U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-KSB

[ X ]    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
   
  For the fiscal year ended December 31, 2004
   
[     ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
   
  For the transition period from __________ to __________
   

Commission File No. 000-26875

VIRAL GENETICS, INC.
(Name of small business issuer in its charter)

Delaware   33-0814123
(State or Other Jurisdiction of
Incorporation or Organization)
    (IRS Employer
Identification No.)

1321 Mountain View Circle, Azusa, CA 91702
(Address of principal executive offices)

(626) 334-5310
(Issuer’s telephone number)

Securities registered pursuant to Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act:

Common Stock, par value $0.0001
(Title of class)

Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the issuer was required to file such report(s)), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is contained in this form, and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this form 10-KSB or any amendment to this Form 10-KSB. [  ]

The issuer's revenue for its most recent fiscal year was: $0

The aggregate market value of the issuer's voting stock held as of March 30, 2005, by non-affiliates of the issuer was $11,477,600.

As of March 30, 2005, the issuer had 90,837,046 shares of its common stock outstanding.

Transitional Small Business Format: Yes [    ] No [ X ]

Documents incorporated by reference: None

TABLE OF CONTENTS

ITEM NUMBER AND CAPTION Page

Part I
 
1. Description of Business 3
2. Description of Property 17
3. Legal Proceedings 17
4. Submission of Matters to a Vote of Security Holders 17
 
Part II
 
5. Market for Common Equity, Related Stockholder Matters and 18
  Registrant Purchases of Equity Securities  
6. Management's Discussion and Analysis or Plan of Operation 18
7. Financial Statements 20
8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 20
8.A Controls and Procedures 21
8.B Other Information 21
 
Part III
 
9. Directors and Executive Officers of the Registrant 21
10. Executive Compensation 23
11. Security Ownership of Certain Beneficial Owners and Management and 24
  Related Stockholder Matters  
12. Certain Relationships and Related Transactions 26
13. Exhibits 27
14. Principal Accountant Fees and Services 28

FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-KSB contains forward-looking statements that are subject to certain risks, uncertainties or assumptions and may be affected by certain other factors, including but not limited to the specific factors discussed in Part I, Item 1 under “Description of business,” and Part II, Item 6 under “Management’s Discussion and Analysis or Plan of Operation.” In some cases, you can identify forward-looking statements by terminology such as “may,” “should,” “could,” “expects,” “plans,” “projected,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continues,” or the negative of these terms or other comparable terminology. Should one or more of these risks, uncertainties or other factors materialize, or should underlying assumptions prove incorrect, actual results, performance or achievements of Viral Genetics may vary materially from any future results, performance or achievements expressed or implied by such forward-looking statements.

Forward-looking statements are based on beliefs and assumptions of Viral Genetics’ management and on information currently available to such management. Forward-looking statements speak only as of the date they are made, and Viral Genetics undertakes no obligation to update publicly any of them in light of new information or future events. Undue reliance should not be placed on such forward-looking statements, which are based on current expectations. Forward-looking statements are not guarantees of performance.

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PART I

Item 1. BUSINESS

Overview

Viral Genetics, Inc. (“Viral Genetics” or the “Company”) is a drug discovery and development company developing products based on its Thymus Nuclear Protein technology aimed primarily at the treatment of infectious disease, and in particular HIV infection and AIDS. The Company’s research interests also include autoimmune diseases and immunological deficiency. If we are successful in our development efforts, our corporate strategy is to partner with third parties through licensing, joint venture, or other arrangements to effect commercial manufacture, marketing and/or distribution. The Company is in the development stage, and currently has no revenues.

At the core of our technology is Thymus Nuclear Protein or “TNP” – a processed extract of mammalian thymus tissue. Our lead drug candidate, based on TNP, is a treatment for HIV and AIDS called VGV-1 which we have studied in 4 human clinical trials outside of the United States for safety and efficacy in reducing HIV viral load. A fifth clinical trial of VGV-1, designated a Phase III study by the South African Medicines Control Council, is now in progress in South Africa, and recently completed enrollment of 135 patients. During our 4 completed trials, we have not observed any significant adverse effects related to VGV-1 by physical exam, subjective complaints from patients, or routine blood work. Based on blood tests of the principal indicators of HIV infection, including PCR (Polymerase Chain Reaction – which detects HIV genetic material) and PBMC (Peripheral Blood Mononuclear Cell – which detects living HIV in the blood) viral load assays, there was a marked decrease in HIV viral load in over half of the subjects tested. This decrease sustained through the post-treatment follow-up evaluation periods of up to 9 months.

We also observed during these studies that some test subjects suffering from other clinical conditions reported anecdotal improvements in the symptoms of other illnesses. Consequently, we have distinguished VGV-1 as a separate drug candidate from other potential applications of the TNP technology. Although we intend to research these other applications in the future, our primary focus continues to be VGV-1.

VGV-1 is in the preclinical stage of development in the USA where we have yet to formally file an Investigational New Drug application (“IND”) with the United States Food and Drug Administration (FDA), and in later-stage development outside the United States. We plan to continue to seek commercial registration of VGV-1 in South Africa and China, but our current primary clinical development goal is to begin human clinical trials of VGV-1 under an IND in the United States.

We are now in the process of completing and filing an IND application with the FDA, which we hope to file later this year.

In South Africa we have completed enrollment of 135 patients for our Phase III study of VGV-1. The last follow-up for this study is scheduled for the last calendar quarter of 2005. We expect final data summaries shortly thereafter. The trial is a double-blind, placebo-controlled study examining VGV-1‘s safety and efficacy with respect to viral load and other markers in Stage CDC-2 HIV-infected subjects.

In 2004, we announced the results of the prospective study of 34 patients treated with VGV-1 that was conducted at Ditan Hospital in Beijing, China, in 2003. In January 2004 we submitted an application to the Chinese State Food and Drug Administration (“SFDA”) requesting permission to import VGV-1 for the treatment of late-stage AIDS patients in China (the “Import Application”). This application remains open and under review, pending our delivery to the SFDA of manufacturing-related documentation, additional human safety and efficacy data, and certain long-term toxicity data. We continue to pursue commercial approval of VGV-1 in China.

Also during 2004, HIV and AIDS Review published a summary report written by the principal investigators of our prospective study of VGV-1 that was conducted at IMSS Hospital 25 in Monterrey, Mexico in 1999-2000. We have suspended all activity in Mexico, as we believe our resources are better allocated elsewhere.

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Our management team consists of 2 executive officers and 1 senior manager, who are supported by a team of 7 employees and consultants. The management team is advised by a Scientific and Medical Advisory Board composed of physicians, scientists, and consultants with substantial experience in the areas of HIV treatment, drug development, public health issues, clinical trials, immunology and biochemistry.

The Company leases two adjacent facilities located at 1321 and 1291 Mountain View Circle in Azusa, California that house its corporate offices and a temporary preclinical production facility. The Company has begun construction of a permanent manufacturing and research facility at 1321 Mountain View Circle suitable for clinical development and early market-entry. We anticipate completion of the facility renovations in 2005. The adjacent 1291 facility is expected to be used for research and development, additional office space, and a quality control laboratory.

Our Chinese subsidiary leases offices in the Chaoyang District of Beijing, China, and is managed by one executive officer who is supported by 2 employees.

The Company was incorporated under the laws of the state of Delaware on June 8, 1998, and in October 2001 acquired its subsidiary, Viral Genetics, Inc., a California corporation formed in 1995 (“VGI”). In September 2004 we completed a restructuring and conversion to equity of an outstanding note payable to Therapeutic Genetic, Inc. pursuant to a merger of that company with and into VGI.

Products, Research and Development

Our research focuses on isolating and identifying biologically-active proteins and protein fragments with diagnostic and therapeutic applications in infectious disease – in particular HIV infection and AIDS — autoimmune conditions, and immunological deficiency. At the core of our technology is TNP — an extract of mammalian thymus tissue. We are also researching other drug candidates, although they are in the very early stages of development.

We view TNP as a platform for development of products with a number of potential therapeutic uses following anecdotal observations of improvements in some subjects suffering from other conditions in our human clinical trials. We elected to distinguish the possible uses of TNP and therefore elected to rename our HIV and AIDS drug candidate as “VGV-1".

VGV-1

Our lead drug candidate, VGV-1, is a prospective treatment for HIV infection and AIDS based on our TNP platform. VGV-1 is extracted from mammalian thymus tissue, processed and administered through intramuscular injection. Historically, the Company has allocated the majority of its efforts to the development of VGV-1. Viral Genetics originally acquired the intellectual property rights underlying VGV-1 from Therapeutic Genetic, Inc. through an Assignment of Patent in 1995. We acquired Therapeutic Genetic, Inc., through its merger with VGI in September 2004.

According to reports published by UNAIDS, approximately 42 million people are currently believed to be HIV positive worldwide. AIDS is the leading cause of death in Africa and the fourth leading cause globally. The means of making available effective treatment to the majority of people with HIV/AIDS is an urgent issue of global significance.

In most developed countries, HIV infection is primarily treated through Highly-Active Antiretroviral Therapy (“HAART”) – combinations of various antiretroviral drugs that target the virus itself or its method of reproduction. The major classes of HIV treatment are Nonnucleoside Reverse Transcriptase Inhibitors, Nucleoside Analog Reverse

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Transcriptase Inhibitors and Protease Inhibitors, with Fusion or Entry Inhibitors representing a newer, less-commonly utilized approach. Where it has succeeded, HAART has altered the nature of HIV infection, transforming an almost uniformly fatal illness into a chronic, but apparently stable condition. According to Rapid Report, XIII International HIV Drug Resistance Workshop, June 2004, an estimated 70% of those receiving HAART are resistant to one or more classes of the antiretroviral drugs comprising HAART, and 11-18% are resistant to all three major classes.

In the poorer nations of the world, simpler versions of such “combination therapy” with fewer, older versions of antiretroviral drugs are sometimes used. However most HIV infected people in the world receive no antiviral medication. In Sub-Saharan Africa it is estimated by UNAIDS that HAART is available to 12% of people with HIV; in Southeast Asia, the figure is estimated at 2%. An estimated 90% of the 5 to 6 million people in low-income countries who require treatment to avoid dying within the next two years are not receiving it.

Even where treatment is available its use is complicated by a number of factors, including moderate to severe side effects, onerous dosing regimens, drug-drug interactions, and the development of mutated drug-resistant strains of the virus. In addition, these drugs are very expensive. Thus, development of new and inexpensive therapeutics with simple dosing regimens is an extremely important task and represents a clear market opportunity.

We have studied VGV-1 in 4 prospective human clinical trials outside of the United States including on HIV-infected patients with no prior history of antiretroviral treatment, patients who were resistant to antiretroviral therapy, and others. We have conducted follow up testing of patients at up to 18 months following treatment. Markers that have been examined have centered on viral load testing, using both PCR-RNA assays and PBMC cultures, as well as CD4+ T cell measurement. In our South African Phase III study we are studying VGV-1 on patients in Stage CDC-2 of HIV infection, which is the stage prior to full-blown AIDS. In the USA, we intend to study VGV-1 as a potential “salvage” therapy – a treatment option for HIV-infected patients who have failed traditional anti-retroviral therapy.

Only mild side effects related to VGV-1 have been noted by physical exam, subjective complaints from patients, or routine blood work during any of the trials. Overall decreases in viral load from baseline were noted in over half of subjects tested. The mean decrease in viral load as measured by PCR-RNA in our 4 human clinical studies has been 0.68 log, equivalent to an approximately 80% decrease in the amount of virus in the blood.

Our most recent data is from the results of our human clinical trial in China. This study was a prospective, masked, non-randomized, single-center study consisting of 34 HIV-1 infected patients with CDC Stage-3 classification of AIDS (less than 200 cells/mm3), who were treatment-naive. Patients received intramuscular injections of VGV-1 biweekly for 8 weeks, and were then followed up until day 240 without additional treatment. Patients tolerated the injections well and there were no significant adverse reactions to VGV-1 reported. The protocol for the trial examined several of the standard measurements of HIV infection and immunological health including PCR RNA levels and CD4+ T cell counts. Other tests performed included standard blood chemistries and HIV-infected PBMC counts.

Overall, analysis of the study data revealed sustained viral suppression during the follow-up period. The mean PCR RNA viral load for all patients at baseline (prior to treatment) was 4.902 log which is equivalent to approximately 79,800 copies of HIV RNA per milliliter of blood. By day 180 during the no-treatment follow-up period, plasma HIV RNA was suppressed with a mean change of -0.70 log from baseline which is approximately equivalent to an 83% decrease in the group’s mean or average viral load. By day 270 during the no-treatment follow-up period, viral load remained suppressed with a mean change of -0.484 log from baseline which is approximately equivalent to a 75% decrease in the group’s mean viral load.

Additionally, 36% of patients overall had a greater than 1 log drop in viral load from baseline by day 180, and 28% of subjects overall were observed to have a greater than 1 log drop in viral load from baseline by day 270. In percentage terms, a 1 log decrease is equivalent to a 90% decrease.

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Overall, counts of CD4+ T cells, which are key components of the human immune system, remained unchanged from baseline during the follow-up period.

In 2004, an article written by the investigators of our study in Monterrey, Mexico, was published in a peer reviewed journal entitled “Diminution of plasma viral load and cultured HIV-infected peripheral blood mononuclear cells in non-responding patients treated with two calf thymus nuclear proteins and conventional antivirals,” HIV & AIDS Review (2004, 3(3), 8-13). The investigators observed that in patients failing anti-retroviral drug therapy, treatment with VGV-1 for sixty days was associated with undetectable PCR RNA viral load in half of the patients (5/10) within three months of treatment. Furthermore, by six months there was an average 1 log drop in virus levels, which is equivalent to a 90% decrease. The trial in Mexico enrolled 10 HIV-positive patients who were failing to respond to their second or third regimen of anti-retroviral drug therapy. Enrolled subjects in the Mexican study had been receiving anti-retroviral therapy but were demonstrating decreasing viral control, and received VGV-1 injections twice weekly for eight consecutive weeks. They were then followed for safety and efficacy on markers of disease progression such as HIV-1 RNA (viral load or virus in the blood) to six months.

The mechanism by which VGV-1 affects HIV infection is not fully understood, and is a current focus of our research. Last year we confirmed that components of VGV-1 bind HIV-1 surface glycoproteins as well as human CD4+ T cells. While further laboratory studies need to be conducted to understand the exact mechanism of action, these binding properties could explain its apparent activity in our 4 clinical studies. We are now engaged in research specifically designed to address the mechanism of action of VGV-1, including extensive immunological assays of the participants in our ongoing South African study.

2004 Research & Development

Viral Genetics spent $1,500,585 on development of its drug candidates in calendar year 2004, compared to $841,461 in 2003. We estimate we will spend $850,000 in 2005 on the construction of our permanent GMP facility and $500,000 on product testing and development. We further estimate approximately $450,000 will be needed to meet our portion of the expenses of the ongoing South African clinical trial.

Joint Ventures, Business Relationships and Distribution

CHINA

Our wholly-owned subsidiary, Viral Genetics (Beijing) Limited, maintains offices at leased facilities in Beijing, China, and is staffed by 3 individuals.

In 2002, we entered into several agreements that culminated in the Chinese Center for Disease Control’s authorization of a prospective clinical study of VGV-1 at the Chinese National AIDS Center at Beijing Ditan Hospital. This study was conducted by Ditan Hospital, with Viral Genetics acting as co-sponsor with its former joint venture partner. The follow-up portion of this study was completed in late 2003, and we announced a summary of the results by press release in July 2004.

In connection with the termination of our former joint venture in China, we will pay royalties to the former joint venture partners totaling 7% of the gross profits generated through the sale of VGV-1 in China for 15 years.

In January 2004 we submitted an application to the Chinese State Food and Drug Administration (“SFDA”) requesting permission to import VGV-1 for the treatment of late-stage AIDS patients in China (the “Import Application”). This application remains open and under review, pending our delivery to the SFDA of manufacturing-related documentation, additional human safety and efficacy data, and certain long-term toxicity data. We intend to rely on the data from the Ditan Hospital study and data gathered from our study in South Africa to address the human safety and efficacy data issue, and we expect to complete the manufacturing documentation and a required toxicity study in 2005. Should the SFDA not find the data or protocols from our human studies appropriate or usable, we expect that we will need to conduct another study in China of between 30-100 subjects. We do not expect approval of our Import Application before 2006, and such approval could be delayed beyond 2006, if the SFDA requires additional data or testing.

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In 2004, we became aware that Ditan Hospital should have obtained permission from the SFDA for the study over and above the authorization provided by the Chinese Center for Disease Control. We understand that the matter was resolved internally and we do not foresee any material effect of this on our future clinical development in China or elsewhere.

South Africa

On December 15, 2004, we entered into a Distribution Management Agreement with Timothy & Thomas LLC, (“T&T”) an Illinois limited liability company, with an effective date of July 1, 2004 (the “Distribution Agreement”). The owners of T&T are a former director of Viral Genetics and a former creditor of Viral Genetics. This Distribution Agreement replaces and supercedes the prior agreements with T&T that were referred to in our reports on Form 10-QSB for the quarters ended September 30, 2004, and June 30, 2004.

The Distribution Agreement granted to T&T the exclusive right to establish, appoint, and manage distribution and sub-distribution of all Viral Genetics products that are used or useful for the prevention or treatment of HIV and/or AIDS in continental Africa and certain island nations off the coast of Africa. The term of the Distribution Agreement is 20 years. In consideration for these rights, T&T made a payment of $650,000 in cash to Viral Genetics, surrendered for cancellation a convertible debenture in the principal amount of $200,000 originally issued in the name of Thomas Little, and agreed to pay expenses of the ongoing clinical trial up to a maximum threshold amount beyond which we are responsible for 50% of expenses. At present, we estimate we will be responsible for approximately $450,000 of expenses for this trial.

As contemplated by the Distribution Agreement, T&T will establish distributors in each African country who will purchase our HIV/AIDS products directly from us and distribute those products in their respective countries. Viral Genetics will pay to T&T a management fee based on gross sales of Viral Genetics products in Africa. Distributors will pay an amount to us for product based on its final selling price, with a minimum guaranteed price. Pursuant to the settlement of a terminated license, we are obligated to pay a former licensee a royalty of 2.5% of the net sales of VGV-1 in Africa for a period of 20 years commencing from the first commercial sale of VGV-1 in Africa.

The human clinical trial we are now conducting in South Africa was authorized by the South African Medicines Control Council (“MCC”) in February 2004. It is a multi-center, randomized, double-blind, placebo-controlled study of VGV-1 treated HIV-infected subjects This study will examine subjects with CD4+ counts of 250-500 at 7 test centers throughout South Africa and is designated by the MCC as a Phase III study. We have completed enrollment of 135 subjects. The primary endpoint for the study is the decrease in viral load as measured by PCR-RNA assay. Other endpoints include CD4+ T cell counts and PBMC culture assays. Patients will receive 16 intra-muscular injections over a 51-day period, and will be followed up post-treatment to day 240. Therefore, unless the protocol is amended, which we do not expect, we anticipate completion of all follow up testing by the fourth calendar quarter of 2005. The study is being administered by Virtus Clinical Development Services, a leading South African contract research organization.

The study also includes extensive immunological assays designed to detect a potential immune response associated with VGV-1 in an effort to further advance our understanding of its mechanism of action.

Manufacturing and Raw Materials

The Company has historically produced VGV-1 for clinical trials and testing purposes in-house or through a subcontracted manufacturer. Using our temporary clean room and existing equipment, we can produce small-scale quantities of VGV-1 for preclinical research purposes. Upon completion of construction at our new facility and finalization of current Good Manufacturing Practices (“cGMP”) documentation, the Company will be able to produce larger batches of VGV-1 suitable for clinical study. The production of such larger batches will require the purchase of additional processing equipment to increase capacity.

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The Azusa facility is designed to have a maximum capacity sufficient to meet early commercial sales of VGV-1, and to support large-scale clinical trials. It is also designed to allow for production of other sterile biologic products.

Design, engineering, permitting, and construction costs of the Azusa facility are estimated at a total of approximately $850,000. Renovations are expected to be completed in 2005.

In order to retain control of certain proprietary processes, the Company intends to complete early stages of production of VGV-1 for the foreseeable future. Later stages of manufacturing, including bottling, labeling, and packaging, will be contracted out to an approved subcontractor.

Proprietary Rights

In the aggregate, considering the vigorous competition among drug manufacturers and the competition we might expect should any of our drug candidates prove to be accepted, our patent and related intellectual property rights are of material importance to our proposed business in the United States and other countries. The patent rights we consider significant in relation to our business as a whole are covered by U.S. patent application number 608/641,936, Compositions and Methods for Detecting and Treating Immunodeficiency Syndrome, which is now pending. These patent rights have been approved in Armenia, Austria, Australia, Azerbaijan, Bulgaria, Belarus, Canada, Switzerland, Germany, Denmark, Eurasia, EPC, Spain, France, Great Britain, Hong Kong, Ireland, Israel, Italy, Kyrgyzstan, Kazakhstan, Liechtenstein, Monaco, Moldova, Netherlands, New Zealand, Russia, Tajikistan, and Turkmenistan. We have also filed for these patent rights in Argentina, Brazil, China, Japan, and South Africa. We are continually evaluating whether additional applications may be appropriate to protect extensions and variations of our product, and have filed additional applications and provisional patents related thereto.

Under international agreements in recent years, global protection of intellectual property rights is improving. The General Agreement on Tariffs and Trade requires participant countries to amend their intellectual property laws to provide patent protection for pharmaceutical products by the end of a ten-year transition period. A number of countries are doing this. Patent protection in other countries where we have registered patents, including, the European Patent Office, The Eurasian Patent Organization, New Zealand, Australia, and Israel, extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage and the availability of legal remedies in the country.

The expiration of a product patent or loss of patent protection resulting from a legal challenge would be expected to result in significant competition from generic products against the covered product and, particularly in the U.S., could result in a significant reduction in sales of the pioneering product. If we were to lose patent protection, we may be able to continue to obtain commercial benefits from product manufacturing trade secrets, patents on use of our product, and patents on processes and intermediates for the economical manufacture of the active ingredients. The effect of product patent expiration or loss also depends upon the nature of the market and the position of the product in it, the growth of the market, the complexities and economics of manufacture of the product, and the requirements of generic drug laws.

Competition

Competition is intense in the pharmaceutical business and includes many large and small competitors. Technological innovations affecting efficacy, safety, patient ease of use, and cost effectiveness by other pharmaceutical companies with greater financial and research resources working on competitive products could result in products that offer the same or similar benefits as our products. We intend to compete with existing products on the basis of product quality and efficacy, product safety, economic benefit, and/or promotion directly and through distributor relationships we are now forming.

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HIV/AIDS

There are currently 26 drugs approved for the treatment of HIV-infection by the United States FDA. The three primary classes of treatment are Nonnucleoside Reverse Transcriptase Inhibitors (“NNRTIs”); Nucleoside Analog Reverse Transcriptase Inhibitors (“NRTIs”), and Protease Inhibitors (“PIs”). Fusion or Entry Inhibitors are a newer, less commonly-used class of anti-HIV medications. There are an estimated 50-60 HIV treatments under various stages of development worldwide.

Combination therapy with 2 or more of the drugs from the 3 primary classes of anti-HIV medications is the standard of care for HIV, and this is known as Highly-Active Antiretroviral Therapy or “HAART”. HAART slows multiplication of the virus and delays the onset of AIDS, but does not cure HIV infection or cure AIDS. HAART drug regimens are complex, often requiring 10 or more pills a day; expensive, costing upwards of $10,000-$15,000 per patient per annum in the United States; and are associated with moderate to severe gastro-intestinal, neurological, and hematological side effects that adversely impact the patient’s quality of life. Furthermore, HIV patients who use the drugs for a long period of time tend to develop resistance to the drugs, resulting in the drugs becoming less effective and engendering resistant strains of the HIV virus. Studies indicate that 70% of patients receiving standard HAART are resistant to one or more of the primary classes of HIV/AIDS drugs and 11-18% are resistant to all three primary classes of antiretrovirals ( Source: Rapid Report, XIII International HIV Drug Resistance Workshop, June 2004 ).

It is estimated by UNAIDS that approximately 50% of the estimated 940,000 to 2.23 million HIV positive patients in the USA and Western Europe are receiving HAART. Based on estimates of drug resistance, we estimate the size of the market for salvage therapies in these regions to be approximately 50,000 to 200,000. Given growth in the number of HIV cases overall, increased usage of HAART, and continued development of resistance, we expect this market to continue to grow for the foreseeable future. Newer formulations of HAART, newer drugs within the 3 primary classes, and newer classes of drugs such as Fusion or Entry Inhibitors present competition for VGV-1, should it be approved. However, all current approaches to HIV treatment are believed to create resistance by their very nature, and we believe that an approach with success in resistant patients that is less likely itself to create resistance possesses a competitive advantage.

Government Regulation

Drug development is time consuming, expensive, and unpredictable. On average, only one out of many thousands of chemical compounds discovered by researchers proves to be both medically effective and safe enough to become an approved medicine. The process from discovery to regulatory approval can take many years; the FDA estimates an average of eight and a half years for this process. Drug candidates can fail at any stage of the process. Candidates may not receive regulatory approval even after many years of research, and products that have been approved and marketed can be ordered to be withdrawn from the market by regulatory authorities.

Pharmaceutical companies are subject to extensive regulation by numerous national, state and local agencies. Of particular importance is the FDA in the United States. It has jurisdiction over virtually all of our business and administers requirements covering the testing, safety, effectiveness, approval, manufacturing, labeling, marketing, advertising and post-marketing surveillance of our pharmaceutical products.

The typical path of drug development in the USA is to file an Investigational New Drug Application, which includes comprehensive data related to the toxicity and pharmacology of the drug candidate. In most cases, this data will have been obtained through animal testing, although in some cases it will include human testing data from outside the USA. Typically, if the candidate is deemed to be free of major harmful side effects or has an acceptable level of side effects, is a well-characterized substance, and its functioning is reasonably well understood, the FDA will grant permission to conduct a Phase I human clinical trial provided that the sponsor adhere to certain ethical principles. Phase I trials involve relatively small numbers of subjects (usually 20-80) and are intended to establish the safety of the candidate in humans, determine safe dosage ranges, and identify side effects. A Phase I human clinical trial typically requires less than a year to complete although there are exceptions.

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Following successful Phase I trials, the candidate will typically be tested in a Phase II human clinical trial. A Phase II trial is intended to further establish the safety of the candidate, as well as obtain certain data related to the efficacy of the candidate. The number of subjects tested is usually 100-300, although sample sizes vary on a case by case basis. Sometimes, more than one Phase II trial can be required. Successful completion of Phase II trials is sometimes referred to as “proof of concept.” It is at this point, prior to Phase III, that many drug development companies seek to license the drug candidate or joint venture.

Finally, following successful Phase II trials, a drug typically moves on to Phase III trials which are very large and expensive studies in which usually 1,000-3,000 subjects are tested at a number of locations in an attempt to establish the efficacy of the candidate, to further monitor side effects and to compare the candidate against existing approved treatments. Following a successful Phase III study, the sponsor of the candidate will file a New Drug Application (“NDA”) or Biologics License Application (“BLA”), depending on the nature of the drug candidate, seeking permission to market the product in the USA.

The FDA will continue to require the collection of data following such approval, and this is typically referred to as Phase IV.

