As filed with the Securities and Exchange Commission on September 18, 2006

Registration No. 333-135584

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

AMENDMENT NO. 1

TO

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

 

 

OCULUS INNOVATIVE SCIENCES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

 

1129 N. McDowell Blvd.

Petaluma, CA 94954

(707) 782-0792

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

 

 

Hojabr Alimi

Chief Executive Officer and President

1129 N. McDowell Blvd.

Petaluma, CA 94954

(707) 782-0792

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

 

 

Copies to:

 

 

 

 

 

Approximate date of commencement of proposed sale to the public:  As soon as practicable after the effective date of this Registration Statement.

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  o 

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same
offering.  o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

 

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

SUBJECT TO COMPLETION, DATED SEPTEMBER 18, 2006

 

PRELIMINARY PROSPECTUS

 

           Shares

 

 

Oculus Innovative Sciences, Inc.

 

Common Stock

 

 

 

 

We are offering           shares of our common stock. This is our initial public offering, and no public market currently exists for our shares. We anticipate that the initial public offering price will be between $      and $      per share. We have applied for quotation of our common stock on the Nasdaq Global Market under the symbol “OCLS.”

 

 

 

 

Investing in our common stock involves a high degree of risk. Before buying any shares, you should carefully consider the risk factors described in “Risk Factors” beginning on page 8 of this prospectus.

 

 

 

 

 

The underwriters may also purchase up to an additional      shares from us at the public offering price, less the underwriting discount, within 30 days after the date of this prospectus to cover over-allotments.

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

The underwriters expect to deliver the shares on or about          , 2006.

 

 

 

 

 

 

 

 

 

The date of this prospectus is          , 2006

 

TABLE OF CONTENTS

 

 

 

You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized anyone to provide you with different information. We are not making an offer to sell these securities in any jurisdiction where the offer is not permitted. You should not assume that the information contained in this prospectus is accurate as of any date other than the respective dates as of which the information is given.

 

PROSPECTUS SUMMARY

Geographic Region		Brand Name		Indication
United States		Dermacyn Wound Care		A medical device product intended for moistening absorbent wound dressings and cleaning, moistening, lubricating and debriding specified types of wounds.
		Vetericyn Wound Care		A product used for the management of traumatic wounds, cuts, abrasions, skin irritations, post-surgical incisions and minor burns in animals.
European Union		Dermacyn Wound Care		A product intended for the reduction of microbial load for use in debriding, irrigating and moistening specified types of wounds.
		Oculus Microcyn Disinfectant		A disinfectant solution for medical devices.
Mexico		Microcyn60		A product used for the antiseptic treatment of wounds and infected areas and for the disinfection of medical instruments and equipment and clean-rooms.
India		Oxum		A product intended for use in cleaning and debriding in wound management.
Canada		Dermacyn Wound Care		A product used in moistening, irrigating, cleansing and debriding skin lesions.

	•	many antiseptics, including Betadine, hydrogen peroxide and Dakin’s solution, are toxic, can destroy human cells and tissue, may cause allergic reactions and can impede the wound healing process;
	•	silver-based products are expensive and require precise dosage and close monitoring by trained medical staff to minimize the potential for allergic reactions and bacterial resistance; and

	•	the increase in antibiotic resistant bacterial strains, such as MRSA and VRE, have compromised the efficacy of some widely used topical antibiotics, including Neosporin and Bacitracin.

	•	Effective.  In physician clinical testing, our products eliminated a wide range of bacteria that cause infection in a variety of acute and chronic wounds. In addition, we believe that, because of its mechanism of action, Microcyn does not target specific strains of bacteria, the practice of which has been shown to promote the development of resistant bacteria. Where Microcyn was used both independently from and in conjunction with other wound care therapeutic products, patients generally experienced less pain, improved mobility and physical activity levels and better quality of life.

	•	Safe.  Clinical data shows that our products are non-toxic, do not cause skin irritation and do not inhibit wound healing. Throughout all our clinical trials and physician clinical studies to date and since commercialization in 2004, we have received no reports of adverse events related to the use of Microcyn products.

	•	Easy to Use.  Our products require no preparation before use or at time of disposal, and caregivers can use our products without significant training. In addition, Microcyn can be stored at room temperature and does not require any specific handling procedures. Unlike other super-oxidized water solutions, which are typically stable for not more than 48 hours, our laboratory tests show that Microcyn has a shelf life ranging from one to two years, depending on the size and type of packaging. Our products are also complementary to most advanced technologies used to treat serious wounds, such as negative pressure wound therapy, jet lavage and tissue-engineered skin substitutes.

