreement effective April 19, 1993, as amended, between SangStat and Baxter Healthcare Corporation. 10.2 (1)(3)License Agreement, dated October 21, 1991, between the Registrant and The Board of Trustees of Leland Stanford Junior University. 10.3 (3) Contract for the Provision of Services, dated October 5, 1993 between the Centre Hospitalier Universitaire de Nantes and SangStat Atlantique. 10.4 (1)(3)License Agreement, dated October 13, 1993, between the Registrant and Pasteur Merieux Serums et Vaccins. 10.5 (1)(3)Letter Agreement between SangStat and Ortho Biotech. 10.6 (2)(3)1990 Stock Option Plan, as amended October 1992 and form of Stock Option Agreement. 10.7 (2)(3)1993 Stock Option/Stock Issuance Plan. 10.8 (3) Series B Stock Purchase Agreement, dated September 21, 1989, between the Registrant and the Investors listed in Schedule A thereto. 10.9 (3) Series C Stock and Warrant Purchase Agreement, dated January 26, 1990, between the Registrant and the Investors listed in Schedule A thereto. 10.10 (3) Series D Stock and Warrant Purchase Agreement, dated July 15, 1991, between the Registrant and the Investors listed in Schedule A thereto. 10.11 (3) Amendment Agreement to the Series D Stock and Warrant Purchase Agreement, dated October 5, 1992, between the Registrant and the Investors listed in Schedule A of that certain Series D Stock and Warrant Purchase Agreement, dated July 15, 1991. 10.12 (3) Note and Warrant Purchase Agreement, dated October 2, 1992, between the Registrant and the Investors listed in the Schedule of Lenders thereto. 10.13 (3) Series E Stock and Warrant Purchase Agreement, dated April 19, 1993, between the Registrant and the Investors listed in Schedule A thereto. 10.14 (2)(3)Amended and Restated Shareholders Agreement, dated January 26, 1990, between the Registrant and Philippe Pouletty. 1993, between the Registrant and the Investors listed in Schedule A thereto. 10.14 (2)(3)Amended and Restated Shareholders Agreement, dated January 26, 1990, between the Registrant and Philippe Pouletty. 10.15 (3) Equipment Lease Agreement dated October 11, 1990 between SangStat and David Rammler. 10.16 (3) Real Property Lease, dated August 20, 1990, between the Registrant and Menlo Business Park and Patrician Associates, Inc. 10.17 (3) Lease Agreement dated September 1, 1993 between SangStat Atlantique and Center Hospitalier, Universitaire de Nantes. 10.18 (7) Form of Indemnification Agreement to be entered into between the Registrant and each of its officers and directors. 10.19 (1)(3)License Agreement, dated November 15, 1993, between the Registrant and the Board of Trustees of Leland Stanford Junior University. 10.20 (3) Letter Agreement between the Registrant and Baxter Healthcare Corporation dated December 11, 1993. 10.21 (1)(5)License Agreement with Pasteur Merieux Serums et Vaccins. 10.22 (2)(5)Supply Agreement with Pasteur Merieux Serums et Vaccins. 10.23 (4) Common Stock Purchase Agreement, dated December 23, 1994, between the Registrant and the Investors listed in Schedule A thereto. 10.25 (8) Rights Agreement, dated as of August 14, 1995, between the Registrant and First National Bank of Boston. 10.26 Real Property Sub-Lease, dated March 8, 1999, between the Registrant and Kelley-Clarke, Inc. Real Property lease between Kelly-Clarke Inc. and Kaiser Development Company dated September 1, 1988 as amended on February 26, 1990, May 1, 1990, May 5, 1990, and April 19, 1995 21.1 Subsidiaries of Registrant. 23.1 Independent Auditors' Consent. 24.1 Power of Attorney. (Reference is made to page 61) 27.1 Financial Data Schedule. ____________ (1) Confidential Treatment has been granted for the deleted portions of this document. (2) Management contract or compensatory plan or arrangement. (3) Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-1 (No. 33-70436). (4) Previously filed as an Exhibit to the Registrant's Form 8-K filed January 6, 1994. (5) Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-1 (No. 33-88432). (6) Previously filed as an Exhibit to Registrant's Form 8-K filed August 14, 1995. (7) Previously filed as an Exhibit to the Registrant's Registration Statement on Form 8-B filed December 4, 1995. (8) Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-3 (No. 333-2301). (9) Previously filed as Exhibits to the Registrant's Form 8-K/A as amended on December 14, 1998. INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of SangStat Medical Corporation: We have audited the accompanying consolidated balance sheets of SangStat Medical Corporation and subsidiaries (the Company) as of December 31, 1998 and 1997, and the related consolidated statements of operations, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the consolidated financial statement schedule listed in Item 14(a)2. These financial statements and financial schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial schedule 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, such consolidated financial statements present fairly, in all material respects, the financial position of SangStat Medical Corporation and subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements as a whole, presents fairly in all material respects the information set forth therein. DELOITTE & TOUCHE LLP San Jose, California February 2, 1999 SANGSTAT MEDICAL CORPORATION CONSOLIDATED BALANCE SHEETS
December 31, ---------------------------- 1998 1997 ------------- ------------- ASSETS CURRENT ASSETS: Cash and cash equivalents..................... $16,285,653 $50,630,819 Short-term investments........................ 13,374,742 41,404,955 Accounts receivable (net of allowance for doubtful accounts $928,917 in 1998 and $139,297 in 1997)............................ 10,962,814 1,012,631 Other receivables............................. 2,441,393 581,420 Inventories................................... 33,375,259 3,757,451 Prepaid expenses.............................. 1,727,058 1,752,036 ------------- ------------- Total current assets.................. 78,166,919 99,139,312 PROPERTY AND EQUIPMENT--Net..................... 3,133,768 2,015,373 INTANGIBLE ASSETS--Net of accumulated amortization of $351,144..................... 14,151,172 -- OTHER ASSETS.................................... 11,875,449 3,199,785 ------------- ------------- TOTAL................................. $107,327,308 $104,354,470 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable.............................. $25,824,098 $3,486,726 Accrued liabilities........................... 3,197,225 1,222,607 Capital lease obligations--current portion.... 492,921 327,222 Notes payable--current portion................ 1,824,768 290,855 ------------- ------------- Total current liabilities............. 31,339,012 5,327,410 ------------- ------------- CAPITAL LEASE OBLIGATIONS....................... 765,290 1,020,361 ------------- ------------- NOTES PAYABLE................................... 15,636,361 536,507 ------------- ------------- COMMITMENTS AND CONTINGENCIES (Notes 9 and 16) STOCKHOLDERS' EQUITY: Preferred stock, $.001 par value, 5,000,000 shares authorized; none outstanding......... -- -- Common stock, $.001 par value, 25,000,000 shares authorized; outstanding: 1998, 16,214,851 shares; 1997, 16,009,531 shares...................................... 160,250,935 159,265,454 Accumulated deficit........................... (100,269,950) (61,806,012) Accumulated other comprehensive income......... (394,340) 10,750 ------------- ------------- Total stockholders' equity............ 59,586,645 97,470,192 ------------- ------------- TOTAL................................. $107,327,308 $104,354,470 ============= =============
See notes to consolidated financial statements. SANGSTAT MEDICAL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, ----------------------------------------- 1998 1997 1996 ------------- ------------- ------------- REVENUES: Net product sales................... $18,585,859 $3,777,170 $2,398,979 Revenue from collaborative agreements (Note 8)............... 1,092,629 750,000 -- ------------- ------------- ------------- Total revenues................... 19,678,488 4,527,170 2,398,979 ------------- ------------- ------------- COSTS AND OPERATING EXPENSES: Cost of sales and manufacturing expenses.......................... 12,531,559 3,735,776 2,845,802 Research and development............ 17,688,113 16,210,198 8,330,129 Selling, general and administrative. 27,148,614 11,067,763 6,120,489 Acquired in-process research and development....................... 3,218,516 -- -- Amortization of intangible assets... 351,144 -- -- ------------- ------------- ------------- Total costs and operating expenses....................... 60,937,946 31,013,737 17,296,420 ------------- ------------- ------------- Loss from operations............. (41,259,458) (26,486,567) (14,897,441) INTEREST INCOME--NET.................. 3,052,721 5,506,381 2,123,606 ------------- ------------- ------------- LOSS BEFORE INCOME TAXES.............. (38,206,737) (20,980,186) (12,773,835) INCOME TAXES.......................... 257,201 -- -- ------------- ------------- ------------- NET LOSS.............................. ($38,463,938) ($20,980,186) ($12,773,835) ============= ============= ============= NET LOSS PER SHARE - Basic and diluted (Note 1).................... ($2.39) ($1.36) ($1.03) ============= ============= ============= WEIGHTED AVERAGE COMMON SHARES........ 16,080,444 15,375,753 12,405,081 ============= ============= =============
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Year Ended December 31, ----------------------------------------- 1998 1997 1996 ------------- ------------- ------------- Net loss.............................. ($38,463,938) ($20,980,186) ($12,773,835) Unrealized gains and losses on marketable securities classified as available for sale............... (493,702) (78,097) 91,969 Foreign currency translation adjustments......................... 88,612 (34,648) (26,177) ------------- ------------- ------------- Total comprehensive loss.............. ($38,869,028) ($21,092,931) ($12,708,043) ============= ============= =============
See notes to consolidated financial statements. SANGSTAT MEDICAL CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated Common Stock Other ------------------------- Accumulated Comprehensive Shares Amount Deficit Income Total ----------- ------------- -------------- ---------- ------------- BALANCES, January 1, 1996............ 9,598,083 $36,275,765 ($28,051,991) $57,703 $8,281,477 Sale of common stock (net of issuance costs of $408,729)........ 3,450,000 45,062,271 -- -- 45,062,271 Exercise of stock options............ 81,117 96,817 -- -- 96,817 Issuance of stock for services....... 360 8,460 -- -- 8,460 Stock option compensation expense.... -- 214,000 -- -- 214,000 Accumulated translation adjustment... -- -- -- (26,177) (26,177) Unrealized gain on investments....... -- -- -- 91,969 91,969 Net loss............................. -- -- (12,773,835) -- (12,773,835) ----------- ------------- -------------- ---------- ------------- BALANCES, December 31, 1996.......... 13,129,560 81,657,313 (40,825,826) 123,495 40,954,982 Sale of common stock (net of issuance costs of $542,325)........ 2,730,000 76,634,775 -- -- 76,634,775 Exercise of stock options............ 146,671 741,160 -- -- 741,160 Issuance of stock for services....... 3,300 79,200 -- -- 79,200 Stock option compensation expense.... -- 153,006 -- -- 153,006 Accumulated translation adjustment... -- -- -- (34,648) (34,648) Unrealized gain on investments....... -- -- -- (78,097) (78,097) Net loss............................. -- -- (20,980,186) -- (20,980,186) ----------- ------------- -------------- ---------- ------------- BALANCES, December 31, 1997.......... 16,009,531 159,265,454 (61,806,012) 10,750 97,470,192 Exercise of stock options............ 205,320 868,973 -- -- 868,973 Stock option compensation expense.... -- 116,508 -- -- 116,508 Accumulated translation adjustment... -- -- -- 88,612 88,612 Unrealized loss on investments....... -- -- -- (493,702) (493,702) Net loss............................. -- -- (38,463,938) -- (38,463,938) ----------- ------------- -------------- ---------- ------------- BALANCES, December 31, 1998.......... 16,214,851 $160,250,935 ($100,269,950) ($394,340) $59,586,645 =========== ============= ============== ========== =============
See notes to consolidated financial statements. SANGSTAT MEDICAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, ----------------------------------------- 1998 1997 1996 ------------- ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss....................................... ($38,463,938) ($20,980,186) ($12,773,835) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization................ 1,937,478 629,018 421,261 Stock compensation expense................... 116,508 232,206 222,460 Acquired in-process research and development. 3,218,516 -- -- Deferred income taxes........................ 257,201 -- -- Changes in assets and liabilities: Accounts receivable........................ (4,162,935) (631,503) 5,167 Other receivables.......................... (656,151) (109,722) (316,123) Inventories................................ (18,979,864) (2,966,786) (37,016) Prepaid expenses........................... 1,464,377 (1,341,952) (344,110) Accounts payable........................... 15,132,367 2,438,310 63,502 Accrued liabilities........................ (815,599) 378,840 232,860 ------------- ------------- ------------- Net cash used in operating activities....... (40,952,040) (22,351,775) (12,525,834) ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment............ (1,383,842) (516,049) (279,888) Maturities of short-term investments........... 34,210,182 13,012,560 16,560,957 Purchase of short-term investments............. (6,673,671) (32,993,651) (33,362,727) Business acquired in purchase transaction, net of cash acquired...................... (10,737,164) -- -- Other assets................................... (8,926,027) (2,919,144) 33,444 ------------- ------------- ------------- Net cash provided by (used in) investing activities......................... 6,489,478 (23,416,284) (17,048,214) ------------- ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Sale of common stock........................... 868,973 77,375,935 45,159,088 Note payable borrowings........................ 216,303 -- 383,000 Notes payable repayments....................... (676,165) (404,547) (446,481) Repayment of capital lease obligations......... (380,327) (355,930) (285,018) ------------- ------------- ------------- Net cash provided by financing activities... 28,784 76,615,458 44,810,589 ------------- ------------- ------------- EFFECT OF EXCHANGE RATE CHANGES ON CASH.......... 88,612 (35,520) (26,787) ------------- ------------- ------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.................................... (34,345,166) 30,811,879 15,209,754 CASH AND CASH EQUIVALENTS, Beginning of year..... 50,630,819 19,818,940 4,609,186 ------------- ------------- ------------- CASH AND CASH EQUIVALENTS, End of year........... $16,285,653 $50,630,819 $19,818,940 ============= ============= ============= NONCASH INVESTING AND FINANCING ACTIVITIES: Property acquired under capital leases......... $290,955 $1,144,459 $318,863 ============= ============= ============= Property acquired under notes payable.......... $ -- $ -- $290,050 ============= ============= ============= Unrealized gain (loss) on investments.......... ($493,702) ($78,097) $91,969 ============= ============= ============= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for interest......... $225,054 $225,562 $149,295 ============= ============= ============= On September 30, 1998, the Company acquired IMTIX (see Note 2). In conjunction with this acquisition, liabilities were assumed as follows: Fair value of assets acquired................ $35,138,650 Acquired in-process research and development. 3,218,516 Cash paid.................................... (11,661,684) Discounted note payable...................... (16,208,456) ------------- Liabilities assumed..................... $10,487,026 =============
See notes to consolidated financial statements. SANGSTAT MEDICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1998, 1997 and 1996 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Organization-SangStat Medical Corporation and subsidiaries (the Company) is a specialty pharmaceutical company applying a disease management approach to improve the outcome of organ transplantation. The Company's products and product candidates are designed to prevent and treat graft rejection and monitor patients throughout the lifelong transplantation process. Principles of Consolidation-The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Intercompany accounts and transactions are eliminated. Revenue Recognition-Revenue from product sales is recognized upon shipment, net of estimated sales allowances. Revenue from collaborative agreements is recognized in accordance with the contract terms, generally as milestones are met and no significant obligation for future services exists (see Note 8). Research and Development-Research and development costs are expensed as incurred and include expenses associated with new product research, clinical trials of existing technologies and regulatory affairs activities associated with product candidates. Cash and Cash Equivalents-The Company considers all highly liquid debt instruments purchased with an original maturity date of three months or less to be cash equivalents. Short-Term Investments - The Company has classified all of its investments as available-for-sale securities. While the Company's practice is to hold debt securities to maturity, the Company has classified all debt securities as available-for-sale securities, as the sale of such securities may be required prior to maturity to implement management strategies. The carrying value of all securities is adjusted to fair market value, with unrealized gains and losses, net of deferred taxes, being excluded from earnings and reported as a separate component of stockholders' equity and is included in accumulated other comprehensive income. Cost is based on the specific identification method for purposes of computing realized gains or losses. Inventories - Inventories are stated at the lower of cost (first-in, first-out) or market. Property and Equipment - Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over estimated useful lives of three to five years. Leasehold improvements and assets under capital leases are amortized over the shorter of their lease term or estimated useful life. Other Assets - At December 31, 1998 and 1997, other assets included a $2.0 and $2.5 million investment in Gensia Sicor, respectively. Gensia Sicor is one of the Company's suppliers of bulk cyclosporine drug substance (see Note 3). At December 31, 1998, other assets also includes $7.5 million of restricted cash that serves as collateral for a note payable (See Note 2) and $727,000 of deferred income tax benefits. Income Taxes - The Company records income taxes using the asset and liability approach, whereby deferred tax assets and liabilities, net of valuation allowances, are recorded for the future tax consequences of temporary differences between financial statement and tax bases of assets and liabilities and for the benefit of net operating loss carryforwards. Foreign Currency Translation - Operations of the Company's foreign subsidiaries are measured using local currency as the functional currency for each subsidiary. Assets and liabilities of the foreign subsidiaries are translated into U.S. dollars at the exchange rates in effect as of the balance sheet dates, and results of operations for each subsidiary are translated using average rates in effect for the periods presented. Foreign currency transaction gains and losses are included in the consolidated statements of operations. Stock-Based Compensation - The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with APB No. 25, Accounting for Stock Issued to Employees ("APB 25"). The Company adopted the disclosure requirements of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, (SFAS 123), which requires the disclosure of pro forma net income and earnings per share as if the Company adopted the fair value-based method in measuring compensation expense. Net Loss Per Share - The Company adopted Statement of Financial Accounting Standards No. 128, Earnings per Share ("SFAS 128"), which replaces the previously reported primary and fully diluted loss per share with basic and diluted earnings per share (EPS) and requires a dual presentation of basic and diluted EPS. Basic EPS excludes dilution and is computed by dividing net loss by the weighted average of common shares outstanding for the period. Diluted EPS reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock. Common share equivalents including stock options, warrants and redeemable convertible preferred stock have been excluded, as their effect would be antidilutive. The following is a reconciliation of the numerators and denominators of the basic and diluted net loss per share computations:
Year Ended December 31, ----------------------------------------- 1998 1997 1996 ------------- ------------- ------------- Net Loss (Numerator): Net loss............................. ($38,463,938) ($20,980,186) ($12,773,835) ============= ============= ============= Shares (Denominator): Weighted average shares outstanding.. 16,080,444 15,375,753 12,405,081 ============= ============= ============= Net Loss Per Share, Basic and Diluted ($2.39) ($1.36) ($1.03) ============= ============= =============
Certain Significant Risks and Uncertainties - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company sells its products to organizations in the healthcare industry in the United States, Canada and Europe, and does not require its customers to provide collateral or other security to support accounts receivable. The Company maintains allowances for estimated potential bad debt losses. The Company participates in the dynamic biopharmaceutical industry. The Company believes that changes in any of the following areas could have a negative impact on the Company in terms of its future financial position and results of operations: ability to obtain additional financing; successful product development; manufacturing and marketing capabilities; ability to negotiate acceptable collaborative relationships; obtaining necessary FDA and foreign regulatory approvals; ability to attract and retain key personnel; litigation and other claims against the Company, including, but not limited to, patent claims; increased competition; uncertainty regarding health care reimbursement and reform; and potential exposure for product liability and hazardous materials. Recently Issued Accounting Standards - In the first quarter of 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 130, Reporting Comprehensive Income, which requires an enterprise to report, by major components and as a single total, the change in its net assets during the period from non-owner sources. The following are the components of accumulated other comprehensive income: December 31, ---------------------------- 1998 1997 ------------- ------------- Unrealized gain (loss) on investments $ (468,938) $ 24,764 Accumulated translation adjustments 74,598 (14,014) ------------- ------------- Total $ (394,340) $ 10,750 ============= ============= In 1998, the Company adopted Financial Accounting Standards Board (FASB) issued SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, which establishes annual and interim reporting standards for an enterprise's business segments and related disclosures about its products, services, geographic areas and major customers. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This Statement requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS 133 will be effective for the Company's fiscal year ending December 31, 2000. Management believes that this statement will not have a significant impact on the Company. Other than the addition of the statement of comprehensive income, the adoption of SFAS Nos. 130 and 131 did not impact the Company's financial statements. 2. ACQUISITION On September 30, 1998, the Company completed the acquisition of Pasteur Merieux Connaught's (PMC) organ transplant business known as IMTIX. The acquisition was accounted for using the purchase method of accounting. The resulting wholly owned subsidiary of the Company, named IMTIX-SangStat, is dedicated to the research, development, manufacture and marketing of pharmaceuticals for transplantation. The aggregate purchase price of approximately $31 million consisted of $10 million paid upon closing and a non-interest bearing note of $21 million payable over five years as follows: $3 million in 1999, $3 million in 2000, $6 million in 2001, $5 million in 2002 and $4 million in 2003. The note payable is discounted at a rate of 9.25% and is included in Notes payable (see Note 7). In addition, the Company will pay PMC certain royalties on IMTIX-SangStat product sales. The aggregate purchase price and approximately $2.5 million of acquisition costs were allocated to the net tangible assets acquired based on their fair value on the date of acquisition, identifiable intangible assets and purchased in-process research and development. The purchased in-process research and development of approximately $3.2 million was charged to the Company's operations in the third quarter of 1998 and represents the value of products that had not yet reached technological feasibility and no alternative future use. The estimated value for the in-process technology was determined using the income approach which discounted to present value the cash flows expected to be derived from the in-process products. The projections were based on historical trends and future expectations of the acquired company's revenue and expenses to be generated from the in-process products. The discount rate used reflected the risk associated with development of the in-process products. The Company currently intends to continue the development of the acquired in-process products and has not yet determined if it will be successful in its efforts to complete as the safety and efficacy of these products has not yet been determined. The determination of the products' safety and efficacy is expected to be completed in 1999 with estimated costs to complete the clinical studies less than $500,000. Depending on the outcome of the ongoing clinical studies, further studies may be required to fully assess the feasibility of the acquired in-process products. Approximately $14.2 million of the purchase price was allocated to various specified intangible assets and is being amortized over their estimated useful lives ranging from five to fourteen years. The amounts allocated to intangible assets were determined on the basis of the appraised value of the related intangible assets. The appraisal techniques used in the Company's acquisitions included certain assumptions, including, the extent, character and utility, the income generating or cost-savings attributes, the nature and timing of the functional or economic obsolescence and the relative risk and uncertainty associated with an investment in intangible assets. Additionally, as part of the acquisition, the Company has approximately $7.5 million of restricted cash that serves as collateral for the standby letter of credit in favor of Pasteur Merieux Connaught. The operating results of IMTIX have been included in the consolidated statements of operations since the date of acquisition. Pro forma results of operations, assuming the acquisition had taken place at January 1, 1997, would be as follows (in thousands except for net loss per share): 1998 1997 ------------ ------------ Revenue................... $36,971 $24,645 Loss from operations...... (41,539) (34,452) Net loss.................. (38,112) (28,079) Net loss per share........ ($2.37) ($1.83) 3. INVESTMENTS Available-for-sale securities consist of the following: December 31, 1998 --------------------------------------------------- Unrealized Unrealized Estimated Amortized Gain on Loss on Fair Cost Investments Investments Value ------------ ------------ ------------ ------------ Corporate bonds ....$13,169,685 $70,897 ($5,840) $13,234,742 One year CD ........ 140,000 -- -- 140,000 ------------ ------------ ------------ ------------ Short-term investments........ 13,309,685 70,897 (5,840) 13,374,742 Corporate equity securities......... 2,500,000 -- (533,995) 1,966,005 ------------ ------------ ------------ ------------ Total...............$15,809,685 $70,897 ($539,835) $15,340,747 ============ ============ ============ ============ December 31, 1997 --------------------------------------------------- Unrealized Unrealized Estimated Amortized Gain on Loss on Fair Cost Investments Investments Value ------------ ------------ ------------ ------------ Corporate bonds ....$30,102,832 $28,260 ($9,267) $30,121,825 Commercial paper ... 11,299,487 -- (16,357) 11,283,130 ------------ ------------ ------------ ------------ Short-term investments........ 41,402,319 28,260 (25,624) 41,404,955 Corporate equity securities......... 2,500,000 22,128 -- 2,522,128 ------------ ------------ ------------ ------------ Total...............$43,902,319 $50,388 ($25,624) $43,927,083 ============ ============ ============ ============ Corporate equity securities represent the Company's investment in Gensia Sicor and are included in other assets. The contractual maturities of available-for-sale debt securities at December 31, 1998 are as follows: Estimated Amortized Fair Cost Value ------------ ------------ Within one year ..............$11,683,437 $11,714,932 One year to two years......... 1,626,248 1,659,810 ------------ ------------ Short-term investments........$13,309,685 $13,374,742 ============ ============ 4. INVENTORIES Inventories consist of: December 31, ------------------------- 1998 1997 ------------ ------------ Raw materials.............................. $18,103,938 $1,929,954 Work in process............................ 8,945,516 144,389 Finished goods............................. 6,325,805 1,683,108 ------------ ------------ Total................................ $33,375,259 $3,757,451 ============ ============ 5. PROPERTY AND EQUIPMENT Property and equipment consist of: December 31, ------------------------- 1998 1997 ------------ ------------ Machinery and equipment.................... $5,800,936 $3,852,666 Furniture and fixtures..................... 574,537 156,955 Leasehold improvements..................... 403,273 283,470 ------------ ------------ Total...................................... 6,778,746 4,293,091 Accumulated depreciation and amortization.. (3,644,978) (2,277,718) ------------ ------------ Property and equipment--net................ $3,133,768 $2,015,373 ============ ============ Included in machinery and equipment at December 31, 1998 and 1997 are assets leased under capital leases of $1,086,578 and $1,330,802 (net of accumulated amortization of $1,022,291 and $813,007), respectively. 6. ACCRUED LIABILITIES Accrued liabilities consist of: December 31, ------------------------- 1998 1997 ------------ ------------ Salaries and related benefits.............. $2,499,443 $1,086,683 Other...................................... 697,782 135,924 ------------ ------------ Total............................. $3,197,225 $1,222,607 ============ ============ 7. NOTES PAYABLE Notes payable consist of: December 31, ------------------------- 1998 1997 ------------ ------------ Notes due to former Series E preferred stockholders.................... $141,586 $462,239 Baxter equipment note....................... 191,038 227,144 Research and development loan............... 16,434 107,381 Other loans................................. 518,662 30,598 Note payable to PMC......................... 21,000,000 -- Discount on note payable to PMC............. (4,406,591) -- ------------ ------------ Total....................................... 17,461,129 827,362 Less current portion........................ (1,824,768) (290,855) ------------ ------------ Long-term................................... $15,636,361 $536,507 ============ ============ Upon the Company's initial public offering in 1993, notes payable of $1,240,897 were issued to Series E preferred stockholders in accordance with certain anti-dilution provisions of the Series E preferred stock purchase agreement. These notes are payable in annual installments through 2003 and bear interest at 6.06%. The Baxter equipment note is payable in quarterly installments through 2003 and bears interest at 8.25%. The research and development loan provided by the French government is denominated in French Francs, does not bear interest and is payable in 1999. Other loans consist primarily of a note payable for insurance and a non-interest bearing loan denominated in French Francs provided by a French government agency. On September 30, 1998, the Company completed the acquisition of Pasteur Merieux Connaught's organ transplant business known as IMTIX. The aggregate purchase price of approximately $31 million consisted of $10 million paid upon closing and $21 million payable over five years as follows: $3 million in 1999, $3 million in 2000, $6 million in 2001, $5 million in 2002 and $4 million in 2003. The note payable is discounted at a rate of 9.25%, which the Company believes is consistent with its normal borrowing rate. The resulting discount of approximately $4.8 million is being accreted as an addition to interest expense over the term of the note. As of December 31, 1998, $384,000 of amortization had been recognized. As of December 31, 1998, future principal payments of notes payable are as follows: Years Ending December 31, - --------------------------------- 1999.......................................... $1,824,768 2000.......................................... 1,804,992 2001.......................................... 5,106,944 2002.......................................... 4,532,777 2003.......................................... 3,864,569 Thereafter.................................... 327,079 ------------ Total............................. $17,461,129 ============ 8. COLLABORATIVE AGREEMENTS In December 1997, the Company signed an agreement with Amgen Inc. ("Amgen") for the exclusive registration, marketing and distribution of SANGCYA and SANG-2000 in selected territories in the Asia/Pacific Rim region. SangStat has retained the exclusive commercial rights to SANGCYA and SANG-2000 in all other territories including North America and Western Europe. Under the terms of the agreement, Amgen will have exclusive rights to market SANGCYA and SANG-2000, under SangStat's branded trademark, in Australia, New Zealand, China and Taiwan. The licensing agreement includes an initial $750,000 payment to SangStat and other milestone and reimbursement payments based on key regulatory submissions and approvals. The initial $750,000 payment was received in 1997 and is included in revenue from collaborative agreements in the Consolidated Statements of Operations. Additional payments and reimbursements of $1,036,145 were received in 1998 and are included in revenue from collaborative agreements in the Consolidated Statements of Operations. In April 1993, the Company entered into a collaborative licensing, marketing and development agreement (the Agreement) with Baxter Healthcare Corporation (Baxter). The Agreement provided to Baxter exclusive marketing rights to certain products. The Agreement was amended upon written consent of the parties such that, effective July 1, 1996, the Company reacquired exclusive commercial rights for the monitoring products from Baxter. Since that date, the Company has been marketing these monitoring products through its own sales staff in the United States and Europe. 9. LEASING ARRANGEMENTS The Company leases administrative facilities under operating leases and machinery and equipment under capital leases expiring through 2003. As of December 31, 1998, future minimum annual payments under capital and operating leases are as follows: Capital Operating Years Ending December 31, Leases Leases - --------------------------------- ----------- ----------- 1999......................................... $639,379 $954,147 2000......................................... 588,921 677,365 2001......................................... 152,230 660,062 2002......................................... 46,430 635,478 2003......................................... 2,100 543,017 ----------- ----------- Total minimum lease payments................. 1,429,060 $3,470,069 =========== Less amounts representing interest........... (170,849) ----------- Present value of minimum lease payments...... 1,258,211 Less current portion......................... (492,921) ----------- Capital lease obligations.................... $765,290 =========== Rent expense for the years ended December 31, 1998, 1997 and 1996 was $760,946, $343,710 and $289,007, respectively. 10. STOCKHOLDERS' EQUITY Common Stock - In March 1996, the Company issued 3,450,000 shares of common stock in a public offering for net consideration of $45,062,271, and in March and April of 1997 issued a total of 2,730,000 shares of common stock in a public offering for net consideration of $76,634,775. Stockholder Rights Plan - In August 1995, the Company's Board of Directors approved a plan to protect stockholders' rights in the event of a proposed takeover of the Company. Under the plan a preferred share purchase right (Right) is attached to each share of common stock. The Rights are exercisable only if a person or group acquires 15% or more of the Company's common stock or announces a tender offer, the consummation of which would result in ownership by a person or group of 15% or more of the Company's common stock. Each Right will entitle stockholders to buy one one-hundredth of a share of a new series of junior participating preferred stock at an exercise price of $45 upon certain events. If, after the Rights become exercisable, the Company is acquired in a merger or other business combination transaction, or sells 50% or more of its assets or earnings power, each Right will entitle its holder to purchase, at the Right's then-current price, a number of the acquiring company's common shares having a market value at the time of twice the Right's exercise price. If a person or group acquires 15% or more of the Company's outstanding common stock, each Right will entitle its holder (other than such person or members of such group) to purchase, at the Right's then-current exercise price, a number of the Company's common shares (or cash, other securities or property) having a market value twice the Right's exercise price. At any time within ten days after a person or group has acquired beneficial ownership of 15% or more of the Company's common stock, the Rights are redeemable for $.01 per Right at the option of the Board of Directors. The Rights expire on August 25, 2005, unless earlier redeemed or exchanged. Stock Option Plans - Under the Company's stock option plans, incentive or non-statutory stock options to purchase up to 3,242,200 shares of common stock may be granted to employees, directors, and consultants. Incentive and non-statutory options must be granted at not less than fair market value at the date of grant. A summary of stock option activity is as follows: Weighted Average Number of Exercise Shares Price ---------- ---------- Balances, January 1, 1996 .............................. 1,014,213 $3.85 Options granted (weighted average fair value of $8.16).. 243,700 15.02 Options exercised....................................... (81,117) 1.19 Options canceled........................................ (7,204) 6.47 ---------- ---------- Balances, December 31, 1996 (737,333) vested at a weighted average exercise price of $6.15)............. 1,169,592 6.61 Options granted (weighted average fair value of $13.81). 487,542 22.35 Options exercised....................................... (146,671) 5.05 Options canceled........................................ (9,274) 18.47 ---------- ---------- Balances, December 31, 1997 (784,199 vested at a weighted average exercise price of $13.16).............1,501,189 11.78 Options granted (weighted average fair value of $16.43). 1,363,757 25.64 Options exercised....................................... (205,320) 4.24 Options canceled........................................ (103,983) 22.31 ---------- ---------- Balances, December 31, 1998............................. 2,555,643 19.32 ========== ========== Options to purchase common stock generally vest over a period of four years, are exercisable immediately and expire ten years from the date of grant. Unvested common shares acquired under the plan are subject to repurchase by the Company at the original issuance price. At December 31, 1998, 1,125 outstanding shares were subject to such repurchase rights at prices ranging from $13.50 to $23.63 per share. As of December 31, 1998, options for 48,720 shares, which were granted outside of the stock option plan, were outstanding and are included in the above table. As of December 31, 1998, 230,017 shares were available under the plan for future grant. During 1996, the Board of Directors, subject to shareholder approval, approved the 1996 Directors' Option Plan and in accordance with the Plan granted options to purchase a total of 74,000 shares of common stock to non-employee Directors in 1996 at option prices of $13.50 to $23.50 per share. At the Annual Stockholder's meeting on June 19, 1997, the 1996 Directors' Option Plan was approved by a vote of the stockholders. Under this Plan, up to a total 250,000 options to purchase shares of the Company's common stock may be issued. The fair market value of the Company's stock on the measurement date of June 19, 1997 was $23.63 per share. The difference between the fair market value on the measurement date and the exercise price of the options granted in 1996 is being amortized over the vesting period of these options. Also in accordance with the Directors' Option Plan, during 1998 and 1997, each of the six non-employee Directors were granted options to purchase 3,000 shares of the Company's common stock. In addition, in 1998, each of the non- employee directors was granted options to purchase 10,000 shares of the Company's common stock. Options granted under the Directors' Option Plan are also included in the above table. Additional information regarding options outstanding as of December 31, 1998 is as follows:
Options Outstanding and Exercisable Vested Options ------------------------------------- --------------------- Weighted Avg. Weighted Weighted Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Prices Outstanding Life (yrs) Price Vested Price - ---------------- ----------- ------------ ----------- --------- ----------- $0.19 - $2.50 138,289 3.3 $0.73 138,289 $0.73 2.51 - 5.00 158,835 6.1 4.92 151,994 4.92 5.10 - 8.25 281,157 5.7 6.24 212,938 6.22 8.26 - 13.50 178,064 7.3 13.50 77,381 13.50 13.51 - 26.50 1,179,928 9.1 21.23 281,020 20.43 26.51 - 30.00 308,588 9.2 28.70 25,384 28.82 30.01 - 35.00 255,782 9.2 33.00 53,762 33.00 35.01 - 55.00 55,000 8.9 36.13 10,000 36.13 ----------- ------------ ----------- --------- ----------- 2,555,643 8.1 $19.32 950,768 $12.44 =========== ============ =========== ========= ===========
Additional Stock Plan Information - Effective for 1996, the Company was required to adopt the disclosure requirements of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123). SFAS 123 defines a fair value method of accounting for stock-based compensation awards to employees. The Company has elected to continue to follow the provisions of Accounting Principals Board No. 25, Accounting for Stock Issued to Employees, and its related interpretations. SFAS 123 requires that the fair value of stock-based awards to employees be calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company's calculations were made using the Black- Scholes option pricing model with the following weighted average assumptions: expected life, five and a half years; stock volatility, 69% in 1998, 61% in 1997, and 54% in 1996; risk free interest rate, approximately 5.25% in 1998, 6% in 1997, and 6% in 1996; and no dividend payments during the expected term. Forfeitures are recognized as they occur. If the computed fair values of the plan awards had been amortized to expense over the vesting period of the awards, pro forma net loss would have been approximately $44,789,000 ($2.79 loss per share) in 1998, $23,647,000 ($1.54 loss per share) in 1997, and $13,378,000 ($1.08 loss per share) in 1996. 11. INCOME TAXES Loss before income taxes and provision for income taxes consists of the following:
December 31, ----------------------------------------- 1998 1997 1996 ------------- ------------- ------------- Income (loss) before income taxes: Domestic..................... ($35,616,375) ($20,655,443) ($12,634,970) Foreign...................... (2,590,362) (324,743) (138,865) Provision for income taxes: Domestic..................... -- -- Foreign - deferred........... 257,201 -- -- ------------- ------------- ------------- Net loss ($38,463,938) ($20,980,186) ($12,773,835) ============= ============= =============
No income tax provision (benefit) has been provided due to the Company's continuing losses. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, as well as operating loss and tax credit carryforwards. Significant components of the Company's deferred income tax assets are as follows:
December 31, --------------------------- 1998 1997 ------------- ------------- Deferred tax assets: Net operating losses............... $34,169,555 $20,249,517 General business credits........... 2,293,271 2,324,855 Accruals and reserves deductible in different periods............. 2,547,209 2,691,360 Depreciation....................... 354,287 196,995 Other.............................. 232,000 -- ------------- ------------- 39,596,322 25,462,727 Valuation allowance................. (38,869,322) (25,462,727) ------------- ------------- Total......................... $727,000 $ -- ============= =============
Based on its history of operating losses, the Company has placed a valuation allowance of $38,869,322 and $25,462,727 against its otherwise recognizable net deferred tax assets at December 31, 1998 and 1997, respectively, due to the uncertainty surrounding the realizability of these benefits. At December 31, 1998,, the Company had federal, California and foreign net operating loss carryforwards of approximately $93,699,000, $24,821,000, and $1,502,000, respectively, available to reduce future taxable income. Such carryforwards expire beginning in 1998 through 2019. Also at December 31, 1998, the Company had research and experimentation credit carryforwards available of approximately $1,490,000 and $803,000 for federal and state tax purposes, respectively. The federal tax credit carryforwards expire beginning in 2004 and the state tax credit carryforwards have no expiration date. Utilization of the net operating losses and credits may be subject to an annual limitation due to ownership change limitations provided by the Internal Revenue Code of 1986 and similar state provisions. The annual limitation may result in the expiration of net operating losses and credits before utilization. 12. EMPLOYEE BENEFIT PLAN The Company has a 401(k) tax-deferred savings plan, whereby eligible employees may contribute a portion of their eligible compensation. Company contributions are discretionary and through December 31, 1998 the Company had not made any contributions. 13. MAJOR CUSTOMERS For the year ended December 31, 1998, the Company did not have any single customer that accounted for more than 10% of revenue. However, one customer, had an accounts receivable balance of 10% of the total accounts receivable as of December 31, 1998. Two customers accounted for approximately 17% and 16%, respectively, of total revenues in 1997. A different customer accounted for approximately 10% of total revenues in 1996. 14. FOREIGN OPERATIONS The Company is engaged in the business of developing and marketing products and services for use in transplantation. The Company's operations in Europe primarily relate to the manufacture, marketing, research and development and clinical study of therapeutic products for transplantation. The Company's operations in the rest of the world are principally sales and marketing related. Summarized data for the Company's domestic and foreign operations are as follows:
UNITED REST OF STATES EUROPE CANADA THE WORLD CONSOLIDATED ------------- ------------ ------------ ----------- ------------- Year ended December 31, 1998: Sales to unaffiliated customers.............. $11,655,898 $4,885,238 $1,355,953 $1,781,399 $19,678,488 ============= ============ ============ =========== ============= Loss from operations...... ($38,923,146) ($2,186,954) ($149,358) -- ($41,259,458) ============= ============ ============ =========== ============= Total assets.............. $67,461,238 $39,413,114 $452,956 -- $107,327,308 ============= ============ ============ =========== ============= Year ended December 31, 1997: Sales to unaffiliated customers.............. $2,761,970 $568,823 $1,196,377 -- $4,527,170 ============= ============ ============ =========== ============= Loss from operations...... ($24,478,875) ($1,650,726) ($356,966) -- ($26,486,567) ============= ============ ============ =========== ============= Total assets.............. $102,337,876 $1,369,084 $647,510 -- $104,354,470 ============= ============ ============ =========== ============= Year ended December 31, 1996: Sales to unaffiliated customers.............. $931,706 $275,154 $1,192,119 -- $2,398,979 ============= ============ ============ =========== ============= Loss from operations...... ($13,431,697) ($1,312,577) ($153,167) -- ($14,897,441) ============= ============ ============ =========== ============= Total assets.............. $43,005,162 $953,026 $791,928 -- $44,750,116 ============= ============ ============ =========== =============
15. BUSINESS SEGMENT DATA The Company is a specialty pharmaceutical company engaged in the discovery, development, manufacturing and marketing of transplantation products worldwide as well as applying a disease management approach to improve the outcome of organ transplantation. The Company is organized and operates in two business segments: transplantation products and transplantation services. Transplantation products consist primarily of products for patient monitoring and therapeutic products for preventing and treating organ rejection. Transplantation services consist principally of mail order pharmaceutical and patient management services. The following information is presented in accordance with the requirements of SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." Transplantation Transplantation Products Services Total -------------- ---------------- -------------- Net Revenues...............1998 $11,294,138 $8,384,350 $19,678,488 1997 3,206,422 1,320,748 4,527,170 1996 2,398,979 -- 2,398,979 Interest income........... 1998 3,610,822 -- 3,610,822 1997 5,716,607 -- 5,716,607 1996 2,261,450 -- 2,261,450 Interest expense...........1998 558,101 -- 558,101 1997 210,226 -- 210,226 1996 137,844 -- 137,844 Depreciation and amortization...............1998 1,872,359 65,119 1,937,478 1997 586,954 42,064 629,018 1996 421,261 -- 421,261 Segment loss...............1998 (35,984,107) (2,479,831) (38,463,938) 1997 (19,586,094) (1,394,092) (20,980,186) 1996 (12,773,835) -- (12,773,835) Segment assets.............1998 104,348,907 2,978,401 107,327,308 1997 103,534,562 819,908 104,354,470 1996 44,750,116 -- 44,750,116 16. SUBSEQUENT EVENTS Litigation Novartis vs. SangStat On February 11, 1999, Novartis Pharmaceuticals Corporation filed a lawsuit (case number 99-065) in Federal District Court for the District of Delaware against the Company alleging infringement of United States patent #5,389,382, a cyclosporine technology patented by Novartis A.G. The Novartis patent does not cover Neoral but rather a separate delivery system not used in the Neoral formulation. Novartis seeks the following relief: (i) a finding that SangStat willfully infringed the patent; (ii) to permanently enjoin SangStat from infringing the Novartis patent; (iii) treble damages; and (iv) reasonably attorneys' fees , costs and expenses. SangStat's answer is due April 5, 1999 and discovery will not begin until after the answer is filed. SangStat believes that the lawsuit is without merit and that it does not infringe the Novartis patent. SangStat intends to defend itself vigorously against this claim. Although the Company is optimistic that this dispute will ultimately be resolved favorably to the Company, the course of litigation is inherently uncertain and there can be no assurance of a favorable outcome. As a result of the Novartis suit, SangStat could be enjoined from selling SANGCYA for a significant period of time or ultimately be prevented from selling SANGCYA. Should this happen, the Company does not believe it would be able to obtain a license from Novartis on acceptable terms because the Company believes cyclosporine is an important product for Novartis and that Novartis would not want to diminish its profits from this product by licensing it on acceptable terms to the Company. Failure to obtain any such required license could prevent the Company from selling SANGCYA entirely, which would have a material adverse effect on the Company's future results of operations. The litigation, whether or not resolved favorably to the Company, is likely to be expensive, lengthy and time consuming, will divert management's attention and could have a material adverse effect on the Company's business, financial condition, cash flows and results of operations. SANG-2000 is not covered by this lawsuit and the Company does not believe that this lawsuit will have an impact on the regulatory approval of Sang-2000. See "Risk Factors-Litigation with Novartis." Novartis vs. FDA Novartis Pharmaceuticals Corporation sued the FDA on February 11, 1999 in the United States District Court for the District of Columbia (case number 1:99CV-00323) alleging that the FDA did not follow its own regulations in approving SANGCYA in October 1998. The lawsuit against the FDA appears to be based on arguments similar to those used in the failed citizen's petition in which Novartis alleged that because Neoral and SANGCYA, both oral solutions, are based on different formulation technologies, they should be classified as different dosage forms. Novartis asks that the court rescind the AB rating that was given to SANGCYA. Loss of the "AB" rating would prevent SANGCYA from being automatically substitutable for Neoral oral solution, which would impede the marketing of SANGCYA. The Company believes that the lawsuit is without merit and that the FDA will prevail in this matter. Although the Company is optimistic that this dispute will ultimately be resolved favorably to the Company, the course of litigation is inherently uncertain and there can be no assurance of a favorable outcome. Novartis' requested relief, if granted, could have a significant negative economic impact on SangStat. In order to defend its interests vigorously, SangStat filed a Motion for Leave to Intervene in this lawsuit on February 23, 1999. The Court has not yet ruled on this motion. See "Risk Factors-Litigation with Novartis." Relocation of Corporate Headquarters The Company will relocate its headquarters from Menlo Park, California to Fremont, California in approximately June 1999. Floor space in Fremont will be approximately 44,000 square feet, including offices, laboratory space, storage area and specialized areas for pilot production and pre-clinical testing. The lease for the Fremont building space will expire in 2005 and may be renewed for subsequent years. The future minimum payments by year and in the aggregate consists of the following: 1999......................................... $222,176 2000......................................... 438,273 2001......................................... 532,123 2002......................................... 692,023 2003......................................... 794,673 Thereafter................................... 1,237,110 ------------- Total minimum lease payments................. $3,916,378 =============
Schedule II SANGSTAT MEDICAL CORPORATION VALUATION AND QUALIFYING ACCOUNTS AND RESERVES For the Years ended December 31, 1998, 1997 and 1996
Balance Additions Balance at charged to at beginning costs end of and of Description period expenses Deductions Other period - -------------------------------- --------- --------- ---------- ---------- --------- 1996 Allowance for doubtful accounts $16,228 $24,150 $ -- -- $40,378 1997 Allowance for doubtful accounts $40,378 $123,626 $24,707 (1) -- $139,297 1998 Allowance for doubtful accounts $139,297 $772,808 $231,041 (1) $247,853 (2)$928,917
(1) Accounts written off, net of recoveries. (2) Allowance added from the acquisition of IMTIX. 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, on March 30, 1999. SANGSTAT MEDICAL CORPORATION By: /s/ JEAN-JACQUES BIENAIME ------------------------- Jean-Jacques Bienaime President and Chief Executive Officer POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Jean-Jacques Bienaime and Carole L. Nuechterlein, and each of them, as his true and lawful attorneys-in- fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. 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. /s/ PHILIPPE POULETTY Chairman of the March 30 , 1999 - ------------------------------- Board of Directors Philippe Pouletty, M.D. /s/JEAN-JACQUES BIENAIME Chief Executive Officer March 30 , 1999 - ------------------------------- Jean-Jacques Bienaime /s/ JAMES F. HINRICHS Chief Financial Officer March 30, 1999 - ------------------------------- (Principal Accounting Officer) James F. Hinrichs, CFA. /s/ FREDRIC J. FELDMAN Director March 30 , 1999 - ------------------------------- Fredric J. Feldman, Ph.D. /s/ ELIZABETH M. GREETHAM Director March 30 , 1999 - ------------------------------- Elizabeth Greetham /s/ RICHARD D. MURDOCK Director March 30 , 1999 - ------------------------------- Richard D. Murdock /s/ ANDREW PERLMAN, M.D, PHD Director March 30 , 1999 - ------------------------------- Andrew Perlman, M.D., Ph.D. /s/ VINCENT WORMS Director March 30 , 1999 - ------------------------------- Vincent Worms SANGSTAT MEDICAL CORPORATION Index to Exhibits Sequentially Exhibit Numbered No. Description Page - ------- ------------------------------------------------------------ 2.1 (7) Agreement and Plan of Merger dated as of July 24, 1995 between the SangStat Delaware, Inc., and SangStat Medical Corporation, a California corporation, as filed with the Delaware Secretary of State on August 11, 1995. 2.2 (9) Master Agreement between SangStat Medical Corporation and Pasteur Merieux Serums & Vaccins, S.A. dated June 10, 1998, including Exhibit 8 thereto. 3.1 (8) Amended and Restated Articles of Incorporation of the Registrant filed November 29, 1993. 3.3 (7) 3.3(7) Bylaws of Registrant. 3.4 (6) Certificate of Designation for the Series A Junior Participating Preferred Stock, filed with the Delaware Secretary of State on August 16, 1995. 4.5 (3) Specimen Common Stock Certificate of Registrant. 10.1 (1)(3)Collaborative Agreement effective April 19, 1993, as amended, between SangStat and Baxter Healthcare Corporation. 10.2 (1)(3)License Agreement, dated October 21, 1991, between the Registrant and The Board of Trustees of Leland Stanford Junior University. 10.3 (3) Contract for the Provision of Services, dated October 5, 1993 between the Centre Hospitalier Universitaire de Nantes and SangStat Atlantique. 10.4 (1)(3)License Agreement, dated October 13, 1993, between the Registrant and Pasteur Merieux Serums et Vaccine. 10.5 (1)(3)Letter Agreement between SangStat and Ortho Biotech. 10.6 (2)(3)1990 Stock Option Plan, as amended October 1992 and form of Stock Option Agreement. 10.7 (2)(3)1993 Stock Option/Stock Issuance Plan. 10.8 (3) Series B Stock Purchase Agreement, dated September 21, 1989, between the Registrant and the Investors listed in Schedule A thereto. 10.9 (3) Series C Stock and Warrant Purchase Agreement, dated January 26, 1990, between the Registrant and the Investors listed in Schedule A thereto. 10.10 (3) Series D Stock and Warrant Purchase Agreement, dated July 15, 1991, between the Registrant and the Investors listed in Schedule A thereto. 10.11 (3) Amendment Agreement to the Series D Stock and Warrant Purchase Agreement, dated October 5, 1992, between the Registrant and the Investors listed in Schedule A of that certain Series D Stock and Warrant Purchase Agreement, dated July 15, 1991. 10.12 (3) Note and Warrant Purchase Agreement, dated October 2, 1992, between the Registrant and the Investors listed in the Schedule of Lenders thereto. 10.13 (3) Series E Stock and Warrant Purchase Agreement, dated April 19, 1993, between the Registrant and the Investors listed in Schedule A thereto. 10.14 (2)(3)Amended and Restated Shareholders Agreement, dated January 26, 1990, between the Registrant and Philippe Pouletty. 10.15 (3) Equipment Lease Agreement dated October 11, 1990 between SangStat and David Rammler. 10.16 (3) Real Property Lease, dated August 20, 1990, between the Registrant and Menlo Business Park and Patrician Associates, Inc. 10.17 (3) Lease Agreement dated September 1, 1993 between SangStat Atlantique and Center Hospitalier. 10.18 (7) Form of Indemnification Agreement to be entered into between the Registrant and each of its officers and directors. 10.19 (1)(3)License Agreement, dated November 15, 1993, between the Registrant and the Board of Trustees of Leland Stanford Junior University. 10.20 (3) Letter Agreement between the Registrant and Baxter Healthcare Corporation dated December 11, 1993. 10.21 (1)(5)License Agreement with Pasteur Merieux Serums et Vaccins. 10.22 (2)(5)Supply Agreement with Pasteur Merieux Serums et Vaccins. 10.23 (4) Common Stock Purchase Agreement, dated December 23, 1994, between the Registrant and the Investors listed in Schedule A thereto. 10.25 (8) Rights Agreement, dated as of August 14, 1995, between the Registrant and First National Bank of Boston. 10.26 Real Property Sub-Lease, dated March 8, 1999, between the Registrant and Kelley-Clarke, Inc. Real Property lease between Kelly-Clarke Inc. and Kaiser Development Company dated September 1, 1988 as amended on February 26, 1990, May 1, 1990, May 5, 1990, and April 19, 1995 21.1 (5) Subsidiaries of Registrant. 23.1 Independent Auditors' Consent. 24.1 Power of Attorney. (Reference is made to page 47) 27.1 Financial Data Schedule. ____________ (1) Confidential Treatment has been granted for the deleted portions of this document. (2) Management contract or compensatory plan or arrangement. (3) Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-1 (No. 33-70436). (4) Previously filed as an Exhibit to the Registrant's Form 8-K filed January 6, 1994. (5) Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-1 (No. 33-88432). (6) Previously filed as an Exhibit to Registrant's Form 8-K filed August 14, 1995. (7) Previously filed as an Exhibit to the Registrant's Registration Statement on Form 8-B filed December 4, 1995. (8) Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-3 (No. 333-2301). (9) Previously filed as Exhibits to the Registrant's Form 8-K/A as amended on December 14, 1998. EX-10.26 2 SUBLEASE OF MARCH 8, 1999 BETWEEN KELLEY-CLARKE, INC., AND SANGSTAT MEDICAL CORPORATION EXHIBIT 10.26 SUBLEASE THIS SUBLEASE ("Sublease") is entered into as of the 8th day of March, 1999 between Kelley-Clarke, Inc., a California corporation ("Sublandlord") and SangStat Medical Corporation, a Delaware corporation ("Subtenant") with reference to the following facts: A. Pursuant to that certain Lease Agreement dated November 28, 1988, as amended on February 26, 1990 ("First Amendment"); May 1, 1990 ("Second Amendment"); May 5, 1992 ("Third Amendment"); and January 18, 1995 ("Fourth Amendment") between TriNet Essential Facilities X, Inc. ("Landlord") and Kelley-Clarke, Inc., as Tenant (collectively Master Lease"), a copy of which is attached hereto as Exhibit A and made a part hereof, Sublandlord leased from Landlord and Landlord leased to Sublandlord approximately 44,000 rentable square feet of space (the "Master Lease Premises") which consists of the' building located at 6300 Dumbarton Circle, Fremont, California ("Building"). B. Subtenant desires to sublet from Sublandlord the Master Lease Premises as more particularly set forth in Exhibit B attached hereto and made a part hereof ("'Subleased Premises"), and Sublandlord does hereby sublet the same to Subtenant upon the terms, covenants and conditions hereinafter set forth. NOW, THEREFORE, in consideration of the covenants herein contained, and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties do hereby agree as follows: 1 - Sublease. Sublandlord does hereby sublease and demise to Subtenant, and Subtenant does hereby hire and take from Sublandlord, all of the Subleased Premises subject to: (i) the covenants, agreements, terms, provisions and conditions of this Sublease for the term hereinafter stated; and (ii) the covenants, agreements, terms, provisions and conditions of the Master Lease. Subtenant hereby acknowledges receipt of the Master Lease attached hereto as Exhibit A. Sublandlord represents to Subtenant that the copy of the Master Lease attached hereto is true and correct and that there are no amendments or modifications to such document other than as so attached. Capitalized terms not otherwise defined herein shall have the meaning ascribed to them in the Master Lease. 