According to the FDA’s “Guidelines for Industry: Acceptance of Foreign Clinical Trials,” the results from human clinical trials conducted outside of the United States but not under an IND can be included in submissions to the FDA if the trials were conducted in accordance with the ethical principles of the Declaration of Helsinki. The trial must also be designed to be otherwise consistent with the FDA’s standards of clinical practice.

According to the FDA’s guidance document “Antiretroviral Drugs Using Plasma HIV RNA Measurements – Clinical Considerations for Accelerated and Traditional Approval”, the FDA has developed a systematic approach to the evaluation of HIV therapies. Treatments seeking accelerated approval must demonstrate a significant reduction in RNA viral load (PCR is one means of detecting HIV RNA) within a 24-week period, whereas treatments seeking traditional approval must demonstrate significant reduction in RNA viral load over a 48 week period. The FDA also considers changes in CD4+ counts consistent with observed HIV RNA changes in both approval processes.

A treatment may be considered for accelerated approval if it is targeting a serious or life-threatening disease, there is a testable indicator that is predictive of clinical benefit (such as HIV RNA in the case of HIV infection) and there must be a demonstrable improvement in activity relative to existing therapies in a population in need of additional therapeutic options. Other bases for accelerated approval include a novel mechanism of action, improved efficacy or safety or tolerability, more convenient dosing schedule, different cross-resistance profile, favorable drug-drug interaction profile, or utility in a specific population in need. This document reveals that the majority of accelerated approvals rely on safety data for 400-500 patients who have received the proposed marketing dose for at least 6 months. Further, efficacy data must include at least 2 well-designed and controlled studies a minimum of 24 weeks in length. If granted accelerated approval, the FDA usually requires that the treatment be studied continuously to monitor side effects, adverse events, and longer term clinical benefit. In connection with preparing our IND for the FDA, we will evaluate whether to pursue the accelerated approval process for VGV-1.

Since 1998, the approval of new drugs across the European Union (“EU”) is possible only using the European Medicines Evaluation Agency’s (“EMEA”) mutual recognition or central approval processes. The use of either of these procedures provides a more rapid and consistent approval within the member states than was the case when the approval processes were operating independently within each member state. In addition, the agreement between the EU and 12 other European states to base their approvals on the centralized EU approval will significantly speed the regulatory process in those countries. The EMEA does not, however, have jurisdiction over patient reimbursement or pricing matters in EU member countries. We will be required to deal with individual countries on such issues.

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In South Africa, the study and approval of drugs comes under the authority of the Medicines Control Council or MCC. In China, the State Food and Drug Administration or SFDA is responsible for drug regulation. Both the SFDA and MCC evaluate drugs for safety and efficacy in general compliance with ICH guidelines adopted by most of the world’s developed nations.

In recent years in the US, various legislative proposals have been offered at the federal and state levels that would bring about major changes in the affected health care systems. Some states have passed such legislation, and further federal and state proposals are possible. Such proposals and legislation include, and future proposals could include, price or patient reimbursement constraints on medicines, increases in required rebates or discounts and restrictions on access to certain products. Similar issues exist in many foreign countries where we may do business. We cannot predict the outcome of such initiatives, but we will work to maintain patient access to our products and to oppose price constraints.

In the US federal proposals have called for substantial changes in the Medicare program, and federal and state proposals have called for substantial changes in the Medicaid program. If such changes are enacted, they may require significant reductions from currently projected government expenditures for these programs. Driven by budget concerns, Medicaid managed care systems have been implemented in many states. If the Medicare and Medicaid programs implement changes that restrict the access of a significant population of patients to our products, our business could be materially affected. On the other hand, relatively little pharmaceutical use is currently covered by Medicare. If changes to these programs shift patients to managed care organizations that cover pharmaceuticals, or if an outpatient drug benefit is added to Medicare, usage of pharmaceuticals could increase. Pressure to lower prices would likely ensue in either case given the enhancement of the purchasing power of the managed care organizations or the federal government.

US law requires us to give rebates to state Medicaid agencies based on each state’s reimbursement of pharmaceutical products under the Medicaid program. Some states are seeking rebates in excess of the amounts required by federal law. We also must give discounts or rebates on purchases or reimbursements of pharmaceutical products by certain other federal and state agencies and programs. Rebates potentially could be viewed as price discounts without appreciable increases in volume as an offset.

We will encounter similar regulatory and legislative issues in most other countries. In Europe and some other international markets, the government provides health care at low direct cost to consumers and regulates pharmaceutical prices or patient reimbursement levels to control costs for the government-sponsored health care system. This international patchwork of price regulation has led to inconsistent prices and could lead to some third-party trade in our products from markets with lower prices. Such trade exploiting price differences between countries could undermine our sales in markets with higher prices.

Human Resources

We presently have 2 full-time executive officers, 1 senior manager, and 2 administrative employees. We also currently have 2 full-time senior consultants and 3 part-time junior consultants focused on operations, compliance, process validation, quality control, and GMP-related documentation. Our Chinese subsidiary is managed by a full-time executive officer, who also has 2 full-time administrative employees. The Company also relies on consulting and advisory relationships with several individuals and firms where a full-time person is not warranted. There are currently 12 entities providing services to the Company as consultants or advisors in areas including domestic and foreign government relations, regulatory affairs, investor relations, public relations, public health issues, finance, corporate and business development, immunology, biochemistry, intellectual property, and other areas.

Risks Associated With Our Business

Notwithstanding our efforts to foresee and mitigate the effects of changes in our business and industry, we cannot predict with certainty all potential changes that might affect our business. Consequently, our business is subject to a number of risks, some of which are as follows.

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We have a history of operating losses. We expect to incur net losses and we may never achieve or maintain profitability.

We have not been profitable since our inception. We reported net losses of approximately $6.9 million and $4.4 million for the years ended 2004 and 2003, respectively. As of December 31, 2004, we had an accumulated deficit of approximately $21.5 million. We have not generated any revenue from product sales or royalties from product sales to date, and it is possible that we will never have significant product sales revenue or royalty revenue. We expect to continue to incur losses for at least the next several years as we and our collaborators pursue clinical trials and research and development efforts. To become profitable, we, either alone or with our collaborators, must successfully develop, manufacture, and market our current product candidates, particularly VGV-1, as well as continue to identify, develop, manufacture, and market new product candidates. It is possible that we will never have significant product sales revenue or receive significant royalties on our licensed product candidates.

We may need additional financing, but our access to capital funding is uncertain.

Our current and anticipated operations, particularly our product development and commercialization programs for VGV-1, require substantial capital. We expect that our existing cash and cash equivalents will sufficiently fund our current and planned operations through at the third quarter of 2005. However, our future capital needs will depend on many factors, including the extent to which we enter into collaboration agreements with respect to any of our proprietary product candidates and make progress in our internally funded research, development and commercialization activities. Our capital requirements will also depend on the magnitude and scope of these activities, our ability to maintain existing and establish new collaborations, the terms of those collaborations, the success of our collaborators in the future to develop and market products under their respective collaborations with us, our success in producing clinical and commercial supplies of our product candidates on a timely basis and in sufficient quantities to meet our requirements, competing technological and market developments, the time and cost of obtaining regulatory approvals, the extent to which we choose to commercialize our future products through our own sales and marketing capabilities, and the cost of preparing, filing, prosecuting, maintaining and enforcing patent and other rights. We do not have committed external sources of funding, and we cannot assure you that we will be able to obtain additional funds on acceptable terms, if at all. If adequate funds are not available, we may be required to:

Engage in equity financings that would be dilutive to current stockholders;
     
Delay, reduce the scope of, or eliminate one or more of our development programs;
 
Obtain funds through arrangements with collaborators or others that may require us to relinquish rights to technologies, product candidates or products that we would otherwise seek to develop or commercialize ourselves; or
 
License rights to technologies, product candidates, or products on terms that are less favorable to us than might otherwise be available.

If funding is insufficient at any time in the future, we may not be able to develop or commercialize our products, take advantage of business opportunities or respond to competitive pressures.

Failure of T&T to obtain government approvals and implement distribution would reduce our prospective revenue and make us more dependent on outside financing sources.

We are reliant on the efforts of T&T to pursue clinical testing and governmental approvals and to establish distribution arrangements in all of Africa. Africa represents a major market for VGV-1 because of the epidemic proportions of HIV and Aids in Africa. If T&T does not dedicate sufficient resources to effecting distribution of VGV-1 or fails in its marketing efforts, the revenues we would expect to receive from such a large market could be substantially diminished and our business and operating results will be adversely affected.

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We have not developed any commercial drugs, and we may never develop any commercial drugs or products that generate revenues.

Our existing product candidates will require significant additional development, clinical trials, regulatory clearances and additional investment before they can be commercialized. Our product development efforts may not lead to commercial drugs for a number of reasons, including the failure of our product candidates to be safe and effective in clinical trials or because we have inadequate financial or other resources to pursue the programs through the clinical trial process. We do not expect to be able to market VGV-1 for at least a year or longer, if at all.

We are substantially dependent on our ability to successfully and timely complete clinical trials and obtain regulatory approval to market our most advanced product candidate, VGV-1. Our business will be materially harmed and our stock price adversely affected if regulatory approval is not obtained with respect to this product candidate.

We have filed a drug import application in China for sale of VGV-1 to late stage AIDS patients and we are pursuing a Phase III clinical trial in South Africa. We hope to file an IND with the FDA in 2005. We are also conducting other laboratory testing and research to support the filing of the IND. Our success will depend, to a great degree, on our ability to obtain the requisite regulatory approval to market VGV-1, initially overseas and then in the US. The process of obtaining regulatory approvals is costly, time consuming, uncertain, and subject to unanticipated delays. In order to obtain the necessary regulatory approval, we must demonstrate with substantial evidence from well-controlled clinical trials and to the satisfaction of the applicable regulatory reviewing agency that VGV-1 is both safe and efficacious. While we have completed clinical trials in China and Mexico and are pursuing a Phase III clinical trial in South Africa, there is no assurance that any regulatory agency will accept and rely on the results of these studies and determine that the applicable regulatory requirements for approval have been met. We cannot predict the ability of our third party service providers to collect the data from our trials with VGV-1, analyze the data, and deliver their final reports to us. There may be significant delays in this process. Regulatory authorities may require additional testing for safety and efficacy, which would result in a substantial delay in the regulatory approval process. If we fail to successfully obtain regulatory approvals for VGV-1 or we face significant delays, our business will be materially harmed and our stock price will be adversely affected.

We intend to establish a manufacturing facility for VGV-1 used in our clinical trials and planned for use in our commercial launch of our products. Product introductions may be delayed or suspended and commercial sales may be restricted, if the manufacture of our products is delayed or interrupted.

We do not have manufacturing facilities to produce sufficient supplies of VGV-1 to support commercial launch of this product, if approved overseas for distribution. We are in the process of developing a research and manufacturing facility that would enable us to meet these product supply needs. Design, engineering, permitting, and construction costs of the facility will require us to fund $850,000, and we plan to have the process complete in 2005. If we encounter delays or difficulties in funding the project or completing the construction, we may not have sufficient product support commercial launch of our product overseas, if approved.

We depend on various suppliers to supply the bovine thymus gland material we use to produce VGV-1. We believe these suppliers can produce sufficient material to support initial commercial launch of VGV-1 overseas, if approved. While we believe there are a number of alternative sources for this material, it is possible that the failure of these suppliers to supply thymus gland material as needed for manufacturing of VGV-1 would cause a disruption of the production schedule until alternative sources are located and material from these sources delivered on a schedule that meets our production obligations. Any such disruptions, if they continue too long, could materially harm our business and financial condition.

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Clinical trials are long, expensive and uncertain processes and overseas regulators and the FDA may ultimately not approve any of our product candidates. We cannot assure you that data collected from preclinical and clinical trials of our product candidates will be sufficient to support approval by overseas regulators or the FDA, the failure of which could delay our profitability and adversely affect our stock price.

All of our research and development programs are at an early stage, except for the human clinical trials on VGV-1 conducted overseas. Clinical trials are long, expensive, and uncertain processes. Clinical trials may not be commenced or completed on schedule, and government regulators may not ultimately approve our product candidates for commercial sale. Further, even if the results of our preclinical studies or clinical trials are initially positive, it is possible that we will obtain different results in the later stages of drug development or that results seen in clinical trials will not continue with longer-term treatment. Drugs in late stages of clinical development may fail to show the desired safety and efficacy traits despite having progressed through initial clinical testing. For example, positive results in early Phase I or Phase II clinical trials may not be repeated in larger Phase II or Phase III clinical trials. All of our potential drug candidates are prone to the risks of failure inherent in drug development. The clinical trials of any of our drug candidates, including VGV-1, could be unsuccessful, which would prevent us from commercializing the drug. Our failure to develop safe, commercially viable drugs would substantially impair our ability to generate revenues and sustain our operations and would materially harm our business and adversely affect our stock price.

If we fail to maintain our existing or establish new collaborative relationships, or if our collaborators do not devote adequate resources to the development and commercialization of our licensed drug candidates, we may have to reduce our rate of product development and may not see products brought to market or be able to achieve profitability.

Our primary strategy for distributing our products is to enter into various relationships with other firms or companies overseas with the resources to pursue the process of obtaining regulatory approvals and implement marketing and distribution. We have not settled on any strategy for distribution in the US and do not expect to formulate a strategy until an IND is issued and/or clinical trials in the US have progressed. We have granted exclusive commercialization and marketing rights to T&T in Africa and will likely establish similar arrangements for other parts of the world. T&T has, and our other collaborators will likely have, full control over those efforts in their territories and the resources they commit to the programs, except for initial funding requirements imposed on our collaborators to fund the regulatory approval process. Accordingly, the success of the commercialization of our products in those territories depends on their efforts and is beyond our control. For us to receive any significant revenues from sale of our products, our collaborators must advance drugs through clinical trials, establish the safety and efficacy of our drug candidates, obtain regulatory approvals and achieve market acceptance of those products. As a result, if a collaborator elects to terminate its efforts, our ability to commercialize our products in the collaborator’s territory may be significantly impaired.

Because of the uncertainty of pharmaceutical pricing, reimbursement, and healthcare reform measures, we may be unable to sell our products profitably.

The availability of reimbursement by governmental and other third-party payors affects the market for any pharmaceutical product. These third-party payors continually attempt to contain or reduce the costs of healthcare. There have been a number of legislative and regulatory proposals to change the healthcare system and further proposals are likely. Significant uncertainty exists with respect to the reimbursement status of newly approved healthcare products. In addition, third-party payors are increasingly challenging the price and cost-effectiveness of medical products and services. We might not be able to sell our products profitably or recoup the value of our investment in product development if reimbursement is unavailable or limited in scope.

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As a result of intense competition and technological change in the pharmaceutical industry, the marketplace may not accept our products, and we may not be able to complete successfully against other companies in our industry and achieve profitability.

Many of our competitors have drug products that have already been approved or are in development, and operate large, well-funded research and development programs in these fields. Many of our competitors have substantially greater financial and management resources, superior intellectual property positions and greater manufacturing, marketing and sales capabilities, areas in which we have limited or no experience. In addition, many of our competitors have significantly greater experience than we do in undertaking preclinical testing and clinical trials of new or improved pharmaceutical products and obtaining required regulatory approvals. Consequently, our competitors may obtain FDA and other regulatory approvals for product candidates sooner and may be more successful in manufacturing and marketing their products than we or our collaborators.

Existing and future products, therapies and technological approaches will compete directly with the products we seek to develop. Current and prospective competing products may provide greater therapeutic benefits for a specific problem, may offer easier delivery or may offer comparable performance at a lower cost. Any product candidate that we develop and that obtains regulatory approval must then compete for market acceptance and market share. Our product candidates may not gain market acceptance among physicians, patients, healthcare payors and the medical community. Further, any products we develop may become obsolete before we recover any expenses we incurred in connection with the development of these products. As a result, we may never achieve profitability.

We may be unable to obtain patents to protect our technologies from other companies with competitive products, and patents of other companies could prevent us from manufacturing, developing or marketing our products.

The patent positions of pharmaceutical and biotechnology firms are uncertain and involve complex legal and factual questions. The U.S. Patent and Trademark Office has not established a consistent policy regarding the breadth of claims that it will allow in biotechnology patents. If it allows broad claims, the number and cost of patent interference proceedings in the U.S. and the risk of infringement litigation may increase. If it allows narrow claims, the risk of infringement may decrease, but the value of our rights under our patents, licenses and patent applications may also decrease. In addition, the scope of the claims in a patent application can be significantly modified during prosecution before the patent is issued. Consequently, we cannot know whether our pending applications will result in the issuance of patents or, if any patents are issued, whether they will provide us with significant proprietary protection or will be circumvented, invalidated, or found to be unenforceable. Until recently, patent applications in the United States were maintained in secrecy until the patents issued, and publication of discoveries in scientific or patent literature often lags behind actual discoveries. Patent applications filed in the United States after November 2000 generally will be published 18 months after the filing date unless the applicant certifies that the invention will not be the subject of a foreign patent application. We cannot assure you that, even if published, we will be aware of all such literature. Accordingly, we cannot be certain that the named inventors of our products and processes were the first to invent that product or process or that we were the first to pursue patent coverage for our inventions.

Our commercial success depends in part on our ability to maintain and enforce our proprietary rights. If third parties engage in activities that infringe our proprietary rights, our management’s focus will be diverted and we may incur significant costs in asserting our rights. We may not be successful in asserting our proprietary rights, which could result in our patents being held invalid or a court holding that the third party is not infringing, either of which would harm our competitive position. In addition, we cannot assure you that others will not design around our patented technology.

Moreover, we may have to participate in interference proceedings declared by the United States Patent and Trademark Office or other analogous proceedings in other parts of the world to determine priority of invention and the validity of patent rights granted or applied for, which could result in substantial cost and delay, even if the eventual outcome is favorable to us. We cannot assure you that our pending patent applications, if issued, would be held valid or enforceable. Additionally, many of our foreign patent applications have been published as part of the patent prosecution process in such countries. Protection of the rights revealed in published patent applications can be complex, costly and uncertain.

15


We also rely on trade secrets, know-how and confidentially provisions in our agreements with our collaborators, employees and consultants to protect our intellectual property. However, these and other parties may not comply with the terms of their agreements with us, and we might be unable to adequately enforce our rights against these people or obtain adequate compensation for the damages caused by their unauthorized disclosure or use. Our trade secrets or those of our collaborators may become known or may be independently discovered by others.

Our products and product candidates may infringe the intellectual property rights of others, which could increase our costs and negatively affect our profitability.

Our success also depends on avoiding infringement of the proprietary technologies of others. In particular, there may be certain issued patents and patent applications claiming subject matter that we or our collaborators may be required to license in order to research, develop or commercialize our product candidates. In addition, third parties may assert infringement or other intellectual property claims against us based on our patents or other intellectual property rights. An adverse outcome in these proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed from third parties or require us to cease or modify our use of the technology. If we are required to license such technology, we cannot assure you that a license under such patents and patent applications will be available on acceptable terms or at all. Further, we may incur substantial costs defending ourselves in lawsuits against charges of patent infringement or other unlawful use of another’s proprietary technology.

We are subject to extensive government regulations that may cause us to cancel or delay the introduction of our products to market.

Our research and development activities and the clinical investigation, manufacture, distribution and marketing of drug products are subject to extensive regulation by governmental authorities in the United States and other countries. Prior to marketing in the United States, a drug must undergo rigorous testing and an extensive regulatory approval process implemented by the FDA under federal law, including the Federal Food, Drug and Cosmetic Act. To receive approval, we or our collaborators must, among other things, demonstrate with substantial evidence from well-controlled clinical trials that the product is both safe and effective for each indication where approval is sought. Depending upon the type, complexity and novelty of the product and the nature of the disease or disorder to be treated, that approval process can take several years and require substantial expenditures. Data obtained from testing are susceptible to varying interpretations that could delay, limit or prevent regulatory approvals of our products. Drug testing is subject to complex FDA rules and regulations, including the requirement to conduct human testing on a large number of test subjects. We, our collaborators or the FDA may suspend human trials at any time if a party believes that the test subjects are exposed to unacceptable health risks. We cannot assure you that any of our product candidates will be safe for human use. Other countries also have extensive requirements regarding clinical trials, market authorization and pricing. These regulatory schemes vary widely from country to country, but, in general, are subject to all of the risks associated with United States approvals.

If any of our products receive regulatory approval, the approval will be limited to those disease states and conditions for which the product is safe and effective, as demonstrated through clinical trials. In addition, results of pre-clinical studies and clinical trials with respect to our products could subject us to adverse product labeling requirements which could harm the sale of such products. Even if regulatory approval is obtained, later discovery of previously unknown problems may result in restrictions of the product, including withdrawal of the product from the market. Further, governmental approval may subject us to ongoing requirements for post-marketing studies. Even if we obtain governmental approval, a marketed product, its respective manufacturer and its manufacturing facilities are subject to unannounced inspections by the FDA and must comply with the FDA’s cGMP and other regulations. These regulations govern all areas of production, record keeping, personnel and quality control. If a manufacturer fails to comply with any of the manufacturing regulations, it may be subject to, among other things, product seizures, recalls, fines, injunctions, suspensions or revocations of marketing licenses, operating restrictions and criminal prosecution. Other countries also impose similar manufacturing requirements.

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If product liability claims are brought against us or we are unable to obtain or maintain product liability insurance, we may incur substantial liabilities that could reduce our financial resources.

The clinical testing and commercial use of pharmaceutical products involves significant exposure to product liability claims. We have obtained limited product liability insurance coverage for our clinical trials on humans, however, our insurance coverage may be insufficient to protect us against all product liability damages. Further, liability insurance coverage is becoming increasingly expensive and we might not be able to obtain or maintain product liability insurance in the future on acceptable terms or in sufficient amounts to protect us against product liability damages. Regardless of merit or eventual outcome, liability claims may result in decreased demand for a future product, injury to reputation, withdrawal of clinical trial volunteers, loss of revenue, costs of litigation, distraction of management and substantial monetary awards to plaintiffs. Additionally, if we are required to pay a product liability claim, we may not have sufficient financial resources to complete development or commercialization of any of our product candidates and our business and results of operations will be adversely affected.

Our operations involve hazardous materials and we must comply with environmental laws and regulations, which can be expensive and restrict how we do business.

Our research and development activities may involve the controlled use of hazardous materials and other potentially dangerous chemicals and biological agents. Although we believe our safety procedures for these materials comply with governmental standards, we cannot entirely eliminate the risk of accidental contamination or injury from these materials. We currently have insurance, in amounts and on terms typical for companies in businesses that are similarly situated, that could cover all or a portion of a damage claim arising from our use of hazardous and other materials. However, if an accident or environmental discharge occurs, and we are held liable for any resulting damages, the associated liability could exceed our insurance coverage and our financial resources.

Item 2. Description of Property.

Our main corporate office, located at 1321 Mountain View Circle in Azusa, California, is leased. We are currently engaged in the renovation of this building to accommodate a cGMP manufacturing facility suitable for clinical study and early market-entry production of VGV-1. This facility will also allow the manufacture of other biologic products. We have also leased the adjacent facility at 1291 Mountain View Circle, and will be using it for additional office space. It currently houses our temporary clean room, which we use for research and development. Following completion of renovations of 1321 Mountain View Circle, the 1291 facility is intended to house our quality control laboratory and to accommodate a small research and development lab.

Item 3. Legal Proceedings.

No legal proceedings are pending against Viral Genetics or any of its officers or directors.

Item 4. Submission of Matters to a Vote of Securities Holders.

On October 23, 2004 stockholders of Viral Genetics holding 51.1 percent of our outstanding common stock signed a written consent of stockholders approving an amendment to the certificate of incorporation of Viral Genetics increasing the authorized number of our common shares from 80,000,000 shares to 250,000,000 shares.




17


PART II

Item 5. Market for Common Equity and Related Stockholder Matters.

Viral Genetics’ common stock is traded on the Over the Counter Bulletin Board (“OTCBB”) market, under the symbol “VRAL”. As of March 30, 2005 we had approximately 363 direct shareholders of record.

The following quotations, as provided by the OTC Bulletin Board, Nasdaq Trading & Market Services, represent prices between dealers and do not include retail markup, markdown or commission. In addition, these quotations do not represent actual transactions.

Calendar Quarter Ended High Bid ($) Low Bid ($)

March 31, 2003 0.55 0.08
June 30, 2003 1.00 0.22
September 30, 2003 0.55 0.27
December 31, 2003 1.01 0.32
March 31, 2004 1.00 0.46
June 30, 2004 0.72 0.33
September 30, 2004 0.88 0.35
December 31, 2004 0.72 0.31

Item 6. Management’s Discussion and Analysis or Plan of Operation.

Plan of Operation

Background

Viral Genetics, Inc., the Company’s subsidiary (“VGI”), was founded in 1995 to discover, develop, and commercialize a series of proprietary proteins. Our research interests include infectious disease – in particular, HIV infection and AIDS – autoimmune conditions and immunological deficiency. In October 2001, all of the issued and outstanding common stock of VGI was acquired by Viral Genetics, Inc., a Delaware corporation.

At the core of our technology is Thymus Nuclear Protein or TNP – a processed extract of mammalian thymus tissue. We have conducted 4 human clinical trials of the lead drug candidate developed from this compound, VGV-1, outside of the United States to examine its safety and efficacy as a treatment for HIV and AIDS. We view TNP as a platform technology following anecdotal observations of other potential applications of the TNP technology.

During and after our human clinical trials, we observed that some test subjects suffering from other clinical conditions and diseases reported anecdotal improvements in their symptoms. We have therefore elected to distinguish VGV-1 from other potential applications of Thymus Nuclear Protein for future research.

Historically, we have allocated the majority of our efforts to the development of VGV-1 and we expect to continue to do so in the immediate future. Further, due to managements’ ties to and experience in foreign markets, we actively pursued clinical development of VGV-1 in markets outside the United States with the goal of attaining commercialization leading to sales and/or licensing with distribution partners.

This strategy resulted in the Company completing 4 human clinical trials of VGV-1 outside the United States, and most recently a 34-patient prospective study in the People’s Republic of China. We have now completed enrollment of a fifth human clinical trial of VGV-1 in the Republic of South Africa, a Phase III study of 135 patients.

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Our primary corporate goal is to pursue development of our drug candidates, starting with VGV-1, through Phase II in the United States and to seek licensing or joint venturing with a partner with global manufacturing, marketing and distribution capabilities.

We are working through various testing related to VGV-1‘s mechanism of action and characterization that we believe is necessary to complete and enhance our IND application. Although it is not strictly required for safety evaluation, this data would further support our request to begin human trials in the USA.

Contemporaneously, we plan to continue to seek commercial registration in China and South Africa, where we are in advanced stages of clinical development and where we believe the demand for VGV-1 will be strongest. We have suspended all activity in Mexico indefinitely.

In December 2004, we entered into a Distribution Management Agreement with Timothy & Thomas LLC, (“T&T”). The Distribution Agreement grants to T&T the exclusive right to establish, appoint, and manage distribution and sub-distribution of all Viral Genetics products that are used or useful for the prevention or treatment of HIV and/or AIDS in continental Africa and certain island nations off the coast of Africa. The term of the Distribution Agreement is 20 years. In consideration for these rights, T&T made a payment of $650,000 in cash to Viral Genetics, surrendered for cancellation a convertible debenture in the principal amount of $200,000 originally issued in the name of Thomas Little, and agreed to pay the expenses incurred to complete the on-going clinical trial of VGV-1 in South Africa up to a maximum threshold amount beyond which we are required to pay for 50% of all expenses. Additional expenses related to the establishment of distribution in Africa over and above the South African clinical trial will also be shared by T&T and the Company.