	•	Cost Effective.  Treatment of many wounds requires extended hospitalization and care, including the use of expensive systemic antibiotics. Infection prolongs the healing time and increases the use of systemic antibiotics. Our clinical trials and physician clinical studies indicate that Microcyn eliminates infection, can accelerate healing time and, in certain cases, reduces the use of systemic antibiotics, thereby lowering overall patient cost.

	•	drive adoption of Microcyn as the standard of care in the wound care market to prevent and eliminate infection;
	•	obtain additional regulatory approvals in the United States;
	•	expand our direct sales force and distribution networks;
	•	pursue opportunities to combine Microcyn with other treatments;
	•	develop strategic collaborations in the wound care market; and
	•	leverage our Microcyn platform to address additional markets.

	•	we have a history of losses, expect to continue to incur losses and may never achieve profitability;

	•	all of our current products are based on our Microcyn platform technology;

	•	Microcyn was recently found to be ineffective as a high level disinfectant in killing certain strains of pathogens under current Environmental Protection Agency testing protocols;

	•	we do not have regulatory approval to market Microcyn as a drug in the United States;

	•	we are required to conduct lengthy and expensive clinical trials, which may not be successful or lead to regulatory approvals; and

	•	in connection with their dismissal in April 2006, our former independent registered public accounting firm has notified us of a number of reportable events it deemed to constitute material weaknesses over financial reporting that could impact our ability to develop reliable financial statements in a timely manner.

Common stock to be offered by us		shares
Common stock to be outstanding after the offering		shares
Initial public offering price per share		$
Use of proceeds		We intend to use the net proceeds from this offering to expand our sales and marketing capabilities, to fund clinical trials and related research, to expand our manufacturing capabilities and for general corporate purposes, including working capital. See “Use of Proceeds.”

Proposed Nasdaq Global Market symbol		OCLS

	•	8,741,074 shares of our common stock issuable upon the exercise of outstanding stock options and options to be granted in connection with this offering, at a weighted-average exercise price of $1.19 per share;

	•	3,892,296 shares of our common stock issuable upon the exercise of outstanding warrants, at a weighted average exercise price of $2.66 per share; and

	•	up to          additional shares of our common stock reserved for future grants under our equity plans, including our 2006 Stock Incentive Plan.

	•	gives effect to the conversion of all outstanding shares of our preferred stock into 15,934,718 shares of our common stock upon the completion of this offering;

	•	does not reflect the exercise of outstanding warrants or options to purchase shares of our common stock;
	•	assumes that the underwriters do not exercise their over-allotment option to purchase additional shares in this offering;

	•	reflects a  -for-one reverse split of our common stock to be effected before completion of this offering;

	•	reflects our reincorporation in Delaware from California; and
	•	reflects the amendment of our certificate of incorporation in connection with this offering to, among other things, change the number of shares authorized for issuance.

	•	on an actual basis;

	•	on a pro forma basis to give effect to the automatic conversion of all outstanding shares of our convertible preferred stock into 15,934,718 shares of our common stock upon the closing of this offering;

	•	on a pro forma as adjusted basis to give effect to:

	•	the completion of the Series C Financing; and

	•	the sale of           shares of common stock in this offering at an assumed initial public offering price of $           per share, after deducting the underwriting discount and our estimated offering expenses.

		Year Ended March 31,												Three Months Ended June 30,
		2004				2005				2006				2005				2006
														(unaudited)
Consolidated Statements of Operations Data:
Revenues
Product		$	95			$	473			$	1,966			$	255			$	904
Service			807				883				618				151				174
Total revenues			902				1,356				2,584				406				1,078
Cost of revenues
Product(1)			1,403				2,211				3,899				490				504
Service(1)			1,265				1,311				1,003				249				201
Total cost of revenues			2,668				3,522				4,902				739				705
Gross profit (loss)			(1,766	)			(2,166	)			(2,318	)			(333	)			373
Operating expenses
Research and development(1)			1,413				1,654				2,600				256				767
Selling, general and administrative(1)			3,918				12,492				15,933				3,395				3,646
Total operating expenses			5,331				14,146				18,533				3,651				4,413
Loss from operations			(7,097	)			(16,312	)			(20,851	)			(3,984	)			(4,040	)
Interest expense			(178	)			(372	)			(172	)			(69	)			(39	)
Interest income			3				8				282				13				58
Other income (expense), net			(26	)			146				(377	)			(25	)			(276	)
Net loss from continuing operations			(7,298	)			(16,530	)			(21,118	)			(4,065	)			(4,297	)
Loss on discontinued operations			—				—				(1,981	)			(77	)			—
Net loss			(7,298	)			(16,530	)			(23,099	)			(4,142	)			(4,297	)
Preferred stock dividends			—				—				(121	)			—				(121	)
Net loss available to common stockholders		$	(7,298	)		$	(16,530	)		$	(23,220	)		$	(4,142	)		$	(4,418	)
Net loss per common share: basic and diluted		$	(0.47	)		$	(1.06	)		$	(1.40	)		$	(0.26	)		$	(0.26	)
Weighted-average number of shares used in per common share calculations: basic and diluted			15,647				15,659				16,602				15,878				16,881
Pro forma net loss per common share: basic and diluted										$	(0.75	)						$	(0.13	)
Pro forma weighted-average number of shares used in per common share calculations: basic and diluted											30,728								32,815