2.Term. A. The term of this Sublease ("Term") shall commence on June 1, 1999 (the "Commencement Date") and shall end June 30, 2005, or on such earlier date upon which said Term may expire or be terminated pursuant to any of the conditions of limitation or other provisions of this Sublease, the Master Lease, or pursuant to law. The parties shall use their best efforts to execute all requisite documents as expeditiously as possible. B. Subtenant shall have the right of access to the Subleased Premises, subject to all of the provisions of this Sublease, other than payment of base rent and Additional Rent (as defined in Section 4-B. below), at any time between the date of Landlord consent to this fully executed Sublease and the Commencement Date for the purposes of performing measurements and space planning and any construction of Alterations (as defined in Section 7.B. below), provided that Subtenant shall give Sublandlord reasonable prior notice in advance of accessing the Subleased Premises. I Use. Subtenant shall use the Subleased Premises for office, administration, R&D and distribution of products related to the transplant industry and otherwise in conformance with allowable uses under the Master Lease. 4. Rent. A. Subtenant shall pay Sublandlord as monthly base rent for the Subleased Premises on the first (1st) day of each calendar month during the Term of this Sublease according to the following schedule: Monthly NNN Months Rent --------- ------------ 1-12 $31,739.45 13-24 $39,939.45 25-36 $47,489.45 37-48 $64,939.45 49-60 $67,139.45 61-73 $69,339.45 The base rent for June 1999 shall be due and payable on the mutual execution of this Sublease. The base rent for October, November and December 1999 shall be paid in full on October 1, 1999. All rent shall be payable, in advance, without any offset, deduction, or abatement, except as otherwise set forth in this Sublease. The base rent shall be a triple net rent, and Subtenant shall also be fully responsible for "Additional Rent" assessed against the Subleased Premises pursuant to Section 4.B. below. B. Subtenant shall also pay to Sublandlord all "Additional Rent"' for the Subleased Premises for each calendar month of the Term within ten (10) business days after delivery by Sublandlord of invoices evidencing "Additional Rent". If Subtenant fails to reimburse Sublandlord for "Additional Rent" within such ten (10) business day period, Subtenant shall also pay interest on such amount at ten percent (10% per annum) from the date due until paid. "Additional Rent" shall consist of Subtenant's share prorated, based on actual square footage on which Subtenant is obligated to pay rent as set forth in the table below, of all payments which Sublandlord is required to pay to Master Landlord for Real Property Taxes and Common Maintenance Costs pursuant to Articles 7 and 8 of the Master Lease and any delinquent charges due and payable by Subtenant to Sublandlord. For purposes herein, "Rent' shall include all monthly base rent, security deposit, and Additional Rent. Subtenant's occupancy schedule shall be as follows: Months Square Feet 1-12 28,000 13-24 32,000 25-36 35,000 37-48 44,000 49-60 44,000 61-73 44,000 5. Incorporation of Master Lease. Except to the extent that they are inapplicable to, or modified by, or excluded by, the terms of this Sublease, all of the covenants, agreements, terms, provisions and conditions of the Master Lease are hereby incorporated into and made a part of this Sublease. Except to the extent that they are inapplicable to, or modified by, the terms of this Sublease, the rights and obligations contained in the Master Lease are hereby imposed upon the respective parties hereto, Sublandlord being substituted for "Lessor" named in the Master Lease, Subtenant being substituted for the "Lessee" named in the Master Lease, and "Subleased Premises" being substituted for the "Premises" named in the Master Lease, except for Articles I, Sections 1. 1, 1.2, 1.4, 1.5 and 1.6, Article 4, Article 5, Sections 6. 1 and 6.2, Article 16, Section 30.2, Article 32, Article 47, Article 48, Section 50.12, Exhibit C, the First Amendment, Second Amendment, Third Amendment and Fourth Amendment, except Section 4 as so excluded, inapplicable or modified, all acts and obligations to be performed and all of the terms and conditions to be observed by Sublandlord as Lessee under the Master Lease with respect to the Master Lease Premises shall be performed and observed by Subtenant with respect to the Subleased Premises. 6. Subordination Rights to the Master Lease and Ground Lease. This Sublease and Subtenant's rights under this Sublease shall at all times be subject and subordinate to we underlying Master Lease. If any conflict between the Master Lease and the Sublease occurs, the Master Lease will control, except as inapplicable to, or modified by, the terms of its Sublease or excluded from the incorporation provisions of Section 5 hereof. Subtenant acknowledge and agrees that any termination of the underlying Master Lease pursuant to Subtenant's rights under the Master Lease shall extinguish the Sublease at Landlord's discretion, upon at least thirty (30) days prior written notice to Subtenant, without liability to Sublandlord; provided, however, that such termination is not due to the default of Sublandlord under the Master Lease or to the voluntary surrender by Sublandlord of its rights under the Master Lease. 7. Condition of Subleased Premium. A. Sublandlord shall deliver the Subleased Premises in broom clean condition, with all existing improvements in place, including without limitation, the UPS and security system, but shall remove the freezers and kitchen equipment as soon as possible. Sublandlord represents and warrants that the roof, including the structure and membrane, foundations and exterior walls shall be in sound condition and repair as of the Commencement Date. In addition, Sublandlord, at its sole cost and expense, shall deliver all building systems, including but not limited to HVAC, mechanical, plumbing, electrical and elevator in good working condition and repair. Sublandlord shall also provide Subtenant a sixty (60) day discovery period from the Commencement Date, whereby Sublandlord after notice from Subtenant, shall repair and/or replace any broken or inoperable building systems, excluding any damage caused by Subtenant. B. Subtenant shall not make or suffer to be made any alterations, additions or improvements (collectively, "Alterations") in, on or to the Subleased Premises without the prior written consent of Sublandlord and Landlord, which shall not be unreasonably withheld or delayed. All Alterations shall be performed in compliance with Article 20 of the Master Lease. The Alterations shall be made by Subtenant, at Subtenant's sole cost and expense, and any contractor or person selected by Subtenant to make the same shall first be reasonably approved by Sublandlord and Landlord. Upon the expiration or sooner termination of this Sublease, Subtenant shall, upon written demand by Landlord (but not Sublandlord), at Subtenant's sole cost and expense, forthwith and with all due diligence, remove any Alterations made by Subtenant, which Landlord requires at the time of its, consent be removed at Sublease expiration: provided, however, Subtenant shall have no obligation to reconstruct any of Sublandlord's improvements that were demolished as part of its Alterations, and Sublandlord shall remain solely responsible, at its cost, for removing the Special Improvements and Additional improvements (as defined in the Master Lease). Finally, Sublandlord shall cooperate with Subtenant and use good faith efforts to acquire Landlord's consent to any Alterations. C. The general terms and conditions regarding Subtenant's construction of its Alterations shall be governed by the terms of the Master Lease; provided, however, that: (i) there shall be no specified subcontractors unless Subtenant approves such subcontractor and the party requesting such subcontractor agrees to pay any additional costs; (ii) neither Sublandlord nor Landlord shall charge a construction management fee; and (iii) if performance or payment bonds are required by Sublandlord and/or Landlord, they would be at such party's expense. 9. Insurance. Subtenant, at its sole cost and expense, shall obtain and keep in full force and effect during the entire term of this Sublease such insurance, and in such amounts, as are required under Sections 10.5, 11.1 and 12.1 of the Master Lease. Sublandlord and the Landlord shall be named as additional insured parties under any such policy of insurance. Subtenant and Sublandlord shall each obtain from their respective insurers hereof a waiver of all rights of subrogation as set forth in Section 14.1 of the Master Lease and the other waivers contained in Section 14.2 of the Master Lease shall apply as between the Subtenant and Sublandlord. 10. Security deposit. Upon execution hereof, Subtenant shall deposit with Sublandlord Sixty Nine Thousand Three Hundred Thirty Nine and 45/100 Dollars ($69,339.45) in cash, as security for the performance by Subtenant of the terms and conditions of this Sublease. If Subtenant is in default after passage of the applicable notice and cure provision, the remaining balance of the security deposit shall be immediately due and payable. If Subtenant fails to pay Rent. Additional Rent or other expenses due hereunder or otherwise defaults with respect to any of this Sublease, Sublandlord may draw upon, use, apply or retain all or any portion of the security deposit for the payment of any Rent. Additional Rent, or other expenses in default, for the payment of any other sum which Sublandlord has become obligated to pay by reason of Subtenant's default, or to compensate Sublandlord for any out-of-pocket expenses which Sublandlord has suffered thereby. If Sublandlord so uses or applies all or any portion of the security deposit, then Subtenant shall within ten (10) business days after written demand therefor, deposit cash with Sublandlord in the amount required to restore the security deposit. If at the end of the Sublease Term, Sublandlord shall return to Subtenant that portion of the security deposit which has not been applied by Sublandlord pursuant to this Section 10, or which is not otherwise required to cure Subtenant's defaults. Notwithstanding the foregoing, Sublandlord shall give Subtenant five (5) business days' prior written notice prior to Sublandlord drawing upon or using in any manner the security deposit. 11. Notices. All notices and other communications which are required or desired to be given by either party to the other hereunder shall be in writing and shall be sent by United States registered or certified mail, postage prepaid, return receipt requested, addressed to the appropriate party at its address as such party shall have last designated by notice to the other party in the manner herein provided. Notices and communications to Sublandlord shall be sent to: Sublandlord: For Mail Purposes: For Delivery Purposes: Kelley Clarke, Inc Kelley Clarke, Inc P.O. Box 5558 1470 S. Valley Vista Ave., Suite 200 Diamond Bar, CA 91765-7558 Diamond Bar, CA 91765-7558 Attn: President Attn: President Subtenant: SangStat Medical Corporation 6300 Dumbarton Circle Fremont, CA 94555 Attn: Ralph Levy Notices and commununications to Subtenant shall be sent to the Subleased Premises. Notices and other communications shall be deemed given on the date so mailed. 12. Amendments. Sublandlord and Subtenant shall not amend in any respect this Sublease unless such is in writing and signed by both parties. 13. Consent. This Sublease shall be subject to the consent by Landlord to the terms and conditions of this Sublease, w1ucti shall not become effective unless and until such consent is executed and delivered by such parties. If Landlord fails to consent to this Sublease within thirty (30) days of the date of this Sublease, the Sublease shall automatically terminate and neither party shall have any continuing rights against or obligations to the other with respect to the Subleased Premises or this Sublease, except that Sublandlord shall return to Subtenant all advance rents and security deposits paid by Subtenant to Sublandlord. 14. Indemnification. A. Subtenant shall indemnify, defend, protect and hold harmless Sublandlord and Sublandlord's officers, directors, agents and employees (collectively, Sublandlord's Parties") from and against all liability, cost, damage and expense (including, without limitation, reasonable attorneys' fees) arising from either: (i) the negligence, willful misconduct, or breach of this Sublease by Subtenant or Subtenant's officers, directors, agents or employees (collectively "Subtenant's Parties"); (ii) the use of the Subleased Premises by Subtenant or Subtenant's Parties; (iii) the construction of the Alterations or any claims for work or labor performed, or for materials or supplies furnished to or at the request of Subtenant in relation thereto; or (iv) the use, release or disposal of Hazardous Materials by Subtenant or Subtenant's Parties in, on or about the Subleased Premises: provided, however, that the indemnification provided in this Section 14-A. shall not apply to the extent that any liability, cost, damage or expense arises from the negligence, willful misconduct, or breach of this Sublease by Sublandlord or Sublandlord's Parties. B. Sublandlord shall indemnify, defend, protect and hold harmless Subtenant's Parties from and against all liability, cost, damage and expense (including, without limitation, reasonable attorneys' fees) arising from either (i) the negligence, willful misconduct, or breach of this Sublease or the Master Lease by Sublandlord or Sublandlord's Parties; (ii) the use of the Master Lease Premises by Sublandlord or Sublandlord's Parties; or (iii) the use, release or disposal of Hazardous Materials by Sublandlord or Sublandlord's, Parties in, on or about the Subleased Premises; provided, however, that the indemnification provided in this Section 14-B. shall not apply to the extent that any liability, cost, damage or expense arises from the negligence, willful misconduct, or breach of this Sublease by Subtenant or Subtenant's Parties. C. The terms of this Section 14 shall survive the expiration or termination of this Sublease. 15. Miscellaneous. A. Subtenant shall be entitled to use, on an exclusive basis and free of charge, 167 parking stalls available for use by Sublandlord for the Subleased Premises as set forth in the Master Lease. B. This Sublease may be executed in counterparts each of which when executed shall constitute but one original, and all of which together shall constitute a single agreement. C. Sublandlord shall remove its existing signs, at its sole expense, as soon as possible after mutual execution of the Sublease. Subtenant shall have the right, at its sole cost and expense, to install: (i) door signage at the entrance to the Premises; (ii) multiple Building Signage; and (iii) monument signage on Dumbarton Circle. All signage shall be subject to the terms of the Master Lease and the consent of Sublandlord, Landlord and the City of Fremont. E. Sublandlord and Subtenant represent and warrant that they have negotiated this Sublease directly with Colliers Parrish ("Colliers") and Tory Corporate Real Estate Advisors, Inc. (dba The Staubach Company) (collectively "Brokers"). Sublandlord shall pay the Brokers a commission pursuant to a separate written agreement with each broker. Subtenant has not authorized or employed, or acted by implication to authorize or to employ, any other real estate broker or salesman to act for Subtenant in connection with this Sublease. Each party shall hold the other harmless from and indemnify and defend the other against any and all claims by any real estate broker or salesman other than the Brokers identified above claiming to represent that party for a commission, finders fee or other compensation as a result of each party entering into this Sublease. F. By consenting to this Sublease, in the event the Sublease is terminated for any reason during the term of this Sublease, Landlord agrees that, so long as Subtenant is not in default under the terms of the Sublease, the right of Subtenant to retain possession of the Subleased Premises shall not be distributed and Subtenant leasehold interest in the Subleased Premises shall not be extinguished, subject to all of the terms, covenants and conditions of this Sublease and such terms, covenants and conditions of the Master Lease as are expressly incorporated into this Sublease by reference thereto. G. Sublandlord represents to Subtenant the following: (i) that the Master Lease is in full force and effect and that, to the best of Sublandlord's knowledge, no default or event that, with the passing of time or the giving of notice or both, would constitute a default, exists on the part of Sublandlord, and to the best of Sublandlord's knowledge, the Landlord thereunder; and (ii) to the best of Sublandlord's knowledge, there are no hazardous materials present in, on or about the Subleased Premises. Sublandlord agrees to maintain the Master Lease, in full force and effect except to the extent its failure to maintain the Master Lease is due to the failure of Subtenant to comply with its obligations under this Sublease, provided Subtenant receives prior written notice from Sublandlord as required by the Master Lease. During the Term, Sublandlord shall not enter into any amendment of the Master Lease that during the initial term, would materially diminish Subtenant's rights or materially increase Subtenant's obligations hereunder. H. The covenants and conditions herein contained shall apply to and bind the heirs, successors, executors, administrators and assigns of all of the parties hereto; and all of the parties hereto shall be jointly and severally liable hereunder. IN WITNESS WHEREOF, the parties hereto have executed this Sublease as of this date first above written. "SUBLANDLORD" "SUBTENANT" KELLEY-CLARKE, INC SANGSTAT MEDICAL CORPORATION, a California corporation a Delaware corporation By: ___________________ By: ___________________ Its: ____________________ Its: ____________________ ARDENWOOD CORPORATE COMMONS KELLEY-CLARKE, INC. FREMONT, CALIFORNIA ARTICLE 1. - SALIENT LEASE TERMS THIS LEASE is dated for reference purposes only this 1st day of September, 1988. 1. 1 Rent KAISER DEVELOPMENT COMPANY Payment: c/o Bedford Properties, Inc. P. 0. Box 1267 Lafayette, CA 94549 1.2 Parties Lessor: KAISER DEVELOPMENT' COMPANY and c/o Bedford Properties, Inc. Notice 3470 Mount Diablo Boulevard, Suite A200 Addresses: Lafayette, CA 94549 Lessee: KELLEY-CLARKE, INC a California corporation 30740 Santana Street Hayward, CA 94540-4801 until commencement, thereafter, at the Leased Premises (Section 4 9. 12) 1.3 Premises: (A) Name and Location of Complex: Ardenwood Corporate Commons Fremont, California (B) Leased Premises: Dumbarton circle Fremont, California (C) Approximately 44,000 square feet of Rentable Area on approximately 2.399 acres of land area. (Section 3-2) 1.4 Term: (A) Initial Term: 120 Months (B) Options to Extend: Two at Five years each (Section 4. 1) 1.5 Rent: Minimum Monthly Rent (A) Commencement through 60th lease month:See Article 6 (B) Balance of Initial Term: 1.1699 x Beginning Rent (C) Each extended Term: 90% of fair market value. (Section 6.1) 1.6 Security Deposit: Fifty Thousand Dollars ($50,000) (Section 16. 1) 1.7 Use: Premises used solely for general office purposes (including, however, a test kitchen and storage area which in the aggregate, may not exceed 5,000 square feet.) (Section 17. 1) 1.8 Initial 1.3% Pro Rata% (Section 8.3) 1.9 Declaration of Restrictions: Date Recorded: Series Number Original March 30, 1984 84-062367 Modified June 29, 1984 84-127903 Modified May 28, 1985 85-061691 Modified October 1, 1986 86-241538 Modified March 12, 1987 87-069602 Two amendments of the Restrictions are to be recorded in the form substantially as attached hereto as Exhibit "H". (Section 3.4) 1.10 Contents: This Lease consists of: Pages 1 through 46 Sections-1 through 50.16 Exhibits: A. Legal Description of Leased Premises B. Plot Plan of Leased Premises C. Construction Obligations D. Acknowledgment of Rent and Commencement of Term E. Plot Plan of Complex F. Lessee's Sign G. Rental Reimbursement Agreement H. Declaration of Restrictions I. Purchase Agreement J. Hazardous Materials Report K. Memorandum of Lease L. Quitclaim Deed M. First Offer Area The above terms are incorporated in this Lease as indicated above and referenced herein. ARTICLE 2. DEFINITIONS 2.1 "Building": The structure or structures upon the Leased Premises which is completely enclosed by walls and a roof. "Commencement of Construction": The date upon which the trenching for foundations of the Building is commenced, in the case of Lessor's work under Exhibit "C"; or in the case of a repair or reconstruction in event of a casualty, the date upon which the general building contractor commences work under the terms of its building contract. "Commencement Date": See Section 4.1. "Common Maintenance Areas": See Section 8.1. "Common Maintenance Costs": See Section 8.4. "Complex": See Section 3.2. "Hazardous Materials":See Section 18.3. "Lease Month": Any calendar month, or portion thereof following the commencement hereof, which period is included the Term. "Leased Premises": The real property, land and improvements thereto leased to Lessee hereunder. "Lessee Delay": : Any delay in delivery of the premises by Lessor following substantial completion of Lessor's work specified in Exhibit "C", as a result of design decisions, revisions or additional work or preparation of plans by Lessee or its agents. "Major Uninsured Casualty": A casualty not covered by the insurance required to be obtained by Lessor pursuant to Section 10.2, (whether or not Lessor has obtained such insurance) , the cost for repair of which exceeds $l00,000 in Lessor's sole good faith judgement. "Occupant": Any party with a possessory right to occupy any premises within the complex, including without limitation, owners, tenants, subtenants or licensees. "Permissible Delay ":Any delay in the performance of any covenant under this Lease, which delay results from strikes, walkouts, riots, shortages of materials, governmental regulations, acts of God, inclement weather, fire, flood or other casualty, or other causes, other than financial causes, beyond the reasonable control of the party obligated to perform the task. "Rent": Minimum Monthly Rent and all other sums required to be paid by Lessee pursuant to the terms of this Lease. "Rentable Area": The area within Building(s) measured to the inside finished surface of the dominant portion of the permanent outer Building walls without deduction. "Restrictions": See Section 3.3. "Structural": Any portion of the Leased Premises or Complex or Building which provides bearing support to any other integral member of the Leased Premises, including by limitation the roof structure (trusses, joists, beams), posts, load bearing walls, foundations, girders, floor joists, footings, and other load bearing members constructed by Lessor. "Substantial Completion": Completion of construction work to a degree that occupancy can occur without material impairment of Lessee's ability to conduct the business operations intended to be conducted within the Leased Premises. "Taxes or Real Estate Taxes": See Section 7.1. " Term": The term of the Lease as specified in Article 4 hereof, including any partial month at the commencement of the Term. "Total Project Costs": Same definition as for Construction Costs as defined in Exhibit "C". "Transfer": See Section 9.2. "Usable Area": The number of square feet computed by measuring to the finished surface of the office side of corridor and other permanent walls, to the center of partitions that separate the permanent walls, to the center of partitions that separate the office from adjoining Usable Areas, and to the inside finished surface of the permanent outer Building walls. No deductions shall be made for the columns and projections necessary to the Building. ARTICLE 3. PREMISES 3.1 Demising Clause. Lessor hereby leases to Lessee, and Lessee hires from Lessor a portion of the Complex as hereinafter defined. 3.2 Description. The "Complex" consists of those parcels of real property originally held in common ownership with, and contiguous to, the parcel of which the Leased Premises forms a part, which is referenced in Section 1.3(A) and delineated in Exhibit "F" attached hereto and made a part hereof by reference. The premises leased herein are described in Section 1.3(B) and Exhibit "A" and delineated on Exhibit "B", which is attached hereto and made a part hereof by reference, consisting of the approximate amount of square footage as specified in Section 1.3(C) hereof. Lessor reserves the area beneath and above the Leased Premises and the use thereof together with the right to install, maintain, use, repair and replace underground pipes, ducts, conduits and wires leading through the Leased Premises serving other parts of the Complex, so long as such items are concealed and Lessor uses reasonable efforts to minimize interference with Lessee's business operations in the Leased Premises. Such reservation in no way affects the maintenance obligations imposed herein. 3.3 Covenants, Conditions and Restrictions. The parties agree that this Lease is subject to the effect of (a) any covenants, conditions, restrictions, easements, mortgages or deeds of trust, ground leases, rights of way of record, and any other matters or documents of record; (b) any zoning laws of the city, county and state where the Complex is situated; and (c) general and special taxes not delinquent. Lessee agrees that as to its leasehold estate, Lessee and all persons in possession or holding under Lessee, will conform to and will not violate the terms of any covenants, conditions or restrictions of record which may now or hereafter encumber the property (hereinafter the "Restrictions"). This Lease is subordinate to the restrictions and any amendments or modifications thereto. Any amendments, modifications or additional Restrictions effectuated after the date hereof, in order to govern this Lease, must have been subject to Lessee's prior written consent which may not be unreasonably withheld or delayed. 3.4 Declaration of Restrictions. The Leased Premises are or will be subject to a Declaration of Restrictions as referenced in Section 1.9 hereof. ARTICLE 4. TERM 4.1 Commencement Date. (a) The Term shall commence on the earlier of: (i) ten (10) days following the date Lessor notifies Lessee of the Substantial Completion of its construction obligations described in Exhibit "C" to this Lease provided a Certificate of Occupancy has been issued; and (ii) when Lessee occupies the Leased Premises for the purpose of conducting business. The Term shall continue for the period of months specified in Section 1.4 of the Lease, plus the portion of a calendar month, if any, immediately following commencement. (b) If despite Lessor's diligent efforts Lessor's work upon the Leased Premises improved in accordance with the provisions of Exhibit "C" are not substantially completed by a date which is 300 days following the date of the issuance of the building permit to the Lessor for construction of the Lessor's work specified in Exhibit "C" (the "Estimated Completion Date") , provided that said date shall be extended for period equal to the time construction has been delayed due to Permissible Delays, then, in such event, for each day of such further delay caused by Lessor, Lessee shall be credited with an amount equal to a sum derived by dividing the Minimum Monthly Rent at commencement of the Term by 30, which credit shall be applicable to Tenant's Minimum Monthly Rent obligation. However, for each day of delay beyond the Estimated Completion Date caused by Lessee Delay, Lessee shall pay additional rent to Lessor computed in the same manner which shall be payable with the first regular installment of Minimum Monthly Rent. However, any such delay, whether caused by Lessee or Lessor, shall be subject to a 5 day period during which the culpable party shall not be responsible for the remedies herein above described. In no event, however, shall extensions resulting from Permissible Delay exceed 180 days. Each party shall notify the other of any delays caused by the other party within a reasonable time following the first party's knowledge of the delay. However, failure to notify shall not constitute a waiver of the rights of either party hereunder arising as a result of the delay. (c) If the Term has not commenced within three (3) years from date of execution hereof, it shall be automatically terminated. 4.2 Acknowledgment of Commencement. After delivery of the Leased Premises to Lessee, Lessee shall execute a written acknowledgement of the date of commencement and the agreed upon rent in the form attached hereto as Exhibit "D" and by this reference it shall be incorporated herein. 4. 