As contemplated by the Distribution Agreement, T&T will establish distributors in each African country who will purchase our HIV/AIDS products directly from us and distribute those products in their respective countries. Viral Genetics will pay to T&T a management fee based on gross sales of Viral Genetics products in Africa. Distributors will pay an amount to us for product based on its final selling price, with a minimum guaranteed price.

The human clinical trial we are now conducting in South Africa was authorized by the South African Medicines Control Council (“MCC”) in February 2004. It is a multi-center, randomized, double-blind, placebo-controlled study of VGV-1 treated HIV-infected subjects. This study will examine subjects with CD4+ counts of 250-500 at 7 test centers throughout South Africa and is designated by the MCC as a “Phase III study”. We have now completed enrollment of 135 subjects. The primary endpoint for the study is the decrease in viral load as measured by PCR-RNA assay. Other endpoints include CD4+ counts and PBMC culture assays. Patients will receive 16 intra-muscular injections over a 51-day period, and will be followed up post-treatment to day 240. Therefore, unless the protocol is amended, which we do not expect, we anticipate completion of all follow up testing and receipt of data by the fourth calendar quarter of 2005. The study is being administered by Virtus Clinical Development Services, a leading South African contract research organization. The study also includes extensive immunological assays designed to detect a potential immune response associated with VGV-1 in an effort to further advance our understanding of its mechanism of action.

If the South African trial is successful, we intend to support an application to seek registration of VGV-1 in South Africa in 2006.

In January 2005, we completed the design and engineering plan for the renovation of our 1321 Mountain View Circle facility. We have begun construction. We expect to be completed construction in 2005 at which time the facility will be capable of supporting cGMP manufacture of VGV-1 for clinical trial purposes although to produce larger quantities of VGV-1 we will be required to add additional manufacturing equipment. We require the completion of the facility to cGMP standards in order to support clinical trials in the USA, as well as to support commercial approval in China and South Africa.

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Through an Assignment of Patent Agreement dated August 1, 1995, VGI acquired all of the rights in the patents pertaining to Thymus Nuclear Protein (“TNP”), which is the basis of several of the Company’s drug candidates. The patents were acquired by VGI from Therapeutic Genetic, Inc., another California corporation (“TGI”), for a note in the principal amount of $6,250,000 (the “Note”) and a continuing royalty equal to 5 percent of the worldwide gross sales of products using the patented technology (the “Royalty). The stockholders of TGI were all of the same persons who were former stockholders of VGI prior to its acquisition by Viral Genetics in October 2001. The Royalty was assigned to a limited liability company with the same shareholders as TGI and TGI has no further interest in the Royalty.

On June 30, 2004, the Company, VGI and TGI entered into an Agreement and Plan of Merger whereby TGI would be merged with our California subsidiary Viral Genetics, Inc., which was the surviving corporation. On September 20, 2004 we filed documents with the state of California for the purpose of closing and effecting this merger. This had the effect of terminating our obligation to repay any indebtedness related to the Note or issue any securities under the Debt Restructuring Agreement dated May 22, 2003, between the Company and TGI

Pursuant to the merger the Company issued 24,708,580 shares of its common stock and warrants to purchase an additional 24,708,580 shares to the former stockholders of TGI for all capital stock of TGI. TGI no longer exists as a legal entity as a consequence of the merger. The 24,708,580 warrants issued to the former stockholders of TGI are exercisable at a price of $0.40 per share over a five-year period expiring on September 19, 2009. Prior to the merger TGI distributed to its stockholders on a pro rata basis options to purchase an additional 1,250,000 shares of the Company’s common stock.

The effect of this transaction was to convert the pre-existing debt obligation of $7.4 million of the Company to TGI, including accrued interest, to equity represented by the common stock and warrants of the Company. This decreased the Company’s liabilities and increased the Company’s equity by a corresponding amount. At the time of the transaction the sole asset of TGI was the Company’s convertible note.

From 1995 through 2002, certain directors of Viral Genetics have made loans and other advances to fund operations (the “Founders’ Notes”). In May 2003, the principal and accrued interest of the Founders’ Notes were restructured such that the due date of repayment was extended to May 22, 2008. It was also agreed that the holders of the Founders’ Notes could exchange the principal and accrued interest for Units of the Company at a price of $0.30 per Unit with each Unit consisting of one share of the common stock of the Company and one warrant to purchase one share of the common stock of the Company for $0.40 exercisable for 5 years. On August 5, 2004, the Founders’ Notes were assigned to Best Investment, Inc., a corporation of which Haig Keledjian, an officer and director, is the sole officer and director. As of December 31, 2004, the total principal and accrued interest on the Founder’s Notes was $2,156,543. If exchanged pursuant to the foregoing terms, the Company would issue to the holders of the Founder’s Notes 7,188,477 shares and 7,188,477 warrants.

At December 31, 2004, we had $1,402,169 of current assets, current liabilities of $569,421, and long-term liabilities of $1,943,605. We estimate that we will need to fund approximately $500,000 of research and development costs in the United States, $150,000 of patent work, $500,000 of administrative expenses and product manufacturing costs, and $850,000 of renovation expenses during 2005. Further, for our South African clinical trial, we will require an additional approximately $450,000 in capital.

Item 7. Financial Statements.

The financial statements of Viral Genetics appear at the end of this report beginning with the Index to Financial Statements on page 30.



Item 8. Changes In and Disagreements with Accountants on Accounting andFinancial
Disclosure.

None.

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Item 8A. Controls And Procedures

With the participation of management, the chief executive officer and chief financial officer of Viral Genetics evaluated its disclosure controls and procedures as of December 31, 2004. Based on this evaluation, the chief executive officer and the chief financial officer concluded that the disclosure controls and procedures are effective in connection with Viral Genetics’ filing of its annual report on Form 10-KSB for the year ended December 31, 2004.
 
During the fourth quarter of the year ended December 31, 2004, there were no significant changes in Viral Genetics’ internal controls or in other factors that could significantly affect these controls, and no significant deficiencies or material weaknesses of internal controls that would require corrective action were identified during that period.

Item 8B. Other Information

 
Not applicable.

PART III

Item 9. Directors and Executive Officers of the Registrant

Directors and Officers

The following table sets forth the names, ages, and positions for each of the directors and officers of Viral Genetics.
   
  Name   Age   Positions   Since
  Haig Keledjian   42   Chief Executive Officer, Chief Financial   Officer, President, Secretary, and Director   October 2001
  Harry Zhabilov, Jr   38    Executive Vice President of Research and   Development, and Director   May 2003
  Hampar Karageozian   64    Director   October 2001
  Arthur Keledjian   37    Director   October 2001
 
The following is information on the business experience of each officer, director and director appointee.

Haig Keledjian

Mr. Keledjian has been instrumental in guiding the growth and development of Viral Genetics, Inc., having acted as its Chairman, CEO and President since its 1995 founding. He has overseen the Company’s completion of 4 human clinical trials, the approval of the ongoing Phase III trial in South Africa, the creation of the Company’s global intellectual property portfolio, and the financing of the Company including a substantial portion of his own assets. Mr. Keledjian formerly practiced tax and estate law and litigation in the State of California. He received his B.S. in Business and Accounting in 1983 from California State University (Los Angeles), followed by a Masters degree in taxation (MBT) from Golden Gate University in 1985. In 1989, Mr. Keledjian completed his undergraduate law studies by obtaining a B.S. in law from Glendale University and in 1991 obtained his Juris Doctorate from Glendale University. He was admitted to the bar of the State of California in 1993.

Harry Zhabilov, Jr.

Mr. Zhabilov, Jr. earned his Masters of Chemistry from the University of Sofia in 1997 and immediately began working with his late father, Dr. Zhabilov, Sr. – Viral Genetics, Inc. co-Founder and TNP’s discoverer. From October 1997 to December 1999, Harry worked with the Company on its Mexican human clinical trials. From January 2000, until May 2003, Harry worked side by side with his father as a research chemist for Viral Genetics. In May 2003, following his father’s passing, Harry was appointed Executive Vice President of Research and Development and was elected as a Director. Harry has been integral in the discovery and development of the Company’s drug candidates. Harry is a member of the American Institute of Chemical Engineers. His main roles are split between Research and Development, and production.
 
21

Hampar Karageozian

Mr. Karageozian received his Masters of Science from MIT in 1969, specializing in biochemistry, and his MBA from the University of California, Irvine in 1977. From 1994 until 2001, he was Senior Vice President of Discovery, Research and Development with ISTA Pharmaceuticals, Inc. where he invented and developed three products for the treatment of various opthamological conditions. From 1992 until 1994, Mr. Karageozian served as President and CEO of Prima Pharmaceutical Inc., a contract manufacturer of pharmaceuticals and related products. From 1970 until 1992, Mr. Karageozian held several progressively higher positions at Allergan Pharmaceuticals, starting as a research chemist and ultimately acting as Senior Vice President of Research and Development where he had responsibility for worldwide research, development, regulatory affairs and matrix marketing for lens care products with $400 million in total revenues. Mr. Karageozian has over 20 patents granted and pending, as well as over 70 developed drugs and devices. During his tenure at Allergan, Mr. Karageozian also managed regulatory and development initiatives in Europe and the Pacific Rim. He has written or collaborated on over 25 publications.

Arthur Keledjian

Arthur Keledjian obtained his B.S. in Marketing from California State University (Los Angeles) in June 1989, and has been employed by Farmers Insurance Group since then. Mr. Keledjian has also served as a volunteer peace officer for the City of Glendale Police Department since 1996. He is the brother of Haig Keledjian.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934 requires officers and Directors of Viral Genetics and persons who own more than ten percent of a registered class of Viral Genetics’ equity securities to file reports of ownership and changes in their ownership with the Securities and Exchange Commission, and forward copies of such filings to Viral Genetics. Based on the copies of filings received by Viral Genetics, during the most recent fiscal year, the directors, officers, and beneficial owners of more than ten percent of the equity securities of Viral Genetics registered pursuant to Section 12 of the Exchange Act, have filed on a timely basis, all required Forms 3, 4, and 5 and any amendments thereto, except for a Form 3 and Form 4 filed on behalf of one of our directors; a Form 5 for Therapeutic Genetics, Inc. related to options acquired through a consulting agreement in 2003, and a Form 4 for Therapeutic Genetics, Inc. related to options acquired through a consulting agreement in 2004.

Board and Committees; Code of Ethics

In the fiscal year ended December 31, 2004, the board of directors of the Company met 4 times and these meetings were attended by a quorum of the directors via teleconference. From time to time the directors also acted through written consents of the board. There are no standing committees of the board of directors. Due to the fact the Company is in the development stage with no operating revenue and activities limited to research and development, the board of directors determined that it is not necessary or practical for the Company to establish an audit committee, recruit a financial expert to serve on the board, or adopt an audit committee charter. Viral Genetics has adopted a Code of Ethics applicable to its principal executive officer and principal financial officer, a copy of which a copy of which will be provided to any person, free of charge, upon request. A request for a copy of the Code of Ethics should be in writing and sent to Haig Keledjian, President, 1321 Mountain View Circle, Azusa, CA 91702.




22


Item 10. Executive Compensation

Annual Compensation

The following table sets forth certain information regarding the annual and long-term compensation for services in all capacities to Viral Genetics for the prior fiscal years ended December 31, 2004, 2003, and 2002 of those persons who were either (i) the chief executive officer during the last completed fiscal year or (ii) one of the other four most highly compensated executive officers as of the end of the last completed fiscal year whose annual salary and bonuses exceeded $100,000 (collectively, the “Named Executive Officers”).

Annual
Compensation

Long Term
Compensation

Name and Principal Position
Year
Salary ($)
Securities
Underlying
Options/SARs (#)

All Other
Compensation ($)

Haig Keledjian 2004 136,556 1,800,000 0
  President, Chief Executive 2003 148,854 2,300,000 1,146
  And Financial Officer 2002 0 0 0
 
Harry Zhabilov, Jr 2004 162,841 1,800,000 32,432
  Executive Vice President of 2003 111,756 2,300,000 38,244
  Research and Development (1) 2002 0 0 0

(1)     Prior to 2003, Mr. Zhabilov, Jr. was employed by Viral Genetics in a non-Executive Officer capacity and he was paid less than $100,000 per annum, including salary and bonuses.

(2)     Represents cash payments made by Viral Genetics on the mortgage for the residence of Mr. Zhabilov.

Stock Options

The following table sets forth certain information with respect to grants of stock options during 2004 to the Named Executive Officers.

Name and Principal Position
Number of
Securities
Underlying
Options Granted

% of Total
Options/SARs
Granted to
Employees in
Fiscal Year

Exercise or
Base Price ($/Sh)

Expiration
Date

Haig Keledjian 1,800,000 44% 0.45 5/31/08
  President Chief Executive
  And Financial Officer
 
Harry Zhabilov, Jr 1,800,000 44% 0.45 5/31/08
  Executive Vice President of
  Research and Development



23


The following table sets forth certain information with respect to unexercised options held by the Named Executive Officers. No outstanding options held by the Named Executive Officers were exercised in 2003.

Number of Securities
Underlying Unexercised
Options
at Fiscal Year End (#)

Value of Unexercised
In-the-Money Options
At Fiscal Year End ($) (1)

Name and Principal Position
Exercisable/ Unexercisable
Exercisable/ Unexercisable
Haig Keledjian 4,100,000/ -0- -0- / -0-
  President Chief Executive
  And Financial Officer
 
Harry Zhabilov, Jr 4,100,000/ -0- -0- / -0-
  Executive Vice President of
  Research and Development

(1)   This value is determined on the basis of the difference between the fair market value of the securities underlying the options and the exercise price at December 31, 2004. The fair market value of Viral Genetics’s common stock at December 30, 2004, is determined by the last sale price on that date, which was $0.41 per share.

Employment Arrangements

On June 1, 2003 Viral Genetics entered into written employment agreements with Haig Keledjian and Harry Zhabilov, Jr. Each of the employment agreements, (1) provides for an annual base salary of $150,000 (2) is for a term of three years and may be renewed for additional one-year terms by agreement of the parties, (3) entitles the employee to participate in employee benefit plans, insurance, and similar programs adopted from time to time for full time employees, (4) provides for an annual grant of options to purchase 1,800,000 common shares with an exercise price set at the market price on the date of grant, (5) may be terminated by Viral Genetics for cause, as defined in the agreement, without severance payment; and (6) may be terminated by Viral Genetics without cause on payment of severance equal to 1 times the employee’s annual base salary.

Item 11. Security Ownership of Certain Beneficial Owners and Management

The following table sets forth as of March 30, 2005, the number and percentage of the 90,837,046 outstanding shares of common stock which, according to the information supplied to Viral Genetics, were beneficially owned by (i) each person who is currently a director, (ii) each executive officer, (iii) all current directors and executive officers of Viral Genetics as a group and (iv) each person who, to our knowledge, is the beneficial owner of more than 5% of the outstanding common stock. Except as otherwise indicated, the persons named in the table have sole voting and dispositive power with respect to all shares beneficially owned, subject to community property laws where applicable.

  Name and Address
Shares Beneficially Owned
Percent of Class

  Haig Keledjian(1)(2)
  P.O. Box 1020
  South Pasadena, CA 91031
  20,522,530(2)
  5,900,000 (3)
  14,376,954 (5)
  9,857,557 (6)
  498,685 (8)

  42.1%
  Hampar Karageozian
  31021 Marbella Vista
  San Juan Capistrano, CA 92675
  10,276,221
  2,300,000 (4)
  9,934,712 (6)
  249,646 (8)

  18.1%

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  Arthur Keledjian (1)
  P.O. Box 1020
  South Pasadena, CA 91032

  -0- 
  0 
  Harry Zhabilov, Jr. (1)(2)(4)
  P.O. Box 1020
  South Pasadena, CA 91031
  7,893,679
  5,900,000 (3)
  4,927,299 (6)
  249,271 (8)

  18.6%
  John D. Lefebvre
  P.O. Box N7120
  Nassau, Bahamas

  8,000,000
  4,000,000 (7)
  12.7%
  Caribou Investments, Inc.   2,817,327
  1,747,719 (6)
  88,417 (8)

  5.0%
  All officers and directors (4 persons)   86,086,438    62.3%

(1)  Officer or Director of Viral Genetics.

(2)  Haig Keledjian holds 2,302,667 shares personally. He holds 5,932,761 and 5,058,001 shares as Trustee for two irrevocable voting trusts for the benefit of his children; 4,005,924 shares as Trustee for an irrevocable trust established for a group of private investors; 3,201,393 shares as Trustee for an irrevocable discretionary trust established for a group of Mr. Keledjian’s family members; and 21,784 shares as Trustee for a non-profit foundation. Mr. Keledjian has sole voting and investment control over the shares he holds as Trustee.

(3)  Each of these persons holds an option to purchase 2,300,000 shares of common stock at an exercise price of $0.52 per share exercisable and an option to purchase 1,800,000 shares of common stock at an exercise price of $0.45 per share. They will each receive in June 2005 additional options to purchase 1,800,000 shares at an exercise price equal to the then market price of Viral Genetics’ common stock. All of these options are exercisable until the earlier of two years following termination of their employment agreement with the Company or May 31, 2008.

(4)   Hampar Karageozian holds an option to purchase 2,300,000 shares of common stock at an exercise price of $0.52 per share exercisable until August 5, 2006.

(5)  Haig Keledjian is the sole officer and director of Best Investments, Inc., which holds three notes totaling $2,156,543 that were assigned to Best Investments, Inc., on August 5, 2004 by Haig Keledjian, Hampar Karageozian, and Tomson Voting Trust (of which Harry Zhabilov, Jr. is a beneficiary). At December 31, 2004, these notes were convertible to 7,188,477 shares of common stock and warrants to purchase an additional 7,188,477 shares at $0.40 per share. If the warrants were exercised, Best Investment, Inc. would hold 14,376,954 shares of the Company. Mr. Keledjian has sole voting and investment control over all of the shares held by Best Investments, Inc., including those it may acquire through exercise of the warrants. In regard to the shares held by Best Investments, Inc., including those it may acquire through exercise of the warrants, Mr. Karageozian and Mr. Zhabilov, Jr. each disclaim any beneficial interest in or control of the shares.

(6)  Each of these persons holds warrants to purchase shares of common stock at a price of $0.40 per share that are exercisable until September 30, 2009. The warrants were issued in connection with the merger of Therapeutic Genetic, Inc., with our California subsidiary, VGI, in September 2004.

(7)  Mr. Lefebvre holds 4,000,000 warrants to purchase shares of common stock at a price of $1.00 per share that are exercisable until November 17, 2006.

25

(8)  Each of these persons holds options acquired through a distribution of options by Therapeutic Genetic, Inc., acquired through a consulting agreement that is now voided. The options are priced as follows: 40% at $0.52 per share; 20% at $0.38 per share; 20% at $0.65 per share, and 20% at $0.58 per share.

Item 12. Certain Relationships and Related Transactions

Pursuant to agreements dated May 22, 2003, Viral Genetics, Inc., completed on June 4, 2003 a restructuring of certain outstanding debt obligations owed to Haig Keledjian, an officer, director and principal stockholder, Hampar Karageozian, an officer, director and principal stockholder, the Tomson Voting Trust of which the trustee is Mr. Keledjian and a beneficiary is Harry Zhabilov, Jr., an officer and director, and Therapeutic Genetics Inc., a privately held California corporation and the principal creditor of Viral Genetics (“TGI”).

Viral Genetics was indebted as of March 31, 2003 to:

Mr. Keledjian in the amount of $835,310 representing the principal and accrued interest on funds previously advanced to Viral Genetics.
     
Mr. Karageozian in the amount of $784,904 representing the principal and accrued interest on funds previously advanced to Viral Genetics.
 
The Tomson Trust in the amount of $460,539 representing the principal and accrued interest on funds previously advanced to Viral Genetics.
 
TGI in the amount of $6,976,758 representing the principal and accrued interest on obligations incurred in connection with the acquisition of the TNP product and technology by Viral Genetics from TGI in 1995.

A substantial portion of the foregoing obligations was due in 2003, and Viral Genetics did not have the funds necessary to pay the obligations. Viral Genetics extended and restructured the obligations through the issuance of convertible promissory notes due 2008 with identical terms but for the principal amounts (the “Notes”). The Notes bear interest at the rate of five percent per annum and all principal and accrued interest is due March 31, 2008. The principal and accrued interest on the Notes may be exchanged at the election of the holder at the rate of $0.30 for one share of common stock and one warrant to purchase an additional share at an exercise price of $0.40 per that expires five years from the date the warrant is issued.

On June 30, 2004, the Company, VGI and TGI entered into an Agreement and Plan of Merger whereby TGI would be merged with our California subsidiary Viral Genetics, Inc., which was the surviving corporation. On September 20, 2004 we filed documents with the state of California for the purpose of closing and effecting this merger. This had the effect of terminating our obligation to repay any indebtedness or issue any securities under the Debt Restructuring Agreement dated May 22, 2003, between the Company and TGI.

At June 30, 2004, the Company was indebted to TGI in the amount of $7,442,808. Pursuant to the merger the Company issued 24,708,580 shares of its common stock and warrants to purchase an additional 24,708,580 shares to the former stockholders of TGI for all capital stock of TGI. TGI no longer exists as a legal entity as a consequence of the merger. The 24,708,580 warrants issued to the former stockholders of TGI are exercisable at a price of $0.40 per share over a five-year period expiring on September 19, 2009.

The effect of this transaction was to convert the pre-existing debt obligation of $7.4 million of the Company to TGI, including accrued interest, to equity represented by the common stock and warrants of the Company. This decreased the Company’s liabilities and increased the Company’s equity by a corresponding amount. At the time of the transaction the sole asset of TGI was the Company’s convertible note.



26


On August 5, 2004, the notes owed by the Company to Haig Keledjian, Hampar Karageozian, and Harry Zhabilov, Jr., were assigned to Best Investment, Inc., a corporation of which Haig Keledjian is the sole officer and director. As of December 31, 2004, the total principal and accrued interest on the notes owed to Best Investment was $2,156,543. Assuming Best Investments, Inc., exchanged its Note for stock and warrants on December 31, 2004, it would have received 7,188,477 shares and 7,188,477 warrants.

Item 13. Exhibits


Copies of the following documents are included as exhibits to this report pursuant to Item 601 of Regulation S-B.

  Exhibit No.   Title of Document
2.1   Agreement and Plan of Merger dated June 30, 2004, including the Agreement of Merger   attached as Exhibit B (1)
3.1   Certificate of Incorporation (2)
3.2   Certificate of Amendment (3)
3.3   Certificate of Amendment effective November 17, 2004
3.4   Bylaws (2)
10.1   Assignment of Patent dated August 5, 1995 (3)
10.2   Debt Restructuring Agreement dated May 22, 2003 with Haig Keledjian (4)
10.3   Debt Restructuring Agreement dated May 22, 2003 with Therapeutic Genetics, Inc. (4)
10.4   Debt Restructuring Agreement dated May 22, 2003 with Hampar Karageozian (4)
10.5   Debt Restructuring Agreement dated May 22, 2003 with The Tomson Trust (4)
10.6   Termination Agreement with New York International Commerce Group (5)
10.7   Termination Agreement with L&M Global Ventures (5)
10.8   Form of Employment Agreement with Executive Officers (5)
10.9   Form of Option issued to Executive Officers (5)
10.10   Consulting Agreement with Therapeutic Genetic, Inc. (5)
10.11   Consulting Agreement with Monica Ord (5)
10.12   Subscription Agreement with John D. Lefebre dated October 13, 2004 (6)
10.13   Form of Warrant issued to John D. Lefebvre (6)
10.14   Distribution Management Agreement effective July 1, 2004
10.15   Lease Agreement for 1321 Mountain View Circle, Azusa, CA
14.1   Code of Ethics (5)
21.1   List of Subsidiaries (5)
31.1   Certification of the Chief Executive Officer and Chief Financial Officer pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002
32.1   Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to Section   906 of the Sarbanes-Oxley Act of 2002

(1)   This exhibit is incorporated herein by this reference to Viral Genetics’ Current Report on Form 8-K filed with the Securities and Exchange Commission on September 28, 2004.

(2)   These exhibits are incorporated herein by this reference to Viral Genetics’ Registration Statement on Form 10-SB filed with the Securities and Exchange Commission on July 29, 1999.

(3)   These exhibits are incorporated herein by this reference to Viral Genetics’ Annual Report on Form 10-KSB for the year ended December 31, 2001, filed with the Securities and Exchange Commission on April 24, 2002.

(4)   These exhibits are incorporated herein by this reference to Viral Genetics’ Current Report on Form 8-K filed with the Securities and Exchange Commission on June 18, 2003.

27


(5)   These exhibits are incorporated herein by this reference to Viral Genetics’ Annual Report on Form 10-KSB for the year ended December 31, 2003, filed with the Securities and Exchange Commission on May 11, 2004.

(6)   These exhibits are incorporated herein by this reference to Viral Genetics’ Current Report on Form 8-K filed with the Securities and Exchange Commission on October 13, 2004.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The Company’s board of directors reviews and approves audit and permissible non-audit services performed by the authorized independent public accountants as well as the fees charged by the authorized independent public accountants for such services. In its review of non-audit service fees and its appointment of the authorized independent public accountants as the Company’s independent accountants, the board of directors considered whether the provision of such services is compatible with maintaining the authorized independent public accountants independence. All of the services provided and fees charged by the authorized independent public accountants in 2004 were pre-approved by the board of directors.

Audit Fees

The aggregate fees billed by Williams & Webster, P.S., the authorized independent public accountants, for professional services for the audit of the annual financial statements of the Company and the reviews of the financial statements of the Company included in the Company’s quarterly reports on Form 10-QSB for 2004 and 2003 were $29,028 and $38,150 respectively, net of expenses.

Audit-Related Fees

There were no other fees billed by Williams & Webster during the last two fiscal years for assurance and related services that were reasonably related to the performance of the performance of the audit or review of the Company’s financial statements and not reported under “Audit Fees” above.

Tax Fees

There were no fees billed for tax services by Williams & Webster, P.S. during the last two fiscal years for tax compliance or related services.

All Other Fees

There were no other fees billed by Williams & Webster, P.S. during the last two fiscal years for products and services provided by authorized independent public accountants.







28


SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

VIRAL GENETICS, INC.

Date: March 30, 2005 By: /s/ Haig Keledjian
Haig Keledjian, President, Chief Executive and Chief Financial Officer

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Date: March 30, 2005 /s/ Haig Keledjian
Haig Keledjian, Director
     
 
Date: March 30, 2005   /s/ Harry Zhabilov, Jr.
Harry Zhabilov, Jr., Director
     
 
Date: March 30, 2005   /s/ Hampar Karageozian
Hampar Karageozian, Director
     
 
Date: March 30, 2005   /s/ Arthur Keledjian
Arthur Keledjian, Director










29


VIRAL GENETICS, INC.