3 Option to Extend the Term-Negotiated Rental-Three Arbitrators (a) Notice of Exercise. Lessee hall have the right to extend the initial term hereof for two (2) additional and consecutive, periods of five (5) years each upon the same terms and conditions as stated herein, except for Minimum Monthly Rent and further, except that the number of additional periods shall be reduced by one for each extension that is exercised. Each such extension is herein referred to as "Extended Term." Failure to timely exercise any extension option hereunder shall cause all subsequent options to immediately become null and void. Lessee must exercise its right, if at all, by written notification (the "Notice of Exercise") to Lessor not less than three hundred sixty (360) days prior to the expiration of the initial term hereof, or the then current Extended Term, if any, provided that Lessee has not caused a Notice of Default under the provisions of Article 26 to be sent to it by Lessor at least five (5) times during the initial term (in the case of exercise of the First Option to Extend) or three (3) times during the first Extended Term (in the case of exercising the Second Option to Extend.) (b) Options Are Personal. The options to extend granted herein are personal to the original Lessee executing this Lease, and notwithstanding anything to the contrary contained in the Lease, the rights contained in this Section 4.3 are not assignable or transferable by such original Lessee except in connection with an assignment made pursuant to Section 9.3(c). However, a sublease shall not invalidate Lessee's rights hereunder. Lessor grants the rights contained herein to Lessee in consideration of Lessee's strict compliance with the provisions hereof, including, without limitation, the manner of exercise of this option. (c) Fair Market Rental. If Lessee exercises the right to extend the Term, then the Minimum Monthly Rent shall be adjusted to be equal to ninety per cent (90%) of the Fair Market Rental for the premises as of the date of the commencement of each such Extended Term, pursuant to the procedures hereinafter set forth. The term "Fair Market Rental" means the Minimum Monthly Rent chargeable for the Leased Premises based upon the following factors applicable to the Leased Premises or any comparable premises: (i) Rental rates being charged for comparable premises in the same geographical location. (ii) The relative locations of the comparable premises (iii) Improvements, or allowances provided for improvements, or to be provided, or the lack thereof. (iv) Rental adjustments, if any, or rental concessions. (v) Services and utilities provided or to be provided. (vi) Use limitations or restrictions. (vii) The age of the building. (viii) That no brokerage commissions are payable. (ix) Any other relevant Lease terms or conditions. In no event, however, shall ninety per cent (90%) of the Fair Market Rental be less than the Minimum Monthly Rent in effect immediately prior to the commencement date of the Extended Term in question. The Fair Market Rental evaluation may include provision for further rent adjustments during the Extended Term in question if such adjustments are commonly required in the market place for similar types of leases. (d) Determination of Fair Market Rental. Upon exercise of the right to extend the term, and included within the Notice of Exercise, Lessee shall notify Lessor of its opinion of Fair Market Rental as above defined for the Extended Term. However, in no event shall Lessor be obligated to join any such discussions, nor shall any appraisal or Arbitration described herein commence prior to three hundred sixty-five (365) days before the expiration of the then current Term. If the parties are unable to agree upon a Minimum Monthly Rent for the Extended Term within thirty (30) days thereafter, then, within ten (10) days after the expiration of such period, either party at its own cost and expense and by giving notice to the other party in writing, may appoint a real estate appraiser who is a Member of the Appraisal Institute, or Society of Real Estate Appraisers, or an equivalent professional organization, with at least five (5) years' experience appraising properties devoted to the same general type of use (e.g. office) as the Leased Premises in the county in which the Leased Premises are located, ("Qualified Appraiser"), to set the Minimum Monthly Rent for the Extended Term. The terms "Minimum Monthly Rent" and ninety per cent (90%) of the "Fair Market Rental" as used in this article shall be interchangeable. If a party does not appoint a Qualified Appraiser within ten (10) days after the first party has given notice of the name of its Qualified Appraiser, the single Qualified Appraiser appointed shall be the sole appraiser and shall set the Fair Market Rental for the Extended Term. If two Qualified Appraisers are appointed by the parties, they shall meet promptly, on five (5) days' notice to the parties, to take such evidence and other information as the parties may deem reasonable to submit to the Qualified Appraisers. Within thirty (30) days after the selection of the last of the two Qualified Appraisers to be appointed by the parties, the Qualified Appraisers shall render their opinions of the Fair Market Rental of the premises as above qualified. If the two valuations are within ten per cent (10%) of each other, they shall be averaged and ninety per cent (90%) of the average of the two shall be the Minimum Monthly Rent for the Extended Term. If only one appraisal is timely submitted, ninety per cent (90%) of that appraisal shall constitute the Minimum Monthly Rent for the Extended Term. If the two valuations are separated by more than ten per cent (10%), then the two appraisers shall, within ten (10) days following the last date for submission of the two appraisals of Fair Market Rental, appoint a third Qualified Appraiser. If they are unable to agree upon a third Qualified Appraiser within such ten (10) day period, either of the parties to this Lease, by giving five (5) days' notice to the other party, may demand Arbitration as specified in Subsection (f) of this Section. If neither party applies for Arbitration within the ten (10) day period herein specified, the two appraisals of value shall be averaged as stated above. (c) Arbitration. In the event the parties are unable to mutually agree upon a Minimum Monthly Rent for the Extended Term, and in such event proceed to the Appraisal or Arbitration procedure herein specified, both parties shall be bound to submit the matter for such determination. The procedure specified in this Article for appointment of Qualified Appraisers, delivery of appraisals, appointment of an Arbitrator, and determination of Fair Market Rental Value thereby is herein collectively referred to as "Arbitration." The Arbitration shall be conducted and determined in the County where the Leased Premises are situated. If the Arbitration is not concluded before the commencement of the Extended Term, Lessee shall pay Minimum Monthly Rent to Lessor in an amount equal to ninety per cent (90%) of the Fair Market Rental set forth in the appraisal by Lessor's Qualified Appraiser until the Fair Market Rental is determined in accordance with the Arbitration provisions hereof. If the Fair Market Rental as determined by Arbitration differs from that stated by Lessor's Qualified Appraiser, then any adjustment required to correct the amount previously paid by Lessee shall be made by payment by the appropriate party within thirty (30) days after the determination of Fair Market Rental by Arbitration has been concluded, as provided herein. Lessee shall be obligated to make payment during the entire Extended Term of the Minimum Monthly Rent determined in accordance with the Arbitration procedures hereunder. (f) Demand for Arbitration. A party demanding Arbitration hereunder shall make its demand in writing ("Demand Notice") within ten (10) days after the delivery of the last of the two appraisals presented by the Qualified Appraisers as specified in Subsection (d) above. A copy of the Demand Notice shall be sent to the Presiding Judge of the Superior Court of Alameda County. The Presiding Judge, is hereinafter referred to as the "Appointer". The Appointer, acting in his personal, private capacity, shall appoint within ten (10) days thereafter a Qualified Appraiser. The Arbitrator shall be qualified to serve as an expert witness, over objection, and to give opinion testimony addressed to the issue in a court of competent jurisdiction. (g) Decision of the Arbitrator. As used herein, the term Arbitrator refers to a third Qualified Appraiser, selected by any of the methods heretofore set forth. The Arbitrator shall, within ninety (90) days after his appointment, state in writing his determination as to whether the Fair Market Rental stated by Lessor's Qualified Appraiser or the Fair Market Rental stated by Lessee's Qualified Appraiser, most closely approximates his own. The Arbitrator shall have the right to consult experts and competent authorities with factual information or evidence pertaining to a determination of Fair Market Rental, but any such consultation shall be made in the presence of both parties with full right to cross examine. The Arbitrator may not state his own opinion of Fair Market Rental, but is strictly limited to the selection of one of the two appraisals submitted by the other two Qualified Appraisers. The Arbitrator shall have no right to propose a middle ground or any modification of either of the proposed valuation, and shall have no power to modify this Lease. The valuation so chosen as most closely approximating that of the Arbitrator shall constitute his decision. The Arbitrator shall render a decision and award in writing, with counterpart copies to each party. (h) Successor Arbitrator; Fees and Expenses. In the event of failure, refusal, or inability of the Arbitrator to act in a timely manner, a successor shall be appointed in the same manner as such Arbitrator was first chosen hereunder. The fees and expenses of the Arbitrator and for the administrative hearing fee, if any, shall be divided equally between the parties. Each party shall bear its own attorneys' fees and other expenses including fees of witnesses in presenting evidence, and the fees and cost of its own Qualified Appraiser. (i) Recission. Within ten (10) days following the date that the Minimum Monthly Rent for the ensuing option period is established by the procedures herein, Lessee may, by written notice to the Lessor, elect to rescind its exercise of the option in which case the Lease term shall expire on the expiration of the then current Term. ARTICLE 5. PRE-TERM POSSESSION 5.1 Conditions of Entry. Lessor may notify Lessee when the Leased Premises are ready for Lessee's fixturing or Lessee's work, which may be prior to Substantial Completion by Lessor. Lessee may thereupon enter the Leased Premises for such purposes at its own risk, to make such improvements as Lessee shall have the right to make, to install fixtures, supplies, furniture and other property. Lessee agrees that it shall not in any way interfere with the progress of Lessor's work by such entry. Should such entry prove an impediment to the progress of Lessor's work, in Lessor's judgment, Lessor may demand that Lessee forthwith vacate the Leased Premises until such time as Lessor's work is complete, and Lessee shall immediately comply with this demand. During the course of any pre-term possession, whether such pre-term period arises because of an obligation of construction on the part of Lessor, or otherwise, all terms and conditions of this Lease, except for rent and commencement, shall apply, particularly with reference to indemnity by Lessee of Lessor under Article 14 herein for all occurrences within or about the Leased Premises. ARTICLE 6 MINIMUM RENT 6.1 Payment. Lessee shall pay to Lessor at the address specified in Section 1.1, or at such other place as Lessor may otherwise designate, as "Minimum Monthly Rent" for the Leased Premises the amount specified in Section 1.5 hereof, payable in advance on the first day of each month during the Term. If the Term commences on other than the first day of a calendar month, the rent for the first partial month shall be prorated accordingly. All payments of Minimum Monthly Rent (including sums defined as rent in Section 27.2) shall be in lawful money of the United States, and payable without deduction, offset, counterclaim, prior notice or demand. 6.2 Calculation of Minimum Monthly Rent. (a) The Minimum Monthly Rent shall be calculated as follows: (i) Total Project Costs, as that term is defined in Exhibit "C" hereto, exclusive of land costs, shall form the basis of the calculation of Minimum Monthly Rent. (ii) Total Project Costs shall be multiplied by ten per cent (10%) and the product thereof divided by .97. (iii) The quotient derived in (ii) above shall be divided by twelve to arrive at the Minimum Monthly Rent at commencement of the Term. (b) At least ten (10) days prior to the date when the first payment of Minimum Monthly Rent is due hereunder, Lessor shall estimate Total Project Costs, make the calculation of Minimum Monthly Rent on an estimated basis in writing, and forward the same to Lessee. Lessee shall pay the Minimum Monthly Rent so estimated until a final determination of initial Minimum Monthly Rent, as hereinafter described, is established. (c) Within ninety (90) days following the Commencement Date, Lessor shall deliver to Lessee an itemized accounting of Total Project Costs. Within thirty (30) days thereafter Lessee may, at its option, have Total Project Costs audited by Lessee's independent certified public accountant. If Lessee's calculation of Total Project Costs and Lessor's calculation thereof differ, Lessee shall submit its calculation thereof in writing to Lessor within the thirty (30) day examination period specified in the preceding sentence. The parties shall negotiate in good faith to resolve their differences within fifteen (15) days following the date of Lessee's notice to Lessor of Lessee's determination of Total Project Costs. If the parties are unable to resolve their differences within this period, the matter may be submitted by either party to the public accounting firm of Peat, Marwick & Mitchell who shall make a final determination within sixty (60) days thereafter. Upon establishment of the Minimum Monthly Rent, should there be a difference from that estimated by Lessor as stated in (b) above, the Lessor shall pay, if the determination so establishes, the due sum for any overpayment received from Lessee during the period of the determination of Total Project Costs, within ten (10) days after the final determination thereof in accordance with the terms of this paragraph. Upon establishment of the Minimum Monthly Rent, the parties, on request of either party, shall amend this Lease to so state the established initial Minimum Monthly Rent. If it is established by the process specified in this Section 6.2(c) that Lessor has overstated Project Costs by more than $100,000.00, Lessor shall pay the reasonable cost of Lessee's certified public accountants who perform Lessee's audit. 6.3 Rent Adjustment. The Minimum Monthly Rent as established in Section 6.2 above shall be effective from the Commencement Date through the sixtieth (60th) Lease Month, commencing with the first (1st) day of the sixty first (61st) Lease Month the Minimum Monthly Rent shall be increased by multiplying the Minimum Monthly Rent established in the preceding Section 6.2 by 1.1699. At such time, either party may require that another Lease amendment be executed setting forth the newly established Minimum Monthly Rent for the balance of the initial term. The Minimum Monthly Rent for any Extended Term has been provided for in Section 4.3 hereof. 6.4 Late Payment. If during any twelve (12) month period Lessee fails on more than one occasion to make any payment of Minimum Monthly Rent to Lessor within five (5) days following receipt of written notice from Lessor that such is due, then Lessor may, by giving written notice to Lessee, require that Lessee pay the Minimum Monthly Rent to Lessor quarterly in advance. Having been caused to commence quarterly payments under the provisions of this section, should Lessee thereafter make its quarterly rental payments on or before the first business day of each quarter for eight (8) consecutive quarters, thereafter Lessee's rental payment schedule shall revert to monthly periods. ARTICLE 7 TAXES 7.1 Definition. In this Article 7 the terms "Real Property Taxes" and "Taxes" are used interchangeably. "Real Property Taxes" as used in this Lease shall include all Real Property Taxes on the Building, the Leased Premises, the land on which the Building is situated, and the various estates in the Building and the land, including this Lease, as well as all personal property taxes levied on the property used in the operation of the Leased Premises, whether or not now customary or within the contemplation of the parties to this Lease. "Taxes" also shall include the reasonable cost to Lessor of contesting the amount, validity, or applicability of any Taxes mentioned in this Section. Further included in the definition of Taxes herein shall be general and special assessments, fees of every kind and nature, commercial rental tax, levy, penalty or tax (other than any tax which may be levied upon or against the general net income or profits of Lessor or its successors or assigns, inheritance or estate taxes) imposed by any authority having the direct or indirect power to tax, as against any legal or equitable interest of Lessor in the Leased Premises in the real property of which the Leased Premises are a part, as against Lessor's right to rent or other income therefrom, or as against Lessor's business of leasing the Leased Premises, any tax, fee, or charge with respect to the possession, leasing, transfer of interest, operation, management, maintenance, alteration, repair, use, or occupancy by Lessee, of the Leased Premises or any portion thereof, the Building, or the Complex, or any tax imposed in substitution, partially or totally, for any tax previously included within the definition of Taxes herein, or any additional tax, the nature of which may or may not have been previously included within the definition of Taxes. 7. 2 Assessments. With respect to any general or special assessments which may be levied upon or against the Leased Premises, the Building, the Complex, or the underlying realty, or which may be evidenced by improvement or other bonds, and which may be paid in annual or semi-annual installments, only the current amount of such installment, pro rated for any partial year, and statutory interest, shall be included within the computation of Taxes for which Lessee is responsible hereunder. 7.3 Payment. Lessee shall pay to the Lessor at least thirty (30) days prior to the date when such Taxes would be delinquent but not prior to ten (10) days following notice from Lessor of the amount due, all Real Property Taxes as hereinabove defined applicable to the Leased Premises or arising under section 7.1 above. 7. 4 Estimated Payments. If required by Lessor's lender Lessor may, at its option, estimate the amount of Taxes next due and collect from Lessee on a monthly or quarterly basis, at Lessor's option, the amount of Lessee's estimated tax obligation. On or before March 1 of each year during the Term, Lessor shall provide Lessee with a reconciliation of Lessee's account with respect to such estimated tax payments. In event it is established upon such reconciliation that Lessee has not paid sufficient amount in estimated tax payments to cover its pro rata share for the year in question, Lessee shall pay to Lessor the full amount of any such shortage within ten (10) days of date of billing. If it is established that Lessee has made an overpayment of its tax obligation upon such reconciliation, Lessee shall receive, at Lessor's option, either a credit applicable to the next ensuing estimated tax payments, or a credit to a tax reserve account to be held by Lessor for application to sums due in respect of reassessment or escape assessments applicable to the period in question, but yet to be billed. 7.5 Personal Property Taxes. Lessee shall pay prior to delinquency all Taxes assessed against and levied upon trade fixtures, furnishings, equipment and all other personal property of Lessee contained in the Leased Premises or elsewhere. When possible, Lessee shall cause such trade fixtures, furnishings, equipment and all other personal property to be assessed and billed separately from the real property of Lessor. If any of Lessee's said personal property shall be assessed with Lessor's real property, Lessee shall pay Lessor Taxes attributable to Lessee within ten (10) days after receipt of a written statement setting forth the Taxes applicable to Lessee's property, including an explanation of the calculation of the sum due from Lessee. 7.6 Net Rent. It is the intention of Lessor and Lessee that the rental received by Lessor be net of any Taxes of any sort to be paid by Lessor, subject to the exclusions stated in Section 7.1. In the event it shall not be lawful for Lessee to reimburse Lessor for any of the Taxes covered by this Article, the Minimum Monthly Rent payable to Lessor under the terms of this Lease shall be increased by the amount of the portion allocable to Lessee so as to net to Lessor the amount which would have been receivable by Lessor if such tax had not been imposed. ARTICLE 8. COMMON MAINTENANCE 8. 1 Definition of Common Maintenance Areas. The term "Common Maintenance Areas" as used herein means all areas and facilities within the Complex, but outside the boundaries of any lot within the recorded subdivision which comprises the Complex, including, however, any recorded lot owned by Lessor or an affiliate of Lessor which is used for the general benefit of the Complex, and further including, without limitation, streets (whether public or private), sidewalks, and landscaped areas, all as generally described on Exhibit "E" attached hereto. Exhibit "E" is tentative and Lessor reserves the right to make alterations thereto from time to time, and to exclude areas of other parcels in the Complex, in Lessor's sole judgment, so long as no such alteration or exclusion shall unreasonably interfere with the access to the Leased Premises, nor shall it cause a material interference as a result of the unreasonable activity of the Lessor, with Lessee's use of the Leased Premises as described in Section 1.7 hereof. 8.2 Rights and Duties of Lessor. Lessor shall, in a manner it deems proper in its opinion, maintain the Common Maintenance Areas in a manner consistent with similar developments in the area, establish and enforce reasonable rules and regulations concerning such areas, close any of the Common Maintenance Areas to whatever extent required in the opinion of Lessor's counsel to prevent a dedication of any of the Common Maintenance Areas or the accrual of any rights of any person or of the public to the Common Maintenance Areas, close temporarily any of the Common Maintenance Areas for maintenance purposes, and make changes to the Common Maintenance Areas including, without limitation, changes in the location of driveways, entrances, exits, vehicular parking spaces, parking area, the designation of areas for the exclusive use of others, the direction of the flow of traffic or construction of additional buildings thereupon; provided, however, that Lessor shall use diligent efforts to minimize interference with Lessee's business, use and enjoyment of the Common Maintenance Areas and the Leased Premises and Lessor shall not prevent Lessee's access to the Leased Premises. Lessee hereby acknowledges that Lessor is under no obligation to provide security for the Maintenance Areas but may do so at its option. 8.3 Payment by Lessee. Lessee shall pay to Lessor, as additional rent, its proportionate share of Common Maintenance costs as hereinafter defined, within ten (10) days of receiving a bill therefore from Lessor, but no more frequently than monthly. Lessee's proportionate share (or "Pro Rata %") shall be that fraction of Common Maintenance Costs the numerator of which is the number of square feet of land area in the Leased Premises and the denominator of which is the gross square footage of land area in all lots, whether or not built upon, within the Complex. Lessee's Initial Pro Rata % of Common Maintenance Costs is stated in Section 1. 8. Lessor may bill Lessee estimated charges in accordance with Section 8.5. Notwithstanding the preceding provisions of this Section 8.3, Lessee's proportionate share as to certain expenses included in Common Maintenance Costs may be calculated differently to yield a higher percentage share for Lessee as to certain expenses in the event Lessor permits other owners or occupants in the Complex to incur such expenses directly rather than have Lessor incur the expense in common for the complex, in such case Lessee's proportionate share of the applicable expense shall be calculated as having as its denominator the gross square footage of land area of all lots in the Complex less the gross leasable area of tenants who have incurred such expense directly. In any case in which Lessee, with Lessor's consent, incurs such expenses directly, Lessee's proportionate share of Common Maintenance Costs will be calculated specially so that expenses of the same character which are incurred by Lessor for the benefit of other occupants in the Complex shall not be charged to Lessee. Nothing herein shall imply that Lessor will permit Lessee or any other occupant of the Complex to incur Common Maintenance Costs. Any such permission shall be in the sole discretion of Lessor, which Lessor may grant or withhold in its sole good faith business judgment. 8.4 Definition of Common Maintenance Costs. (a) "Common Maintenance Costs" means all sums (including "Capital Costs" as hereinafter defined and to the extent stated herein) expended by Lessor for the maintenance, repair, replacement and operation of the Common Maintenance Areas, as well as liability insurance premiums, security services for the Complex, Ardenwood Corporate Commons Owners' Association expenses, property taxes on property held for the general benefit of the Complex and a management fee of ten per cent (10%) of Common Maintenance Area costs. Capital Costs are defined as those expenditures which do not normally recur more frequently than at five (5) year intervals in the normal course of operation and maintenance of the Complex. Notwithstanding anything above which may be to the contrary, Common Maintenance Costs shall include a portion of all Capital Costs, representing any costs of capital improvements made by Lessor to the Complex for the purpose of reducing recurring expenses or utility costs and from which Lessee can expect a reasonable benefit, or that are required by governmental law, ordinance, regulation or mandate, not applicable to the Complex at the time of the original construction. The portion thereof to be included each year in Common Maintenance Costs shall be that fraction allocable to the calendar year in question calculated by amortizing. the cost over the reasonably useful life of such improvement, as determined by Lessor, with interest on the unamortized balance at ten per cent (10%) per annum or such higher rate as may have been paid by Lessor for funds borrowed for the purpose of constructing such improvements, but in no event to exceed the highest rate permissible by law. (b) Exclusions from Common Maintenance Costs. The following costs and expenses shall be excluded from the definition of Common Maintenance Costs: (i) Any costs or expense to the extent to which Lessor is paid or reimbursed from any person (other than as payment for Common Maintenance Costs), including, but not limited to, (1) work or services performed for any tenant (including Lessee) at such tenant's cost, (2) the cost of any item for which Lessor is or is entitled to be paid or reimbursed by insurance or otherwise, and (3) increased insurance or Real Estate Taxes assessed specifically to any tenant of the Complex; (ii) The cost of correcting defects in the design, construction, or equipment, or latent defects in any buildings in the complex or on the Common Maintenance Areas in the complex; (iii) The cost of installing, operating and maintaining any athletic or recreation club, provided, however, if Lessor does install and or operate such a facility, Lessee and Lessee's employees may not have the use thereof. (iv) Salaries and bonuses of officers and executives of Lessor; (v) The cost of any work or services performed for any facility other than the Complex; (vi) Repaving or resurfacing costs of the parking and driveway areas except to the extent the charges included are based on an amortization of such costs over the reasonably useful life of the work done at an interest rate equal to the prime rate chargeable by Bank of America to its best customers plus 1%, adjusted annually not to exceed the maximum that may be charged under law and then only if such repaving or resurfacing is not due to negligent construction of the parking and driveway; (vii) Interest on debt or amortization payments on any mortgage and rental under any ground lease or other underlying lease; (viii) Any fees, costs and commissions incurred in procuring or attempting to procure other tenants including brokerage commissions, finders' fees, attorneys' fees, entertainment costs and travel expenses; (ix) Any costs representing an amount paid to a person, firm, corporation or other entity related to Lessor which is in excess of the amount which would have been paid in the absence of such relationship; (x) Any cost of painting or decorating of any interior parts of the buildings in the Complex other than buildings in the Common Maintenance Areas: (xi) Lessor's general overhead: (xii) The cost of initial cleaning and rubbish removal from the Complex and the buildings thereon to be performed prior to final completion of the building; (xiii) The cost of the initial landscaping of the complex; (xiv) Attorneys' fees, accounting fees, and expenditures incurred in connection with negotiations, disputes and claims of other tenants or occupants of the Complex or with other third parties except as specifically otherwise provided in the Lease; (xv) The cost of any uninsured repairs or replacements other than the deductible portion of any insured risk: (xvi) Costs which, under generally accepted accounting principles, are properly classified as capital expenses, except for capital costs as defined in Subsection (a) above, and except as specifically set forth in this Subsection (b); (xvii) The cost of the initial stock of tools and equipment for operation, repair and maintenance of the Complex and the Buildings thereon; (xviii) The cost of acquiring sculptures, paintings and other objects of art; (xviiii) Costs related to correcting items which were not in compliance with law for any of the buildings, the Complex, or the Common Maintenance Areas as of the Commencement Date. 8.5 Estimated Payments. Lessor shall have the right, at its option, to estimate Lessee's pro rata share of Common Maintenance Costs due in the future from Lessee and to collect from Lessee on a monthly or quarterly basis, as Lessor may elect, the amount of Lessee's estimated pro rata share of such costs. Lessor shall provide Lessee with a reconciliation of Lessee's account at least annually, and if such reconciliation shall indicate that Lessee's account is insufficient to satisfy Lessee's pro rata share of Common Maintenance Costs for the period estimated, Lessee shall immediately pay to Lessor any deficiency. Any excess in such account indicated by the reconciliation shall be credited to Lessee's account to reduce the estimated payments for the next ensuing period. 8.6 Audit Rights. At anytime within ninety (90) days following the date that Lessor presents Lessee with a reconciliation of Lessee's account with respect to Common Maintenance Costs for the preceding year, Lessee shall have the right upon five (5) days prior written notice to Lessor to cause Lessor's books and records with respect to Common Maintenance Costs to be audited by an independent certified public accountant of Lessee's selection (the "Lessee's Accountant"). Should Lessee's Accountant establish in its judgment that the actual Common Maintenance Costs were more than five percent (5%) less than those charged to Lessee by Lessor for the period in question, Lessor shall either: (i) Repay Lessee the amount of the overpayment plus the reasonable costs for the audit chargeable by Lessee's Accountant; or (ii) Contest the findings of Lessee's Accountant by demanding the matter be submitted to arbitration under the Rules of the American Arbitration Association in San Francisco, California. In the latter case, both parties shall promptly submit the matter to arbitration. The decision of the arbitrator elected by the San Francisco office of the American Arbitration Association shall be conclusive. The cost of the arbitrator shall be paid by the unsuccessful party to the arbitration. ARTICLE 9. ASSIGNMENT AND SUBLETTING 9.1 "Transfer of the Leased Premises" Defined. The terms "Transfer of the Leased Premises" or "Transfer" as used herein shall include any assignment of all or any part this Lease (including assignment by operation of law), subletting of all or any part the Leased Premises or transfer of possession, or right of possession or contingent right of possession of all or any portion of the Leased Premises including without limitation, concession, mortgage, devise, hypothecation, agency, franchise or management agreement, or to suffer any other person (the agents and servants of Lessee excepted) to occupy or use the said Leased Premises or any portion thereof. If Lessee is a corporation which is not deemed a public corporation, or is an unincorporated association or partnership, or Lessee consists of more than one party, the transfer, assignment or hypothecation of any stock or interest in such corporation, association, partnership or ownership interest, in the aggregate in excess of twenty-five percent (25%), shall be deemed a Transfer of the Leased Premises. 