December 31, 2004

CONTENTS

Report of Independent Registered Public Accounting Firm
 
Financial Statements:
 
         Consolidated Balance Sheets
 
         Consolidated Statements of Operations
 
         Consolidated Statement of Stockholders' Equity (Deficit)
 
         Consolidate Statements of Cash Flows
 
Notes to Consolidated Financial Statements















Board of Directors
Viral Genetics, Inc.
Azusa, CA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We have audited the accompanying consolidated balance sheets of Viral Genetics, Inc. (a development stage company) as of December 31, 2004 and 2003 and the related consolidated statements of operations, stockholders’ equity (deficit) and cash flows for the years ended December 31, 2004 and 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). 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 audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Viral Genetics, Inc. as of December 31, 2004 and 2003 and the results of its operations, stockholders’ equity (deficit) and cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplates continuation of the Company as a going concern. As discussed in Note 2, the Company has incurred an accumulated deficit of $21,545,406 through December 31, 2004, has substantial debt, and has recurring losses from operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans regarding those matters also are described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Williams & Webster, P.S.
Certified Public Accountants
Spokane, Washington
March 29, 2005





VIRAL GENETICS, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED BALANCE SHEETS

December 31,
2004

December 31,
2003

ASSETS            
 
      CURRENT ASSETS    
          Cash and cash equivalents     $ 1,402,169   $ 265,207  

              Total Current Assets       1,402,169     265,207  

      PROPERTY AND EQUIPMENT, net       135,552     64,115  

      OTHER ASSETS    
          Deposits       42,940     1,850  
          Goodwill and patents       5,206,052     5,206,052  

              Total Other Assets       5,248,992     5,207,902  

           TOTAL ASSETS     $ 6,786,713   $ 5,537,224  

LIABILITIES AND STOCKHOLDERS' DEFICIT    
 
      CURRENT LIABILITIES    
          Accounts payable     $ 281,483   $ 241,657  
          Accrued wages payable       75,000     450,000  
          Accrued interest       212,938     1,209,381  
          Other notes payable       --     269,986  
          Other current liability       --     100,000  

              Total Current Liabilities       569,421     2,271,024  

      LONG-TERM LIABILITIES    
          Convertible notes payable, related parties       1,943,605     7,722,384  

           TOTAL LIABILITIES       2,513,026     9,993,408  

      STOCKHOLDERS' EQUITY (DEFICIT)    
          Preferred stock, 20,000,000 shares authorized,    
              $0.0001 par value; no shares issued and outstanding       --     --  
          Common stock, 250,000,000 shares authorized,    
              $0.0001 par value; 90,117,246 and 49,111,013    
              shares issued and outstanding, respectively       9,012     4,911  
          Additional paid-in capital       18,558,348     8,124,846  
          Common stock warrants       3,501,483     169,878  
          Common stock options       3,750,250     1,846,000  
          Deficit accumulated during development stage       (21,545,406 )   (14,601,819 )

              Total Stockholders' Equity (Deficit)       4,273,687     (4,456,184 )

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)     $ 6,786,713   $ 5,537,224  


The accompanying notes are an integral part of these financial statements
 
2

VIRAL GENETICS, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF OPERATIONS

Year Ended
December 31,

From
July 11,
1995
(Inception)
to
December 31,
2004
2003
2004
REVENUES     $ --   $ --   $ 347,750  

EXPENSES    
     Research and development       1,500,585     841,461     6,764,147  
     Management salaries       1,028,750     237,500     2,423,945  
     Depreciation expense       45,146     42,378     216,710  
     Legal and professional       306,796     95,467     601,086  
     Consulting fees       3,689,897     2,456,106     6,889,919  
     Joint venture costs       76,990     168,700     295,690  
     General and administrative       995,828     398,831     2,683,713  

        TOTAL EXPENSES       7,643,992     4,240,443     19,875,210  

LOSS FROM OPERATIONS       (7,643,992 )   (4,240,443 )   (19,527,460 )
 
OTHER INCOME/(EXPENSE)    
     Sale of distribution rights       1,059,966     250,000     1,309,966  
     Interest income       2,040     111     2,151  
     Interest expense       (361,601 )   (452,775 )   (3,330,063 )

        TOTAL OTHER INCOME (EXPENSE)       700,405     (202,664 )   (2,017,946 )

LOSS BEFORE INCOME TAXES       (6,943,587 )   (4,443,107 )   (21,545,406 )
 
INCOME TAXES       --     --     --  

NET LOSS     $ (6,943,587 ) $ (4,443,107 ) $ (21,545,406 )

     NET LOSS    
        PER COMMON SHARE, BASIC AND DILUTED     $ (0.12 ) $ (0.10 )

     WEIGHTED AVERAGE NUMBER OF    
        COMMON SHARES OUTSTANDING,    
        BASIC AND DILUTED       60,127,809     43,195,447  


The accompanying notes are an integral part of these financial statements

3


VIRAL GENETICS, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIT)

Common
Stock
Number of
Shares
Amount Additional
Paid-in
Capital
Stock
Warrants
Deficit
Accumulated
During
Development
Stage
Total
Stockholders'
Equity
(Deficit)
 Issuance of common stock                            
    for cash at nil per share       23,800,079   $ 2,380   $ (1,380 ) $ --   $ --   $ 1,000  
 
 Net loss for period ended    
    December 31, 1995       --     --     --     --     (707,167 )   (707,167 )
 
Balance, December 31, 1995       23,800,079     2,380     (1,380 )   --     (707,167 )   (706,167 )
 
 Issuance of common stock    
    for cash at $0.84 per share       59,500     6     49,994     --     --     50,000  
 
 Issuance of common stock    
    for services at $0.84 per share       357,001     36     299,964     --     --     300,000  
 
 Net loss for year ended    
    December 31, 1996       --     --     --     --     (810,189 )   (810,189 )
 
Balance, December 31, 1996       24,216,580     2,422     348,578     --     (1,517,356 )   (1,166,356 )
 
Issuance of common stock    
    for cash at $0.84 per share       339,151     34     284,966     --     --     285,000  
 
Issuance of common stock    
    for services at $0.84 per share       499,802     50     419,950     --     --     420,000  
 
Net loss for year ended    
    December 31, 1997       --     --     --     --     (577,066 )   (577,066 )
 
Balance, December 31, 1997       25,055,533     2,506     1,053,494     --     (2,094,422 )   (1,038,422 )
 
 Issuance of common stock       --  
      for cash at $0.84 per share       345,101     35     289,965     --     --     290,000  
 
Net loss for year ended    
   December 31, 1998       --     --     --     --     (708,567 )   (708,567 )
 
Balance, December 31, 1998       25,400,634     2,541     1,343,459     --     (2,802,989 )   (1,456,989 )
 
 Issuance of common stock    
      for cash at $0.42 per share       595,002     59     249,941     --     --     250,000  
 
 Issuance of common stock    
      for cash at $0.84 per share       34,272     3     28,797     --     --     28,800  
 
Net loss for year ended    
    December 31, 1999       --     --     --     --     (2,037,638 )   (2,037,638 )
 
 Balance, December 31, 1999       26,029,908     2,603     1,622,197     --     (4,840,627 )   (3,215,827 )
 
Issuance of common stock    
    for cash at $0.42 per share       595,002     59     249,941     --     --     250,000  
 
Issuance of common stock    
    for cash at $0.84 per share       842,523     84     707,916     --     --     708,000  
 
Issuance of common stock    
    for cash at $1.94 per share       51,567     6     99,994     --     --     100,000  
 
 Issuance of common stock    
      for services at $0.84 per share       2,163,824     216     1,818,117     --     --     1,818,333  
 
Net loss for year ended    
    December 31, 2000       --     --     --     --     (2,185,117 )   (2,185,117 )
Balance, December 31, 2000       29,682,824   $ 2,968   $ 4,498,165   $ --   $ (7,025,744 ) $ (2,524,611 )

The accompanying notes are an integral part of these financial statements

4

VIRAL GENETICS, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIT)
Common
Stock
Number of
Shares
Common
Stock
Amount
Additional
Paid-in
Capital
Common
Stock
Options
Common
Stock
Warrants
Deficit
Accumulated
During
Development
Stage
Total
Stockholders'
Equity
(Deficit)
 Balance, December 31, 2000       29,682,824   $ 2,968   $ 4,498,165   $ --   $ --   $ (7,025,744 ) $ (2,524,611 )
 
Issuance of common stock    
    for cash at $0.84 per share       29,464     3     24,747     --     --     --     24,750  
 
Issuance of common stock    
    for services at $0.84 per share       37,811     4     31,464     --     --     --     31,468  
 
Recapitalization through reverse merger    
   and acquisition of 5 Starliving Online, Inc.       8,035,693     804     (281,079 )   --     --     --     (280,275 )
 
Miscellaneous adjustment due to merger       481     --     --     --     --     --     --  
 
Net loss for the year ended December 31, 2001       --     --     --     --     --     (1,356,117 )   (1,356,117 )
 Balance, December 31, 2001       37,786,273     3,779     4,273,297     --     --     (8,381,861 )   (4,104,785 )
 
Issuance of common stock    
    for cash at $0.70 per share       215,000     21     149,979     --     --     --     150,000  
 
Issuance of common stock from the exercise    
    of options for cash at $0.01 per share       1,000,000     100     149,900     --     --     --     150,000  
 
Issuance of common stock for    
    debt at $0.80 per share       1,654,027     165     1,223,815     --     99,242     --     1,323,222  
 
Issuance of common stock for    
     services at $0.22 per share       67,837     7     14,993     --     --     --     15,000  
 
Net loss for the year ended December 31, 2002    
        --     --     --     --     --     (1,776,851 )   (1,776,851 )
Balance, December 31, 2002       40,723,137     4,072     5,811,984     --     99,242     (10,158,712 )   (4,243,414 )
 
Issuance of options for    
    services at $0.10 to $0.66       --     --     --     2,384,000     --     --     2,384,000  
 
Issuance of warrants for    
    services at $0.29 to $0.35       --     --     --     --     177,000     --     177,000  
 
Issuance of common stock for    
     cash at $0.20 to $0.35 per share       3,531,456     354     873,889     --     --     --     874,243  
 
Issuance of common stock    
    for cash at $0.2135 per share       2,341,675     234     499,766     --     --     --     500,000  
 
Issuance of common stock from the exercise    
    of options for cash at $0.01 per share       700,000     70     269,930     (263,000 )   --     --     7,000  
 
Issuance of common stock from the exercise    
     of options for debt at $0.01 per share       480,769     48     197,260     (192,500 )   --     --     4,808  
 
Issuance of common stock from the exercise    
    of options for services at $0.01 per share       250,000     25     84,975     (82,500 )   --     --     2,500  
 
Issuance of common stock from the exercise    
      of warrants for expenses at $0.05 per share       250,000     25     84,975     --     (72,500 )   --     12,500  
 
Issuance of common stock for services    
     at $0.20 to $0.70 per share       383,096     38     132,984     --     --     --     133,022  
 
 Issuance of common stock and warrants for    
    debt and interest at $0.30 per share       450,880     45     69,841     --     65,378     --     135,264  
 
Allocation of expired warrants to    
      additional paid-in capital       --     --     99,242     --     (99,242 )   --     --  
 
Net loss for the year ended    
    December 31, 2003       --     --     --     --     --     (4,443,107 )   (4,443,107 )
 Balance, December 31, 2003       49,111,013     4,911     8,124,846     1,846,000     169,878     (14,601,819 )   (4,456,184 )

The accompanying notes are an integral part of these financial statements

VIRAL GENETICS, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIT)

Common
Stock
Number of
Shares
Common
Stock
Amount
Additional
Paid-in
Capital
Common
Stock
Options
Common
Stock
Warrants
Deficit
Accumulated
During
Development
Stage
Total
Stockholders'
Equity
(Deficit)
Balance, December 31, 2003       49,111,013   $ 4,911   $ 8,124,846   $ 1,846,000   $ 169,878   $ (14,601,819 ) $ (4,456,184 )
 
Issuance of common stock and    
    warrants for cash at $0.25 per share       8,000,000     800     1,799,200     --     200,000     --     2,000,000  
 
Issuance of common stock and    
      warrants for debt at $0.30 per share       24,708,580     2,471     4,274,965     --     3,226,838     --     7,504,274  
 
Issuance of common stock for exercise of    
  warrants for cash at $0.01 to $0.05 per share       350,000     35     119,965     --     (104,500 )   --     15,500  
 
Issuance of options for consulting services    
    at $0.34 to $0.84 per option       --     --     --     3,892,960     --     --     3,892,960  
 
Isssuance of common stock from    
      the exercise of options at $0.01 per share       2,913,400     291     1,497,553     (1,468,710 )   --     --     29,134  
 
Issuance of common stock for services    
     at $0.30 to $0.67 per share       979,722     98     467,589     --     --     --     467,687  
 
Issuance of common stock for cash    
     at $0.30 to $0.53 per share       1,337,865     134     506,769     --     --     --     506,903  
 
Issuance of common stock and warrants    
     for debt conversion at $0.30 per share       66,666     7     10,726     --     9,267     --     20,000  
 
Issuance of common stock for settlement    
     at $0.44 to $0.70 per share       1,750,000     175     834,825     --     --     --     835,000  
 
Issuance of common stock    
     for finders fee at $0.45 per share       1,000,000     100     449,900     --     --     --     450,000  
 
Cancellation of common stock for shares    
     issued in error at $0.48 per share       (100,000 )   (10 )   (47,990 )   --     --     --     (48,000 )
 
Allocation of expired options to    
    additional paid in capital       --     --     520,000     (520,000 )   --     --     --  
 
Net loss for the year ended    
    December 31, 2004       --     --     --     --     --     (6,943,587 )   (6,943,587 )

Balance, December 31, 2004       90,117,246     9,012     18,558,348     3,750,250     3,501,483     (21,545,406 )   4,273,687  




The accompanying notes are an integral part of these financial statements

6


VIRAL GENETICS, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS

Year Ended
December 31,
From
July 11,
1995
(Inception)
to
2004 2003 December 31,
2004
CASH FLOWS FROM OPERATING ACTIVITIES                
    Net loss     $ (6,943,587 ) $ (4,443,107 ) $ (21,545,406 )
    Depreciation       45,146     42,378     216,710  
    Non-cash operating expenses       --     --     144,901  
    Non-cash income       (309,966 )   (309,966 )
    Issuance of common stock for services       419,687     133,022     3,137,510  
    Issuance of common stock for finders fee       450,000     450,000  
    Options and warrants issued for services       3,892,960     2,561,000     6,453,960  
    Options exercised for services       --     2,500     2,500  
    Warrants exercised for services       --     12,500     12,500  
    Issuance of common stock for expenses paid by third party       --     --     593,947  
    Issuance of common stock for settlement agreement       835,000     835,000  
    Issuance of stock for interest       1,254,213     1,922     1,256,135  
    Notes payable issued for expenses       762,527     144,822     907,349  
    Expenses paid with notes payable       (43 )   (10,000 )   (10,043 )
    Notes payable converted to accrued wages       --     (25,000 )   (25,000 )
    Increase (decrease) in accrued interest       (996,443 )   185,809     212,938  
    Increase (decrease) in accounts payable       39,826     (25,215 )   281,482  
    Increase (decrease) in accrued wages payable       (375,000 )   450,000     75,000  
    Decrease in bank overdrafts payable       --     (5,291 )   --  
    Proceeds from customer deposit       (100,000 )   --     --  
Net cash used in operations       (1,025,680 )   (974,660 )   (7,310,483 )
CASH FLOWS FROM INVESTING ACTIVITIES    
    Increase in leasehold improvements       (78,965 )   --     (78,965 )
    Increase in deposits       (41,090 )   (1,440 )   (42,940 )
    Acquisition of equipment       (37,618 )   (2,977 )   (312,698 )
    Increase in patent       --     --     (5,206,051 )
Net cash used in investing activities       (157,673 )   (4,417 )   (5,640,654 )
CASH FLOWS FROM FINANCING ACTIVITIES    
    Proceeds from notes payable       39,980     399,883     9,178,956  
    Payments on notes payable       (271,202 )   (536,842 )   (1,044,980 )
    Proceeds from exercise of options and warrants       44,634     7,000     51,634  
    Proceeds from sale of common stock       2,506,903     1,374,243     6,167,696  

Net cash provided by financing activities       2,320,315     1,244,284     14,353,306  

Change in cash       1,136,962     265,207     1,402,169  
 
Cash and cash equivalents, beginning of period       265,207     --     --  
Cash and cash equivalents, end of period     $ 1,402,169   $ 265,207   $ 1,402,169  
SUPPLEMENTAL CASH FLOW DISCLOSURES:       --  
 
    Interest expense paid     $ 78,792   $ 13,607   $ 145,853  
    Income taxes paid     $ --   $ --   $ --  
NON-CASH TRANSACTIONS:    
 
    Issuance of common stock for services     $ 419,687   $ 133,022   $ 3,137,510  
    Issuance of common stock for settlement agreement     $ 835,000   $ --   $ 835,000  
    Options and warrants issued for services     $ 3,892,960   $ 2,561,000   $ 6,453,960  
    Options and warrants exercised for services     $ --   $ 15,000   $ 15,000  
    Non-cash operating expenses     $ --   $ --   $ 144,901  
    Issuance of common stock for debt paid by third party     $ --   $ --   $ 593,947  
    Issuance of common stock for debt and interest     $ 7,524,274   $ 1,922   $ 8,255,471  
    Notes payable issued for services     $ 2,333   $ 144,822   $ 147,155  
    Notes payable issued for expenses     $ 43   $ 10,000   $ 10,043  
    Notes payable issued for accrued wages     $ --   $ 25,000   $ 25,000  
    Issuance of common stock for finders fee     $ 450,000   $ --   $ 450,000  

The accompanying notes are an integral part of these financial statements

7

VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

NOTE 1 – ORGANIZATION AND DESCRIPTION OF BUSINESS

Viral Genetics Inc. (“the Company”) was incorporated in California on July 11, 1995 and is in the development stage. The Company is engaged in the research and development of protein-based therapeutic and diagnostic products with applications in infectious disease, autoimmune conditions, and immunological deficiency. The Company was acquired by a Delaware corporation and reporting issuer on October 1, 2001 The Company’s year-end is December 31. As of September 30, 2004, the Company merged with Therapeutic Genetic, Inc. See Note 11.

Viral Genetics, Inc. owns 100% of a Chinese subsidiary called Viral Genetics Beijing, Ltd. which was organized for prospective operations in China. At this time, the office in China has a president and two full-time employees working on regulatory related activity seeking registration for the Company’s HIV/AIDS product. There is no financial activity in this office other than monthly stipends sent from the U.S. company to cover certain expenses, which are included in the reported operating expenses of Viral Genetics, Inc. The Company established a subsidiary in South Africa in 2003 which has been subsequently sold in May 2004. See Note 5.

NOTE 2 -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

This summary of significant accounting policies is presented to assist in understanding the financial statements. The financial statements and notes are representations of the Company’s management, which is responsible for their integrity and objectivity. These accounting policies conform to accounting principles generally accepted in the United States of America, and have been consistently applied in the preparation of the financial statements.

Accounting Methods

The Company’s financial statements are prepared using the accrual method of accounting.

Accounting for Stock Options and Warrants Granted to Employees and Non-employees

Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (hereinafter “SFAS No. 123”), defines a fair value-based method of accounting for stock options and other equity instruments. The Company has adopted this method, which measures compensation costs based on the estimated fair value of the award and recognizes that cost over the service period.

Cash and Cash Equivalents

For purposes of the statements of cash flows, the Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.

Compensated Absences

The Company’s policy is to recognize the cost of compensated absences when actually paid to employees. If the amount were estimatable, it would not be currently recognized as the amount would be deemed immaterial.

Consolidated Financial Statements

The accompanying financial statements include those of the Company and its subsidiaries. All intercompany balances have been eliminated upon consolidation.

8

VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

Derivative Instruments

In April 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (hereinafter “SFAS No. 149”). SFAS No. 149 amends and clarifies the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This statement is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The adoption of SFAS No. 149 is not expected to have a material impact on the financial position or results of operations of the Company.

In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 (“SFAS No. 133”), “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities – Deferral of the Effective Date of FASB No. 133", and SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities”, which is effective for the Company as of January 1, 2001. These standards establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. They require that an entity recognize all derivatives as either assets or liabilities in the consolidated balance sheet and measure those instruments at fair value.

If certain conditions are met, a derivative may be specifically designated as a hedge, the objective of which is to match the timing of gain or loss recognition on the hedging derivative with the recognition of (i) the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk or (ii) the earnings effect of the hedged forecasted transaction. For a derivative not designated as a hedging instrument, the gain or loss is recognized in income in the period of change.

Historically, the Company has not entered into derivatives contracts to hedge existing risks or for speculative purposes.

At December 31, 2004 and 2003, the Company has not engaged in any transactions that would be considered derivative instruments or hedging activities.

Development Stage Activities

The Company has been in the development stage since its formation on July 11, 1995. It is primarily engaged in medical research and development.

Earnings Per Share

On January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 128, which provides for calculation of “basic” and “diluted” earnings per share. Basic earnings per share includes no dilution and is computed by dividing net income (loss) available to common shareholders by the weighted average common shares outstanding for the period. Diluted earnings per share reflect the potential dilution of securities that could share in the earnings of an entity similar to fully diluted earnings per share. Although there was approximately 58,403,000 common stock equivalents outstanding at December 31, 2004, they were not included in the calculation of earnings per share because they would have been considered anti-dilutive.

9


VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

Fair Value of Financial Instruments

The Company’s financial instruments as defined by Statement of Financial Accounting Standards No. 107, “Disclosures about Fair Value of Financial Instruments,” include accounts payable, accrued expenses and borrowings from related parties. All of the Company’s financial instruments are accounted for on a historical cost basis, which approximates fair value at December 31, 2004.

Going Concern

As shown in the accompanying financial statements, the Company has incurred an accumulated deficit of $21,545,406 through December 31, 2004. The Company is currently in need of funds to continue its research and development goals. The Company has substantial debt and recurring losses from operations. These factors and uncertainties raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of recorded assets, or the amounts and classification of liabilities that might be necessary in the event the Company cannot continue in existence. Management has designed plans for sales of the Company’s products. Management intends to seek additional capital from new equity securities offerings and from debt financing that will provide funds needed to increase liquidity, fund internal growth and fully implement its business plan.

An estimated $2.4 million of cash is believed necessary to continue operations and increase development through the next fiscal year. The timing and amount of capital requirements will depend on a number of factors, including demand for products and services and the availability of opportunities for international expansion through affiliations and other business relationships. Management intends to seek additional capital from new equity securities issuances to provide funds needed to increase liquidity, fund internal growth, and fully implement its business plan.

Goodwill and Patents

Goodwill represents the excess of the purchase price and related direct costs over the fair value of net assets acquired as of the date of the acquisition of patents from Therapeutic Genetic, Inc., (hereinafter “TGI”). In completing the acquisition, the Company issued to TGI notes, which were cancelled for exchange of Company’s common stock in the merger with TGI. See Note 11. The Company periodically reviews its goodwill to assess recoverability based on projected undiscounted cash flows from operations. Impairments are recognized in operating results when a permanent diminution in value occurs. The Company intends to amortize the aforementioned patent assets once the Company begins operations.

Impaired Asset Policy

In October 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”). SFAS No. 144 replaces SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” This standard establishes a single accounting model for long-lived assets to be disposed of by sale, including discontinued operations. SFAS No. 144 requires that these long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or discontinued operations. This statement is effective beginning for fiscal years after December 15, 2001, with earlier application encouraged. The Company adopted SFAS No. 144 and does not believe any adjustments are needed to the carrying value of its assets at December 31, 2004.



10


VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

Provision for Taxes

Income taxes are provided based upon the liability method of accounting pursuant to Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” Under this approach, deferred income taxes are recorded to reflect the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end. A valuation allowance is recorded against deferred tax assets if management does not believe the Company has met the “more likely than not” standard imposed by SFAS No. 109 to allow recognition of such an asset.

Reclassification

Certain amounts from prior periods have been reclassified to conform to the current period presentation. These reclassifications have not resulted in any changes to the Company’s accumulated deficit or the net losses presented.

Research and Development

Research and development expenses are charged to operations as incurred.

Revenue Recognition

The Company recognizes revenue from product sales upon shipment to the customer if collectability is reasonably assured.

Segment Reporting

The Company does not utilize segment information at this time as defined by Statement of Financial Accounting Standards No. 131 because it has only one principal business activity and because its wholly owned Beijing subsidiary had no activity other than expenses of $220,122 which are included in the statement of operations as of December 31, 2004.

Use of Estimates

The process of preparing financial statements in conformity with accounting principles generally accepted in the United States of America requires the use of estimates and assumptions regarding certain types of assets, liabilities, revenues, and expenses. Such estimates primarily relate to unsettled transactions and events as of the date of the financial statements. Accordingly, upon settlement, actual results may differ from estimated amounts.






11


VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 153. This statement addresses the measurement of exchanges of nonmonetary assets. The guidance in APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that opinion; however, included certain exceptions to that principle. This statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetrary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. This statement is effective for financial statements for fiscal years beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges incurred during fiscal years beginning after the date of this statement is issued. Management believes the adoption of this statement will have no impact on the financial statements of the Company.

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 152, which amends FASB statement No. 66, “Accounting for Sales of Real Estate,” to reference the financial accounting and reporting guidance for real estate time-sharing transactions that is provided in AICPA Statement of Position (SOP) 04-2, “Accounting for Real Estate Time-Sharing Transactions.” This statement also amends FASB Statement No. 67, “Accounting for Costs and Initial Rental Operations of Real Estate Projects,” to state that the guidance for (a) incidental operations and (b) costs incurred to sell real estate projects does not apply to real estate time-sharing transactions. The accounting for those operations and costs is subject to the guidance in SOP 04-2. This statement is effective for financial statements for fiscal years beginning after June 15, 2005. Management believes the adoption of this statement will have no impact on the financial statements of the Company.

In December 2004, the Financial Accounting Standards Board issued a revision to Statement of Financial Accounting Standards No. 123R, “Accounting for Stock Based Compensations.” This statement supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related implementation guidance. This statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. This statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This statement does not change the accounting guidance for share based payment transactions with parties other than employees provided in Statement of Financial Accounting Standards No. 123. This statement does not address the accounting for employee share ownership plans, which are subject to AICPA Statement of Position 93-6, “Employers’ Accounting for Employee Stock Ownership Plans.” The Company has determined that there was no impact on the Company’s financial statements from the adoption of this statement.

This statement does not change the accounting guidance for share based payment transactions with parties other than employees provided in Statement of Financial Accounting Standards No. 123. This statement does not address the accounting for employee share ownership plans, which are subject to AICPA Statement of Position 93-6, “Employers’ Accounting for Employee Stock Ownership Plans.” The Company has determined that there was no impact on the Company’s financial statements from the adoption of this statement.

12


VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 151, Inventory Costs— an amendment of ARB No. 43, Chapter 4. This Statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that “. . . under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges. . . .” This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Management does not believe the adoption of this Statement will have any immediate material impact on the Company.

In May 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (hereinafter “SFAS No. 150”). SFAS No. 150 establishes standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity and requires that those instruments be classified as liabilities in statements of financial position. Previously, many of those instruments were classified as equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company has determined that there was no impact on the Company’s financial statements from the adoption of this statement.

NOTE 3 — PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. The useful lives of property, plant and equipment for purposes of computing depreciation are three to five years. The estimated useful lives of leasehold improvements are twenty years, the expected term of the lease plus extensions.

The following is a summary of property, equipment, and accumulated depreciation:

December 31,
2004

December 31,
2003

Equipment     $ 273,298   $ 235,679  
Leasehold improvements       78,965     --  
        (216,711 )   (171,564 )
Less accumulated depreciation    

      $ 135,552   $ 64,115  

Equipment principally consists of machines that can be used to manufacture the Company’s drug candidates. Depreciation for the years ended December 31, 2004 and 2003 was $45,146 and $42,378, respectively. The Company evaluates the recoverability of property and equipment when events and circumstances indicate that such assets might be impaired. The Company determines impairment by comparing the undiscounted future cash flows estimated to be generated by these assets to their respective carrying amounts. Maintenance and repairs are expensed as incurred. Replacements and betterments are capitalized. The cost and related reserves of assets sold or retired are removed from the accounts, and any resulting gain or loss is reflected in results of operations.