9.2 No Transfer Without Consent. Lessee shall not suffer a Transfer of the Leased Premises or any interest therein, or any part thereof, or any right or privilege appurtenant thereto without the prior written consent of Lessor, and a consent to one Transfer of the Leased Premises shall not be deemed to be a consent to any subsequent Transfer of the Leased Premises. Any transfer of the Leased Premises without such consent shall be void, and shall, at the option of Lessor, terminate this Lease 9.3 When Consent Granted. (a) The consent of Lessor to a Transfer may not be unreasonably withheld. Lessor shall respond to Lessee's request for consent within ten (10) business days following Lessor's receipt of the information described in Section 9.4 hereof. Should Lessor deny consent it shall specify its reasons therefor in its written denial. Should Lessor fail to respond within ten (10) business days to Lessee's request for consent, Lessor's consent shall be deemed to have been granted. (b) Should Lessor withhold its consent for any of the following reasons, which list is not exclusive, such withholding shall be deemed to be reasonable if exercised in good faith: (i) Financial strength of the proposed transferee is adequate in Lessor's reasonable judgment to meet the obligations of this lease; (ii) A proposed transferee whose occupation of the Leased Premises would cause a diminution in the reputation of the Complex or the other businesses located therein; (iii) A proposed transferee whose impact on the common facilities or the other occupants of the Complex would be disadvantageous; or (iv) A proposed transferee whose occupancy will require a variation in the terms of the Lease. (v) Lessee agrees that its personal business skills or operation and philosophy were an important inducement to Lessor for entering into this Lease Agreement and that Lessor may reasonably object to the transfer of the Leased Premises to another whose proposed use, while permitted by the use clause of this Lease, would involve a different quality, manner or type of business skills than that of Lessee. (c) Notwithstanding any other provision hereof, Lessee shall have the right, without the prior consent of Lessor, to assign this Lease in connection with a merger or consolidation of Lessee, or to a subsidiary of Lessee, or to a company incorporated or to be incorporated by Lessee, provided that Lessee owns or beneficially controls all or substantially all of the issued and outstanding shares of capital stock of such company. In any of such events, Lessee shall be required to provide Lessor written notice of such event, and to further provide Lessor with the name of the Assignee. In the event of an assignment of this Lease described in this Subsection 9.3(c), the provisions of Subsection 9.5(b) shall not be applicable. All other provisions of this Lease, including the balance of the provisions of section 9.5 shall apply. 9.4 Procedure for Obtaining Consent. (a) Lessor need not commence its review of any proposed Transfer, or respond to any request by Lessee with respect to such, unless and until it has received from Lessee adequate descriptive information concerning the business to be conducted by the proposed transferee, the transferee's financial capacity, and such other information as may reasonably be required in order to form a prudent judgment as to the acceptability of the proposed Transfer, including, without limitation, the following: (i) If an individual or unincorporated entity for which there is personal liability: The past two year's Federal Income Tax returns of the proposed transferee or, in the alternative, the past two years' audited annual Balance Sheets and Profit and Loss statements, certified correct by a Certified Public Accountant (the "Audited Statements");. (ii) If a Corporate entity: the past two (2) years' Audited Statements; (iii) Banking references of the proposed transferee; (iv) A resume of the business background and experience of the proposed transferee; (v) An executed copy of the instrument by which Lessee proposes to effectuate the Transfer. (b) Lessee shall reimburse Lessor as additional rent for Lessor's reasonable costs and attorney's fees, not to exceed $2,500 per request, incurred in conjunction with the processing and documentation of any proposed Transfer of the Leased Premises, whether or not consent is granted. 9.5 Effect of Transfer. If Lessor consents to a Transfer, the following conditions shall apply: (a) Each and every. covenant, condition or obligation imposed upon Lessee by this Lease and each and every right, remedy or benefit afforded Lessor by this Lease shall not be impaired or diminished as a result of such Transfer. (b) (i) On a monthly basis, any sums of money, or other economic consideration received by Lessee from the Transferee in such month (whether or not for a period longer than one month), including higher rent, bonuses, key money, or the like which exceed, in the aggregate, the total sums which Lessee pays Lessor under this Lease in such month, or the prorated portion thereof the numerator of which is the Transfer Space and denominator of which is 44,000 (the "Prorata Portion") if the Leased Premises transferred is less than the entire Leased Premises (the "Transfer Profit"), shall be payable as follows: A. Transfer Profit realized on the first 10,000 square feet of Rentable Area, in the aggregate for which a Transfer is contracted (the "Threshold Transfer Space") shall be divided equally between Lessor and Lessee provided, however, following deduction for the benefit of Lessee for those subleasing costs incurred by Lessee and described in Subsection 9.5(b) (ii) below, Lessor is first allocated the sum of $4,730 per month (or the, applicable Prorata Portion thereof) representing a return on Lessor's investment in the land which is part of the Leased Premises; B. However, once Lessee contract Transfer, in the aggregate, more than the Threshold Transfer Space then all Transfer Profit (including that realized thereafter from Threshold Transfer Space) shall be allocated eighty percent (80%) to Lessor and twenty percent (20%) to Lessee. (ii) Lessor's share of the Transfer Profit shall be paid with Lessee's payment of Minimum Monthly Rent each month. Notwithstanding the provisions above, there shall be no allocation of land profit to Lessor as described in Subsection (A) above if Landlord's entitlement is governed by the provisions of Subsection (B). Further, in the case of a profit split governed by the provisions of Subsection (ii), Lessee shall be entitled, prior to calculation of Transfer Profit, and as a deduction therefrom, to a return of brokerage commissions, advertising costs, rent concessions and tenant improvements provided to the Transferee and paid for by the Lessee which sum, prior to deduction, shall be calculated as based upon an amortization of such costs at no interest over the remaining term of the applicable Transfer. Thus, by example, if Lessee expends the sum of $10,000 to place a Transferee in possession of a. portion of the Premises, and the term of the sublease applicable to such Transfer is three (3) years, then, each month the Lessee shall be entitled to a prior allocation from Transfer Profit in the amount of $277.77. (c) No Transfer, whether or not consent of Lessor is required hereunder, shall relieve Lessee of its primary obligation to pay the rent and to perform all other obligations to be performed by Lessee hereunder. The acceptance of rent by Lessor from any person shall not be deemed to be a waiver by Lessor of any provision of this Lease or to be a consent to any Transfer of the Leased Premises. (d) If Lessor consents to a sublease, such sublease shall not extend beyond the expiration of the Term except as follows: (i) Lessee may exercise an option to extend the term, keeping in effect any sublease it may have entered into, provided that Kelley-Clarke, Inc. is in possession of not less than 22,000 square feet of Rentable Area; or (ii) If Kelley-Clarke, Inc.(or an assignee of Kelley-Clarke, Inc. described in Subsection 9.3(c)), is not in possession at commencement of any Extended Term of at least 22,000 square feet of Rentable Area, it may exercise an option to extend provided the sublessee has been approved by the Lessor herein in accordance with the provisions of this Article 9 and this Lease is amended in a writing executed by all parties to restate the rent for the Extended Term to be one hundred percent (100%) of fair market value instead of ninety-percent (90%) of fair market value as described in Section 6.2 herein. (e) No Transfer shall be valid and no transferee shall take possession of the Leased Premises or any part thereof unless, within ten (10) days after the execution of the documentary evidence thereof, Lessee shall deliver to Lessor a duly executed duplicate original of the Transfer instrument in form reasonably satisfactory to Lessor which provides that (i) the transferee assumes Lessee's obligations for the payment of rent and for the full and faithful observance and performance of the covenants, terms and conditions contained herein, (ii) such transferee will, at Lessor's election, attorn directly to Lessor in the event Lessee's Lease is terminated for any reason on the terms set forth ARTICLE 10. PROPERTY INSURANCE 10.1 Use of Premises. No use shall be made or permitted to be made on the Leased Premises, nor acts done, which will increase the existing rate of insurance upon any other building in the complex or cause the cancellation of any insurance policy covering the Building, or any part thereof, nor shall Lessee sell, or permit to be kept, used or sold, in or about the Leased Premises, any article which may be prohibited by the standard form of all-risk fire insurance policies. Lessee shall, at its sole cost and expense, comply with any and all requirements pertaining to the Leased Premises, of any insurance organization or company, necessary for the maintenance of reasonable property damage and public, liability insurance, covering the Leased Premises, the Building or the Complex. 10.2 Lessor's Property Insurance. Subject to reimbursement by Lessee as provided herein, Lessor shall obtain "All Risk" property insurance (including inflation endorsement and sprinkler leakage endorsement excluding coverage of any of Lessee's personal property on or in the building) for full replacement value of the Building owned by Lessor exclusive of foundations and footings. Such insurance shall also include coverage for rental loss on an All Risk basis for a period of not less than six (6) months commencing from the date of the loss. Further, such insurance may, if required by Lessor's lender, or if commercially available, include earthquake and flood peril coverage. 10.3 Pro rata Share of Premiums. (a) Lessee shall pay to Lessor, during the Term, as additional rent, its pro rata share (as reasonably determined- by Lessor's insurance advisor) of the insurance premiums for the property insurance carried by Lessor covering the Complex (the "Complex Insurance Premium") Such pro rata share shall be computed by evaluating all the risk factors for each property covered by Lessor's insurance policy or policies, including without limitation, size of premises, type of construction, use, and fire safety provisions. Lessor's policy may be a blanket coverage policy including properties beyond those in the Complex. The sum due under this subsection shall be in addition to that which may be due under the previous section of this Lease. (b) Lessee shall pay any such premium portion to Lessor within ten (10) days after receipt by Lessee of Lessor's billing therefor. 10.4 Estimated Payments. Lessor shall have the right, at its option, to estimate Lessee's pro rata share of insurance premiums for property insurance to be due in the future from Lessee, and to collect from Lessee on a monthly or quarterly basis, as Lessor may elect, the amount of Lessee's prorate share of such cost. Lessor shall provide Lessee with a reconciliation of Lessee's account at least annually, and if such reconciliation shall indicate that Lessee's account is insufficient to satisfy Lessee's pro rata share of insurance premiums for the period estimated, Lessee shall immediately pay to Lessor any deficiency. Any excess in such account indicated by the reconciliation shall be credited to Lessee's account to reduce the estimated payments for the next ensuing period. 10.5 Personal Property Insurance. Lessee shall maintain in full force and effect on all of its fixtures and equipment in the Leased Premises a policy or policies Of fire and casualty insurance in "all risk" form to the extent of at least ninety percent (90%) of their replacement cost, or that percentage of the replacement cost required to negate the effect of a co-insurance provision, whichever is greater. No such policy shall have a deductible in a greater amount than FIVE HUNDRED DOLLARS ($500.00). Lessee shall also insure in the same manner the physical value of all its leasehold improvements in the Leased Premises. During the Term, the proceeds from any such policy or policies of insurance shall be used for the repair or replacement of the fixtures, equipment, and leasehold improvements so insured. Lessor shall have no interest in said insurance, and will sign all documents necessary or proper in connection with the settlement of any claim or loss by Lessee. Lessee shall also maintain insurance for all plate glass upon the Leased Premises. Lessee may self insure the plate glass. ARTICLE 11, LIABILITY INSURANCE 11.1 Lessee's Insurance. Lessee shall, at Lessee Is expense, obtain and keep in force during the Term, a comprehensive general liability insurance policy insuring Lessor and Lessee against the risks of personal injury and property damage arising out of the ownership, use, occupancy or maintenance of the Leased Premises and all areas appurtenant thereto. Such insurance shall be a combined single limit policy in an amount not less than ONE MILLION DOLLARS ($1,000,000.00) per occurrence and an umbrella policy of THREE MILLION DOLLARS ($3, 000,000. 00) combined single 1imit per occurrence. The policy shall contain cross liability endorsements and shall insure performance by Lessee of the indemnity provisions of this Lease. In addition, such policy shall cover contractual liability, and products liability. The limits of said insurance shall not, however, limit any liability of Lessee hereunder. Said insurance shall have a Lessor's protective liability endorsement attached thereto. Not more frequently than every three (3) years, if, in the reasonable opinion of Lessor, the amount of liability insurance required hereunder is not adequate, Lessee shall promptly increase said insurance coverage as required by Lessor. ARTICLE 12, INSURANCE POLICY REQUIRMENTS 12.1 General Requirements. All insurance policies required to be carried by Lessee hereunder shall conform to the following requirements: (a) The insurer in each case shall carry a designation in "Best's Insurance Reports"' as issued from time to time throughout the Term as follows: Policy holders, rating of A; financial rating of not less than X; (b) The insurer shall be qualified to do business in the state in which the Leased Premises are located; (c) The policy shall be in a form reasonably acceptable to Lessor; (d) Each policy (except Lessee ' s Personal Property Insurance) shall name Lessor as an additional insured and, at Lessor's request, shall carry a lender's loss payee endorsement in favor of Lessor's lender and such other endorsement(s) as Lessor may from time to time require; (e) An executed copy of each insurance policy or a certificate thereof, shall be delivered to Lessor at commencement of the Term and shall remain in effect throughout the Term, including copies of any renewals or certificates thereof, at least thirty (30) days prior to the expiration of such policies: (f) These policies shall require that Lessor be in writing by the insurer at least thirty (30) days prior to any cancellation or expiration of such policy, or any reduction in the amounts of insurance carried; (g) Each policy shall be primary, not contributing with, and not in excess of, coverage which Lessor may carry; (h) All liability insurance required to be carried by Lessee hereunder shall state that Lessor is entitled to recovery for the negligence of Lessee even though Lessor is named as an additional insured; shall provide for severability of interest; shall provide that an act or omission of one of the insureds or additional insureds which would void or otherwise reduce coverage shall not void or reduce coverages as to the other insured or additional insured; and shall afford coverage after the expiration of the Term (by separate policy or extension if necessary) for all claims based -on acts, -omissions, injury or damage which occurred or arose (or the onset of which occurred or arose) in whole or in part during the Term. ARTICLE 13. LESSEE INSURANCE DEFAULT 13.1 Rights of Lessor. In the event that Lessee fails to obtain any insurance required of it under the terms of this Lease, Lessor may, at its option, but is not obligated to, obtain such insurance on behalf of Lessee and bill Lessee, as additional rent, for the cost thereof. Payment shall be due within ten (10) days of receipt of the billing therefor by Lessee. ARTICLE 14. IMDEMIFICATION, WAIVER OF CLAIMS AND SUBROGATION 14.1 Waiver of Subrogation. Lessor and Lessee release each other, and their respective authorized representatives, from any claims for damage to any person or to the Leased Premises and the Building and other improvements in which the Leased Premises are located, and to the fixtures, personal property, Lessee's improvements and alterations of either Lessor or Lessee, in or on the Leased Premises and the Building and other improvements in which the Leased Premises are located, including loss of income, that are caused by or result from risks insured or required under the terms of this Lease to be insured against under any property insurance policies carried or to be carried by either of the parties. 14.2 Form of Policy Each party shall cause each such insurance policy obtained by it to provide that the insurance company waives all rights of recovery by way of subrogation against either party in connection with any damage covered by such policy. Neither party shall be liable to the other for any damage caused by fire or any other risks insured against under any property insurance policy carried under the terms of this Lease. If any such insurance policy cannot be obtained with a waiver of subrogation without payment of an additional premium charge above that charged by the insurance companies issuing such policies without waiver of subrogation, the party receiving the benefit shall elect to either forfeit the benefit or shall pay such additional premium to the insurance carrier requiring such additional premium. 14.3 Indemnity. (a) Lessee, as a material part of the consideration to be rendered to Lessor, shall indemnify, defend, protect and hold harmless Lessor against all actions, claims, demands, damages, liabilities, losses, penalties, or expenses of any kind which may be brought or imposed upon Lessor or which Lessor may pay or incur by reason of injury to person or property, from whatever cause, all or in any way connected with the condition or use of the Leased Premises, or the Improvements or personal property there in or thereon, including without limitation any liability or injury to the person or property of Lessee, its agents, officers, employees or invitees, but excluding any demands, damages, liabilities, losses, penalties or expenses of any kind arising out of, or in connection with, the sole negligence or willful act of the Lessor, its agents, officers, employees or invitees. Lessee agrees to indemnify, defend and protect Lessor and hold it harmless from any and all liability, loss, cost or obligation on account of, or arising out of, any such injury or loss however occurring, including breach of the provisions of this Lease and the negligence of the parties hereto. (b) Lessor as a material part of the consideration to be rendered to Lessee, shall indemnify, defend, protect and hold Lessee harmless against all actions, claims, demands, damages liabilities, losses, penalties, or expenses of any kind, including attorney's fees and costs related thereto, which may be brought or imposed upon Lessee or which Lessee may pay or incur by reason of injury to person or property caused by the negligence or willful act of Lessor, or Lessor's breach of the Restrictions, or, only to the extent of liability in excess of the policy limits of the insurance policies required to be carried by Lessee hereunder, Lessor's breach of this Lease. 14.4 Defense of Claims. In the event any action, suit or proceeding is brought against Lessor by reason of any such occurrence, Lessee, upon Lessor's request will at Lessee's expense resist and defend such action, suit or proceeding, or cause the same to be resisted and defended by counsel designated either by Lessee or by the insurer whose policy covers the occurrence and in either case approved by Lessor. The obligations of Lessee under this Section arising by reason of any occurrence taking place during the Lease term shall survive any termination of this Lease. 14.5 Waiver, of Claims. Lessee, as a material part of the consideration to be rendered to Lessor, hereby waives all claims against Lessor for damages to goods, wares, merchandise and loss of business in, upon or about the Leased Premises from any cause arising at any time, including breach of the provisions of this Lease and the negligence of the parties hereto. 14.6 References. Wherever in this Article the term Lessor or Lessee is used and such party is to receive the benefit of a provision contained in this Article, such term shall refer not only to that party but also to its officers, directors, employees, partners and agents. ARTICLE 15. DESTRUCTION 15.1 Rights of Termination. In the event the Leased Premises suffers (a) a Major Uninsured Casualty, or (b) a casualty which cannot be repaired within two hundred ten (10) days from the date of destruction under the laws and regulations of state-federal, county or municipal authorities, or other authorities with jurisdiction (hereinafter collectively a "Major Casualty"), Lessor may terminate this Lease as at the date of the damage upon written notice to Lessee following the casualty. However, if Lessor elects to terminate this Lease as a result of a Major Uninsured Casualty, within fifteen (15) days following the date Lessee receives notice of Lessor's election to terminate, Lessee may cause this Lease to continue in full force and effect by written notice to Lessor stating that Lessee will pay the full cost of the repair of such casualty provided that within ten (10) days following receipt of a written estimate of Lessor's building contractor retained for the purpose of reconstruction of the Major Uninsured Casualty, Lessee deposits with Lessor the full amount of such estimate subject to additional payments for other charges as are incurred in the course of Lessor's good faith reconstruction. In the event of a Major Casualty, Lessor shall deliver to Lessee at the time that it elects to terminate under the provisions hereof, or if Lessor does not elect to terminate, then within sixty (60) days of the date of the casualty, a statement of Lessor's best good faith judgment of the cost of the reconstruction, and the time estimated to elapse from the date of the casualty through completion of the reconstruction (the "Reconstruction Period"). If the Reconstruction Period is estimated to take longer than two hundred ten (210) days, then, Lessee may elect by written notice to the Lessor within thirty (30) days following the date of Lessee's receipt of the estimates described in the preceding sentence, to terminate this Lease. 15.2 Repairs. In the event of a casualty other than a Major Casualty, or, in the alternative, in the event either party elects to terminate this Lease under the terms of Section 15.1 above, then this Lease shall continue in full force and effect and Lessor shall forthwith undertake to make such repairs to reconstitute the Leased Premises to as near the condition as existed prior to the casualty as practicable. Such partial destruction shall in no way annul or void this -Lease except that Lessee shall be entitled to a proportionate reduction of Minimum Monthly Rent following the casualty and until the time th6 Leased Premises are restored. Such reduction shall be an amount, which reflects the degree of interference with Lessee's business. So long as Lessee conducts its business in the Leased Premises there shall be no abatement until the parties agree on the amount thereof. If the parties cannot agree within forty five (45) days of the casualty, the matter shall be submitted to Arbitration under the rules of the American Arbitration Association. Upon the resolution of the dispute, the settlement shall be retroactive and Lessor shall within ten (10) days thereafter refund to Lessee any sums due in respect of the reduced rental from the date of the casualty. Lessor's obligations to restore shall in no way include any construction originally performed by Lessee or subsequently undertaken by Lessee, but shall include solely that property constructed by Lessor prior to commencement of the Term. 15.3 Repair Costs. The cost of any repairs to be made by Lessor, pursuant to Section 15.2 of this Lease, shall be paid by Lessor utilizing available insurance proceeds. Lessee shall reimburse Lessor upon completion of the repairs for any deductible for which no insurance proceeds will be obtained under Lessor's insurance policy, or if other premises are also repaired, a pro rata share based on total costs of repair equitably apportioned to the Leased Premises. Lessee shall, however, not be responsible to pay any deductible or its share of any deductible to the extent that Lessee ' s payment would be in excess of $10, 000 if Lessee `s consent has not been received by Lessor, unless such denial of consent by Lessee s unreasonable. 15.4 Waiver. Lessee hereby waives all statutory or common law rights of termination in respect to any partial destruction or casualty which Lessor is obligated to repair or may elect to repair under the terms of this Article. 15.5 End of Term Casualty. (a) In the event of a casualty occurring during the last twelve (12) full calendar months of the original Term hereof or of any Extended Term the cost for repair of which exceeds $50,000 in Lessor's best good faith judgment, either Lessor or Lessee shall have the right to terminate this Lease by written notice to the other delivered, in Lessor's case within thirty (30) days of the date of the casualty and, in the Lessee's case within thirty (30) days of the date of receipt from Lessor of Lessor's best good faith estimate of the cost of repair. (b) In the event of a casualty occurring during the period commencing with the first day of the twenty-fourth (24th) month prior to the expiration of the then current Term, and expiring on the last day of the thirteenth (13th) month prior to the expiration of the then current Term, the cost for repair of which exceeds two hundred thousand dollars ($200,000) in Lessor's best good faith judgment, either party shall have the right to terminate this Lease provided it gives the other party one hundred twenty (120) days written notice thereof, which notice shall be delivered not later than thirty (30) days following the date that Lessor delivers to Lessee Lessor's best good faith estimate of the cost of repair. (c) Notwithstanding the foregoing, if within thirty (30) days of the date of the casualty described in this Section 15.5, Lessee has the right under the terms of this Lease to extend the Term, and does exercise its right to do so within thirty (30) days of the date of the casualty, the election by Lessor to terminate under the provisions of this Section 15.5 shall be void and the repair of the Leased Premises or termination of the Lease shall be subject to the other provision of this Article 15. ARTICLE 16, SECURITY DEPOST 16.1 Payment on Lease Execution. Lessee shall pay Lessor upon execution hereof the sum specified in Section 1.6.. This sum is designated as a Security Deposit and shall remain the sole and separate property of Lessor until actually repaid to Lessee (or at Lessor's option the last assignee, if any, of Lessee's interest hereunder), said sum not being earned by Lessee until all conditions precedent for its payment to Lessee have been fulfilled. As this sum both in equity and at law is Lessor's separate property, Lessor shall not be required to keep said deposit separate from his general accounts. If Lessee fails to pay rent or other charges when due hereunder, or otherwise defaults with respect to any provision of this Lease, including and not limited to Lessee's obligation to restore or clean the Leased Premises following vacation thereof, Lessee, at Lessor's election, shall be deemed not to have earned the right to repayment of the Security Deposit, or those portions thereof used or applied by Lessor for the payment of any rent or other charges in default, or for the payment of any other sum to which Lessor may become obligated by reason of Lessee's default, or to compensate Lessor for any loss or damage which Lessor may suffer thereby. Lessor may retain such portion of the Security Deposit, as it reasonably deems necessary to restore or clean the Leased Premises following vacation by Lessee. The Security Deposit is not to-be characterized as rent until and unless so applied in respect of a default by Lessee. Within sixty (60) days following the expiration of the Term, provided Lessee is not in default at expiration of the Term under this Lease, Lessor shall repay to Lessee that portion of the Security Deposit not applied as provided herein (the "Unused Deposit"), with interest on the Unused Deposit at 7% per annum for the entire period of the Term during which such Unused Deposit had not been applied by the Lessor. 16.2 Restoration of Deposit. If Lessor elects to use or apply all or any portion of the Security Deposit as provided in Section 16.1, Lessee shall within ten (10) days after written demand therefor pay to Lessor in cash, an amount equal to that portion of the Security Deposit used or applied by Lessor, and Lessee's failure to so do shall be a material breach of this Lease. The ten (10) day notice specified in the preceding sentence shall insofar as not prohibited by law, constitute full satisfaction notice of default provisions required by law or ordinance. 16.3 Early Earnback. If Lessee has not been in default under the provisions of this Lease at any time during the first thirty six (36) full months of the term hereof and, further, Lessee has maintained a net worth computed in accordance with generally accepted accounting principles of not less than four million ($4,000,000) dollars during such period, then, in such event, Lessee shall have earned the right to have Lessor repay to Lessee within ten (10) days following the date upon which Lessee provides Lessor with satisfactory evidence that it has met the conditions set forth in this Subsection 16.3, the full amount of the Security Deposit plus interest thereon at seven percent (7%) per annum, compounded, from commencement of the term through the* date of repayment. Lessee represents to Lessor that it has a- net worth at commencement of the term, calculated in accordance with generally accepted accounting principles, of not less than four million dollars (4,000,000). Lessee shall provide on request of Lessor, not more frequently than annually, during the Term, copies of its most recent financial statements certified to be true and correct by the Chief Financial officer of the company, to such officer's best knowledge and belief. If at any time the net worth of Lessee declines below four million dollars ($4,000,000), then it shall so notify Lessor, and within ten (10) days following request therefor from Lessor, Lessee shall reinstate the Security Deposit by cash payment to Lessor in the full amount thereof, subject to its right to once again earn back the Security Deposit as provided in this Section 16.3. ARTICLE 17, USE 17.1 Permitted Use. The Leased Premises may be used and occupied only for the purposes specified in Section 1.7 hereof, and for no other purpose or purposes. Lessee shall promptly comply with all laws, ordinances, orders and regulations affecting the Leased Premises, their cleanliness, safety, occupation and use. Lessor represents that the Lessee's use as specified in Section 1.7 is permissible by law in the Leased Premises at commencement of the Term. This representation pertains only to compliance as at the Commencement Date and does not apply to use or law violations or activities occurring thereafter. ARTICLE 18. COMPLIANCE WITH LAWS AND REGULATIONS 18.1 Lessee's Obligations. Lessee shall, at its sole cost and expense, comply with all of the requirements of all municipal, state and federal authorities now in force, or which may hereafter be in force, pertaining to the Leased Premises, and shall faithfully observe in the use of the Leased Premises all municipal ordinances and state and federal statutes now in force or which may hereafter be in force. The judgment of any court of competent jurisdiction, or the admission of Lessee in any action or proceeding against Lessee, whether Lessor be a party thereto or not, that any such ordinance or statute pertaining to the Leased Premises has been violated, shall be conclusive of that fact as between Lessor and Lessee. 18.2 Condition of Leased Premises. Lessee shall be deemed to have accepted the Leased Premises on the Commencement Date subject to all applicable zoning, municipal, county and state laws, ordinances, rules, regulations, orders, restrictions of record, and requirements in -effect during the Term or any part of the Term hereof regulating the Leased Premises, but, however, subject to Lessee's right to inspect the Premises for a period of thirty (30) days following commencement and to provide to Lessor within that period a list of all items improperly or inadequately completed, or which are defective (the "Punch List") Lessor shall diligently undertake to correct the Punch List items. 18.3 Hazardous Materials. (a) Hazardous Materials Defined. As used herein, the term "Hazardous Materials" shall mean (i) any hazardous or toxic wastes, materials or substances, and any other pollutants or contaminants, which are or may become regulated by any applicable local, state or federal laws, including but not limited to, 33 U.S.C. Section 1251 et seg.,42 U.S.C. 6901 et seg., 42 U.S.C. Section 7401 et seg., 42 U.S.C. 9601 et seg., and California Health and Safety Code Sections 25100 et seg., and 25300 et seg., California Water Code, Section 13020 et seg., or any successor(s) thereto (collectively "Environmental Laws"); (ii) petroleum: (iii) asbestos; (iv) polychlorinated biphenyls; and (v) radioactive materials. (b) Use. etc. of Hazardous Materials. Lessee agrees that during the Term of this Lease, there shall be no use, presence, disposal, storage, generation, (collectively "Hazardous Use"), or intentional Release, as defined in 42 U.S .C. Section 9601 (22), or any successor(s) thereto, or threatened Release of Hazardous Materials on, from or under the Leased Premises except to the extent that, and. in accordance with such conditions as, Lessor may have previously approved in writing. It is further agreed that Lessee shall be entitled to use and store only those Hazardous Materials which are necessary for Lessee's business, provided that such usage and storage is in full compliance with Environmental Laws, and all judicial and administrative decisions pertaining thereto. Lessee shall not be entitled to install any tanks under, on or about the Leased Premises for the storage of Hazardous Materials without the express written consent of Lessor, which may be given or withheld in Lessor's sole arbitrary judgment. (c) Hazardous Materials _Report. At any time during the Term, upon five (5) days prior written notice to Lessee, Lessor may arrange for the preparation, including the tests necessary therefor, of a written report by a professional consultant with respect to Hazardous Materials (the "Report"). Should the Report indicate the existence of Hazardous Materials in excess of the levels specified in that report described in Exhibit "J" attached hereto (the "Hazardous Materials Report") which indicates the level of Hazardous Materials, if any, in existence on the Leased Premises at date hereof and further, the presence of such Hazardous materials has been caused by the Hazardous Use by Lessee, then, in such case, the cost of the Report shall be borne by the Lessee and Lessee shall pay the full cost thereof within ten (10) days following the date it receives a written invoice therefor. If the Report does not so indicate, Lessor shall bear the cost of the Report. (d) Release of Hazardous materials: Notification and Clean-up. If at any time during the Term Lessee or Lessor knows or believes that any Release of any Hazardous Materials -has come or will come to be located upon, about, or beneath the Leased Premises, then Lessee or Lessor, as the case may be, shall, as soon as reasonably possible, either prior to the Release or following the discovery thereof, give verbal and. follow-up written notice of that condition to the other party. Lessee covenants to investigate, clean up and otherwise remediate any Release of Hazardous Materials caused by the acts or omissions of Lessee, or its agents, employees, representatives, invitees, licensees, subtenants, customers or contractors at Lessee's cost and expense; such investigation, clean-up and remediation shall be performed only after Lessee has obtained Lessor's written consent, which shall not be unreasonably withheld; provided, however, that Lessee shall be entitled to respond immediately to an emergency without obtaining Lessor's written consent. All clean-up and remediation shall be done to the reasonable satisfaction of Lessor. (e) Indemnity. Lessee shall indemnify, defend and hold Lessor harmless from and against any and all claims, judgments, damages, penalties, fines, liabilities, losses, suits, administrative proceedings and costs (including, but not limited to, attorneys and consultants fees) arising from or related to Hazardous Use or Release of Hazardous Materials on or about the Leased Premises caused by the acts or omissions of Lessee, its agents, employees, representatives, invitees, licensees, subtenants, customers or contractors. 18. 4 Indemnity . Lessee agrees to indemnify, defend, protect and hold harmless Lessor, its directors, officers, employees, partners, and agents' from and against any and all losses, claims, demands, actions, damages (whether direct or consequential) penalties, liabilities, costs and expenses, including all attorneys' fees and legal expenses, arising out of any violation or alleged Violation of any of the laws or regulations referred to in this Article 18, or breach of any of the provisions of this Article. This indemnification shall survive termination of this Lease. 18.5 Lessor's Indemnity. Lessor shall indemnify, defend and hold Lessee harmless from and against any and all claims, judgments, damages, penalties, fines, liabilities, losses, suits, administrative proceedings and costs. (including, but not limited. to, attorneys' and consultants' fees) arising from or related to Hazardous Use or release of Hazardous Materials on or about the Leased Premises caused by the acts or omissions of Lessor, its agents, employees, representatives, or arising out of any violation or alleged violation of any of the laws or regulations referred to in Article 18, or breach of any of -the provisions of this Article 18, by Lessor. This indemnification shall survive termination of this Lease. ARTICLE 12. UTILITIES 19.1 Payment by Lessee. Lessee, from the time it first enters the Leased Premises for the purpose of setting fixtures, or from the commencement of this Lease, whichever date shall first occur, and throughout the term of this Lease, shall pay all charges including connection fees for water, gas, heat, sewer, power, telephone services and any other utility supplied to or consumed in or on the Leased Premises. Lessee shall not allow refuse, garbage or trash to accumulate outside of the Leased Premises except on the day of scheduled scavenger pick-up services, and then only in areas designated for that purpose by Lessor. Lessor shall not be responsible or liable for any interruption in utility services, except when* caused by Lessor's sole negligence, nor shall such interruption affect the continuation or validity of this Lease. In the event of an interruption in utility service caused by the sole negligence of the Lessor, which interruption continues unabated for 72 consecutive hours following written notice to Lessor, during business days, thereafter, Lessee shall bill to the Lessor the amount of 1/30th of the Minimum Monthly Rent then in effect for each day of such interruption during which Lessee is unable to operate its business in the Leased Premises. ARTICLE 20. ALTERATIONS 20.1 Consent or Lessor; Ownership. Lessee shall not make, or suffer to be made, any alterations to the Leased Premises, or any part thereof, unless the cost of which will not exceed S25,000 in the aggregate and the alterations are nonstructural and interior in nature, without the written consent of Lessor first had and obtained. Notwithstanding anything to the contrary herein, Lessee may not demolish or remove any improvements paid for by Lessor without Lessor's prior consent. Any additions to, or alterations of, the Leased Premises, except trade fixtures, shall upon expiration or termination of this Lease become a part of the realty and belong to Lessor. Except as otherwise provided in this Lease, Lessee shall have the right to remove its trade fixtures placed upon the Leased Premises provided that Lessee restores the Leased Premises as indicated below. 20.2 Requirements Any alterations additions or installations performed by Lessee (hereinafter collectively "Alterations") shall be subject to strict conformity with the following requirements: (a) All alterations shall be at the sole cost and expense of Lessee; (b) Prior to Commencement of any work of alteration, Lessee shall submit detailed plans and specifications, including working drawings if available, (hereinafter referred to as "Plans") of the proposed alterations, which shall be subject to the consent of Lessor in accordance with the terms of Section 20.1 above; (c) Following approval of the Plans by Lessor, Lessee shall give Lessor at least tan (10) days prior written notice of commencement of work in the Leased Premises so that Lessor may post notices of non-responsibility in or upon the Leased Premises as provided by law; (d) No alterations shall be commenced without Lessee having previously obtained all appropriate permits and approvals required by and of governmental agencies copies of which shall be provided to Lessor prior to commencement of work; (e) All alterations shall be performed in a skillful and workmanlike manner, consistent with the best practices and standards of the construction industry, and pursued with diligence in accordance with the Plans previously approved by Lessor and in full accord with all applicable laws and ordinances. All material, equipment, and articles incorporated in the alterations is to be new, and of recent manufacture except for specialty design features with unique high quality characteristics, and of the most suitable grade for the purpose intended; (f) Lessee must obtain the prior written approval from Lessor for Lessee's contractor prior to commencement of the work. Lessee's contractor shall maintain all of the insurance reasonably required by Lessor, including comprehensive general liability, workers' compensation, builder's risk insurance and course of construction insurance; (g) As a condition of approval of the alterations, Lessor may require performance and labor and materialmen's payment bonds issued by a surety approved by Lessor, in a sum equal to the cost of the alterations guarantying the completion of the alterations free and clear of all liens and other charges in accordance with the Plans. Such bonds shall name Lessor as beneficiary; (h) The alterations must be performed in a manner such that they will not interfere with the quiet enjoyment of the other lessees in the Complex. 20.3 Liens. Lessee shall keep the Leased Premises and the Complex in which the Leased Premises are situated, free from any liens arising out of any work performed, materials furnished or obligations incurred by Lessee In the event a mechanic's or other lien is filed against the Leased Premises or the Complex of which the Leased Premises forms a part as a result of a claim arising through Lessee, Lessor may demand that Lessee furnish to Lessor a surety bond satisfactory to Lessor in an amount equal to at least one hundred fifty percent (150%) of the amount of the contested lien claim or demand, indemnifying Lessor against liability for the same and holding the Leased Premises free from the effect of such lien or claim. Such bond must be posted within twenty (20) days following notice from Lessor unless. Lessee otherwise expunges such liens from the record. In addition, Lessor may require Lessee to pay Lessor's attorney's fees and costs in participating in any action to foreclose such lien if Lessor shall decide it is to it; best interest to do so. Lessor may pay the claim prior to the enforcement thereof, in which event Lessee shall reimburse Lessor in full, including attorney's fees, for any such expense, as additional rent, with the next due rental. 20.4 Restoration. Lessee shall return the Leased Premises to Lessor at the expiration or earlier termination of this Lease in good and sanitary order, condition and repair, free of rubble and debris, broom clean, reasonable wear and tear excepted and subject to the provisions of Article 15. All damage to the Leased Premises caused by the removal of trade fixtures and other personal property that Lessee is permitted or required to remove under the terms of this Lease and/or such restoration shall be repaired by Lessee at its sole cost and expense prior to termination. 20.5 Removal. In no event shall Lessee be obligated to remove any improvements initially installed in the Leased Premises as of the Commencement Date. Notwithstanding any other provision hereof, any improvements or other alterations made subsequent to the Commencement Date that Lessor will require Lessee to remove upon the expiration of the Term shall be designated as items to be removed by Lessor at the time Lessor grants its consent for such alterations pursuant to Section 20.1 of the Lease. If Lessor does not so designate for removal, such alterations or improvements may be removed by Lessee at its discretion prior to the expiration of the term. ARTICLE 21. MAINTENANCE AND REPAIRS 21.1 Obligations of Lessee. Except as specifically set forth herein, Lessee shall, at its sole cost and expense, keep and maintain the Leased Premises and appurtenances, and every part thereof in good and sanitary order, condition and repair including all necessary replacements. Notwithstanding the foregoing, Lessor shall, at Lessee's expense, perform all necessary repairs, maintenance and replacement of the heating, ventilating and air conditioning system ("HVAC"), painting of exterior walls for maintenance of appearance, but not solely for design purposes (not less than once in each five year period of the term, including extensions) and maintenance of the Leased Premises outside of the Building such as the parking and landscaped areas, (the "Premises Maintenance costs") . Lessee shall, at its sole cost, keep and maintain all utilities, fixtures and mechanical equipment used by Lessee in good order, condition and repair. Lessor need not competitively bid the work described herein, provided the costs billed to Lessee do not exceed those which are normal and customary for the work performed. 21.2 Premises Maintenance Costs. Lessee shall pay to Lessor, as additional rent, all Premises Maintenance Costs plus a management fee in the amount of 10% thereof, within ten (10) days of receiving a billing therefor from Lessor, but no more frequently than monthly. Lessor may bill Lessor estimated charges in accordance with Section 21.3. it is the intent of the parties -that all maintenance and replacement expenditures with respect to the Leased Premises and the Building be borne by Lessee, whether performed by Lessee or Lessor, this Lease being intended to be absolutely net except for costs incurred as a result of the willful act or sole negligence of the Lessor, its agents, contractors or employees or other costs to be borne by the Lessor as expressly set forth in this Lease. 21.3 Estimated Payments. Lessor shall have the right, at its option, to estimate Lessee's Premises Maintenance Costs due in the future from Lessee and to collect from Lessee on a monthly or quarterly basis, as Lessor may elect, the amount of Lessee's estimated Premises Maintenance Costs. Lessor shall provide Lessee with a reconciliation of Lessee's account at least annually, and if such reconciliation shall indicate that Lessee's account is insufficient to satisfy the Premises Maintenance Costs for the period estimated, Lessee shall immediately pay to Lessor any deficiency. Any excess in such account indicated by the reconciliation shall be credited to Lessee's account to reduce the estimated payments for the next ensuing period. 21.4 Lessor Maintenance Obligation.. Except for the negligence of Lessee, Lessor, at Lessor's expense, shall be responsible for the maintenance, repair and replacement of the following: structural portions of the Building (including foundation slab, structure of the exterior walls, columns and roof structure), roof membrane and plumbing installed in the concrete slab. Lessee covenants that Lessee, its agents, contractors or representatives shall not at any time enter upon the roof except in the physical presence of the Lessor. A breach of this provision shall constitute a material breach of this Lease. 21.5 Waiver. Subject to the provisions of Section 30.1(b) Lessee waives all rights it may have under law to make repairs at Lessor's expense. ARTICLE 22. CONDEMNATION 22.1 Definitions. (a) "Condemnation" means (i) the exercise of any governmental power, whether by legal proceedings or otherwise, by a condemnor and/or (ii) a voluntary sale or transfer by Lessor to any condemnor, either under threat of condemnation or while legal proceedings for condemnation are pending. (b) "Date. of taking" means the date the condemnor has the right to possession of the property being condemned. (c) "Award" means all compensation, sums or anything of value awarded, paid or received on a total or partial condemnation. (d) "Condemnor" means any public or quasi-public authority, or private corporation or individual, having the power of condemnation. 22.2 Total Taking. If the Leased Premises are totally taken by condemnation, this Lease shall terminate on the date of taking. 22.3 Partial Taking; Common Area. (a) If any portion of the Leased Premises is taken by condemnation, this Lease shall remain in effect, except that Lessee can elect to terminate this Lease if so much of the Building is taken as to materially interfere with Lessee's use of the Leased Premises. (b) If any part of the area of the Leased Premises outside the Building are taken by condemnation, this Lease shall remain in full force and effect so long as there is no material interference with the access to the Leased Premises, except that if thirty percent (30%) or more of such Area is taken by condemnation, either party shall have the election to terminate this Lease pursuant to this Section. (c) If fifty percent (50%) or more of the Building is taken, Lessor shall have the election to terminate this Lease in the manner prescribed herein. 22.4 Termination or Abatement. If either party elects to terminate this Lease under the provisions of Section 22.3(such party is hereinafter referred to as the "Terminating Party") it must terminate by giving notice (the "Notice of Termination") to the other party (the "Non terminating Party") within thirty (30) days after the nature and extent of the taking have been finally determined (the "Decision Period"). The Terminating Party shall notify the Non terminating Party of the date of termination, which date shall not be earlier than sixty (60) days after the Terminating Party has notified the Non terminating Party of its election to terminate nor later than the date of taking. If Notice of Termination is not given within the Decision Period, the Lease shall continue in full force and effect except that Minimum Monthly Rent shall be reduced by subtracting therefrom an amount calculated by multiplying the Minimum Monthly Rent in effect prior to the taking by a fraction the numerator of which is the number of square feet taken from the Leased Premises and the denominator of which is the number of square feet in the Leased Premises prior to the taking. 22.5 Restoration. If there is a partial taking of the Leased Premises and this Lease remains in full force and effect pursuant to this Article, Lessor, at its cost, shall accomplish all necessary restoration so that the Leased Premises is returned as near as practical to its condition immediately prior to the date of the taking, but in no event shall Lessor be obligated to expend more for such restoration than the extent of funds actually paid to Lessor by the condemnor. 22.6 Award. Any award arising from the condemnation or the settlement thereof shall belong to and be paid to Lessor except that Lessee shall receive from the award compensation for the following if specified in the award by the condemning authority, so long as it does not reduce Lessor's award in respect of the real property: Lessee's trade fixtures, tangible personal property, goodwill, loss of business and relocation expenses. At all events, Lessor shall be solely entitled to all award in respect of the real property, including the bonus value of the leasehold. Lessee shall not be entitled to any award until Lessor has received the above sum in full. ARTICLE 23. INTERUPTION 23.1 Interruption If as a result of Lessor's uninsured negligence the Leased Premises suffers a casualty which results in Lessee being unable to operate its business upon the Leased Premises for one hundred -twenty (120) consecutive days, then, within thirty (30) days following the expiration of such one hundred twenty (120) consecutive day period, Lessee by written notice within such period to Lessor may terminate this Lease. ARTICLE 24, ENTRY BY LESSOR 24.1 Rights of Lessor Lessee shall permit Lessor and Lessors agents upon 24 hours prior telephonic notice (except in the case of emergencies or regularly scheduled contract maintenance) to enter the Leased Premises at all reasonable times for the purpose of inspecting the same or for the purpose of maintaining the Building, or for the purpose of making repairs, alterations or additions to any portion of the Building, including the erection and maintenance of such scaffolding, canopies, fences and props as may be required, or for the purpose of posting notices of non-responsibility for alterations, additions or repairs', or for the purpose of placing upon the Building any usual or ordinary "for sale" signs. if such entry upon the Premises by the Lessor will cause a material interruption in the business operations of the Lessee, Lessee must so inform the Lessor when Lessor makes its request. In such case Lessor shall agree to delay its entry for up to five (5) days to avoid such interruption. During any entry exercised by Lessor hereunder, Lessor shall diligently attempt to minimize any interruption or interference with Lessee's use of the Leased Premises and its business operations. In the event a material interruption in Lessee's business operations occurs as a result of Lessor's negligence, Lessee shall bill to the Lessor the amount of 1/30th of the Minimum Monthly Rent then in effect for each day of such interruption following written notice to Lessor during which Lessee is unable to operate its business in the Leased Premises. Lessee shall permit Lessor, at any time within one hundred eighty (180) days prior to the expiration of this Lease, to place upon the Leased Premises any usual or ordinary "to let" or "to lease" signs. This Section in no way affects the maintenance obligations of the parties hereto. ARTICLE 25. SIGNS 25.1 Approval. Installation and Maintenance. Lessee shall not place on the Leased Premises or on the Complex, any exterior signs or advertisements nor any interior signs or advertisements that are visible from the exterior of the Leased Premises, without Lessor's prior written consent, which Lessor reserves the right to withhold for any aesthetic reason in its sole judgment. However, Lessor may not exercise its rights hereunder in such a manner as to discriminate against Lessee as compared to other occupants of the Complex. The cost of installation and regular maintenance of any such signs approved by Lessor shall be at the sole expense of Lessee. At the termination of this Lease or any extension thereof, Lessee shall remove all his signs, and all. damage caused by such removal shall be repaired at Lessee's expense. Upon approval of Lessee's sign by Lessor, an exhibit thereof shall be attached hereto as Exhibit "F." ARTICLE 26. DEFAULT 26.1 Definition. The occurrence of any of the following shall constitute a material default and breach of this Lease by (a) Any failure by Lessee to pay the rental or to make any other payment required to be made by Lessee hereunder within five (5) days following written notice from Lessor that such is due (any such notice shall be concurrent with any required statutory default notice); (b) A failure by Lessee to observe and perform any other provision of this Lease to be observed or performed by Lessee, where such failure continues for fifteen (15) days after written notice thereof by Lessor to Lessee; provided, however, that if the nature of the default is such that the same cannot reasonably be cured within the fifteen (15) day period allowed, Lessee shall not be deemed to be in default if Lessee shall, within such ten (10) day period, commence to cure and thereafter diligently prosecute the same to completion; (c) Either (1) the appointment of a receiver (except a receiver appointed at the instance or request of Lessor) to take possession of all or substantially all of the assets of Lessee, or (2) a general assignment by Lessee for the benefit of creditors, or (3) any action taken or suffered by Lessee under any insolvency or bankruptcy act shall constitute a breach of this Lease by Lessee. In such event, Lessor may, at its option, declare this Lease terminated and forfeited by Lessee, and Lessor shall be entitled to immediate possession of 'the Leased Premises. Upon such notice of termination, this Lease shall terminate immediately and automatically by its own limitation. ARTICLE 27. REMEDIES UPON DEFAULT 27.1 Termination and Damage. In the event of any default by Lessee, then, in addition to any other remedies available to Lessor herein or at law or in equity, Lessor shall have the immediate option to terminate this Lease and all rights of Lessee hereunder by giving written notice of such intention to terminate. In the event that Lessor shall elect to so terminate this Lease, then Lessor may recover from Lessee: (a) The worth at the time " of award of any unpaid rent which had been earned at the time of such termination; plus (b) 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 Lessee proves could have been reasonably avoided; plus (c) 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 Lessee proves could be reasonably avoided; plus (d) Any other amount necessary to compensate Lessor for all the detriment proximately caused by Lessee's failure to perform its obligations under this Lease or which in the ordinary course of events would be likely to result therefrom; and (e) At Lessor's election, such other amounts in addition to or in lieu of the foregoing as may be permitted from time to time by the applicable law in the state in which the Leased Premises are located. 27.2 Definitions. (a) The term "rent", as used in this Lease, shall be deemed to be and to mean the Minimum Monthly Rent and all other sums required to be paid by Lessee pursuant to the terms of this Lease. (b) As used in Sections 27.1(a) and (b) above, the ..worth at the time of award" is computed by allowing interest at the rate of ten percent (10%) per annum. As used in Section 27.1(c) above, the "worth at the time of award" is computed by discounting such amount at the discount rate of the Federal Reserve Bank for the region in which the Complex is located at the time of award plus one percent (1%). 27.3 Personal Property. In the event of any default by Lessee, Lessor shall also have the right, with or without terminating this Lease, to reenter the Leased Premises and remove all persons and property from the Leased Premises; such property may be removed and stored in a public warehouse or elsewhere at the cost of and for the account of Lessee. 27.4 Recovery of Rent; Reletting. (a) In the event of the vacation or abandonment of the Leased Premises by Lasses or in the event that Lessor shall elect to reenter as provided in Section 27.3 above, or shall take possession of the Leased Premises pursuant to legal proceeding or pursuant to any notice provided by law, then if Lessor does not elect to terminate this Lease as provided in Section 27.1 above, Lessor may from time to time, without terminating this Lease, either recover all rental as it becomes. due or relet the Leased Premises or any part thereof for such term or terms and. at such rental or rentals and upon such other terms and conditions as Lessor in its sole discretion, may deem advisable with the right to make alterations and repairs to the Leased Premises. (b) In the event that Lessor shall elect to so relet, then rentals received by Lessor from such reletting shall be applied: first, to the payment of any indebtedness other than rent due hereunder from Lessee to Lessor; second, to the payment of any cost of such reletting; third, to the payment of the cost of any alterations and repairs to the Leased Premises; fourth, to the payment of rent due and unpaid hereunder; and the residue, if any, shall be held by Lessor and applied in payment of future rent as the same may become due and payable hereunder. Should that portion of such rentals received from such reletting during any month, which is applied by the payment of rent hereunder, be less than the rent payable during that month by Lessee hereunder, then Lessee shall pay such deficiency to Lessor immediately upon demand therefor by Lessor. Such deficiency shall be calculated and paid monthly. Lessee shall also pay to Lessor as soon as ascertained, any costs and expenses incurred by Lessor in such reletting or in making such alterations and repairs not covered by the rentals received from such reletting. (c) No reentry -or taking possession of the Leased Premises or any other action under this Section shall be construed as an election to terminate this Lease unless a written notice of such intention, be given to Lessee or unless the termination thereof be decreed by a court of competent jurisdiction. Notwithstanding any reletting without termination by Lessor because of any default by Lessee, Lessor may at any time after such reletting elect to terminate this Lease.