13

VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

NOTE 4 – PATENTS

The Company has the following patents issued:

Region
Date Issued
Patent No.
Australia October 19, 2000  721463 
Canada March 18, 2003  2220347 
EPC (Austria, Denmark, France, Germany, Great September 5, 2001  69615015.8 
Britain, Ireland, Italy, Liechtenstein, Monaco,
Netherlands, Spain, and Switzerland)
Hong Kong August 9, 2002  HK1009457 
Israel January 5, 1996  118103/5 
Russia and Former Soviet Republics July 4, 2000  001100 

These patents all relate to certain of the Company’s products which are based on TNP. The Company intends to amortize the aforementioned patent assets once the Company begins production. The Company also has patents issued in Bulgaria and New Zealand, and pending patent applications in Argentina, Brazil, China, Japan, South Africa and United States.

The Company can give no assurance that other companies, having greater economic resources, will not be successful in developing products similar to those of the Company. There can be no assurance that patents, if obtained for the aforementioned patent applications, will be enforceable. Patents that had been acquired from Therapeutic Genetics, Inc. were the security for notes payable issued for the aforementioned patents. (See Note 11 ). These notes were subsequently cancelled upon the issuance of the company’s common stock for the acquisition of Therapeutic Genetic.

NOTE 5 — COMMITMENTS AND CONTINGENCIES

Product Liability

The Company may be subjected to future claims resulting from the use of its drug candidates, although the Company is unaware of any product-related litigation or potential claims to date. As of December 31, 2004, the Company does not have product liability insurance for any of its drug candidate products.

Investment Banking Agreement

In November 2001, the Company signed an agreement with Burlington Capital Markets, Inc. (“Burlington”), whereby Burlington would provide strategic relationships and assistance in connection with future financing of the Company in exchange for a combination of cash payments, common stock and stock warrants. In 2003, this agreement was terminated and the Company has been indemnified against any future litigation related thereto by a limited liability company whose controlling member and manager is a former officer and principal shareholder of Burlington. This matter was settled with the issuance of stock. (See Note 13)

Consulting Agreements

In December 2002, the Company signed an agreement with Voluto Ventures, LLC for various management and advisory services. Under the agreement, the Company issued 1,000,000 common stock options with an exercise price of $0.01 per share, which were exercised in December 2002 and the Company agreed to issue to Voluto Ventures, LLC up to a total of

14

VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

2,000,000 additional stock options with an exercise price of $0.01 per share and agreed to pay $10,000 per month for services rendered under certain circumstances. During the year ended December 31, 2003, Voluto Ventures, LLC received and exercised 480,769 options in accordance with this agreement. The agreement was terminated during June 2003, and both parties provided each other with a mutual release.

During the year ended December 31, 2004, the Company had in place agreements with several individuals and entities for various consulting and advisory services which provided that each contracted consultant or advisor would periodically receive stock or stock options (See Note 10 regarding stock options). As of December 31, 2004, the Company had eleven individuals and firms engaged under such agreements.

The Company also has other agreements with consultants for future issuance of common stock as compensation, including an investor relations agreement for $6,500/month in cash and 150,000 shares of restricted stock, and a business services agreement for 500,000 shares related to financing and investor relations.

Joint Venture

The Company also has other agreements with consultants for future issuance of common stock as compensation, including an investor relations agreement for $6,500/month in cash and 150,000 shares of restricted stock, and a business services agreement for 500,000 shares related to financing and investor relations.

Finder’s Fee

As a finder’s fee in relation to the joint venture with NYIC, the Company entered into a Services Agreement with L&M Global Ventures, Inc. (“L&M”). This agreement provided for payment of a royalty to L&M upon successful registration of the Company’s prospective HIV and AIDS treatment. The agreement also provided L&M with certain options to purchase shares of the Company’s common stock. This agreement was terminated effective October 1, 2003.

Employment Agreements

On June 1, 2003, the Company entered into employment agreements with three executive officers who are also directors and principal shareholders of the Company, Mr. Haig Keledjian as president and chief executive officer; Mr. Hampar Karageozian as chief operating officer; and Mr. Harry Zhabilov, Jr. as executive vice president of research and development. Mr. Hampar Karagezian resigned his position on August 5, 2004, which voids his employment agreement. The two remaining agreements are effective until May 31, 2006 and may be extended for additional one year terms upon the mutual consent of the employee and the Company. Each agreement provides for a salary of $150,000 per anum, a signing bonus of 500,000 options to purchase shares of the Company’s common stock at a price equal to market value on the date of the options’ issuance, and an annual grant of 1,800,000 stock options to purchase shares of the Company’s common stock at a price equal to market value on the date of the options’ issuance. See Note 9 regarding stock options.

Distribution Agreements

In June 2002, the Company received $100,000 from an arm’s length party relating to the potential sale of a pharmaceutical product, VGV-1, in Mexico. In January 2003, the Company entered into a distribution agreement with the same party in relation to the testing, distribution and marketing of VGV-1 in Africa. Under this African distribution agreement, the Company received approximately $250,000 as a non-refundable deposit in 2003. In April 2003, this African distribution agreement was cancelled. The same arms length party had also advanced a total of $109,966 to the Company as unsecured notes payable on various occasions.

15

VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

On March 24, 2004, the arm’s length party accepted an offer to purchase 10% of the Company’s former South African subsidiary for total consideration of $500,000. The Company agreed to the first 5% being fully paid for by $100,000 advanced in June, 2002, and the second 5%, which was valued at $400,000, was to be paid no later than November 30, 2004. In relation to this, the $109,966 unsecured note was cancelled. Subsequently, in May 2004, the Company and the arm’s length party agreed to cancel all outstanding agreements and in lieu of this the Company has granted to this party a royalty of 2.5% of the net sales of VGV-1 in Africa for a period of 20 years commencing from the first commercial sale of VGV-1 in Africa with no further obligations in regard to the $109,966 note or the $100,000 advanced in June, 2002. Further, this party was granted an option to acquire 1,000,000 shares of the Company’s common stock at a purchase price of $0.40 per share, exercisable until December 31, 2004. This option has expired unexercised.

In May and June 2004, the Company entered into several agreements with Timothy and Thomas LLC (“T & T”) which is controlled by the holder of the $200,000 convertible debenture issued by the Company in September 2003, and Timothy W. Wright III, a former director of the Company. The agreements included the sale of the former South African subsidiary, Viral Genetics South Africa (Pty) Limited (“VGSA”), to the buyer for cash consideration of $650,000 and forgiveness of the $200,000 convertible debenture. In December 2004, the Company and T & T entered into an agreement which superceded previous agreements and obligated T & T to pay for the costs of the Company’s ongoing clinical trial of VGV-1 in South Africa up to a maximum threshold amount. As the exclusive distribution management partner of the Company in Africa with respect to Company’s HIV and AIDS products, T & T will secure and establish distributors in Africa, and provide management and oversight of the Company’s relationships with distributors. VGSA is the exclusive distributor of the Company’s HIV and AIDS products in South Africa.

Lease

On April 7, 2004, the Company signed a five year lease for an administrative, research and development facility to commence August 1, 2004. The base rent and fees are $6,450 per month after payment of an initial deposit of $40,590. The Company expects to have its corporate headquarters, primary manufacturing, and primary research and development facilitate located at this new facility.

NOTE 6 – COMMON STOCK

On September 20, 2004, the Company filed documents with the state of California amending its certificate of incorporation to increase its authorized common shares to 250,000,000.

In December 2004, the Company issued 230,000 shares to five consultants for cash of $2,300 and services valued a $108,632.

In November 2004, for cash of $2,000,000, the Company issued to John D. Lefebvre 8,000,000 shares. Also in November 2004, the Company issued 1,000,000 shares valued at $450,000 to two parties for finder’s fees; 150,000 shares for investor relations services valued at $52,500; and 719,800 shares to four consultants for cash of $7,190 and services valued at $293,618.

16

VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

In October 2004, the Company issued 124,000 shares to two consultants for exercise of options for cash of $124 and services valued at $99,500.

In September 2004, the Company issued 24,708,580 shares to 37 entities in connection with the merger with Therapeutic Genetic, Inc. Included in this total are 19,719,452 shares issued to three directors of the Company or controlled entities. Also in September 2004, the Company issued 315,600 shares to 5 consultants for cash of $3,156 and services valued at $157,924. These shares were issued in reliance on the exemption from registration set forth in Section4(2) of the Securities Act of 1933. No commission was paid to any person in connection with the transactions.

In August 2004, the Company cancelled 100,000 shares that were issued in error pursuant to a consulting agreement that did not take effect.

In July 2004, the Company issued 275,000 shares to two consultants for exercise of an option for cash of $2,750 and services valued at $137,500, and 121,065 shares to an individual for cash of $50,000. These shares were issued in reliance on the exemption from registration set forth in Section4(2) of the Securities Act of 1933. No commission was paid to any person in connection with the transactions.

In May, 2004, the Company issued 175,000 shares to a consultant for exercise of an option for cash of $1,750 and services valued at $96,600 and 1,500,000 shares valued at $660,000 to two arm’s length entities for settlement of terminated agreements. These shares were issued in reliance on the exemption from registration set forth in Section4(2) of the Securities Act of 1933. No commission was paid to any person in connection with the transactions.

During the three months ended March 31, 2004, the Company issued 1,240,800 shares for cash of $477,349 and subscription receivable of $600; 950,000 shares for exercise of options for cash of $9,500; 350,000 shares for exercise of warrants for a subscription receivable of $3,500; 729,722 shares for services valued at $370,187; 66,666 shares in exchange for debt of $10,726; and 250,000 shares in exchange for a settlement agreement valued at $175,000.

In December 2003, the Company issued 330,000 shares for cash of $99,000; 200,000 shares for exercise of options for cash of $2,000 and services valued at $98,000; 30,000 shares for exercise of warrants for cash of $1,500 and services valued at $8,700; 480,769 shares upon exercise of options in exchange for debt of $4,808; and 117,307 shares in exchange for debt valued at $35,192.

In November 2003, the Company issued 2,388,956 shares for cash of $612,695; 88,648 shares for services valued at $22,162; 67,760 shares for services valued at $16,940; and 10,819 shares for services valued at $3,787.

In October 2003, the Company issued 812,500 shares for cash of $162,500; 47,500 shares for services valued at $9,500; 9,450 shares for services valued at $1,890; 333,573 shares in exchange for convertible debt and interest valued at $100,072; 220,000 shares for exercise of warrants for cash of $11,000 and services valued at $63,800.

In September 2003, the Company issued 250,000 shares for exercise of options for services valued at $118,500. Also in September 2003, the Company received $1,000 for the exercise of options for 100,000 common shares.

In August 2003, the Company issued 25,000 shares for services valued at $5,000.

In July 2003, the Company issued 1,405,005 shares for cash of $300,000 and 200,000 shares for exercise of options for cash of $2,000 and services valued at $66,000.

17

VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

In May 2003, the Company issued 33,919 shares for services valued at $23,743; 936,670 shares for cash of $200,000; 100,000 shares for services valued at $50,000; and 200,000 shares for exercise of options for cash of $2,000 and services valued at $66,000.

NOTE 7 — INCOME TAXES

At December 31, 2003, the Company had net deferred tax assets of approximately $5,260,110 (calculated at an expected rate of 34%) principally arising from net operating loss carryforwards for income tax purposes. As management of the Company cannot determine that it is more likely than not that the Company will realize the benefit of the net deferred tax asset, a valuation allowance equal to the net deferred tax asset was recorded at December 31, 2004 and 2003.

The significant components of the deferred tax asset at December 31, 2004 and 2003 were as follows:

December 31, 2004
December 31, 2003
Net operating loss carryforward before adjustments     $ 21,545,406   $ 14,988,342  
Section 197 amortization of patents       347,070   347,070  
Tax over book depreciation       32,395   26,668
Options/warrants issued for expenses       (6,453,960 )   (2,561,000 )

Net operating loss carryforward       15,470,911   12,801,080

 
Deferred tax asset     $ 5,260,110   $ 4,352,367  
Deferred tax asset valuation allowance     $ (5,260,110 ) $ (4,352,367 )

At December 31, 2004, the Company has utilizable net operating loss carryforwards of approximately $15,470,000, which expire in the years 2016 through 2025. The Company recognized approximately $3,892,960 of losses from issuance of restricted common stock and stock options for services in fiscal 2004, which are not deductible for tax purposes and are not included in the above calculation of deferred tax assets. The change in the allowance account from December 31, 2003 to December 31, 2004 was $907,743.

NOTE 8 – NOTES PAYABLE AND RELATED PARTY TRANSACTIONS

At December 31, 2004 and 2003, respectively, the Company had the following obligations:

2004
2003
Convertible notes payable and accrued     $ 2,156,543   $ 8,931,765  
     interest to related parties    
Other notes payable    
        --     269,986  

Total     $ 2,156,543   $ 9,201,751  


18

VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

Although a large portion of the related party notes were due in 2003, the Company did not have the funds necessary to pay the obligations. The debts were restructured in June 2003 with the issuance of 5% convertible notes whose terms included all underlying principal and interest due March 31, 2008. All of these convertible notes are exchangeable into units of the Company at the rate of $0.30 per unit. Each unit consists of one common share of the Company’s common stock and one warrant to purchase a share of the Company’s common stock at a price of $0.40, exercisable for 5 years.

On June 30, 2004, the Company entered into an agreement and plan of merger with one of the former principal creditors of the Company and holder of approximately $7.4 million of the convertible notes, Therapeutic Genetic, Inc., (“TGI”), considered an affiliated company. The notes originated with a patent transfer to the Company from TGI. The patents that were transferred were the collateral underlying the notes. Two directors and principal stockholders of the Company, were also principal stockholders of the affiliated company, TGI. On September 20, 2004, documents were filed with the State of California effecting the merger, and on September 28, 2004, the Company issued 24,708,580 shares and 24,708,580 warrants to purchase shares of the Company to the former stockholders of TGI.

On September 30, 2003, the Company executed a convertible debenture in the amount of $200,000 with an arms length individual. The terms of this note require payment due on the earlier of December 30, 2003, or the date of any event of default as defined in the agreement. However, any amount of the outstanding principal can be converted at any time at the option of the holder. On December 30, 2003, the debenture holder agreed to extend the maturity date of the debenture to July 31, 2004. The rights to this note were assigned to the Company on May 21, 2004 as part of the sale of the former South African subsidiary, and it has been effectively cancelled. See Note 5.

NOTE 9 – WARRANTS

During the three months ended December 31, 2004, the Company granted 4,000,000 warrants to John D. Lefebvre in connection with a private placement of 8,000,000 units for $2,000,000 cash.

During the three months ended September 30, 2004, the Company granted 24,708,580 warrants as part of the merger with TGI (see Note 9).

During the three months ended March 31, 2004, the Company granted 66,666 warrants in exchange for debt valued at $9,267.

During the year ended December 31, 2003, the Company granted 600,000 warrants for compensation for consulting services.

The Company also issued 450,880 warrants as part of the units issued pursuant to the exchange of debts totaling $135,264.

During the year ended December 31, 2004, the fair value of each warrant granted was estimated using the Black-Scholes Option Price Calculation. The following assumptions were made in estimating fair value: risk free interest of 4%, volatility of 77% to 137%, expected life of 2-5 years, and no expected dividends. The value of these warrants was estimated at $3,436,105. Of this total, $3,236,105 reduced notes payable and accrued interest and $200,000 was the purchase price of 4,000,000 warrants included in the purchase of 8,000,000 common stock shares.

During the year ended December 31, 2003, the fair value of each warrant granted was estimated using the Black-Scholes Option Price Calculation. The following assumptions were made in estimating fair value: risk free interest of 4%, volatility of 164%, expected life of 1-5 years, and no expected dividends. The value of these warrants in the amount of $242,378 is included in consulting fees expense in the accompanying financial statements.



19

VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

The following is a summary of stock warrants activity:

Number
of Warrants

Weighted
Average
Exercise
Price

Warrants outstanding at December 31, 2002       --   $ --  
Granted       550,000 0.05  
Granted       50,000 0.01  
Granted       450,880 0.40  
Exercised       (250,000 ) $ 0.05  

Warrants outstanding and exercisable at December 31, 2003       800,880   $ 0.20  

Weighted average fair value of warrants granted during                
  the year ended December 31, 2004     $ 0.23  


Number
of Warrants

Weighted
Average
Exercise
Price

Warrants outstanding at December 31, 2003       800,880   $ 0.20  
Granted       28,775,246 $ 0.49  
Exercised       (350,000 ) $ 0.05  

Warrants outstanding and exercisable at December 31, 2004       29,226,126   $ 0.49  

Weighted average fair value of warrants granted during                
  the year ended December 31, 2004     $ 0.12  


NOTE 10 – STOCK OPTIONS

During the three months ended December 31, 2004, the Company granted 623,800 options under various consulting or advising services agreements at an exercise price of $0.01. These options are generally granted at varying rates per consultant or advisor for every three months of service until the termination of the individual agreements. At December 31, 2004, 548,800 of the options granted had been exercised.

During the three months ended September 30, 2004, the Company granted 1,139,600 options under various consulting or advising services agreements at an exercise price of $0.01. These options are generally granted at varying rates per consultant or advisor for every three months of service until the termination of the individual agreements. In one case, the consultant was granted a lump-sum option of 500,000 shares. The options are valid until two years following termination of the consultant or advisor or May 31, 2008, whichever is sooner. At December 31, 2004, 1,039,600 of the options granted had been exercised.

20


VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

During the three months ended June 30, 2004, the Company granted 550,000 options under various consulting or advising services agreements at exercise price of $0.01. These options are granted at varying rates per consultant or advisor for every three months of service until the termination of the individual agreements. The options are valid until two years following termination of the consultant or advisor or May 31, 2008, whichever is sooner. At December 31, 2004, 475,000 of the options granted had been exercised. Also during this period, the Company issued 1,800,000 options to Mr. Haig Keledjian and Mr. Harry Zhabilov Jr. pursuant to each officer’s Employment Agreement (more fully described in Note 4). These options are at exercise prices of $0.45 and are exercisable until two years following termination of the officer of May 31, 2008, whichever is sooner. The Company also issued 1,000,000 options to a company in conjunction with a cancelled distribution agreement exercisable at $0.40 per share. This option expired unexercised December 31, 2004.

During the three months ended March 31, 2004, the Company granted 1,050,000 options under various consulting or advising services agreements at exercise prices of $0.01 to $0.58. These options are granted at varying rates per consultant or advisor for every three months of service until the termination of the individual agreements. The options are valid until two years following termination of the consultant or advisor, or May 31, 2008, whichever is sooner. At December 31, 2004, 450,000 of the options granted had been exercised.

During the year ended December 31, 2003, the Company granted 13,080,769 options under various consulting or advising services agreements at exercise prices of $0.01 to $1.00. These options are granted at varying rates per consultant or advisor for every three months of service until the termination of the individual agreements. The options are valid until two years following termination of the consultant or advisor, or May 31, 2008, whichever is sooner. At December 31, 2004, 2,830,769 of these options had been exercised.

The Company issued 2,300,000 options each to three directors. which includes 1,800,000 options as part of an annual option and 500,000 options as a signing bonus which were granted pursuant to each officer’s employment agreement; 1,250,000 options to consultants as compensation for management roles. Another 250,000 options were issued as a finder’s fee.

During the year ended December 31, 2004, the fair value of each option granted was estimated using the Black-Scholes Option Price Calculation. The following assumptions were made in estimating fair value: risk free interest of 4%; volatility of 77% to 137%; expected life of 1-5 years; and no expected dividends. The value of these options in the amount of $3,892,960 is included in consulting fees, research and development, and management salaries expense in the accompanying financial statements.

During the year ended December 31, 2003, the fair value of each option granted was estimated using the Black-Scholes Option Price Calculation. The following assumptions were made in estimating fair value: risk free interest of 4%; volatility of 164%; expected life of 1-5 years; and no expected dividends. The value of these options in the amount of $2,524,000 is included in consulting fees expense in the accompanying financial statements.

21


VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

The following is a summary of stock option activity:

Number of Options
Weighted
Average
Exercise Price

Options outstanding at January 1, 2003     --   $ --  
Granted during 2003       13,080,769     .42  
Exercised during 2003       (2,430,769 )   .01  

Options outstanding and exercisable at December 31, 2003       10,650,000   $ .42  

Weighted average fair value of options granted during the year    
ended December 31, 2004     $ 0.19  


Number of Options
Weighted Average
Exercise Price

Options outstanding at January 1, 2004       10,650,000   $ .42  
Granted during 2004       8,063,400     .29  
Expired during 2004       (1,000,000 )   .40  
Exercised during 2004       (2,913,400 )   .01  

Options outstanding and exercisable at December 31, 2004        14,800,000     .38  

Weighted average fair value of options granted during the year    
ended December 31, 2004     $ 0.49  


There is no formal stock option plan in place. Stock options are issued by management for consulting services as deemed appropriate.

NOTE 11 – MERGER AND ACQUISITION

Acquisitions

On June 30, 2004, the Company entered into an agreement and plan of merger with Therapeutic Genetic, Inc. (hereinafter “TGI”) a California corporation, whereby a subsidiary of the Company would acquire the assets and liabilities of TGI. The Company issued 24,708,580 shares of common stock and 24,708,580 common stock warrants in this acquisition under Internal Revenue Code Section 368(a)(2)(D).

This transaction had the effect of reducing the Company’s long-term debt and accrued interest liabilities by $7,504,274 with a corresponding increase in common stock, common stock warrants, and additional paid-in-capital. In the transaction, a note in the amount of $7,504,274 owed to TGI from the Company was cancelled.

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VIRAL GENETICS, INC.
(A Development Stage Company)
Notes to the Consolidated Financial Statements
December 31, 2004

On October 1, 2001, Viral Genetics, Inc., a Delaware corporation, acquired all of the outstanding common stock of the Company. For accounting purposes, the acquisition has been treated as a recapitalization of Viral Genetics, Inc., a Delaware corporation, with the Company as the acquirer (reverse acquisition), wherein the Company became the continuing reporting entity. The net book value of liabilities assumed was $280,275 in the form of notes payable. The historical financial statements prior to October 1, 2001 are those of the Company, and are restated for the exchange of 29,750,580 shares of common stock for the original capital stock of the Company.

NOTE 12 – OTHER INCOME

In January 2003, the Company reached an arms length distribution agreement with an unaffiliated party in relation to the testing, distribution and marketing of its prospective HIV and AIDS treatment. Under the agreement in 2003 the Company received approximately $250,000 as a non-refundable deposit. In April 2003, the agreement was cancelled. The money received under the agreement was non-refundable and is classified as other non-operating income (see Note 13).

NOTE 13 – SUBSEQUENT EVENTS

On January 1, 2005, the Company signed a three year lease for additional administrative, research and development facility to commence immediately. The base rent and fees are $6,018 per month. The Company expects to locate additional office space, as well as a quality control laboratory, at this new facility.








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Certification

I, Haig Keledjian, certify that:

1.     I have reviewed this annual report on Form 10-KSB for the year ended December 31, 2004 of Viral Genetics, Inc.;

2.     Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.     Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report;

4.     The small business issuer’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the small business issuer and have:

        (a)        Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

        (b)        Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

        (c)        Evaluated the effectiveness of the small business issuer’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

        (d)        Disclosed in this report any change in the small business issuer’s internal control over financial reporting that occurred during the small business issuer’s most recent fiscal quarter (the small business issuer’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the small business issuer’s internal control over financial reporting; and

5.     The small business issuer’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer’s auditors and the audit committee of the small business issuer’s board of directors (or persons performing the equivalent functions):

        (a)        All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer’s ability to record, process, summarize and report financial information; and

        (b)        Any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer’s internal control over financial reporting.


Date: March 30, 2005   By:   /s/ Haig Keledjian  
            Haig Keledjian
    Chief Executive Officer
    Chief Financial Officer
 

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.

        In connection with the Annual of Viral Genetics, Inc. (the “Company”) on Form 10-KSB for the period ending December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Haig Keledjian, Chief Executive Officer and Chief Financial Officer of the Company, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 30, 2005   By:   /s/ Haig Keledjian  
            Haig Keledjian
    Chief Executive Officer
    Chief Financial Officer
 

A signed original of this written statement required by Section 906 has been provided to Viral Genetics, Inc. and will be retained by Viral Genetics, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.

CERTIFICATE OF AMENDMENT OF
CERTIFICATE OF INCORPORATION OF
VIRAL GENETICS, INC.

        Viral Genetics, Inc., a corporation organized and existing under the General Corporation Law of

the State of Delaware (the “Corporation”) does hereby certify that:

        The amendment to the Corporation’s Certificate of Incorporation set forth below was duly adopted

by resolutions approved by the Corporation’s Board of Directors and stockholders in accordance with

the provisions of Section 242 of the General Corporation Law of the State of Delaware. The

amendments will be effective as of 12:01 am Eastern Time on November 17, 2004.

         Amendment No. 1.   The Certificate of Incorporation of the corporation is amended by striking article FOURTH in its entirety and replacing there for:

        FOURTH.        The total number of shares of all classes of capital stock that the corporation shall have authority to issue is 270,000,000 shares. Stockholders shall not have any preemptive rights, nor shall stockholders have the right to cumulative voting in the election of directors or for any other purpose. The classes and the aggregate number of shares of stock of each class that the corporation shall have authority to issue are as follows:


        (a)        250,000,000 shares of Common Stock, $0.0001 par value (“Common Stock”).


        (b)        20,000,000 shares of Preferred Stock, $0.0001 par value (“Preferred Stock”).


          The Preferred Stock may be issued from time to time in one or more series, with such distinctive serial designations as may be stated or expressed in the resolution or resolutions providing for the issue of such stock adopted from time to time by the Board of Directors; and in such resolution or resolutions providing for the issuance of shares of each particular series, the Board of Directors is also expressly authorized to fix: the right to vote, if any; the consideration for which the shares of such series are to be issued; the number of shares constituting such series, which number may be increased (except as otherwise fixed by the Board of Directors) or decreased (but not below the number of shares thereof then outstanding) from time to time by action of the Board of Directors; the rate of dividends upon which and the times at which dividends on shares of such series shall be payable and the preference, if any, which such dividends shall have relative to dividends on shares of any other class or classes or any other series of stock of the corporation; whether such dividends shall be cumulative or noncumulative, and if cumulative, the date or dates from which dividends on shares of such series shall be cumulative; the rights, if any, which the holders of shares of such series shall have in the event of any voluntary or involuntary liquidation, merger, consolidation, distribution or sale of assets, dissolution or winding up of the affairs of the corporation; the rights, if any, which the holders of shares of such series shall have to convert such shares into or exchange such shares for shares of any other class or classes or any other series of stock of the Corporation or for any debt securities of the corporation and the terms and conditions, including price and rate of exchange, of such conversion or exchange; whether shares of such series shall be subject to redemption, and the redemption price or prices and other terms of redemption, if any, for shares of such series including, without limitation, a redemption price or prices payable in shares of Common Stock; the terms and amounts of any sinking fund for the purchase or redemption of shares of such series; and any and all other designations, preferences, and relative, participating, optional or other special rights, qualifications, limitations or restrictions thereof pertaining to shares of such series’ permitted by law.