-for any such default. 27.5 No Waiver. Efforts by Lessor to mitigate the damages caused by Lessee's default in this Lease shall not constitute a waiver of Lessor's right to recover damages hereunder, nor shall Lessor have any obligation to mitigate damages hereunder. 27.6 Curing Defaults. Should Lessee fail to repair, maintain, and/or service the Leased Premises, or any part or contents thereof at any time or times, or perform any other obligations imposed by this Lease or otherwise, then after having given Lessee reasonable notice of the failure or failures and a reasonable opportunity, which in no case shall exceed fifteen (15) days subject to the proviso of Section 26.1(b), to remedy the failure, Lessor may perform or contract for the performance of the repair, maintenance, or other Lessee obligation, and Lessee shall pay Lessor for all direct and indirect costs incurred in connection therewith within ten (10) days of receiving a bill therefor from Lessor. 27.7 Cumulative Remedies. The various rights, options, election powers, and remedies of Lessor contained in this Article and elsewhere in this Lease shall be construed as cumulative and no one of them exclusive of any others or of any legal or equitable remedy which Lessor might otherwise have in the event of breach or default, and the exercise of one right or remedy by Lessor shall not in any way impair its right to any other right or remedy. ARTICLE 28. FORFITURE OF PROPERTY AND LESSOR'S LIEN 28.1 Removal of Personal Property. Lessee agrees that as at the date of termination of this Lease or repossession of the Leased Premises by Lessor, by way of default or otherwise, it shall remove all personal property to which it has the right to ownership pursuant to the terms of this Lease. -Any and all such property of Lessee not removed by such date shall, at the option of Lessor, irrevocably become the sole property of Lessor. Lessee waives all rights to notice and all common law and statutory claims and causes of action which it may have against Lessor subsequent to such date as regards the storage, destruction, damage, loss of use and ownership of the personal property affected by the terms of this Article. Lessee acknowledges Lessor's need to relet the Leased Premises upon termination of this Lease or repossession of the Leased Premises and understands that the forfeitures and waivers provided herein are necessary to aid said reletting, and to prevent Lessor incurring a loss for inability to deliver the Leased Premises to a prospective lessee. ARTICLE 29. SURRENDER OF LEASE 29.1 No Merger. The voluntary or other surrender of this Lease by Lessee, or a mutual cancellation thereof, shall not work as a merger, and shall, at the option of Lessor, terminate all or any existing subleases or subtenancies, or may, at the option of Lessor, operate as an assignment to it of any or all such subleases or subtenancies. ARTICLE 30. LESSOR'S EXCULPATION AND DEFAULT 30.1 Default by Lessor. (a) Lessor shall not be in default unless Lessor fails to perform obligations required of Lessor within a reasonable time, but in no event later than fifteen (15) days after written notice of Lessee to Lessor specifying wherein Lessor has failed to perform such obligations; provided, however, that if the nature of Lessor's obligation is such that more than fifteen (15) days are reasonably required for performance, then Lessor shall not be in default if Lessor commences performance within such fifteen (15) day period and thereafter diligently prosecutes the same to completion. (b) Lessee's Right to Perform Lessor's Covenants. If Lessor fails to make any payment or perform any other act-on its part to be performed under this Lease, provided that Lessee has delivered to Lessor written notice of such default and Lessor has failed to cure such default within the time period required under this article, Lessee may, but shall not be obligated to and without waiving or releasing Lessor from any obligation of Lessor under this Lease, make such payment or perform such other act to the extent Lessee may deem desirable, and in connection therewith, pay expenses and employ counsel. All sums so paid by Lessee and all penalties, interest and other costs in connection therewith shall be due and payable by Lessor within five (5) days after receipt of notice of payment by Lessee, together with interest thereon at the maximum rate permitted by law, plus collection costs and attorneys' fees. 30.2 Limited Liability. In the event of default, breach, or violation by Lessor (which term includes Lessor's partners, co-ventures, co-tenants, officers, directors, employees, agents, or representatives) of any Lessor's obligations under this Lease, Lessor's liability to Lessee shall be limited to its ownership interest in the Leased Premises (or its interest in the Complex, if applicable) or the proceeds of a public sale of such interest pursuant to foreclosure of a judgment against Lessor. Lessor may, at its option, and among its other alternatives, relieve itself of all liability under this Lease by conveying the Leased Premises to Lessee. Notwithstanding any such -conveyance, Lessee's leasehold and ownership interest shall not merge. 30.3 No Recourse. Lessor (as defined in Section 30.1) shall not be personally liable for any deficiency beyond its interest in the Leased Premises. 30.4 Valid . The provisions of Section 30.2 and 30.3 shall be valid so long as the Leased Premises are not encumbered by Deeds of Trust the outstanding balance of which at the time such were recorded, in the aggregate, did not exceed eighty' percent (80%) of the fair market value of the Leased Premises. The valuation of an institutional lender secured by the Leased Premises shall be conclusive as to the test described in this Section 30.4. ARTICLE 31. ATTORNEY'S FEES 31.1 Actions. Proceedings, etc. Lessee hereby agrees to pay, as additional rent, all attorney's fees and disbursements, and all other court costs or expenses of legal proceedings or other 'legal services which Lessor may incur or pay out by reason of, or in connection with: (a) any action or proceeding brought by Lessor wherein Lessor obtains a final judgment. or award against Lessee (including Arbitration) on account of any default by Lessee in the observance or performance of any obligation under this Lease including, but not limited to, matters involving payment of rent and additional rent, alterations or other Lessee's work and subletting or assignment; (b) any action or proceeding brought by Lessee against Lessor (or any officer, partner, or employee of Lessor) in which Lessee fails to secure a final judgment against Lessor; (c) any other appearance by Lessor (or any officer, partner, or employee of Lessor) as a witness or otherwise in any action or proceeding whatsoever involving or affecting Lessee or this Lease; (d) provisions (a), (b) and (c) above in this Section 31.1 shall be reciprocal for the benefit of the Lessee when the Lessor has been the causative and unsuccessful party. 31.2 Survival. The obligations of the Parties under this Section shall survive the expiration or any other termination of this Lease. This Section is intended to supplement (and not to limit) other provisions of this Lease pertaining to indemnities and/or attorney's fees. 31.3 Counsel Fees. Should it be necessary for either party to employ legal counsel to enforce any of the provisions of this Lease, the unsuccessful party agrees to pay, as additional rent, all attorney's fees and Court costs reasonably incurred thereby, whether or not Lessor commences any legal action or proceeding. The "unsuccessful party" is the party against who the relief sought is obtained. ARTICLE 33. NOTICES 32.1 Writing. All notices, demands and requests required or permitted to be given or made under any provision of this Lease, shall be in writing and shall be given or made by personal service or by mailing same by registered or certified mail, return receipt requested, postage prepaid, or by reputable courier which provides written evidence of delivery, addressed to the respective party at the address set forth in Section 1.2 Of this Lease or at such other address as the party may from time to time designate, by a written notice, sent to the other in the manner aforesaid. 32.2 Effective Data. Any such notice, demand or request ("notice") shall be deemed given or made on the fifth day after the date so mailed. Notwithstanding the foregoing, notice given by personal delivery to the party at its address as aforesaid, shall be deemed given on the day on which delivery is made. Notice given by a reputable courier service which provides written, evidence of delivery shall be deemed given on the business day immediately following deposit with the courier service. 32.3 Authorization to Receive. Each person and/or entity whose signature is affixed to this Lease as Lessee or as guarantor of Lessee's obligations ("obligor") designates such other obligor their agent for the purpose of receiving any notice pertaining to this Lease or service of process in the event of any litigation or dispute arising from any obligation imposed by this Lease. ARTICLE 33. SUBORDIRATION 33.1 Priority of Encumbrances. This Lease, at Lessor's option, shall be subordinate to any ground lease, mortgage, deed of trust, or any other hypothecation for security now or hereafter placed upon the real property of which the Leased Premises are a part and to any and all advances made on the security thereof and to all renewals, modifications, consolidations, replacements and extensions thereof. Notwithstanding such subordination, Lessee's right to quiet possession of the Leased Premises shall not be disturbed if Lessee is not in default and so long as Lessee shall pay the rent and observe and perform all the provisions of this Lease, unless this Lease is otherwise terminated pursuant to its terms. If any mortgagee, trustee or ground lessor shall elect to have this Lease prior to the lien of its mortgage, deed of trust or ground lease, and shall give written notice thereof to Lessee, this Lease shall be deemed prior to such mortgage, deed of trust or ground lease, whether this Lease is dated prior or subsequent to the date of said mortgage, deed of trust or ground lease or the date of recording thereof. 33.2 Execution of Documents. Provided Lessee receives a written nondisturbance, recognition and attornment agreement in form reasonably satisfactory to Lessee from the Lender for whose benefit Lessee agrees to execute any documents required to effectuate such subordination as is described in Section 33.1, or to make this Lease prior to the lien of any mortgage, deed of trust or ground lease, as the case may be. It is understood by all parties, that Lessee's failure to execute the subordination documents referred to above may cause Lessor serious financial damage by causing the failure of a financing or sale transaction. 33.3 Attornment. Lessee shall attorn to any purchaser at any foreclosure sale, or to any grantee or transferee designated in any Deed given in lieu of foreclosure. ARTICLE 34. ESTOPPEL CERTIFICATE 34.1 Execution by Lessee. Within ten (10) days of request therefor by Lessor, Lessee shall execute a Written statement acknowledging the commencement and termination dates of this Lease that it is in full force and effect, has not been modified (or if it has, stating such modifications), and providing any other pertinent information as Lessor or its agent might reasonably request. Failure to comply with this Article shall be a material breach of this Lease by Lessee giving Lessor all rights and remedies under Article 27 hereof, as well as a right to damages caused by the loss of a loan or sale which may result from such failure by Lessee. 34.2 Financing. if Lessor desires to finance or refinance the Leased Premises, or any part thereof, or the Building, Lessee hereby agrees to deliver to any lender designated by Lessor such financial statements of Lessee as may be reasonably required by such lender. Such statements shall include the past two (2) years, financial statements of Lessee. All such financial statements shall be received by Lessor prior to the default date specified in Section 26.1(a) in confidence and shall be used only for the purposes herein set forth. ARTICLE 35. WAIVER 35.1 Effect of Waiver. The waiver by Lessor of any breach of any Lease provision shall not be deemed to be a waiver of such Lease provision or any subsequent breach of the same or any other term, covenant or condition therein contained. The subsequent acceptance of rent hereunder by Lessor shall not be deemed to be a waiver of any preceding breach by Lessee of any provision of this Lease, other than the failure of Lessee to pay the particular rental so accepted, regardless of Lessor's knowledge of such preceding breach at the time of acceptance of such rent. ARTICLE 36. HOLDING OVER 36.1 Month-to-Month Tenancy on Acceptance. If Lessee should remain in possession of the Leased Premises after the expiration of the. Term and without executing a new Lease, then, upon acceptance of rent by Lessor, such holding over shall be construed as a tenancy from month to month, subject to all the conditions, provisions and obligations of this Lease as existed during the last month of the term hereof, so far as applicable to a month to month tenancy, except that the Minimum Monthly Rent shall be equal to 1251 of the Minimum Monthly Rent payable immediately prior to the expiration or sooner termination of the Lease. ARTICLE 37. SUCCESSORS AND ASSIGNS 37.1 Binding Effect. The covenants and conditions herein contained shall, subject to the provisions as to assignment, apply to and bind the heirs, successors, executors, administrators and assigns of all of the parties hereto; and all of the parties hereto shall be jointly and severally liable hereunder. ARTICLE 38. TIME 38.1 Time is of the Essence Time is of the essence this Lease with respect to each and every article, section and subsection hereof. ARTICLE 39, EFFECT OF LESSOR'S CONVEYANCE 39.1 Release of Lessor. If, during the term of this Lease, Lessor shall sell its interest in the Building or Complex of which the Leased Premises forms a part, or the Leased Premises, then from and after the effective date of the sale or conveyance, Lessor shall be released and discharged from any and all obligations and' responsibilities under this Lease, except those already accrued. ARTICLE 40, TRANSFER OF SECURITY 40.1 Transfer to Purchaser. If any security be given by Lessee to secure the faithful performance of all or any of the covenants of this Lease on the part of Lessee, Lessor may transfer and/or deliver the security, as such, to the purchaser of the reversion, in the event that the reversion be sold, and thereupon Lessor shall be discharged from any further liability in reference thereto. ARTICLE 41, CORPORATE AUTHORITY 41.1 Authorization to Execute. (a) Each individual executing this Lease on behalf of Lessee corporation, . represents and warrants that he is duly authorized to execute and deliver this Lease an behalf of said corporation in accordance with a duly adopted resolution of the Board of Directors of said corporation or in accordance with the Bylaws of said corporation, and that this Lease is binding upon said corporation in accordance with its terms. Further, Lessee shall, within thirty (30) days after execution of this Lease, deliver to Lessor a certified copy of a resolution of the Board of Directors of said corporation authorizing or ratifying the execution of this Lease. (b) The parties executing this Lease on behalf of the Lessor corporation represent and warrant that they are authorized to do so under the terms of a valid resolution. ARTICLE 42, WAIVER OF CALIFORNIA CODE SECTIONS 42.1 Waiver by Lessee. Lessee waives (for itself and all persons claiming under Lessee) the provisions of civil Code Sections 1932(2) and 1933(4) with respect to the destruction of the Leased Premises, Civil Code Sections 1941 and 1942 with respect to Lessor's repair duties and Lessee's right to repair, Code of Civil Procedure Section 1265.130, allowing either party to petition the Superior Court to terminate this Lease in the event of a partial taking of the Leased Premises by condemnation as herein defined, and any right of redemption or reinstatement of Lessee under any present or future case law or statutory provision (including Code of Civil Procedure Sections 473 and 1179 and Civil Code Section 3275) in the event Lessee is dispossessed from the Leased Premises for any reason. This waiver applies to future statutes enacted in addition to or in substitution for the statutes specified herein. ARTICLE 43, WASTE 43.1 Waste or Nuisance. Lessee shall not commit, or suffer to be committed, any waste upon the Leased Premises, or any nuisance, or other act or thing which may disturb the quiet, enjoyment of any other tenant or occupant of the Complex in which the Leased Premises are located. in the instrument of transfer and (iii) such instrument of transfer contains such other assurances as Lessor reasonably deems necessary. ARTICLE 44. BANRUPTCY 44. 1 Bankruptcy Events. If at any time during the Term shall be filed by or against Lessee in any court pursuant to any statute either of the United States or of any State a petition in bankruptcy or insolvency or for reorganization or for the appointment of a receiver or trustee of all or a portion of Lessee's property, or if a receiver or trustee takes possession of any of the assets of Lessee, or if the leasehold interest herein passes to a receiver, or if Lessee makes an assignment for the benefit of creditors or petitions for or enters into an arrangement (any of which are referred to herein as "a bankruptcy event") , then the following provisions shall apply: (a) At all events any receiver or trustee in bankruptcy or Lessee as debtor in possession ("debtor"), shall either expressly assume or reject this Lease within sixty (60) days following the entry of an "Order for Relief". (b) In the event of an assumption of the Lease by a debtor, receiver, or trustee, such debtor, receiver, or trustee shall immediately after such assumption (1) cure any default or provide adequate assurances that defaults will be promptly cured; and (2) compensate Lessor f or actual pecuniary loss or provide adequate assurances that compensation will be made for actual pecuniary loss; and (3) provide adequate assurance of future performance. For the purposes of this paragraph 44.1 (b), adequate assurance of future performance of all obligations under this Lease shall include, but is not limited to: (i) written assurance that rent and any other consideration due under the Lease shall first be paid before any other of Lessee's costs of operation of its business in the Leased Premises are paid; (ii) written agreement that assumption of this Lease will not cause a breach of any provision hereof including, but not limited to, any provision relating to use or exclusivity in this or any other Lease, or agreement relating to the Leased Premises, or if such a breach is caused, the debtor, receiver or trustee will indemnify Lessor against such loss (including costs of suit and attorney's fees), occasioned by such breach; (c) Where a default exists under the Lease, the party assuming the Lease may not require Lessor to provide services or supplies .11-.ncidental to the Lease before its assumption by such trustee or debtor, unless Lessor is compensated under the terms of the Lease for such services and supplies provided before the assumption of such Lease. (d) The debtor, receiver, or trustee may only assign this Lease if adequate assurance of future performance by the assignee is provided, whether or not there has been a default under the Lease. Any consideration paid by any assignee in excess of the rental reserved in the Lease shall be the sole property of, and paid to, Lessor. Upon assignment by the debtor or trustee the obligations of the Lease shall be deemed to have been assumed and the assumptor shall execute an assignment agreement on request of Lessor. (e) Lessor shall be entitled to the fair market value for the Leased, Premises and the services provided by Lessor (but in no event less than the rental reserved in the Lease) subsequent to commencement of a bankruptcy event. (f) Lessor specifically reserves any and all remedies available to Lessor in Article 27 hereof or at law or in equity in respect of a bankruptcy event by Lessee to the extent such remedies are permitted by law. ARTICLE 45. LATE CHARGE 45.1 Late Payment by Lessee. Lessee acknowledges that late payment by Lessee to Lessor of rent or any other payment due hereunder will cause Lessor to incur costs not contemplated by this Lease, the exact amount of such costs being extremely difficult and impractical to fix. Such costs include, without limitation, processing and accounting charges, and late charges that may be imposed on Lessor by the terms of any encumbrance and note secured by any encumbrance covering the Leased Premises. Therefore, if any installment of rent, or any other payment due hereunder from Lessee is not received by Lessor within ten (10) days following* written notice from Lessor, Lessee shall pay to. Lessor an additional sum of five per cent (5%) of such rent or other charge as a late charge" The parties agree that this late charge represents a fair and reasonable estimate of the cost that Lessor will incur by reason of late payment by Lessee. Acceptance of any late charge shall not constitute a waiver of Lessee default with respect to the overdue amount, or prevent Lessor from exercising any other rights or remedies available to Lessor. ARTICLE 46, MORTGAGEE PROTECTION 46.1 Notice And Right to cure Default. Lessee agrees to give any mortgagee(s) and/or trust deed holders, by registered mail, a copy of any notice of default served upon Lessor, provided that prior to such notice Lessee has been notified, in writing (by way of Notice of Assignment of Rents and Leases, or otherwise), of the address of such mortgagees and/ or trust deed holders. Lessee further agrees that if Lessor shall have failed to cure such default within the time provided for in this Lease, then the mortgagees and/or trust deed holders shall have an additional thirty (30) days within which to cure such default or if such default cannot be cured within that time, then such additional time as may be necessary if within such thirty (30) days, any mortgagee and/or trust deed holder has commenced and is diligently pursuing the remedies necessary to cure such default (including but not limited to commencement of foreclosure proceedings, if necessary to effect such cure) , in which event this Lease shall not be terminated while such remedies are being so diligently pursued; provided, however, that notwithstanding the time extension provided herein, Lessee may undertake the cure of a Lessor default after the expiration of the period permitted Lessor under the provisions of this Lease. ARTICLE 47, EXISTING LEASE 47.1 Procedure. At commencement of the term, vacation of the Existing Lease premises by the Lessee, and occupancy of the Leased Premises by Lessee, Lessor agrees to reimburse Lessee or, to pay on behalf of Lessee, as Lessee shall elect, the Minimum Monthly Rent obligation of its existing lease at 30740 Santana Street, Hayward, California, (the "Existing Lease") , by execution of Agreement in form and substance as attached hereto as Exhibit "G", by both parties. 47.2 Financial Obligation. In no event shall Lessor's obligation under the Existing Lease for payment of its obligation under this Article 47, and Exhibit G exceed two hundred fifty three thousand dollars ($253,000). ARTICLE 48. OPTION TO PURCHASE 48.1 Grant Lessee shall I have the option to purchase the Leased Premises ("option") on the terms and conditions set forth in this Article 48 and in Exhibit I. 48.2 Exercise Periods. The Option shall be exercisable only within the following time periods (the "Exercise Periods") : (a) Within sixty (60) days following the Commencement Date; or (b) During the sixty first (61st) Lease Month of the Term; or (c) During the one hundred-twenty first (121st) Lease Months of the Term, provided, however, Lessee has timely exercised its first option to extend the Term. 48.3 Method of Exercise. The exercise of this Option shall be by written notice delivered to Lessor prior to the expiration of each Exercise Period, but not before commencement of the applicable Exercise Period, accompanied by a fully executed copy of the Purchase Agreement attached hereto as Exhibit I, with all blanks filled in, but otherwise unaltered (the "Purchase Agreement"). 48.4 Effect of Exercise. Upon Lessee's exercise of this Option, this Purchase Agreement shall constitute a contract for the purchase of the Leased Premises. 48.5 Purchase Price. The purchase price must be established prior to the exercise of the Option. The purchase price shall be the higher of the following: (a) One hundred ten percent (110%) multiplied by the sum of the following: (i)Total Project Costs which formed the basis for the calculation of minimum monthly rent under the provisions of Section 6.2 hereof; and (ii) "Negative Cash Flow" as hereinafter defined; and (iii)five dollars thirty cents ($5.30) per square foot times the number of square feet of land area in the Leased Premises (the "Land Value") or (b) The fair market value of the Leased Premises determined in accordance with the provisions of Section 48.6. The term "Negative Cash Flow" means an annual sum computed as at each anniversary of the term of this Lease, provided such sum is negative, by subtracting the following from all sums received by the Lessor from the Lessee during the annual period which is the subject of the calculation: (i)all costs of operation, maintenance, insurance, tax, administration, management, supervision, and reconstruction, related to the Leased Premises other than (1) those costs included in Construction Costs as defined in Exhibit "C" hereto upon which the initial calculation of minimum monthly rent was based; (2) those costs which have been paid or reimbursed to Lessor by Lessee pursuant to this Lease; and (ii)all interests costs for any note secured by a deed of trust encumbering the Leased Premises which were not included in Total Project Costs, provided the principal amount of such note does not exceed an amount equivalent to the Total Project costs plus the Land Value. It is the intent of the parties that the purchase price not be less than one hundred tan percent (110%) of all sums of any type or nature expended by the Lessor in respect of the Leased Premises f or which Lessor has not received reimbursement. 48.6 Fair Market Value. The Fair Market Value of the Leased Premises shall be determined as follows: (a) Not less than one hundred twenty (120) days prior to Lessee I s planned exercise of-this Option. Lessee* shall notify Lessor of its opinion of the fair market value of the Leased Premises as that term is hereinafter defined. If the parties are unable t ' q agree upon a fair market value within thirty (30) days thereafter (the "Negotiation Period") , then within ten (10) days after the expiration of the -Negotiation Period, either party at its own cost and expense and by giving notice to the other in writing, may appoint a real estate appraiser who is a member of the American Appraisal Institute, or the Society or Real Estate Appraisers, or an equivalent professional organization, with at lease five (5) years experience appraising office properties in Alameda County California ("Qualified Appraiser") , to set the fair market value in writing. If a party does not appoint a Qualified Appraiser within ten (10) days after the first party has given notice of the name of its Qualified Appraiser, the single Qualified Appraiser shall be the sole appraiser and shall set the fair market value for purposes of establishing a purchase price. If two Qualified Appraisers are appointed by the parties, they shall meet promptly, on five (5) days notice to the parties, to take such evidence and other information as the parties may deem reasonable to submit to the Qualified Appraisers. Within thirty (30) days after the selection of the last of the two Qualified Appraisers to be appointed by the parties, the Qualified Appraisers shall render their opinions of the fair market value in writing. If the two valuations are within ten (10%) percent of each other, they shall be averaged and the average of the two shall be the fair market value. If only one appraisal is timely submitted, that appraisal shall constitute the fair market value. If the two valuations are separated by more than ten (10%) percent, than the two appraisers shall, within. ten (10) days following the last for submission of the two appraisals of fair market value, appoint a third Qualified Appraiser. If they are unable to agree upon a third Qualified Appraiser within such ten (10) day period, either of the parties to this Lease, by giving five (5) days notice to the other party, may demand Arbitration as specified below. If neither party applies for Arbitration within the ten (10) day period herein specified, the two appraisals of value shall be averaged as stated above. (b) Fair Market Value . The term "fair market value" as used in this Article 48 shall mean the fair market value of the Leased Premises deter-mined in accordance with good appraisal practice including consideration of the following factors: (i) Rental rates being charged for comparable premises in the same geographical area; (ii) The rental rate specified in this Lease increased, however, by a factor calculated as follows: A. The total number of square feet in the land area underlying the Leased Premises shall be multiplied by five dollars and thirty-five cents ($5.30) B. The product derived in "All shall be multiplied by ten percent (10%). C. The product derived in "B" shall be divided by .97; D. The quotient derived in "C" above shall be multiplied by 1.1699; and E. The product of "D" above shall be divided by 12 and the quotient added to the current Minimum Monthly Rent under the terms of this Lease for purposes of establishing the Minimum Monthly Rent to be considered the contract rent hereunder for valuation purposes. (iii) It is the intent of the parties that the fair market value of the Leased Premises shall be determined by the comparable value market analysis, reproduction costs, and end income analysis methods of appraisal. The income analysis shall give consideration to both (i) the fair market rental value of the Leased Premises as if unencumbered by this Lease, and (ii) the contract rentals hereunder increased as provided in (ii) above. (iv) All terms and conditions of any financing secured by deeds of trust encumbering the Leased Premises. (v) The outstanding principal balance of any assessment bonds encumbering the Leased Premises or as the close of escrow. (c) Arbitration In the event the parties are to mutually agree upon a fair market value, and in such event proceed to the Appraisal or Arbitration procedure herein specified, both parties shall be bound to submit the matter for such determination. The procedure specified in this article for appointment of Qualified Appraisers, delivery of appraisals, appointment of an Arbitrator, and determination of fair market value thereby, is herein collectively referred to as "Arbitration" The Arbitration shall be conducted and determined in Alameda County where the Leased Premises are situated. (d) Demand for Arbitration.