         IN WITNESS WHEREOF , Viral Genetics, Inc., has caused this Certificate to be signed by its

duly authorized officer this 1st day of November 2004.

VIRAL GENETICS, INC.


  By:   /s/ Haig Keledjian  
            Haig Keledjian, President  

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Version Attached as Exhibit to 10-K SB

Distribution Management Agreement

        This Distribution Management Agreement (this “Agreement”) is made and entered into as of the date indicated below, but deemed effective by the Parties as of July 1, 2004, by and between Viral Genetics, Inc., a Delaware corporation, located at 1321 Mountain View Circle, Azusa, CA 91702 (“VGI”), and Timothy & Thomas LLC, an Illinois limited liability company, located at 2625 South Loomis Street, Chicago, IL 60608 (“T&T”).

Recitals

A. T&T has made payments to VGI in the total amount of $650,000 to partially defray certain expenses which VGI will incur under the terms of this Agreement.

B. T&T has assigned to VGI all rights under a Convertible Debenture agreement between Tom Little and Viral Genetics, Inc. dated September 30 2003 in the amount of $200,000 USD to partially compensate VGI for certain expenses which VGI will incur under the terms of this Agreement.

C. Therapeutic Genetic, Inc. has been merged with VGI.

D. VGI holds all patent rights to pharmaceutical products, which are intended for treatment of HIV and the related condition, AIDS, including, without limitation, a product based on thymus nuclear protein identified as “VGV-1.”

E. VGI plans to manufacture pharmaceutical products, which are intended for treatment of HIV and the related condition known as AIDS, including, without limitation, a product based on thymus nuclear protein identified as “VGV-1.”

F. T&T plans to obtain government approvals, licenses, and authorizations from certain governments of African nations for distribution of products imported from other countries (including the United States of America) and to manage and secure distribution capabilities in African nations through local sales channels, affiliated companies based in Africa, or strategic distribution arrangements with unrelated third parties.

G. VGI desires to retain T&T’s services and T&T desires to provide services to manage the distribution of its pharmaceutical products in Africa.

Agreement

Wherefore, in consideration of the foregoing Recitals, which are incorporated by reference in this Agreement, and the mutual promises set forth below, the Parties hereto mutually agree as follows:






Definitions:

AIDS:

        Acquired Immunodeficiency Syndrome

Alternate Product:

  Any product, drug and/or medical device for which VGI acquires the right to market, distribute and/or sell during the term of this Agreement which is not a Product as defined herein.

Applicable Regulations:

  Any and all regulations pertaining to the manufacture, marketing and/or distribution of pharmaceuticals promulgated by the Food and Drug Administration of the United States of America or any governmental regulatory body in the Territory.

Clinical Trial:

  The multi-center, randomized, double-blind, placebo-controlled human clinical trial of a product named VGV-1 as approved by letter dated February 27, 2004, from the Medicines Control Council of South Africa to be performed in accordance with an agreement between Viral Genetics, Inc. and Virtus Clinical Development (Pty) Ltd. dated August 1, 2003 including any amendments thereto.

Distributor:

  Any entity, designated by T&T which has entered into a contract with VGI to market, purchase, receive, store, sell and distribute the Product for use in a designated portion of the Territory.

Distribution Agreement:

  Any agreement authorized by T&T between VGI and any Distributor which assigns a License to that Distributor.

HIV:

      Human Immunodeficiency Virus infection

Late Stage Manufacturing:

        The packaging and labeling of the Product in accordance with Applicable Regulations.

License:

  The sole and exclusive right to purchase, receive, store, sell and distribute the Product in a designated portion of the Territory and/or to secure governmental approval including licenses and

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  registrations as required for said activities. The term “License” as used herein shall not impart to any party any right to any intellectual property or authorize any party to exercise any particular rights under any patent, patent pending or patent application.

Parties:

        Viral Genetics, Inc. and Timothy & Thomas LLC collectively.

Product:

  Any product for which VGI has secured or will secure marketing rights, distribution rights or patent rights for the prevention or treatment of HIV and/or AIDS including but not limited to that formulation which is described in United States patent application number 08/641,936, Compositions and Methods for Detecting and Treating Immunodeficiency Syndrome , which is now pending and South Africa patent application number 96/3474 (formerly referred to as “TNP”). “Product” includes any future or subsequent modifications, improvements, reformulations, substitutes and other enhancements developed by VGI for the prevention or treatment of HIV or AIDS.

Purchaser:

        Any party to which a Distributor sells or delivers the Product.

T&T:

      Timothy & Thomas LLC.

Territory:

  The sovereign countries of Angola, Ascension Island, Benin, Botswana, Burkina Faso, Burundi, Cameroon, Cape Verde, Central African Republic, Chad, Comoros, Congo, Republic of (Brazzaville), Congo, Democratic Republic of the, Cote d’Ivoire, Djibouti, Egypt, Equitorial Guinea, Eritrea, Ethiopia, Gabon, Gambia, The Ghana, Guinea, Guinea-Bissau, Kenya, Lesotho, Liberia, Libya, Madagascar, Malawi, Mali, Mauritania, Mauritius, Mayotte, Morocco, Mozambique, Namibia, Niger, Nigeria, Reunion, Rwanda, Saint Helena Island, Sao Tome and Principe, Senegal, Seychelles, Sierra Leone, Somalia, South Africa, Sudan, Swaziland, Tanzania, Togo, Tunisia, Uganda, Western Sahara, Zambia and Zimbabwe.

Treatment Unit:

  Currently, that quantity and form of the Product which has been approved for the complete dosing of HIV-1 infected and CDC stage AIDS patients by the Medicines Control Council of the Republic of South Africa, which is currently defined as sixteen (16) vials, each containing 2 milliliters of the Product in suspension and which is designated to be dosed through biweekly intramuscular injections for eight (8) weeks. Treatment Unit dosing regimen and/or quantities may be altered from time to time to conform to VGI specifications and/or to Applicable Regulations. Each Treatment Unit shall be sealed and labeled in accordance with Applicable Regulations. Each vial shall be suitably sized and configured to provide a single human injection.

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VGI:

      Viral Genetics, Inc.

1.     Appointment:

  A. VGI hereby appoints T&T, and T&T hereby accepts the appointment by VGI to be the exclusive independent agent for VGI for the management of the distribution of the Product in the Territory.

  B. Prior to any assignment, transfer, delegation or disposal of its rights and obligations under this Agreement T&T shall tender 30 days’ prior written notice to VGI of such proposed assignment, transfer, delegation or disposal of its rights and obligations. During that 30 day period T&T shall extend to VGI the right to accept such proposed assignment, transfer, delegation or disposal of its rights and obligations under terms and conditions equivalent to the terms proposed to T&T by any third party.

  C. Prior to any assignment, transfer, delegation or disposal of controlling interest in T&T by T&T’s current members, T&T’s members shall tender 30 days’ prior written notice to VGI of such proposed assignment, transfer, delegation or disposal of controlling interest. During that 30 day period T&T shall extend to VGI the right to accept such proposed assignment, transfer, delegation or disposal of controlling interest under terms and conditions equivalent to the terms proposed to T&T’ members by any third party.

2.     Distribution Agreements:

  A. T&T shall designate to VGI one or more Distributors. T&T shall designate a specific geographic area to be assigned to each Distributor so designated.

  B. VGI shall enter into a Distribution Agreement with each Distributor designated by T&T. Each such Distribution Agreement shall assign to the Distributor a specific geographic area designated by T&T. VGI shall not be required to enter into or to maintain a Distribution Agreement with any prospective Distributor which is affiliated with, controlled by or owned by any entity which holds any interest which is competitive with or in conflict with VGI’s interest or T&T’s interest. VGI may from time to time require sufficient identity information to clearly ascertain whether any Distributor or prospective Distributor is affiliated with, controlled by or owned by any entity which holds any interest which is competitive with or in conflict with VGI’s interest or T&T’s interest.

  C. VGI shall faithfully fulfill and perform its duties and obligations under each Distribution Agreement. D. Each Distributor shall faithfully fulfill and perform its duties and obligations under its applicable Distribution Agreement.

  D. Each Distributor shall faithfully fulfill and perform its duties and obligations under its applicable Distribution Agreement.

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  E. VGI shall terminate each Distribution Agreement at the time and in accordance with the terms and conditions designated by T&T. T&T shall not direct VGI to terminate any Distribution Agreement if such termination would cause a breach of the applicable Distribution Agreement by VGI.

  F. In the event VGI determines that any Distributor is in breach of its applicable Distribution Agreement:

  1. VGI shall notify T&T by email and fax of such breach. Such notification shall include all facts, evidence and information which have caused VGI to determine that said Distribution Agreement has been breached.

  2. Within 30 days after receiving such notice of breach T&T shall either cause the Distributor to have cured such breach or T&T shall direct VGI to terminate the applicable Distribution Agreement.

  3. If, upon the expiration of said 30 day period, T&T has failed to cause the breach to be cured and further, has failed to direct VGI to terminate the applicable Distribution Agreement then VGI may at its sole option either continue or terminate the applicable Distribution Agreement.

  4. VGI’s option to so continue or terminate the applicable Distribution Agreement shall cease upon subsequent notification by T&T that T&T has caused the Distributor to cure the breach or upon subsequent direction by T&T to VGI to terminate the applicable Distribution Agreement.

  G. VGI may require any Distributor to provide VGI with identity information for any prospective Purchaser prior to sale of the Product to said prospective Purchaser. Required identity information may include but not necessarily be limited to the Purchaser’s commercial identity and the identity of all persons having controlling interest in the prospective Purchaser. VGI may require sufficient identity information to clearly ascertain whether the prospective Purchaser is affiliated with, controlled by or owned by any entity which holds any interest which is competitive with or in conflict with VGI’s interest or T&T’s interest.

  H. VGI may deny any Distributor the right to sell Product to any prospective Purchaser which is affiliated with, controlled by or owned by any entity which holds any interest which is competitive with or in conflict with VGI’s interest or T&T’s interest.

  I. VGI may deny any Distributor the right to sell Product to any prospective Purchaser if such sale is determined to violate Applicable Regulations.

  J. Each Distributor shall expressly agree that it shall not, and shall cause its Purchasers to agree not to, export, directly or indirectly, re-export, divert, or transfer any Product to any destination, company or person, or for any end use, restricted or prohibited by Applicable Regulations or Export Controls maintained by the USA.

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3.     Distribution Agreement Terms and Conditions:

  Each Distribution Agreement shall incorporate terms and/or conditions specifically designated by VGI and/or T&T for that specific Distribution Agreement.

4.     Product Delivery:

  A. Upon receipt of an order as described herein VGI shall deliver Product to Distributors f.o.b. the bonded warehouse or commercial equivalent designated by the Distributor and approved by VGI at the port of entry within the Territory designated by the Distributor. Each designated bonded warehouse or commercial equivalent shall conform to all Applicable Regulations. VGI shall complete each delivery in conformity with Applicable Regulations.

  B. VGI agrees to allocate and make available for delivery to all Distributors an absolute minimum delivery of [omitted as confidential and filed separately with the SEC] Treatment Units in each calendar month.

  C. On or before the last day of each calendar month each Distributor shall transmit a Purchase Order to VGI by Email and Facsimile. Each Purchase Order shall specify the delivery location, the type or model number of Product, and the quantity of Product (designated as number of Treatment Units) to be delivered to the Distributor on or before the last day of the following calendar month. Delivery on or before the last day of the following calendar month shall be considered delivery in a timely manner.

  D. Should VGI determine that it is unable to deliver all Product ordered by all Distributors in a timely manner VGI shall notify T&T of such inability no later than 5 work days after the end of the month in which Distributor Purchase Orders are transmitted to VGI. Should VGI fail to transmit such notice of inability to deliver in a timely manner, VGI shall deliver all product ordered in at timely manner. In any such notice of inability to deliver in a timely manner VGI shall state the number of Treatment Units in excess of [omitted as confidential and filed separately with the SEC] Treatment Units which VGI will deliver in a timely manner.

  E. In the event VGI determines that it is unable to deliver all Product ordered by all Distributors in a timely manner VGI shall allocate the month’s Product deliveries among Distributors as designated by T&T.

  F. At any time after all Distributors have ordered a cumulative total of [omitted as confidential and filed separately with the SEC] Treatment Units in monthly increments of [omitted as confidential and filed separately with the SEC] or less and further, provided that no Distributor is in arrears in payments due to VGI, T&T may direct VGI to increase its capacity to deliver product to [omitted as confidential and filed separately with the SEC] Treatment Units per calendar month. Within [omitted as confidential and filed separately with the SEC] after receiving such direction from T&T, VGI shall increase its capacity to deliver product at the rate of [omitted as confidential and filed separately with the SEC] Treatment Units per calendar month. [omitted as confidential and filed separately with the SEC] months after receiving such direction from T&T, VGI agrees to allocate and make available for delivery to all Distributors an absolute minimum delivery of [omitted as confidential and filed separately with the SEC] Treatment Units in each subsequent calendar month.

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  G. VGI acknowledges that the monetary damages that T&T will suffer in the event of a breach by VGI of the terms of this Product Delivery Section will be difficult to fully assess and that T&T will suffer irreparable harm as a result of such breach. Accordingly, in addition to any other relief to which T&T may be entitled for any such breach by VGI or VGI’s agents of the terms of this Product Delivery Section, T&T and/or any Distributors will be entitled to enforce said terms through temporary, preliminary and/or permanent injunctive relief against VGI and against any other persons or entities that may be acting in concert with or in participation with VGI in connection with any such breach by VGI. This provision with respect to injunctive relief shall not, however, in any way diminish T&T’s right to claim and to recover monetary damages in addition to injunctive relief.

5.     Late Stage Manufacturing:

  A. VGI and T&T conclude that it will be expeditious, required, or necessary to perform Late Stage Manufacturing in certain parts of the Territory. In the event T&T determines that it is expeditious, required, or necessary to perform Late Stage Manufacturing in any part of the Territory, then VGI shall either:

  1. authorize T&T to establish, maintain and operate, for the term of this Agreement, a facility for such Late Stage Manufacturing in that part of the Territory;

  2. or authorize T&T to establish, maintain and operate, for the term of this Agreement, a facility for such Late Stage Manufacturing in an alternative location designated by VGI which T&T determines to be equally advantageous.

  B. In the event T&T elects to establish, maintain or operate a facility for such Late Stage Manufacturing:

  1. VGI will provide T&T and/or its designated agent with all information necessary to design, construct, equip, install and operate the facility for the Late Stage Manufacturing by the most safe, efficient and cost effective methods known to and available to VGI.

  2. T&T and/or its designated agent will cause any person who gains access to Intellectual Property belonging to VGI to enter into an agreement not to disclose any such Intellectual Property to any third party.

  3. T&T and/or its designated agent will provide funds for, establish, maintain & operate said Late Stage Manufacturing facilities in conformity with Applicable Regulations.

  4. T&T will designate those Distributor Purchase Orders which will be delivered by any Late Stage Manufacturing facility.

  5. Each Distributor will pay VGI for all Product delivered from each Late Stage Manufacturing facility in accordance with the payment terms of this Agreement.

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  6. VGI shall reimburse T&T for all costs incurred by T&T and/or its designated agent for the establishment, maintenance and/or operation of the Late Stage Manufacturing facility including general and administrative costs associated therewith but excluding any profit margin payable to T&T. The calculation of costs shall be based on widely-accepted manufacturing cost accounting providing for, among other things, the allocation of costs attributable to capital investment on a per unit basis over a reasonable period of time. On or before the last day of each calendar month VGI shall tender payment to T&T in an amount equal to all costs incurred in the previous calendar month.

  C. VGI will not be required to render any assistance to T&T and T&T shall not establish any Late Stage Manufacturing facility unless any persons and/or entities involved in establishing and operating these facilities, other than the employees and consultants employed or engaged by VGI, agree in writing to be bound by the terms and provisions of this Agreement regarding protection of VGI’s Rights to Intellectual Property.

6.     Timely Payment:

  A. Payment for all Product delivered by VGI to each Distributor in each calendar month shall be deposited by the Distributor via wire transfer to the bank account designated by VGI on or before the last day of the calendar month following the month in which delivery has been made (referred to herein as “timely payment”). All Distributor payments shall be denominated in currency of the United States of America.

  B. In the event any Distributor fails to make timely payment to VGI, VGI shall notify T&T of such failure. Within ten (10) days after receiving such notice T&T shall either cause Distributor to pay to VGI any past due amount or direct VGI to cease delivery of Product to that Distributor.

  C. Fifteen days after having tendered such notice to T&T, VGI may refuse orders or refuse to ship Product to any Distributor which has failed to pay VGI any past due balance in excess of $[omitted as confidential and filed separately with the SEC] USD.

7.     Tariffs, Duties & Taxes:

  A. VGI shall comply fully with all Applicable Regulations imposed by any governmental authority at the location from which Product is shipped, including but not limited to, U.S. Export Administration Regulations and USFDA regulations as applied to VGI’s export of Product from the United States of America.

  B. VGI shall pay any export license fees, tariffs, customs duties, taxes, or other charges imposed by any authority at the location from which VGI ships Product.

  C. T&T shall cause each Distributor to pay any tariff, customs duty, tax, or other charge imposed by any authority at the destination designated by Distributor for delivery of Product by VGI.

  D. VGI shall not be obligated to pay any tariff, customs duty, tax, or other charge imposed under the laws of any jurisdiction in the Territory.

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8.     Intellectual Property:

  A. All testing protocols, methodologies, data, reports, results, analyses, summaries, and other information pertaining to the testing and study of the Product in the Territory are the sole and exclusive property of VGI, and T&T will take all action, and will cause each Distributor to take all action, required to preserve VGI’s ownership thereof.

  B. VGI shall make available to each Distributor any Intellectual Property necessary or expedient for the purpose of securing any registration or licensing under Applicable Regulations.

  C. Where so required by Applicable Regulations, Intellectual Property documentation shall be stored and made available in the office of the Distributor.

  D. All right, title and interest in and to any and all know-how, trade secrets, trade names, trade marks, service marks, copyrights, and patents (issued, pending or provisional), and all other intellectual property rights and any license right to any patent (collectively the “Rights”) in any way pertaining to the Product or Product materials as provided by VGI, including all future improvements to Product from any source, do now and shall in the future belong solely to VGI. No sale of Product to T&T or any Distributor shall confer upon any of them, nor shall T&T or any Distributor be authorized to confer upon any Purchaser, any legal right or license of any kind regarding any of the Rights owned or controlled by VGI.

  E. Any data, trade secrets, formulations, test results, manufacturing processes, and other Product related information regarding the Product (collectively, the “Proprietary Data”) furnished to T&T by VGI before, after, or contemporaneously with the execution of this Agreement are confidential and proprietary to VGI, are intended for confidential use by T&T only, shall remain the exclusive property of VGI, and shall not be used by T&T except for the express purposes of this Agreement. All such Proprietary Data are based on VGI’s knowledge and work. T&T agrees not to reverse-engineer for its own use or for others, or to disclose to any other parties, any formulas, techniques, inventions, trade secrets or other Proprietary Data revealed to T&T by VGI in connection with this Agreement. T&T acknowledges that the monetary damages that VGI would suffer in the event of a breach by T&T of the restrictions and covenants contained herein would be extremely difficult to calculate and that VGI would suffer irreparable harm as a result of such breach. Accordingly, in addition to any other relief to which VGI may be entitled for any breach by T&T of the restrictions and covenants contained herein, VGI shall be entitled to enforce said restrictions and covenants through temporary, preliminary and/or permanent injunctive relief against T&T and against any other persons or entities that may be acting in concert or participation with T&T in connection with any such breach by T&T. This provision with respect to injunctive relief shall not, however, in any way diminish VGI’s right to claim and to recover monetary damages in addition to injunctive relief. The restrictions and covenants pertaining to Proprietary Data shall survive the termination or expiration of this Agreement.

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9.     Product Descriptions, Advertising and Promotional Materials:

  A. T&T shall monitor each Distributor to determine that no Distributor makes any representation or claim regarding the Product which has not been substantiated by VGI. Neither T&T nor any Distributor shall produce or disseminate any material, advertising, or document, whether in paper, electronic, digital, audio, video, or other format which does not conform to Applicable Regulations or does not accurately represent information which has been provided by VGI.

  B. VGI shall provide to T&T and to Distributors at VGI’s expense, current, accurate, English language information pertaining to the Product and the administration thereof including but not limited to promotional and descriptive documentation. For purposes of promotion of VGI’s Product, T&T and/or Distributors may use such information and materials, and may create and distribute derivative works, including translations thereof, provided such derivative works accurately replicate and represent information provided by VGI and conform to Applicable Regulations.

  C. VGI agrees to provide to T&T at VGI’s expense, at least one copy of any of VGI’s Product information and/or related materials promptly, when developed by VGI from time to time. For purposes of promotion of VGI’s Product, T&T may use such Product information and materials, and may create derivative works thereof that may be used by T&T and/or Distributors provided such derivative works conform to Applicable Regulations.

  D. All Product descriptions, specifications, and informational materials and any copyrighted materials supplied by VGI to T&T shall be used in conformity with all Applicable Regulations and may be used by T&T only for the express purposes of this Agreement; and T&T agrees not to use these materials in any other manner.

  E. T&T shall not make or permit any Distributor to make any representations or claims regarding the Product or their efficacy other than those which conform to all Applicable Regulations and set forth in Product information, marketing materials, brochures, etc., supplied by or approved in advance in writing by VGI.

10.     Licenses & Registrations

  A. To the extent required by Applicable Regulations VGI shall obtain and maintain at VGI’s sole cost any certifications or approvals for the manufacture and/or importation of the Product in conformity with all Applicable Regulations. To the extent required by Applicable Regulations drug applications and applications for authorizations or licenses for the manufacture and/or importation of the Product in the Territory shall be applied for by VGI and secured in the name of VGI.

  B. T&T shall cause each Distributor in each designated portion of the Territory to obtain and maintain at that Distributor’s sole cost any licenses, certifications or approvals and to conduct every aspect of its business in conformity with all Applicable Regulations. T&T shall cause each Distributor in its designated portion of the Territory to apply for all authorizations or licenses to distribute the Product in its designated portion of the Territory. Said authorizations or licenses shall be applied for by the designated Distributor in the name of said Distributor or its designee.

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  C. T&T shall cause each Distributor in each designated portion of the Territory to obtain and maintain any required registration and/or approval of the Product required by regulatory authorities in the designated portion of the Territory. All applications for registration and/or approval of the Product shall be made in the name of VGI or the Distributor as may be designated by T&T. All costs incurred by each Distributor in securing registration and/or approval of the Product shall be borne by T&T or the Distributor as determined by T&T.

  D. VGI shall assist each Distributor in securing, any licenses, registrations, authorizations, certifications and/or approvals from any regulatory authorities which are necessary for said Distributor to perform Distributor’s duties and obligations in accordance with its Distribution Agreement. Said assistance shall include but not be limited to:

  1. Services of competent persons to prepare, submit and/or present information required and/or requested by governmental representatives.

  2. Preparation and dissemination of English language documentation, information and data reasonably required and/or requested by governmental representatives.

  3. Preparation and submittal of license applications.

  4. Personal presentations reasonably required and/or requested by governmental representatives.

  5. Assistance in the design and conduct of clinical trials necessary to secure such governmental approval.

  E. VGI shall provide such assistance, exclusive of travel expenses, at VGI’s sole cost. T&T shall pay all expenses for travel, meals, and lodging incurred by VGI as a result of providing such assistance.

11.     Illegal Activities

  A. The Parties hereto represent that no part of any consideration received hereunder will be used by the Parties hereto for any purpose, nor have the Parties hereto taken, nor will the Parties hereto take any action, which would constitute a violation of any law of any jurisdiction in the Territory or of the United States, including, without limitation, the Foreign Corrupt Practices Act. The Parties hereto represent that they do not desire and will not request any service or action which would or might constitute any such violation. Further, the Parties hereto have not previously paid or promised to, and agree prospectively not to, pay or promise to pay or give or promise to give anything of value, either directly or indirectly, to an official of any government for the purpose of influencing an act or decision in his or her official capacity, inducing him or her to use his or her influence with a foreign government, assisting any of the Parties hereto in obtaining or retaining business for or with, or directing business to, any person or as a political contribution of any kind.

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  B. The Parties hereto agree to comply fully with all relevant export laws and regulations of the United States and foreign governments, including, but not limited to, the U.S. Export Administration Regulations (collectively, the “Export Controls”). Without limiting the generality of the foregoing, the Parties hereto expressly agree that they shall not, and shall cause its representatives to agree not to, export, directly or indirectly, re-export, divert, or transfer the Product to any destination, company or person, or for any end use, restricted or prohibited by Export Controls.

  C. The Parties hereto each represent, warrant and covenant that neither they nor any person who owns a controlling interest in or otherwise controls them is or shall be (i) listed on the Specially Designated Nationals and Blocked Persons List maintained by the Office of Foreign Assets Control (“OFAC”), Department of the Treasury, and/or on any other similar list maintained by OFAC pursuant to any authorizing statute, Executive Order or regulation (collectively, “OFAC Laws and Regulations”), (ii) a “Designated National” as defined in the Cuban Assets Control Regulations, 31 C.F.R. Part 515, or (iii) a person designated under Section 1 (b), (c) or (d) of Executive Order No. 13224 (September 23, 2001), any related enabling legislation or any other similar Executive Orders (collectively, the “Executive Orders”); and they are in compliance with all OFAC Laws and Regulations, Executive Orders and related government guidance.

  D. The Parties hereto each represent, warrant and covenant that neither they nor any person who owns a controlling interest in or otherwise controls them (i) is under investigation by any governmental authority for, or has been charged with, or convicted of, money laundering (under either 18 U.S.C. Section 1956 or 1957), or drug trafficking, terrorist-related activities or other money laundering predicate crimes or a violation of the Bank Secrecy Act laws (31 U.S.C. Sections 5311, et seq.), (ii) has been assessed civil penalties under these or related laws (collectively, “Anti-Money Laundering Laws”), or (iii) has had any of its funds seized or forfeited in an action under Anti-Money Laundering Laws.

  E. The Parties hereto each represent, warrant and covenant that they consent to the disclosure to U.S. regulators and law enforcement authorities of such information either of the Parties hereto reasonably deems necessary or appropriate to comply with U.S. Anti-Money Laundering Laws, the USA PATRIOT Act and other anti-terrorists laws and regulations or OFAC Laws and Regulations.

12.     Product Pricing

  A. VGI shall sell Product to each Distributor at a price per Treatment Unit equal to the greater of $[omitted as confidential and filed separately with the SEC] USD or [omitted as confidential and filed separately with the SEC] percent of the Distributor’s sale price to each Purchaser.

  B. VGI and T&T agree to cause the prices paid to VGI by each Distributor to be adjusted to compensate for any change in VGI’s manufacturing costs which result from changes to the Product, improvements to the Product, material changes in manufacturing costs, or changes agreed upon between VGI and T&T.

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  C. On the second anniversary of this Agreement and at two (2) year intervals thereafter VGI and T&T agree to cause the prices paid to VGI by each Distributor to be adjusted to compensate for changes in the value of the currency of the United States of America relative to commodities and other currencies.

  D. Notwithstanding other prices stated herein, VGI agrees to sell the Product to Distributor at the most favorable prices, terms and/or conditions extended by VGI to any third party.

13.     T&T Management Fees

  VGI shall tender monthly payments to T&T in amounts equal to [omitted as confidential and filed separately with the SEC] of the sum of all payments received by VGI in the preceding calendar month for Product delivered to Distributors by VGI. VGI shall cause payments due in each calendar month to be deposited via wire transfer to the bank account designated by T&T on or before the 10th day of that month.

14.     Distributor Management

  A. T&T shall cause each Distributor and their respective employees and agents to be thoroughly trained in and to understand any directions, applications, contraindications, and cautions, including limitations on the improper uses which pertain to the Product as documented in information provided by VGI.

  B. T&T shall cause each Distributor to perform the Distributor’s duties and obligations in accordance with the applicable Distribution Agreement and in accordance with all Applicable Regulations.

  C. VGI shall cause Product to be delivered to each Distributor in accordance with all Applicable Regulations. D. T&T shall cause each Distributor to receive, store and distribute all Product in accordance with all Applicable

  D. T&T shall cause each Distributor to receive, store and distribute all Product in accordance with all Applicable Regulations.

  E. T&T shall cause each Distributor to maintain accurate records indicating the Purchaser to which each Treatment Unit is delivered. Said records shall indicate the identity of the Purchaser, the date of delivery and the identity of the Treatment Unit.

15.     Clinical Trials

  A. T&T shall pay $1,600,000 (One Million Six Hundred Thousand Dollars US) to complete the Clinical Trial. T&T shall pay any additional costs in excess of $1,600,000 (One Million Six Hundred Thousand Dollars US) incurred to complete the Clinical Trial. VGI shall reimburse T&T in an amount equal to one half of any such additional costs in excess of $1,600,000 (One Million Six Hundred Thousand Dollars US) incurred to complete the Clinical Trial. Said reimbursements shall be tendered by VGI to T&T on a monthly basis on or before the 10 th day of each calendar month following the month in which said costs are paid by T&T.

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  B. T&T will cooperate and provide all assistance, and will cause each Distributor to cooperate and provide all assistance, reasonably requested by VGI in the design and implementation of any and all tests, protocols, studies, or trials of the Product in the Territory.

  C. VGI will provide reasonable assistance at its cost in the preparation and submission of applications reasonably required to obtain permission for any clinical trial or marketing approval of the Product in the Territory. VGI will design at its cost tests, protocols, studies, or trials of the Product in the Territory, and provide reasonable assistance in implementing and conducting such tests, protocols, studies, or trials. If the preparation and submission of any application or design and implementation of any test, protocol, study, or trial requires travel of any VGI employees or consultants, T&T will pay all expenses for travel, meals, and lodging.

  D. In the event T&T concludes that it will be expedient or necessary, for the purpose of selling and distributing the Product in a significant part of the Territory, to retain the services of any third party to conduct part of or all of any future clinical trial services, the Parties hereto agree to share the cost of such third party services equally.

16.     Product Changes & Improvements

  Promptly provide T&T with current, accurate notice of any modifications or improvements made by VGI to the Product and/or formulae including any available information pertaining to the efficacy and/or health-related consequences of such modifications as well as any known serious adverse effects related to such modifications or improvements.

17.     Alternative Products

  A. In the event VGI develops or secures the right to sell an Alternate Product in the Territory, VGI shall enter into a contract with T&T whereby VGI assigns to T&T the right to manage the distribution of such Alternative Products in accordance with mutually agreeable terms and conditions which terms and conditions shall generally conform with the terms and conditions of this Distribution Management Agreement. The term of any such Alternative Product contract shall be 5 years.

  B. If, during the initial 6 months of any such Alternative Product contract VGI receives a bona-fide offer to manage the distribution of the Alternative Product which offer incorporates terms which are more favorable to VGI than the then existing Alternative Product contract between VGI and T&T, VGI shall notify T&T of such offer and shall provide an accurate copy of said offer to T&T.

  C. Upon tendering such notification VGI shall extend to T&T a 30 day option to revise the then existing Alternative Product contract to incorporate terms which are equally favorable to VGI.

  D. If T&T fails to exercise its 30 day option in a timely manner VGI may unilaterally terminate the then existing Alternative Product contract between VGI and T&T. Upon such termination VGI shall tender payment to T&T in an amount equal to any expenses which have been incurred prior to such termination by T&T in the performance of the terminated Alternative Product contract.

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18.     Manufacturing and Packaging Standards:

  A. VGI and/or any third party which performs Late Stage Manufacturing shall:

  1. Affix to each 2 milliliter vial of the Product a unique label in a form such that said label can subsequently be uniquely identified.

  2. Affix to each Treatment Unit a unique label in a form such that said label can subsequently be uniquely identified. Each label shall indicate expiration date of the potency period of the Product contained therein.

  3. Maintain a record of the unique identity of each 2 milliliter vial contained in each Treatment Unit.

  B. Maintain a record of the unique identity of each 2 milliliter vial contained in each Treatment Unit. B. VGI shall be solely responsible for all manufacturing of the Product, and delivery of the same to any Distributor. Manufacturing in accordance

  C. Maintain a record of the unique identity of each 2 milliliter vial contained in each Treatment Unit. B. VGI shall be solely responsible for all manufacturing of the Product, and delivery of the same to any Distributor. C. Any Distributor which performs Late Stage Manufacturing shall perform such Late Stage Manufacturing in accordance with Applicable Regulations.

  D. VGI warrants that the Product sold hereunder will conform to the formulation authorized by applicable governmental agencies for distribution in the Territory and will be free from any material defects in material and manufacture. VGI makes no other warranties, express, implied, or otherwise, and in particular VGI makes no implied warranties of merchantability or fitness for a particular purpose concerning the Product.

19.     Patent Infringement

  A. VGI shall defend and indemnify any claim or suit, foreign or domestic, that any party may institute against T&T for alleged infringement of a patent or patents or rights relating to VGI’s Product, and T&T shall provide all commercially reasonable assistance in the defense of same. However, this Section shall apply only to such infringements as shall arise from the use of the Product alone, and not as a part of any combination by T&T or any third party with any other product, substances or formulas. Furthermore, VGI’s obligation to comply with this Section shall only arise if:

  1. The Distributor or Distributors in the country where the claim originates have made all payments then due under the applicable Distribution Agreements.

  2. T&T and/or the Distributor or Distributors in the country where the claim originates give VGI immediate notice in writing of the alleged infringement and of the institution of any claim or suit.

  3. T&T and/or the Distributor or Distributors in the country where the claim originates permit VGI to defend such suit.

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  4. T&T and/or the Distributor or Distributors in the country where the claim originates furnish to VGI all reasonable information, assistance, and authority which is necessary to defend such claim or suit.

  B. VGI shall have no liability under this Section for any compromise reached by T&T or any Distributor without VGI’s written consent. Unless established as a direct consequence of litigation, which VGI has itself defended under the terms of this Section or established as a consequence of a settlement agreement entered into by VGI, VGI shall have no liability for any patent infringement. VGI shall not be required to defend any claims or suits or pay any damages arising, directly or indirectly, from the use of any other Product, substances or formulas not furnished by VGI or from any misuse of the Product. To discharge its obligations under this Section, VGI may, at its option and in its sole discretion, either obtain for T&T and the affected Distributors the right to continue distributing the Product, or modify the Product so that it is no longer infringing while retaining reasonably equivalent efficacy and safety.

20.     Indemnification

  A. Each party agrees to indemnify and hold harmless the other and their respective officers, directors and employees from and against any and all claims, suits, causes of action, liabilities, defaults, obligations, injuries, losses or damages, including reasonable attorneys’ fees and costs, arising from or relating to the indemnifying party’s material breach of any of its obligations under this Agreement or the indemnifying party’s negligent or intentionally wrongful acts or omissions in connection therewith.

  B. VGI shall provide clinical trial results, data, data summary analyses and any other information pertaining to the Product which is or will be submitted to and/or required by any governmental authority in the Territory. VGI warrants all such information to be true, accurate and complete in every respect. To the fullest extent permitted by the laws of the government under which such information is submitted, VGI shall indemnify and hold T&T and any Distributor and their respective officers, directors and employees harmless from any claim, allegation or determination that any such information is false, inaccurate or incomplete. Such indemnification shall include but not be limited to compensation by VGI to the indemnified parties for consequential damages, including loss of income and/or loss of credibility suffered by said indemnified parties as a result of any such false, inaccurate or incomplete information.

21.     Term of Agreement

  A. The term of this Agreement is for a period of 20 years commencing on July 1, 2004 and ending on June 30, 2024.

22.     Termination of Agreement

  Either party to this Agreement may terminate this Agreement immediately upon notice to the other party if the other party files a petition for bankruptcy protection and liquidation under Title 11, Chapter 7 of the United States Code.

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23.     Resolution of Disputes

  A. This Agreement has been entered into and is to be performed in part in the State of California, and therefore shall be construed and interpreted under the laws of the State of California, without regard to conflicts of law principles.

  B. In the event that either party hereto shall be found in default or breach of this Agreement by a court of competent jurisdiction, said party shall be liable to pay all reasonable attorney’s fees, arbitration and court costs and other reasonably related collection costs and expenses incurred by the other party in enforcing its rights hereunder.

24.     T&T Representations:

  A. T&T represents, warrants and covenants that the person who has duly executed this Agreement on behalf of the T&T is duly authorized to so act.

  B. T&T represents, warrants and covenants that T&T (i) is a limited liability company duly organized, validly existing and in good standing under the laws of the State of Illinois; and (ii) has all requisite power and all governmental licenses, authorizations, consents and approvals necessary to own its assets and carry on its business as now being and as proposed to be conducted and to consummate the transactions contemplated by the Agreement.

  C. T&T represents, warrants and covenants that the execution, delivery and performance by T&T of this Agreement and the consummation of the transactions contemplated thereby: (i) have been duly authorized by all requisite action of T&T, and, if required, any action on the part of the owners of T&T; and (ii) do not and will not: (1) violate any provision of law, statute, rule or regulation, any order of any governmental authority or any provision of the articles of organization or operating agreement of T&T; (2) violate, conflict with, result in a breach of or constitute (alone or with notice or lapse of time or both) a default or an event of default under any indenture, agreement, mortgage, deed of trust, note, lease, contract or other instrument to which T&T is a party or by which T&T or any of its property is or may be bound; or (3) result in the creation or imposition of any lien upon any property or assets of T&T.

  D. T&T represents, warrants and covenants that this Agreement has been duly executed and delivered by T&T and constitutes the legal, valid and binding obligation of T&T enforceable against T&T in accordance with its terms.

25.     VGI Representations:

        VGI represents, warrants and covenants that the following:

  A. VGI represents, warrants and covenants that the person who has duly executed this Agreement on behalf of the VGI is duly authorized to so act.

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  B. VGI represents, warrants and covenants that VGI (i) is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware; and (ii) has all requisite power and all governmental licenses, authorizations, consents and approvals necessary to own its assets and carry on its business as now being and as proposed to be conducted and to consummate the transactions contemplated by the Agreement.

  C. VGI represents, warrants and covenants that the execution, delivery and performance by VGI of this Agreement and the consummation of the transactions contemplated thereby: (i) have been duly authorized by all requisite action of VGI, and, if required, any action on the part of the owners of VGI; and (ii) do not and will not: (1) violate any provision of law, statute, rule or regulation, any order of any governmental authority or any provision of the certificate of incorporation or bylaws of VGI; (2) violate, conflict with, result in a breach of or constitute (alone or with notice or lapse of time or both) a default or an event of default under any indenture, agreement, mortgage, deed of trust, note, lease, contract or other instrument to which VGI is a party or by which VGI or any of its property is or may be bound; or (3) result in the creation or imposition of any lien upon any property or assets of VGI.

  D. VGI represents, warrants and covenants that this Agreement has been duly executed and delivered by VGI and constitutes the legal, valid and binding obligation of VGI enforceable against VGI in accordance with its terms.

26.     General:

        A.     Independent Contractors

  The relationship created between VGI and T&T by this Agreement is solely that of independent contractors, with T&T providing distribution management services for the Product and VGI acting as manufacturer and exporter to the Territory. Nothing herein shall be construed as creating a joint venture. Further, T&T is not an employee, agent, partner, franchisee, fiduciary or representative of VGI, and does not have, nor shall it hold itself out as having, any right, power or authority to create any contract or obligation, either express or implied, on behalf of, in the name of, or binding upon VGI, unless VGI consents thereto in advance in writing. Further, VGI is not an employee, agent, partner, franchisee, fiduciary or representative of T&T, and does not have, nor shall it hold itself out as having, any right, power or authority to create any contract or obligation, either express or implied, on behalf of, in the name of, or binding upon T&T, unless T&T consents thereto in advance in writing.

        B.     Notices.

  All notices or other communications under this Agreement shall be in writing and shall be mailed by Registered U.S. mail service. Any notice shall be deemed given on the date of receipt.

        C.     Entire Agreement, Modification, and Severability.

  This Agreement constitutes the entire agreement between VGI and T&T regarding the matters addressed herein and it may be modified only by a subsequent written agreement signed by

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  duly authorized representatives of both Parties, and not by any oral waiver or course of conduct. In the event of any conflict between the provisions of this Agreement and the provisions contained in any prior agreement, contract or understanding, the provisions of this Agreement shall govern and control. If any part of this Agreement is held by a court of competent jurisdiction or an arbitrator to be invalid, void or unenforceable, the remainder of the provisions shall remain in full force and effect and in no way be affected, impaired or invalidated. This Agreement supersedes all prior agreements, written or oral.

        D.     Binding Effect.

  This Agreement shall be binding upon and inure to the benefit of the Parties hereto, their heirs, personal representatives, successors and permitted assigns.

  E. Covenant To Not Disclose:

  1. The Parties agree that the terms and conditions of this Agreement, shall remain confidential as between the Parties and shall not be disclosed or otherwise disseminated to any other person(s) or individual(s), except as otherwise specifically indicated and permitted herein.

  2. The Parties agree that communication pertaining to the existence or substance of this Agreement will be limited to their attorneys, accountants and/or authorized agents. Such communications will be strictly limited to that information which is necessary for such attorneys, accountants and/or authorized agents to perform their respective duties. Prior to such communication the party which proposes to make such communication shall contractually bind each such attorney, accountant and authorized agent to abide by the terms of this covenant not to disclose.

  3. The Parties agree that the existence or substance of this Agreement may be communicated under the terms of an order of a court in the United States of America having valid jurisdiction but not in response to any subpoena or notice of deposition. Such communication shall be strictly limited to the scope of such court order.

  4. The Parties hereto agree that the existence or substance of this Agreement may be communicated or published as required by any law or regulation of the United States of America. Such communication of publication shall be strictly limited to those parts of this Agreement which are so required to be communicated and/or published.

  5. The Parties agree that neither the Parties nor their attorneys nor any other representative shall in any way publicize in or give comment to any news or communication media (including, but not limited to, newspapers, magazines, radio, television or any internet based service) regarding the existence or substance of this Agreement except as required and to the extent required by law.

         F.     Force Majeure.

  Neither party shall be liable for any failure to perform any obligations under this Agreement because of acts of God, nature, war, or civil disturbance.

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IN WITNESS WHEREOF, the Parties have entered into this Agreement on the date first above written.

VIRAL GENETICS, INC. TIMOTHY & THOMAS, LLC

By:     /s/   By:     /s/
 

Printed Name:        Printed Name:     
 

Title:        Title:     
 

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AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION
STANDARD INDUSTRIAL/COMMERCIAL SINGLE-TENANT LEASE — NET
(DO NOT USE THIS FORM FOR MULTI-TENANT BUILDINGS)

1.      Basic Provisions (“Basic Provisions”) .
        1.1     Parties:   This Lease ( “Lease” ), dated for reference purposes only, April 7, 2004, is made by and between Lewis Azusa Property, LLC ( “Lessor” ) and Viral Genetics, Inc., a Delaware Corporation ( “Lessee” ), (collectively the “Parties,” or individually a “Party” ).
        1.2     Premises:   That certain real property, including all improvements therein or to be provided by Lessor under the terms of this Lease, and commonly known as 1321 Mountain View Circle, Azusa, located in the County of Los Angeles, State of CA, and generally described as (describe briefly the nature of the property and, if applicable, the “Project” , if the property is located within a Project) A single tenant building consisting of approximately 10,119 Sq. Ft.     ( “Premises” ). (See also Paragraph 2)
        1.3     Term:    Five (5) years and 0 months ( “Original Term” ) commencing August 1, 2004 ( “Commencement Date” ) and ending July 31, 2009 ( “Expiration Date” ). (See also Paragraph 3)
        1.4     Early Possession:   Upon Execution of Lease ( “Early Possession Date” ). (See also Paragraphs 3.2 and 3.3)
        1.5     Base Rent:   $6,375.00 per month ( “Base Rent” ), payable on the 1st day of each month commencing August 1, 2004.     (See also Paragraph 4)
[ X]     If this box is checked, there are provisions in this Lease for the Base Rent to be adjusted.
        1.6     Base Rent and Other Monies Paid Upon Execution:
                  (a)     Base Rent:    $6,375.00 for the period August 1, 2004 — August 31, 2004.
                  (b)     Security Deposit:    $40,590.00 ( “Security Deposit” ). (See also Paragraph 5)
                  (c)     Association Fees:    $75.00 for the period August 1, 2004 — August 31, 2004.
                  (d)      Other:    $ N/A for ________.
                  (e)     Total Due Upon Execution of this Lease:    $47,040.00.
         1.7      Agreed Use:   Biotechnology & Pharmaceutical Research, Development, Manufacturing, and Administration. (See also Paragraph 6)
         1.8      Insuring Party:   Lessor is the “Insuring Party” unless otherwise stated herein. (See also Paragraph 8)
         1.9      Real Estate Brokers:   (See also Paragraph 15)
                  (a)     Representation:   The following real estate brokers (the “Brokers” ) and brokerage relationships exist in this transaction (check applicable boxes):
[ X]     Ashwill Associates — City of Industry represents Lessor exclusively ( “Lessor’s Broker” );
[ X]     Lee & Associates — Commerce, Inc. represents Lessee exclusively ( “Lessee’s Broker” ); or
[    ] _______________________ represents both Lessor and Lessee (“Dual Agency”).
                  (b)     Payment to Brokers:   Upon execution and delivery of this Lease by both Parties, Lessor shall pay to the Broker the fee agreed to in their separate written agreement (or if there is no such agreement, the sum of Sep agrmt or N/A % of the total Base Rent) for the brokerage services rendered by the Brokers.
        1.10     Guarantor.   The obligations of the Lessee under this Lease are to be guaranteed by ___________________ ( “Guarantor” ). (See also Paragraph 37)
        1.11      Attachments.   Attached hereto are the following, all of which constitute a part of this Lease:
[ X]     an Addendum consisting of Paragraphs 51 through 53;
[    ]    a plot plan depicting the Premises;
[    ]    a current set of the Rules and Regulations;
[    ]   a Work Letter;
[ X]    other (specify):Standard Broker Disclosure

2.    Premises.
        2.1     Letting.   Lessor hereby leases to Lessee, and Lessee hereby leases from Lessor, the Premises, for the term, at the rental, and upon all of the terms, covenants and conditions set forth in this Lease. Unless otherwise provided herein, any statement of size set forth in this Lease, or that may have been used in calculating Rent, is an approximation which the Parties agree is reasonable and any payments based thereon are not subject to revision whether or not the actual size is more or less. Note: Lessee is advised to verify the actual size prior to executing this Lease.

   
   
Initials Page 1 of 25 Initials

    (C)1997 - American Industrial Real Estate Association REVISED FORM STN-7-R/01E

        2.2     Condition.    Lessor shall deliver the Premises to Lessee broom clean and free of debris on the Commencement Date or the Early Possession Date, whichever first occurs ( “Start Date” ), and, so long as the required service contracts described in Paragraph 7.1(b) below are obtained by Lessee and in effect within thirty days following the Start Date, warrants that the existing electrical, plumbing, fire sprinkler, lighting, heating, ventilating and air conditioning systems ( “HVAC” ), loading doors, sump pumps, if any, and all other such elements in the Premises, other than those constructed by Lessee, shall be in good operating condition on said date and that the structural elements of the roof, bearing walls and foundation of any buildings on the Premises (the “Building” ) shall be free of material defects. If a non-compliance with said warranty exists as of the Start Date, or if one of such systems or elements should malfunction or fail within the appropriate warranty period, Lessor shall, as Lessor’s sole obligation with respect to such matter, except as otherwise provided in this Lease, promptly after receipt of written notice from Lessee setting forth with specificity the nature and extent of such non-compliance, malfunction or failure, rectify same at Lessor’s expense. The warranty periods shall be as follows: (i) 6 months as to the HVAC systems, and (ii) 30 days to the remaining systems and other elements of the Building. If Lessee does not give Lessor the required notice within the appropriate warranty period, correction of any such non-compliance, malfunction or failure shall be the obligation of Lessee’s sole cost and expense.
        2.3     Compliance.    Lessor warrants that the improvements on the Premises comply with the building codes, applicable laws, covenants or restrictions of record, regulations, and ordinances ( “Applicable Requirements” ) that were in effect at the time that each improvement, or portion thereof, was constructed. Said warranty does not apply to the use to which Lessee will put the Premises, modifications which may be required by the Americans with Disabilities Act or any similar laws as a result of Lessee’s use (see Paragraph 50), or to any Alterations or Utility Installations (as defined in Paragraph 7.3(a)) made or to be made by Lessee. NOTE: Lessee is responsible for determining whether or not the Applicable Requirements, and especially the zoning, are appropriate for Lessee’s intended use, and acknowledges that past uses of the Premises may no longer be allowed. If the Premises do not comply with said warranty, Lessor shall, except as otherwise provided, promptly after receipt of written notice from Lessee setting forth with specificity the nature and extent of such non-compliance, rectify the same at Lessor’s expense. If Lessee does not give Lessor written notice of a non-compliance with this warranty within 6 months following the Start Date, correction of that non-compliance shall be the obligation of Lessee at Lessee’s sole cost and expense. If the Applicable Requirements are hereafter changed so as to require during the term of this Lease the construction of an addition to or an alteration of the Premises and/or Building, the remediation of any Hazardous Substance, or the reinforcement or other physical modification of the Unit, Premises and/or Building ( “Capital Expenditure” ), Lessor and Lessee shall allocate the cost of such work as follows:
                  (a)     Subject to Paragraph 2.3(c) below, if such Capital Expenditures are required as a result of the specific and unique use of the Premises by Lessee as compared with uses by tenants in general, Lessee shall be fully responsible for the cost thereof, provided, however that if such Capital Expenditure is required during the last 2 years of this Lease and the cost thereof exceeds 6 months’ Base Rent, Lessee may instead terminate this Lease unless Lessor notifies Lessee, in writing, within 10 days after receipt of Lessee’s termination notice that Lessor has elected to pay the difference between the actual cost thereof and an amount equal to 6 months’ Base Rent. If Lessee elects termination, Lessee shall immediately cease the use of the Premises which requires such Capital Expenditure and deliver to Lessor written notice specifying a termination date at least 90 days thereafter. Such termination date shall, however, in no event be earlier than the last day that Lessee could legally utilize the Premises without commencing such Capital Expenditure.
                  (b)     If such Capital Expenditure is not the result of the specific and unique use of the Premises by Lessee (such as, governmentally mandated seismic modifications), then Lessor and Lessee shall allocate the obligation to pay for such costs pursuant to the provisions of Paragraph 7.1(d); provided, however, that if such Capital Expenditure is required during the last 2 years of this Lease or if Lessor reasonably determines that it is not economically feasible to pay its share thereof, Lessor shall have the option to terminate this Lease upon 90 days prior written notice to Lessee unless Lessee notifies Lessor, in writing, within 10 days after receipt of Lessor’s termination notice that Lessee will pay for such Capital Expenditure. If Lessor does not elect to terminate, and fails to tender its share of any such Capital Expenditure, Lessee may advance such funds and deduct same, with interest, from Rent until Lessor’s share of such costs have been fully paid. If Lessee is unable to finance Lessor’s share, or if the balance of the Rent due and payable for the remainder of this Lease is not sufficient to fully reimburse Lessee on an offset basis, Lessee shall have the right to terminate this Lease upon 30 days written notice to Lessor.
                  (c)     Notwithstanding the above, the provisions concerning Capital Expenditures are intended to apply only to non-voluntary, unexpected, and new Applicable Requirements. If the Capital Expenditures are instead triggered by Lessee as a result of an actual or proposed change in use, change in intensity of use, or modification tot eh Premises then, and in that event, Lessee shall either: (i) immediately cease such changed use or intensity of use and/or take such other steps as may be necessary to eliminate the requirement for such Capital Expenditure, or (ii) complete such Capital Expenditure at its own expense. Lessee shall not, however, have any right to terminate this Lease.

   
   
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        2.4     Acknowledgements.    Lessee acknowledges that: (a) it has been advised by Lessor and/or Brokers to satisfy itself with respect to the condition of the Premises (including but not limited to the electrical, HVAC and fire sprinkler systems, security, environmental aspects, and compliance with Applicable Requirements and the Americans with Disabilities Act), and their suitability for Lessee’s intended use, (b) Lessee has made such investigation as it deems necessary with reference to such matters and assumes all responsibility therefor as the same relate to its occupancy of the Premises, and (c) neither Lessor, Lessor’s agents, nor Brokers have made any oral or written representations or warranties with respect to said matters other than as set forth in this Lease. In addition, Lessor acknowledges that: (i) Brokers have made no representations or warranties with respect to said matters other than as set forth in this Lease. In addition, Lessor acknowledges that: (i) Brokers have made no representations, promises or warranties concerning Lessee’s ability to honor the Lease or suitability to occupy the Premises, and (ii) it is Lessor’s sole responsibility to investigate the financial capability and/or suitability of all proposed tenants.
        2.5     Lessee as Prior Owner/Occupant.   The warranties made by Lessor in Paragraph 2 shall be of no force or effect if immediately prior to the Start Date Lessee was the owner or occupant of the Premises. In such event, Lessee shall be responsible for any necessary corrective work.

3.    Term.
        3.1     Term.   The Commencement Date, Expiration Date and Original Term of this Lease are as specified in Paragraph 1.3.
        3.2      Early Possession.    If Lessee totally or partially occupies the Premises prior to the Commencement Date, the obligation to pay Base Rent shall be abated for the period of such early possession. All other terms of this Lease (including but not limited to the obligations to pay Real Property Taxes and insurance premiums and to maintain the Premises) shall, however, be in effect during such period. Any such early possession shall not affect the Expiration Date.
        3.3      Delay in Possession.    Lessor agrees to use its best commercially reasonable efforts to deliver possession of the Premises to Lessee by the Commencement Date. If, despite said efforts, Lessor is unable to deliver possession by such date, Lessor shall not be subject to any liability therefor, nor shall such failure affect the validity of this Lease. Lessee shall not, however, be obligated to pay Rent or perform its other obligations until Lessor delivers possession of the Premises and any period of rent abatement that Lessee would otherwise have enjoyed shall run from the date of delivery of possession and continue for a period equal to what Lessee would otherwise have enjoyed under the terms hereof, but minus any days of delay caused by the acts or omissions of Lessee. If possession is not delivered within 60 days after the Commencement Date, Lessee may, at its option, by notice in writing within 10 days after the end of such 60 day period, cancel this Lease, in which event the Parties shall be discharged from all obligations hereunder. If such written notice is not received by Lessor within said 10 day period, Lessee’s right to cancel shall terminate. If possession of the Premises is not delivered within 120 days after the Commencement Date, this Lease shall terminate unless other agreements are reached between Lessor and Lessee, in writing.
        3.4      Lessee Compliance.    Lessor shall not be required to deliver possession of the Premises to Lessee until Lessee complies with its obligation to provide evidence of insurance (Paragraph 8.5). Pending delivery of such evidence, Lessee shall be required to perform all of its obligations under this Lease from and after the Start Date, including the payment of Rent, notwithstanding Lessor’s election to withhold possession pending receipt of such evidence of insurance. Further, if Lessee is required to perform any other conditions prior to or concurrent with the Start Date, the Start Date shall occur but Lessor may elect to withhold possession until such conditions are satisfied.