- A party demanding Arbitration hereunder shall make its demand in writing ("Demand Notice") within ten (10) days after the delivery of the last of the two appraisals presented by the Qualified Appraisers as specified above. A copy of the Demand Notice shall be sent to the Presiding Judge of the* highest trial court in such county for the state in which the Leased Premises are located. The Presiding Judge is hereinafter referred to as the "Appointer". The Appointer, acting in his personal, private capacity, shall appoint within ten (10) days thereafter a Qualified Appraiser. The Arbitrator shall be qualified to serve as an expert witness, over objection, to give opinion testimony addressed to the issue in a court of competent jurisdiction. (e) Decision of the Arbitrator. As used herein, the term Arbitrator refers to a third Qualified Appraiser, selected by any of the methods heretofore set forth. The Arbitrator shall, within sixty (60) days after his appointment, state in writing his determination as to whether the fair market value stated by Lessor's Qualified Appraiser or the fair market value stated by Lessee's Qualified Appraiser, most closely approximates his own. the Arbitrator shall have the right to consult experts and competent authorities with factual information or evidence pertaining to a determination of fair market value, but any such consultation shall be made in the presence of both parties with full right to cross examine. The Arbitrator may not state his own opinion of fair market value, but is strictly limited to the selection of one of the two appraisals submitted by the other two Qualified Appraisers. The Arbitrator shall have no right to propose a middle ground or any modification of either of the proposed valuations, and shall have no power to modify this Lease. The valuation so chosen as most closely approximating that of the Arbitrator shall constitute his decision and shall be final and binding upon the parties absent fraud or gross error. The Arbitrator shall render a decision and award in writing, with counterpart copies to each party. Judgment may be entered thereon in any court of competent jurisdiction. (f) Successor Arbitrator; Fees and Expenses. In the event of failure, refusal, or inability of the Arbitrator to act in a timely manner, a successor shall be appointed in the same manner as such Arbitrator was first chosen hereunder. The fees and expenses of the Arbitrator and for the administrative hearing fee, if any, shall be divided equally between the parties. Each party shall bear its own attorneys' fees and other expenses including fees of witnesses in presenting evidence, and the fees and cost of its own Qualified Appraiser. 48.7 Payment. The purchase price shall be payable in cash at closing over the above; (i) outstanding balance of assessment bonds encumbering the Leased Premises; and (ii) the outstanding principal balance of any loan encumbering the Leased Premises which is not subject to early prepayment. All assumption fees, the responsibility for qualifying for assumption, payment of prepayment penalties or other costs associated with financing which encumbers the Leased Premises at the time of closing shall be at the sole cost and expense of Lessee. 48.8 Time. Time is of the essence of the Lease and this Option agreement, and the Option Exercise Periods set forth herein are agreed by the parties to have been negotiated subject to no variation whatsoever without the express written consent of both parties, it being further agreed and understood that the dates for exercise and closing were not intended to be approximate, but are intended to be exact. 48.9 Assignment. This Option to purchase is not assignable except as provided in Subsection 9.3(c) and shall become null and void and of no further force or effect upon the assignment of this Lease or the sublease of more than thirty percent (30%) of the Building. 48.10 Memorandum Lessee shall have 'the right to record a short form memorandum of this Lease disclosing Lessee's option to purchase set forth herein, and Lessor shall execute and have acknowledged such short form lease memorandum, in the form attached hereto as Exhibit M. 48.11 Quitclaim Deed. On the expiration of the last to occur of the Exercise Periods described in Section 48.2, without exercise of the option described in this Article 48 by the Lessee, Lessee shall, on demand of Lessor, execute a Quitclaim Deed in the form attached hereto as Exhibit "L", in recordable form, for recordation by the Lessor to expunge Lessee's rights under this Article 48. ARTICLE 49. PARKING 49.1 Lessor shall provide that Lessee shall have available to it not less than four (4) parking places per 1, 000 square feet of Usable Area. ARTICLE 50. MISCELLANEOUS PROVISIONS 50.1 Captions. The captions of this Lease are for convenience only and are not a part of this Lease and do not in any way limit or amplify the terms and provisions of this Lease. 50.2 Number and gender.. Whenever the singular number is used in this Lease and when required by the context, the same shall include the plural, the plural shall include the singular, and the masculine gender shall include the feminine and neuter genders, and the word "Person" shall include corporation, firm or association. If there be more than one Lessee, the obligations imposed under this Lease upon Lessee, shall be joint and several. 50.3 Modifications. This instrument contains all of the agreements, conditions and representations made between the parties to this Lease and may not be modified orally or in any other manner than by an agreement in writing signed by all of the parties to this Lease. 50.4 Payments. Except as otherwise expressly stated, each payment required to be made by Lessee shall be in addition to and not in substitution for other payments to be made by Lessee. 50.5 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. 50.6 No Offer. The preparation and submission of a draft of this Lease by either party to the other shall not constitute an offer nor shall either party be bound to any terms of this Lease or the entirety of the Lease itself until both parties have fully executed a final document and an original signature document has been received by both parties until such time as described in the previous sentence, either party is free to terminate negotiations with no obligation to the other. 50.7 Disputed Sums. Under the terms of this Lease numerous charges are and may be due from Lessee to Lessor including, without limitation, Common Area charges, real estate taxes, insurance reimbursement and other items of a similar nature including advances made by Lessor in respect of Lessee I s default at Lessor I s option. In event that at any time during the term there is a dispute between the parties as to the amount due f or any of such charges claimed by Less-or to be due, the amount demanded by Lessor shall be paid by Lessee until the resolution of the dispute between the parties or by litigation. Failure by Lessee to pay the disputed sums until resolution shall constitute a default under the terms of the Lease. 50.8 Light, Air and View. No diminution of light, air, or view by any structure which may hereafter be erected (whether or not by Lessor) shall entitle Lessee to any reduction of rent, result in any liability of Lessor to Lessee, or in any other way affect this Lease or Lessee's obligations hereunder. 50.9 Public Transportation Information. Lessee shall establish and maintain during the Term hereof a program to encourage maximum use of public transportation by personnel of Lessee employed on the Leased Premises, including without limitation the distribution to such employees of written materials explaining the convenience and availability of public transportation facilities adjacent or proximate to the Complex, staggering working hours of employees, and encouraging use of such facilities, all at Lessee's sole reasonable cost' and expense. Lessee shall comply with all requirements of any local transportation management ordinance. 50.10 Rules and Regulations. Lessee agrees to comply with all reasonable rules and regulations adopted and promulgated by Lessor and applicable to all tenants in the Complex for the lawful, orderly, clean, safe, aesthetic, quiet, and beneficial use, operation, maintenance, management, and enjoyment of the complex, provided Lessee has received prior written notice thereof. 50.11 Joint and Several Liability. Should Lessee consist of more than one person or entity, they shall be jointly and severally liable on this Lease. 50.12 First Offer - Adjacent Space. During the first sixty (60) Lease months of the Term hereof, Lessee shall have the right, subject to the specific conditions expressly provided herein to negotiate for additional space within the Complex provided: (a) Lessee first notifies Lessor in writing that it wishes to lease additional space which may be no more than 10,0.00 square feet of Rentable Area; and (b) That the building area to which the right specified in this Section 50.12 is applicable are those buildings which may be constructed upon any parcel within the Complex all or a portion of which lies within the areas described by cross-hatching on Exhibit "M" attached hereto and made a part hereof by reference and this right shall apply to no other area of the Complex; and (c) That the rental which shall form the basis of the negotiation between the Lessor and the Lessee with regard to such additional space shall be ninety percent (90%) of Lessor's good faith judgment as to the fair market value thereof, in Lessors sole good faith discretion; and (d) That Lessor shall have no obligation to negotiate with Lessee for any space for which it is currently in lease discussions with any prospective tenant provided, however, that once such discussions are conclusively terminated, and Lessee has indicated an interest therein, Lessor shall make that space available as "First Offer Space" under the provisions of this section 50.12; and (e) Lessor's obligation extends to a good faith negotiation with Lessee and neither party is bound to proceed to execute a lease which it deems to be unsatisfactory as to the First Offer Space: and (f) The rights under this Section 50.12 shall expire and be of no further force and affect on the expiration of the sixtieth (60th) Lease, month following commencement of the Term hereof. 50.13 Reimbursable Expenditures. Lessee shall not be obligated for a pro rata share of any expenditures due to be paid by it hereunder to the extent of the unreasonableness of such expenditure. 50.14 Lien Waivers. Subject to review and satisfaction of counsel for Lessor, Lessor shall execute any reasonable Lien Waiver forms submitted to it by Lessee releasing any interest Lessor may have in Lessor's personal property and or alterations that Lessee may remove pursuant to Article 20 hereof, in favor of a third party vendor, lender, or Lessor, provided that such reasonable documentary alterations as Lessor or Lessor's counsel requests to protect the interest of Lessor in the Leased Premises are adequately provided. Lessor shall execute such documentation within ten (10) days of receipt of a document in form agreeable to Lessor's counsel. 50.15 Consents. Wherever the consent or approval of either party is required under this Lease, such consent or approval shall not be unreasonably withheld or delayed, unless otherwise specified in this Lease. 50.16 Lessor's Representations. Notwithstanding any other provision hereof, Lessor hereby warrants that as of the Commencement Date the Leased Premises are in good condition and repair and built in a good and workmanlike manner in accordance with the approved Final Plans. Lessor also warrants that all building equipment is in good operating order as of the Commencement Date and that the Leased Premises and the Common Maintenance Areas are in compliance with all applicable laws and governmental regulations as of the Commencement Date, but makes no warranty as to conditions or compliance with laws and regulations thereafter. IN WITNESS WHEREOF, Lessor and Lessee have executed this Lease as of the day and year first written above. LESSOR LESSEE KAISER DEVELOPMENT COMPANY KELLEY-CLARKE, INC. By: /s/ Edward T Pike, III By: /s/ John F. Blazin, VP LEASE AMENDMENT This Lease Amendment ("Amendment") is made this 26th day of February, 1990 by and between BEDFORD DEVELOPMENT COMPANY ("Lessor") and KELLEY-CLARKE, INC. ("Lessee"). RECITALS A. Lessor's predecessor in interest, Kaiser Development Company, and Lessee entered into that certain Lease dated September 1, 1988 (the "Lease") for premises located in Ardenwood Corporate Commons, Fremont, California ("Leased Premises") as more fully described in the Lease. B. Lessor is currently constructing the Leased Premises. C. The parties wish to amend the Lease to reflect, among other things, additional construction to be required of Lessor. CONSIDERATION In consideration of the covenants and agreements herein contained, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties agree as follows: TERMS 1. Lessor agrees to perform and install the following additional improvements which were not part of Lessor's construction obligations under the Lease and which shall not be deemed part of the Total Project Costs, as that term is defined in the Lease: Construction of a commercial kitchen, an employee kitchen, a walk-in freezer, a walk-in cooler, pallet racks, and an outdoor enclosure for the freezer and cooler ("Special Improvements") Lessor shall pay all costs associated with the design, engineering and installation of the Special Improvements which shall be more particularly described in the "Plans" defined below. 2. The parties have agreed to Plans ("Plans") adequately describing the Special Improvements. 3. Lessor shall pay for the first one hundred sixty-two thousand six hundred dollars ($162,600) of such Special Improvement costs. If the costs exceed one hundred sixty-two thousand six hundred dollars ($162,600), Lessee shall have the option of reducing the scope of work of the Special Improvements to reduce the costs thereof, or of paying in cash to Lessor prior to construction of such Special Improvements the costs thereof exceeding one hundred sixty-two thousand six hundred dollars ($162,600). All delays in construction caused by the engineering, design or installation of the Special Inprovements and the review process required thereby shall be "Lessee Delays" as defined in the Lease. 4. Minimum Monthly Rent, calculated in accordance with Section 6.2 of the Lease shall be increased by the sum of two thousand two hundred forty dollars ($2,240). 5. Notwithstanding the provision of the Lease, Lessee shall be required to remove all Special Improvements from the Leased Premises at the expiration or termination of the Lease unless Lessor agrees to the contrary. 6. Notwithstanding any provision of the Lease to the contrary, Lessee shall maintain and repair (and replace as necessary) at its sole cost and expense all Special Improvements. 7. Sections 48.2(a) and 48.2(c) of the Lease are hereby deleted. 8. Section 49.1 of the Lease is hereby deleted and replaced with the following: "49.1 Lessor shall provide that Lessee shall have available to it not less than four (4) parking places per 1,000 square feet of Usable Area, but in no event is Lessor required to provide for Lessee's use more than 156 parking spaces." 9. Exhibit "B" of the Lease is hereby deleted and replaced with Exhibit "B" attached hereto which shall henceforth be deemed the Exhibit "B" to the Lease. IN WITNESS WHEREOF, the parties have executed this Amendment. LESSOR LESSEE BEDFORD DEVELOPMENT COMPANY KELLEY-CLARKE, INC. By: __________________________ By: _________________________ William C. Pratt, Its: Area Manager President By: __________________________ John F. Blazin, Vice President SECOND LEASE AMENDMENT This Second Lease Amendment ("Amendment") is made this 1st day of May, 1990 by and between BEDFORD DEVELOPMENT COMPANY ("Lessor") and KELLEY-CLARKE, INC. ("Lessee"). RECITALS WHEREAS, A. Lessor's predecessor in interest, Kaiser Development Company, and Lessee entered into that certain Lease dated September 1, 1988 (the "Lease") for premises located in Ardenwood Corporate Commons, Fremont, California ("Leased Premises") as more fully described in the Lease. B. The Lease vas modified by Lease Amendment dated February 26, 1990. C. Lessor is currently constructing the Leased Premises. D. The parties wish to further amend the Lease to reflect, among other things, additional construction to be required of Lessor. CONSIDERATION In consideration of the covenants and agreements herein contained, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties agree as follows: TERMS 1. Lessor agrees to perform and install the following additional improvements which were not part of Lessor's construction obligations under the Lease and which shall not be deemed part of the Total Project Costs, as that term is defined in the Lease: Construction of a computer room with raised floor and ramp, together with necessary plumbing, hvac, electrical and fire suppression systems ("Additional Improvements"). Lessor shall pay all costs ("Costs") associated with the design, engineering and installation of the Additional Improvements (including permit, application and other processing fees, and legal fees associated with this Second Amendment) which shall be more particularly described in the "Plans" defined below. 2. The Parties have agreed to Plans ("Plans") adequately describing the Additional Improvements. 3. All delays in construction caused by the engineering, design or installation of the Additional Improvements and the review process required thereby shall be "Lessee Delays" as defined in the Lease. 4. Minimum Monthly Rent, as calculated in accordance with Section 6.2 of the Lease and as adjusted per the Lease Amendment shall be increased by the sum of one thousand three hundred eighty dollars and seventy-two cents ($1,380.72) per month. 5. Notwithstanding the provision of the Lease, Lessee shall be required to remove all Additional Improvements from the Leased Premises at the expiration or termination of the Lease unless Lessor agrees to the contrary. 6. Notwithstanding any provision of the Lease to the contrary, Lessee maintain and repair (and replace as necessary) at its sole cost and expense all Additional Improvements. 7. Lessee will accept the Additional Improvements as constructed in accordance with the Plans and shall hold Lessor harmless from all liabilities with respect thereto from and after the date of delivery of the Leased Premises to Lessee. IN WITNESS WHEREOF, the Parties have executed this Amendment. LESSOR LESSEE BEDFORD DEVELOPMENT COMPANY KELLEY-CLARKE, INC. By: __________________________ By: _________________________ William C. Pratt, Its: Area Manager President By: __________________________ John F. Blazin, Vice President THIRD AMENDMENT TO LEASE This Third Amendment ("Third Amendment") in made this 5th day of May, 1992 by and between BEDFORD DEVELOPMENT COMPANY ("Lessor") and KELLEY-CLARKE, INC. ("Lessee"). RECITALS A. Lesser and Lessee entered into that certain lease dated September 1, 1988 (the "Original Lease"), which was amended on February 26, 1990 (the "First Amendment") and on May 1, 1990, (the "Second Amendment"), for certain property generally situated at 6300 Dumbarton Circle, Fremont, California, which collectively are hereinafter called the "Lease". The Lease affects Premises which are more particularly described in the Lease (the "Leased Premises"); B. The parties hereto wish by this Amendment to amend the Lease. CONSIDERATION Therefore, in consideration of the agreements herein contained, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the Parties agree as follows: 1. Unless otherwise stated any capitalized term is hereby given the same meaning as set forth in the Lease. 2. Except as otherwise stated in this Amendment, the terms of the Lease remain in full force and effect and the Lease, as hereby amended shall bind, and inure to the benefit of, the successors of the parties hereto. 3. MINIMUM MONTHLY RENT. Notwithstanding any provision of the Lease to the contrary, the Minimum Monthly Rent as set forth in Section 1.5 of the Lease shall be amended to read as follows: Months 1-60 $40,951.29 per month Months 61-121 $47,908.92 per month 4. All other terms and conditions of the Lease are hereby ratified and reconfirmed. IN WITNESS WHEREOF, the parties have executed this Amendment. LESSOR LESSEE BEDFORD DEVELOPMENT COMPANY KELLEY-CLARKE, INC. By: __________________________ By: _________________________ J. Randell Moore John F. Blazin, Vice President President/CEO Date: 6/9/92 Date: May 18, 1992 By: __________________________ FOURTH AMENDMENT TO LEASE This Fourth Amendment ("Fourth Amendment") is made this 19th day of April, 1995 ("Effective Date") by and between KRDC, Inc., a California Corporation, formerly Bedford Development Company and also Kaiser Development Company ("Lessor"), and Kelley-Clarke, Inc., a California corporation ("Lessee"). RECITALS WHEREAS, A. Lessor and Lessee entered. into that certain Lease dated September 1, 1988 (the "Original Lease") which was amended on February 26, 1990 (the "First Amendment") ; on May 1, 1990, (the "Second Amendment") ; and on May 5, 1992, (the "Third Amendment") for certain property generally situated at 6300 Dumbarton Circle, Fremont, California, (the Original Lease, as amended, is referred to herein as the "Lease"). The Lease covers the premises which are more particularly described therein (the "Leased Premises"); B. The parties hereto wish by this Amendment to amend the Lease. CONSIDERATION Therefore, in consideration of the agreements herein contained, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties agree as follows: TERMS 1. Unless otherwise stated, any capitalized term is hereby given the same meaning as set forth in the Lease. 2. Except as otherwise stated in this Amendment, the terms of the Lease remain in full force and effect and the Lease, as hereby amended shall bind, and inure to the benefit of, the successors of the parties hereto. 3. Premises. Effective October 25, 1994, Section 1. 3 (C) of the Lease is amended by deleting "2.399 acres" and substituting in place thereof "approximately 2.64 acres" to reflect the increased gross square footage of land area in the Complex as depicted on Parcel Map No. 6773 (being a subdivision of Parcel 1 through 4, inclusive of Parcel Map 4483, filed for record in Book 152 of Maps at Pages 78-82, Alameda County Records, City of Fremont, County of Alameda, State of California). The detailed legal description of the Leased Premises is forthcoming and shall be attached hereto upon final completion. A copy of Parcel Map No. 6773 is attached hereto for reference as Exhibit "A". 4. Term. The term shall be extended by an additional sixty (60) months, commencing July 1, 2000 and expiring June 30, 2005. 5. Option to Extend. The provisions pertaining to the Options to Extend (two at five years each) as specified in Sections 1.4 (B), 1.5(C) and 4.3 of the Lease shall be deleted in their entirety and the provisions attached hereto as Exhibit "B" shall be substituted in their place. 6. Minimum Monthly Rent. The Minimum Monthly Rent as set forth in Section 1.5 of the Lease shall be amended to read as follows: 07/01/1995 - 06/30/2000 $ 44,572.00 per month 07/01/2000 - 06/30/2005 $ 51,920.00 per month Section 1. 5 (C) of the Lease is hereby deleted and of no further force and effect. 7. Initial Pro Rata %. Due to the increase in the gross square footage of land area in the Complex as described in Paragraph 3 of this Amendment, effective January 1, 1995, Lessee's Initial Pro Rata % as set forth in Section 1.8 of the Lease shall be revised from "1.3%" to "0.9136%" (approximately 2.64 acres/approximately 288.96 total acres). 8. 0ption to Purchase. The provisions of Article 48 .(Option to Purchase) of the Lease are hereby deleted in their entirety and shall hereafter be of no further force and effect. 9. Parking. The provisions in Section 49.1 of the Lease are hereby amended as follows: Notwithstanding anything to the contrary in the Lease, Lessor shall provide within six (6) months from execution of this Amendment, at Lessor's expense: i) ten (10) additional parking stalls; and ii) thirty one (31) relocated stalls, as shown on the attached Exhibit "C" (Parking Plan). The Exhibit "C" is intended as a preliminary parking plan and is subject to all necessary governmental approvals and compliance with all applicable laws, ordinances and regulations. 10. First Offer - Adjacent Space. The provisions in Section 50.12 of the Lease shall hereinafter be deleted and of no further force and effect. 11. Right of First Offer to Purchase. (a) Grant. Subject to the terms of this Section 11, Lessor grants to Lessee a right of first offer to purchase the Leased Premises (the "Purchase Right"). (b) Term. The term of the Purchase Right ("Purchase Right Term") shall commence on the earlier to occur of (i) one (1) year after the Effective Date, or (ii) one (1) day after the date on which Lessor conveys fee title to the Leased Premises to a bona fide third party, and shall terminate on the expiration or earlier termination of the initial Lease term. (c) Covenants of Lessor. Subject to the conditions precedent established by Section 11(e) below, if, at any time during Purchase Right Term, Lessor decides to offer the Leased Premises for sale to a bona fide third party, Lessor shall first provide Lessee with a written notice ("Sale Notice") detailing the purchase price of the Leased Premises, payment terms, conditions of title, costs of escrow and other relevant terms. (d) Exercise of Lessee's Purchase Right. (i) Within five (5) business days of receipt of a Sale Notice from Lessor, Lessee shall either (a) provide written notice ("Purchase Notice") to Lessor of Lessee's election to purchase the Leased Premises on the terms stated in the Sale Notice and deliver to Lessor a refundable deposit in the amount of S50,000 ("Deposit") to be used toward the purchase price for the Leased Premises, or (b) provide written notice ("Counteroffer Notice") to Lessor of Lessee's election not to purchase the Leased Premises, but stating the purchase price ("Counteroffer") at which Lessee would be willing to purchase the Leased Premises. If Lessee shall fail to provide to Lessor either a Purchase Notice or a Counteroffer Notice, Lessee shall be deemed to have waived its right to purchase the Leased Premises (under any terms) for the twelve (12) month period immediately following the applicable Sale Notice. (ii) Within fifteen (15) business days of Lessee's delivery to Lessor of the Purchase Notice, Lessor and Lessee shall execute an agreement of purchase and sale satisfactory to Lessor (which agreement shall contain the terms specified in the Sale Notice). If Lessor and Lessee shall fail to execute an agreement of purchase and sale within such time, Lessee shall be deemed to have waived its right to purchase the Leased Promises for the twelve (12) month period immediately following the Sale Notice, as long as the terms in the agreement of purchase and sale to a bona fide third party do not materially differ from the terms of the agreement of purchase and sale presented to Lessee by Lessor. (iii) If Lessee shall deliver to Lessor a Counteroffer Notice, Lessor may, at any time during the twelve (12) month period following the date of the Sale Notice, either (a) notify Lessee in writing ("Counteroffer Acceptance Notice") of Lessor's acceptance of the Counteroffer, or (b) proceed with the sale of the Leased Premises to a bona fide third party provided the purchase price for such sale is in excess of the Counteroffer and the terms of sale are otherwise generally in accordance with the terms stated in the Sale Notice. If Lessor elects to accept Lessee's Counteroffer, Lessee shall deliver the Deposit to Lessor within five (5) business days of receipt of the Counteroffer Acceptance Notice and Lessor and Lessee shall, within fifteen (15) business days following delivery of the Deposit, execute an agreement of purchase and sale satisfactory to Lessor (which agreement shall contain the terms specified in the Sale Notice except that the purchase price shall be the amount of the Counteroffer). If Lessor and Lessee shall fail to execute an agreement of purchase and sale within such time, Lessee shall be deemed to have waived its right to purchase the Leased Premises for the twelve (12) month period immediately following the Counteroffer Acceptance Notice, as long as the terms in the agreement of purchase and sale to a bona fide third party do not materially differ from the terms of the agreement of purchase and sale presented to Lessee by Lessor. (e) Conditions to Purchase Right. Notwithstanding anything to the contrary in this Section 11, Lessor shall have no obligation to provide Lessee with a Sale Notice, and Lessee shall have no right to exercise Lessee's Purchase Right, if Lessee is in default either: (i) at the time Lessor seeks to sell the Leased Premises, or (ii) upon the date Lessee seeks to close escrow on the sale of the Leased Premises. The Purchase Right shall be personal to Lessee and shall not be transferable with any assignment of this Lease or subletting of the Premises. (f) Terms for Purchase Right. In the event that Lessee exercises Lessee's Purchase Right, Lessee's purchase of the Leased Premises shall be on all of the same terms and conditions described in the Sale Notice. (g) Continuing Right. Lessee's failure to exercise its Purchase Right shall not be deemed a waiver or relinquishment of such right if Lessor fails to convey the Leased Premises to a bona fide third party within one (1) year of the date of the Sale Notice. (h) Exceptions to Offer. Notwithstanding anything to the contrary in this Section 11, Lessor shall not be obligated to provide Lessee with a Sale Notice, and the terms of this Section 11 shall not apply, in the event of: (i) a transfer of the Premises to an affiliate of Lessor (ii) a portfolio sale, or (iii) a foreclosure sale. (i) Subordinate Nature. Lessee's Purchase Right shall be subject and subordinate to the lien of any mortgage, deed of trust or other lien resulting from any other method of financing or refinancing, now or hereafter in force against the Building or Leased Promises, and to all advances made or hereafter to be made upon the security thereof. (j) Closing Costs. Lessor and Lessee shall each pay the fees of their respective attorneys and consultants in connection with the sale of the Leased Promises to Lessee. All closing costs incurred in connection with that sale shall be apportioned in accordance with local custom. (k) Successors and Assigns. Lessee's Purchase Right shall be binding on the successors and assigns of Lessor. All other terms and conditions of the Lease are hereby ratified and reconfirmed. IN WITNESS WHEREOF, the parties have executed this Amendment. LESSOR: LESSEE: KRDC, Inc., a California corporation Kelley-Clarke, Inc., a California corporation By: Kemper Real Estate Management Company, a Delaware corporation, its duly authorized agent By: ________________________________ By: ________________________________ Lisa A. Berlin C. William Frankland its duly authorized agent its: Vice-Chairman, Chief Financial Officer Date: ______________________________ Date: 4/21/95 EX-23.1 3 CONSENT OF DELOITTE & TOUCHE LLP 1 Exhibit 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement Nos. 33-77300, 33-80155, 33-353181 and 33-363345 on Forms S-8 and No. 33-96766 on Form S-3 of SangStat Medical Corporation of our report dated February 2, 199appearing in this Annual Report of Form 10-K of SangStat Medical Corporation for the year ended December 31, 1998. /s/ DELOITTE & TOUCHE LLP - --------------------------- DELOITTE & TOUCHE LLP San Jose, California March 30, 1999 EX-27 4 ARTICLE 5 FIN. DATA SCHEDULE FOR 10-K
5 This schedule contains summary financial information extracted from the Consolidated Balance Sheet and Consolidated Statement of Income included in the Company's Form 10-K for the period ended December 31, 1998 and is qualified in its entirety by reference to such Financial Statements. 1 Dec-31-1998 Jan-01-1998 Dec-31-1998 12-MOS 16,285,653 13,374,742 11,891,731 928,917 33,375,259 78,166,919 6,778,746 3,644,978 107,327,308 31,339,012 0 0 0 160,250,935 (100,664,290) 107,327,308 18,585,859 19,678,488 12,531,559 12,531,559 44,836,727 0 (3,052,721) (38,206,737) 257,201 0 0 0 0 (38,463,938) ($2.39) ($2.39)
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