4.     Rent.
        4.1      Rent Defined.    All monetary obligations of Lessee to Lessor under the terms of this Lease (except for the Security Deposit) are deemed to be rent ( “Rent” ).
        4.2      Payment.   Lessee shall cause payment of Rent to be received by Lessor in lawful money of the United States on or before the day on which it is due, without offset or deduction (except as specifically permitted in this Lease). Rent for any period during the term hereof which is for less than one full calendar month shall be prorated based upon the actual number of days of said month. Payment of Rent shall be made to Lessor at its address stated herein or to such other persons or place as Lessor may from time to time designate in writing. Acceptance of a payment which is less than the amount then due shall not be a waiver of Lessor’s rights to the balance of such Rent, regardless of Lessor’s endorsement of any check so stating. In the event that any check, draft, or other instrument of payment given by Lessee to Lessor is dishonored for any reason, Lessee agrees to pay to Lessor the sum of $25 in addition to any Late Charge and Lessor, at its option, may require all future payments to be made by Lessee to be by cashier’s check. Payments will be applied first to accrued late charges and attorney’s fees, second to accrued interest, then to Base Rent and Operating Expenses increase, and any remaining amount to any other outstanding charges or costs.
   
   
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        4.3      Association Fees.    In addition to the Base Rent, Lessee shall pay to Lessor each month an amount equal to any owner’s association or condominium fees levied or assessed against the Premises. Said monies shall be paid at the same time and in the same manner as the Base Rent.

5.      Security Deposit.    Lessee shall deposit with Lessor upon execution hereof the Security Deposit as security for Lessee’s faithful performance of its obligations under this Lease. If Lessee fails to pay Rent, or otherwise Defaults under this Lease, Lessor may use, apply or retain all or any portion of said Security Deposit for the payment of any amount due Lessor or to reimburse or compensate Lessor for any liability, expense, loss or damage which Lessor may suffer or incur by reason thereof. If Lessor uses or applies all or any portion of the Security Deposit, Lessee shall within 10 days after written request therefor deposit monies with Lessor sufficient to restore said Security Deposit to the full amount required by this Lease. If the Base Rent increases during the term of this Lease, Lessee shall, upon written request from Lessor, deposit additional moneys with Lessor so that the total amount of the Security Deposit shall at all times bear the same proportion to the increased Base Rent as the initial Security Deposit bore to the initial Base Rent. Should the Agreed Use be amended to accommodate a material change in the business of Lessee or to accommodate a sublessee or assignee, Lessor shall have the right to increase the Security Deposit to the extent necessary, in Lessor’s reasonable judgment, to account for any increased wear and tear that the Premises may suffer as a result thereof. If a change in control of Lessee occurs during this Lease and following such change the financial condition of Lessee is, in Lessor’s reasonable judgment, significantly reduced, Lessee shall deposit such additional monies with Lessor as shall be sufficient to cause the Security Deposit to be at a commercially reasonable level based on such change in financial condition. Lessor shall not be required to keep the Security Deposit separate from its general accounts. Within 14 days after the expiration or termination of this Lease, if Lessor elects to apply the Security Deposit only to unpaid Rent, and otherwise within 30 days after the Premises have been vacated pursuant to Paragraph 7.4(c) below, Lessor shall return that portion of the Security Deposit not used or applied by Lessor. No part of the Security Deposit shall be considered to be held in trust, to bear interest or to be prepayment for any monies to be paid by Lessee under this Lease.

6.     Use.
        6.1      Use.    Lessee shall use and occupy the Premises only for the Agreed Use, or any other legal use which is reasonably comparable thereto, and for no other purpose. Lessee shall not use or permit the use of the Premises in a manner that is unlawful, creates damage, waste or a nuisance, or that disturbs occupants of or causes damage to neighboring premises or properties. Lessor shall not unreasonably withhold or delay its consent to any written request for a modification of the Agreed Use, so long as the same will not impair the structural integrity of the improvements on the Premises or the mechanical or electrical systems therein, and/or is not significantly more burdensome to the Premises. If Lessor elects to withhold consent, Lessor shall within 7 days after such request given written notification of same, which notice shall include an explanation of Lessor’s objections to the change in the Agreed Use.
        6.2     Hazardous Substances.
                  (a)     Reportable Uses Require Consent.    The term “Hazardous Substance” as used in this Lease shall mean any product, substance, or waste whose presence, use, manufacture, disposal, transportation, or release, either by itself or in combination with other materials expected to be on the Premises, is either: (i) potentially injurious to the public health, safety or welfare, the environment or the Premises, (ii) regulated or monitored by any governmental authority, or (iii) a basis for potential liability of Lessor to any governmental agency or third party under any applicable statute or common law theory. Hazardous Substances shall include, but not be limited to, hydrocarbons, petroleum, gasoline, and/or crude oil or any products, by-products or fractions thereof. Lessee shall not engage in any activity in or on the Premises which constitutes a Reportable Use of Hazardous Substances without the express prior written consent of Lessor and timely compliance (at Lessee’s expense) with all Applicable Requirements. “Reportable Use” shall mean (i) the installation or use of any above or below ground storage tank, (ii) the generation, possession, storage, use, transportation, or disposal of a Hazardous Substance that requires a permit from, or with respect to which a report, notice, registration or business plan is required to be filled with, any governmental authority, and/or (iii) the presence at the Premises of a Hazardous Substance with respect to which any Applicable Requirements requires that a notice be given to persons entering or occupying the Premises or neighboring properties. Notwithstanding the foregoing, Lessee may use any ordinary and customary materials reasonably required to be used in the normal course of the Agreed Use, ordinary office supplies (copier toner, liquid paper, glue, etc.) and common

   
   
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household cleaning materials, so long as such use is in compliance with all Applicable Requirements, is not a Reportable Use, and does not expose the Premises or neighboring property to any meaningful risk of contamination or damage or expose Lessor to any liability therefor. In addition, Lessor may conditions its consent to any Reportable Use upon receiving such additional assurances as Lessor reasonably deems necessary to protect itself, the public, the Premises and/or the environment against damage, contamination, injury and/or liability, including, but not limited to, the installation (and removal on or before Lease expiration or termination) of protective modifications (such as concrete encasements) and/or increasing the Security Deposit.
                  (b)     Duty to Inform Lessor.   If Lessee knows, or has reasonable cause to believe, that a Hazardous Substance has come to be located in, on, under or about the Premises, other than as previously consented to by Lessor, Lessee shall immediately give written notice of such fact to Lessor, and provide Lessor with a copy of any report, notice, claim or other documentation which it has concerning the presence of such Hazardous Substance.
                  (c)     Lessee Remediation.   Lessee shall not cause or permit any Hazardous Substance to be spilled or released in, on , under, or about the Premises (including through the plumbing or sanitary sewer system) and shall promptly, at Lessee’s expense, comply with all Applicable Requirements and take all investigatory and/or remedial action reasonably recommended, whether or not formally ordered or required, for the cleanup of any contamination of, and for the maintenance, security and/or monitoring of the Premises or neighboring properties, that was caused or materially contributed to by Lessee, or pertaining to or involving any Hazardous Substance brought onto the Premises during the term of this Lease, by or for Lessee, or any third party.
                  (d)     Lessee Indemnification.   Lessee shall indemnify, defend and hold Lessor, its agents, employees, lenders and ground lessor, if any, harmless from and against any and all loss of rents and/or damages, liabilities, judgments, claims, expenses, penalties, and attorneys’ and consultants’ fees arising out of or involving any Hazardous Substance brought onto the Premises by or for Lessee, or any third party (provided, however, that Lessee shall have no liability under this Lease with respect to underground migration of any Hazardous Substance under the Premises from adjacent properties not caused or contributed to by Lessee). Lessee’s obligations shall include, but not be limited to, the effects of any contamination or injury to person, property or the environment created or suffered by Lessee, and the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease. No termination, cancellation or release agreement entered into by Lessor and Lessee shall release Lessee from its obligations under this Lease with respect to Hazardous Substances, unless specifically so agreed by Lessor in writing at the time of such agreement.
                  (e)     Lessor Indemnification.    Lessor and its successors and assigns shall indemnify, defend, reimburse and hold Lessee, its employees and lenders, harmless from and against any and all environmental damages, including the cost of remediation, which result from Hazardous Substances which existed on the Premises prior to Lessee’s occupancy or which are caused by the gross negligence or willful misconduct of Lessor, its agents or employees. Lessor’s obligations, as and when required by the Applicable Requirements, shall include, but not be limited to, the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease.
                  (f)     Investigations and Remediations.    Lessor shall retain the responsibility and pay for any investigations or remediation measures required by governmental entities having jurisdiction with respect to the existence of Hazardous Substances on the Premises prior to Lessee’s occupancy, unless such remediation measure is required as a result of Lessee’s use (including “Alterations”, as defined in paragraph 7.3(a) below) of the Premises, in which event Lessee shall be responsible for such payment. Lessee shall cooperate fully in any such activities at the request of Lessor, including allowing Lessor and Lessor’s agents to have reasonable access to the Premises at reasonable times in order to carry out Lessor’s investigative and remedial responsibilities.
                  (g)     Lessor Termination Option.    If a Hazardous Substance Condition (see Paragraph 9.1(e)) occurs during the term of this Lease, unless Lessee is legally responsible therefor (in which case Lessee shall make the investigation and remediation thereof required by the Applicable Requirements and this Lease shall continue in full force and effect, but subject to Lessor’s rights under Paragraph 6.2(d) and Paragraph 13), Lessor may, at Lessor’s option, either (i) investigate and remediate such Hazardous Substance Condition, if required, as soon as reasonably possible at Lessor’s expense, in which event this Lease shall continue in full force and effect, or (ii) if the estimated cost to remediate such condition exceeds 12 times the then monthly Base Rent or $100,000, whichever is greater, given written notice to Lessee, within 30 days after receipt by Lessor of knowledge of the occurrence of such Hazardous Substance Condition, of Lessor’s desire to terminate this Lease as of the date 60 days following the date of such notice. In the event Lessor elects to give a termination notice, Lessee may, within 10 days thereafter, give written notice to Lessor of Lessee’s commitment to pay the amount by which the cost of the remediation of such Hazardous Substance Condition exceeds an amount equal to 12 times the then monthly Base
   
   
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Rent or $100,000, whichever is greater. Lessee shall provide Lessor with said funds or satisfactory assurance thereof within 30 days following such commitment. In such event, this Lease shall continue in full force and effect, and Lessor shall proceed to make such remediation as soon as reasonably possible after the required funds are available. If Lessee does not give such notice and provide the required funds or assurance thereof within the time provided, this Lease shall terminate as of the date specified in Lessor’s notice of termination.
        6.3        Lessee’s Compliance with Applicable Requirements.    Except as otherwise provided in this Lease, Lessee shall, at Lessee’s sole expense, fully, diligently and in a timely manner, materially comply with all Applicable Requirements, the requirements of any applicable fire insurance underwriter or rating bureau, and the recommendations of Lessor’s engineers and/or consultants which relate in any manner to the such Requirements, without regard to whether such Requirements are now in effect or become effective after the Start Date. Lessee shall, within 10 days after receipt of Lessor’s written request, provide Lessor with copies of all permits and other documents, and other information evidencing Lessee’s compliance with any Applicable Requirements specified by Lessor, and shall immediately upon receipt, notify Lessor in writing (with copies of any documents involved) of any threatened or actual claim, notice, citation, warning, complaint or report pertaining to or involving the failure of Lessee or the Premises to comply with any Applicable Requirements.
        6.4      Inspection; Compliance.    Lessor and Lessor’s “Lender” (as defined in Paragraph 30) and consultants shall have the right to enter into Premises at any time, in the case of an emergency, and otherwise at reasonable times after reasonable notice, for the purpose of inspecting the condition of the Premises and for verifying compliance by Lessee with this Lease. The cost of any such inspections shall be paid by Lessor, unless a violation of Applicable Requirements, or a Hazardous Substance Condition (see paragraph 9.1) is found to exist or be imminent, or the inspection is requested or ordered by a governmental authority. In such case, Lessee shall upon request reimburse Lessor for the cost of such inspection, so long as such inspection is reasonably related to the violation or contamination. In addition, Lessee shall provide copies of all relevant material safety data sheets (MSDS) to Lessor within 10 days of the receipt of a written request therefor.

7.    Maintenance; Repairs, Utility Installations; Trade Fixtures and Alterations.
        7.1      Lessee’s Obligations.
                  (a)     In General.    Subject to the provisions of Paragraph 2.2 (Condition), 2.3 (Compliance), 6.3 (Lessee’s Compliance with Applicable Requirements), 7.2 (Lessor’s Obligations), 9 (Damage or Destruction), and 14 (Condemnation), Lessee shall, at Lessee’s sole expense, keep the Premises, Utility Installations (intended for Lessee’s exclusive use, no matter where located), and Alterations in good order, condition and repair (whether or not the portion of the Premises requiring repairs, or the means of repairing the same, are reasonably or readily accessible to Lessee, and whether or not the need for such repairs occurs as a result of Lessee’s use, any prior use, the elements or the age of such portion of the Premises), including, but not limited to, all equipment or facilities, such as plumbing, HVAC equipment, electrical, lighting facilities, boilers, pressure vessels, fire protection system, fixtures, walls (interior and exterior), foundations, ceilings, roofs, roof drainage systems, floors, windows, doors, plate glass, skylights, landscaping, driveways, parking lots, fences, retaining walls, signs, sidewalks and parkways located in, on, or adjacent to the Premises. Lessee, in keeping the Premises in good order, condition and repair, shall exercise and perform good maintenance practices, specifically including the procurement and maintenance of the service contracts required by Paragraph 7.1(b) below. Lessee’s obligations shall include restorations, replacements or renewals when necessary to keep the Premises and all improvements thereon or a part thereof in good order, condition and state of repair. Lessee shall, during the term of this Lease, keep the exterior appearance of the Building in a first-class condition (including, e.g. graffiti removal) consistent with the exterior appearance of other similar facilities of comparable age and size in the vicinity, including, when necessary, the exterior repainting of the Building.
                  (b)     Service Contracts.    Lessee shall, at Lessee’s sole expense, procure and maintain contracts, with copies to Lessor, in customary form and substance for, and with contractors specializing and experienced in the maintenance of the following equipment and improvements, if any, if and when installed on the Premises: (i) HVAC equipment, (ii) boiler, and pressure vessels, (iii) fire extinguishing systems, including fire alarm and/or smoke detection, (iv) landscaping and irrigation systems, (v) roof covering and drains, (vi) clarifiers, (vii) basic utility feed to the perimeter of the Building, and (viii) any other equipment, if reasonably required by Lessor. However, Lessor reserves the right, upon notice to Lessee, to procure and maintain any or all of such service contracts, and if Lessor so elects, Lessee shall reimburse Lessor, upon demand, for the cost thereof.
                  (c)     Failure to Perform.    If Lessee fails to perform Lessee’s obligations under this Paragraph 7.1, Lessor may enter upon the Premises after 10 days’ prior written notice to Lessee (except in the case of an emergency, in which case no notice shall be required), perform such obligations on Lessee’s behalf, and put the Premises in good order, condition and repair, and Lessee shall promptly pay to Lessor a sum equal to 115% of the cost thereof.
                  (d)     Replacement.    Subject to Lessee’s indemnification of Lessor as set forth in Paragraph 8.7 below, and without relieving Lessee of liability resulting from Lessee’s failure to exercise and perform good maintenance practices, if an

   
   
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item described in Paragraph 7.1(b) cannot be repaired other than at a cost which is in excess of 50% of the cost of replacing such item, then such item shall be replaced by Lessor, and the cost thereof shall be prorated between the Parties and Lessee shall only be obligated to pay, each month during the remainder of the term of this Lease, on the date on which Base Rent is due, an amount equal to the product of multiplying the cost of such replacement by a fraction, the numerator of which is one, and the denominator of which is 144 (ie. 1/144th of the cost per month). Lessee shall pay interest on the unamortized balance at a rate that is commercially reasonable in the judgment of Lessor’s accountants. Lessee may, however, prepay its obligations at any time.
        7.2      Lessor’s Obligations.   Subject to the provisions of Paragraphs 2.2 (Condition), 2.3 (Compliance), 9 (Damage or Destruction) and 14 (Condemnation), it is intended by the parties hereto that Lessor have no obligation, in any manner whatsoever, to repair and maintain the Premises, or the equipment therein, all of which obligations are intended to be that of the Lessee. It is the intention of the Parties that the terms of this Lease govern the respective obligations of the Parties as to maintenance and repair of the Premises, and they expressly waive the benefit of any statute now or hereafter in effect to the extent it is inconsistent with the terms of this Lease.
        7.3     Utility Installations; Trade Fixtures; Alterations.
                  (a)     Definitions.    The term “Utility Installations” refers to all floor and window coverings, air and/or vacuum lines, power panels, electrical distribution, security and fire protection systems, communication cabling, lighting fixtures, HVAC equipment, plumbing and fencing in or on the Premises. The term “Trade Fixtures” shall mean Lessee’s machinery and equipment that can be removed without doing material damage to the Premises. The term “Alterations” shall mean any modification of the improvements, other than Utility Installations or Trade Fixtures, whether by addition or deletion. “Lessee Owned Alterations and/or Utility Installations” are defined as Alterations and/or Utility Installations made by Lessee that are not yet owned by Lessor pursuant to Paragraph 7.4(a).
                  (b)     Consent.    Lessee shall not make any Alterations or Utility Installations to the Premises without Lessor’s prior written consent. Lessee may, however, make non-structural Utility Installations to the interior of the Premises (excluding the roof) without such consent but upon notice to Lessor, as long as they are not visible from the outside, do not involve puncturing, relocating or removing the roof or any existing walls, will not affect the electrical, plumbing, HVAC, and/or life safety systems, and the cumulative cost thereof during this Lease as extended does not exceed a sum equal to 3 month’s Base Rent in the aggregate or a sum equal to one month’s Base Rent in any one year. Notwithstanding the foregoing, Lessee shall not make or permit any roof penetration and/or install anything on the roof without the prior written approval of Lessor. Lessor may, as a precondition to granting such approval, require Lessee to utilize a contractor chosen and/or approved by Lessor. Any Alterations or Utility Installations that Lessee shall desire to make and which require the consent of the Lessor shall be presented to Lessor in written form with detailed plans. Consent shall be deemed conditioned upon Lessee’s: (i) acquiring all applicable governmental permits, (ii) furnishing Lessor with copies of both the permits and the plans and specifications prior to commencement of the work, and (iii) compliance with all conditions of said permits and other Applicable Requirements in a prompt and expeditious manner. Any Alterations or Utility Installations shall be performed in a workmanlike manner with good and sufficient materials. Lessee shall promptly upon completion furnish Lessor with as-built plans and specifications. For work which costs an amount in excess of one month’s Base Rent, Lessor may condition its consent upon Lessee providing a lien and completion bond in an amount equal to 150/5 of the estimated cost of such Alteration or Utility Installation and/or upon Lessee’s posting an additional Security Deposit with Lessor.
                  (c)     Liens; Bonds.   Lessee shall pay, when due, all claims for labor or materials furnished or alleged to have been furnished to or for Lessee at or for use on the Premises, which claims are or may be secured by any mechanic’s or materialmen’s lien against the Premises or any interest therein. Lessee shall give Lessor not more than 10 days notice prior to the commencement of any work in, on or about the Premises, and Lessor shall have the right to post notices of non-responsibility. If Lessee shall contest the validity of any such lien, claim or demand, then Lessee shall, at its sole expense defend and protect itself, Lessor and the Premises against the same and shall pay and satisfy any such adverse judgment that may be rendered thereon before the enforcement thereof. If Lessor shall require, Lessee shall furnish a surety bond in an amount equal to 150% of the amount of such contested lien, claim or demand, indemnifying Lessor against liability for the same. If Lessor elects to participate in any such action, Lessee shall pay Lessor’s attorneys’ fees and costs.
        7.4      Ownership; Removal; Surrender; and Restoration.
                  (a)     Ownership.    Subject to Lessor’s right to require removal or elect ownership as hereinafter provided, all Alterations and Utility Installations made by Lessee shall be the property of Lessee, but considered a part of the Premises. Lessor may, at any time, elect in writing to be the owner of all or any specified part of the Lessee Owned Alterations and Utility Installations. Unless otherwise instructed per paragraph 7.4(b) hereof, all Lessee Owned Alterations and Utility Installations shall, at the expiration or termination of this Lease, become the property of Lessor and be surrendered by Lessee with the Premises.
   
   
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                  (b)     Removal.    By deliver to Lessee of written notice from Lessor not earlier than 90 and not later than 30 days prior to the end of the term of this Lease, Lessor may require that any or all Lessee Owned Alterations or Utility Installations be removed by the expiration or termination of this lease. Lessor may require the removal at any time of all or any part of any Lessee Owned Alterations or Utility Installations made without the required consent.
                  (c)     Surrender; Restoration.    Lessee shall surrender the Premises by the Expiration Date or any earlier termination date, with all of the improvements, parts and surfaces thereof broom clean and free of debris, and in good operating order, condition and state of repair, ordinary wear and tear excepted. “Ordinary wear and tear” shall not include any damage or deterioration that would have been prevented by good maintenance practice. Notwithstanding the foregoing, if this Lease is for 12 months or less, then Lessee shall surrender the Premises in the same condition as delivered to Lessee on the Start Date with NO allowance for ordinary wear and tear. Lessee shall repair any damage occasioned by the installation, maintenance or removal of Trade Fixtures, Lessee owned Alterations and/or Utility Installations, furnishings, and equipment as well as the removal of any storage tank installed by or for Lessee. Lessee shall completely remove from the Premises any and all Hazardous Substances brought onto the Premises by or for Lessee, or any third party (except Hazardous Substances which were deposited via underground migration from areas outside the Premises, or if applicable, the Project) even if such removal would require Lessee to perform or pay for work that exceed statutory requirements. Trade Fixtures shall remain the property of Lessee and shall be removed by Lessee. Any personal property of Lessee not removed on or before the Expiration Date or any earlier termination date shall be deemed to have been abandoned by Lessee and may be disposed of or retained by Lessor as Lessor may desire. The failure by Lessee to timely vacate the Premises pursuant to this Paragraph 7.4(c) without the express written consent of Lessor shall constitute a holdover under the provisions of Paragraph 26 below.

8.    Insurance; Indemnity.
        8.1      Payment For Insurance.    Lessee shall pay for all insurance required under Paragraph 8 except to the extent of the cost attributable to liability insurance carried by Lessor under Paragraph 8.2(b) in excess of $2,000,000 per occurrence. Premiums for policy periods commencing prior to or extending beyond the Lease term shall be prorated to correspond to the Lease term. Payment shall be made by Lessee to Lessor within 10 days following receipt of an invoice.
        8.2      Liability Insurance.   
                  (a)     Carried by Lessee.    Lessee shall obtain and keep in force a Commercial General Liability policy of insurance protecting Lessee and Lessor as an additional insured against claims for bodily injury, personal injury and property damage based upon or arising out of the ownership, use, occupancy or maintenance of the Premises and all areas appurtenant thereto. Such insurance shall be on an occurrence basis providing single limit coverage in an amount not less than $1,000,000 per occurrence with an annual aggregate of not less than $2,000,000, an “Additional Insured-Managers or Lessors of Premises Endorsement” and contain the “Amendment of the Pollution Exclusion Endorsement” for damage caused by heat, smoke or fumes from a hostile fire. The policy shall not contain any intra-insured exclusions as between insured persons or organizations, but shall include coverage for liability assumed under this Lease as an “insured contract” for the performance of Lessee’s indemnity obligations under this Lease. The limits of said insurance shall not, however, limit the liability of Lessee nor relieve Lessee of any obligation hereunder. All insurance carried by Lessee shall be primary to and not contributory with any similar insurance carried by Lessor, whose insurance shall be considered excess insurance only.
                  (b)     Carried by Lessor.    Lessor shall maintain liability insurance as described in Paragraph 8.2(a), in addition to, and not in lieu of, the insurance required to be maintained by Lessee. Lessee shall not be named as an additional insured therein.
        8.3     Property Insurance – Building, Improvements and Rental Value.
                  (a)     Building and Improvements.    The Insuring Party shall obtain and keep in force a policy or policies in the name of Lessor, with loss payable to Lessor, any ground-lessor, and to any Lender insuring loss or damage to the Premises. The amount of such insurance shall be equal to the full replacement cost of the Premises, as the same shall exist from time to time, or the amount required by any Lender, but in no event more than the commercially reasonable and available insurance value thereof. If Lessor is the Insuring Party, however, Lessee Owned Alterations and utility Installations, Trade Fixtures, and Lessee’s personal property shall be insured by Lessee under Paragraph 8.4 rather than by Lessor. If the coverage is available and commercially appropriate, such policy or policies shall insure against all risks of direct physical loss or damage (except the perils of flood and/or earthquake unless required by a Lender), including coverage for debris removal and the enforcement of any applicable Requirements requiring the upgrading, demolition, reconstruction or replacement of any portion of the Premises as the result of a covered loss. Said policy or policies shall also contain an agreed valuation provision in lieu of any coinsurance clause, waiver of subrogation, and inflation guard protection causing an increase in the annual property insurance coverage amount by a factor of not less than the adjusted U.S. Department of Labor Consumer Price
   
   
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Index for All Urban Consumers for the city nearest to where the Premises are located. If such insurance coverage has a deductible clause, the deductible amount shall not exceed $1,000 per occurrence, and Lessee shall be liable for such deductible amount in the event of an Insured Loss.
                  (b)     Rental Value.    The Insuring Party shall obtain and keep in force a policy or policies in the name of Lessor with loss payable to Lessor and any Lender, insuring the loss of the full Rent for one year with an extended period of indemnity for an additional 180 days (“Rental Value Insurance”). Said insurance shall contain an agreed valuation provision in lieu of any coinsurance clause, and the amount of coverage shall be adjusted annually to reflect the projected Rent otherwise payable by Lessee, for the next 12 month period. Lessee shall be liable for any deductible amount in the vent of such loss.

                  (c)     Adjacent Premises.    If the Premises are part of a larger building, or a group of buildings owned by Lessor which are adjacent to the Premises, the Lessee shall pay for any increase in the premiums for the property insurance of such building or buildings if said increase is caused by Lessee’s acts, omissions, use or occupancy of the Premises.
        8.4      Lessee’s Property; Business Interruption Insurance.
                  (a)     Property Damage.   Lessee shall obtain and maintain insurance coverage on all of Lessee’s personal property, Trade Fixtures, and Lessee Owned Alterations and Utility Installations. Such insurance shall be full replacement cost coverage with a deductible of not to exceed $1,000 per occurrence. The proceeds from any such insurance shall be used by lee for the replacement of personal property, Trade Fixtures and Lessee Owned Alterations and Utility Installations. Lessee shall provide Lessor with written evidence that such insurance is in for