(1)		Includes the following stock-based compensation charges:

														Three Months Ended
		Year Ended March 31,												June 30,
		2004				2005				2006				2005				2006
														(unaudited)
Cost of revenues
Product		$	—			$	2			$	2			$	1			$	—
Service			10				3				1				—				—
Operating expenses
Research and development			56				5				52				12				20
Selling, general and administrative			358				2,339				542				96				104

		As of June 30, 2006
						Pro Forma
		Actual				As Adjusted
						(unaudited)
Consolidated Balance Sheet Data:
Cash and cash equivalents(1)		$	6,134
Working capital(1)			3,393
Total assets(1)			13,378
Total liabilities			9,073
Total stockholders’ equity(1)			4,305

(1)		A $1.00 increase or decrease in the assumed initial public offering price of $      per share would increase or decrease, as applicable, this amount on a pro forma as adjusted basis by approximately $      million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discount and our estimated offering expenses.

 

Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below with all of the other information included in this prospectus before making an investment decision. If any of the following risks actually occur, our business, results of operations or financial condition would likely suffer. In that case, the market price of our common stock could decline and you could lose all or part of your investment in our common stock. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations.

 

Risks Related to Our Business

 

We have a history of losses, we expect to continue to incur losses and we may never achieve profitability.

 

We have incurred significant net losses in each fiscal year since our inception, including losses of $7.3 million, $16.5 million, $23.1 million and $4.3 million for the years ended March 31, 2004, 2005 and 2006 and the three months ended June 30, 2006, respectively. Our accumulated deficit as of June 30, 2006 was $54.7 million. We have yet to demonstrate that we can generate sufficient sales of our products to become profitable. The extent of our future operating losses and the timing of profitability are highly uncertain, and we may never achieve profitability. Even if we do generate significant revenues from our product sales, we expect that increased operating expenses will result in significant operating losses in the near term as we, among other things:

 

 

 

 

As a result of these activities, we will need to generate significant revenue in order to achieve profitability and may never become profitable. We must also maintain specified cash reserves in connection with our loan and security agreement which may limit our investment opportunities. Failure to maintain these reserves could result in our lender foreclosing against our assets or imposing significant restrictions on our operations. Even if we do achieve profitability, we may not be able to sustain or increase profitability on an ongoing basis.

 

Because all of our products are based on our Microcyn platform technology, we will need to generate sufficient revenues from the sale of Microcyn to execute our business plan.

 

All of our products are based on our Microcyn platform technology, and we do not have any non-Microcyn product candidates that will generate revenues in the foreseeable future. Accordingly, we expect to derive substantially all of our future revenues from sales of our Microcyn products. We have only been selling our products since July 2004, and substantially all of our historical product revenues have been from sales of Microcyn in Mexico. Although we began selling in Europe in October 2004 and in the United States in June 2005, our product revenues outside of Mexico to date have not been significant. For example, product revenues from countries outside of Mexico were 34.3% of our product revenues for the three months ended June 30, 2006, but were just 9.1% of our product revenues for the year ended March 31, 2006. Microcyn has not been adopted as a standard of care for wound treatment in any country and may not gain acceptance among physicians, nurses, patients, third-party payors and the medical community. Existing protocols for wound care are well established within the medical community and tend to vary geographically, and healthcare providers may be reluctant to alter their protocols to include the use of Microcyn. If Microcyn does not achieve an adequate level of acceptance, we will not generate sufficient revenues to become profitable.

 

One of our products was recently found to be ineffective as a high level disinfectant in killing certain strains of pathogens under current Environmental Protection Agency, or EPA, testing protocols. As a result, we have discontinued marketing our Cidalcyn disinfectant.

 

We previously offered our Microcyn-based pesticide product, Cidalcyn, as a hospital disinfectant, and stated on its label, registered with the EPA, that it was effective in eliminating a broad range of bacteria, as well as the HIV virus and certain fungi. Although we have not marketed Cidalcyn on a large commercial scale, we have provided it in small quantities to numerous hospitals for use in product evaluation. In August 2006, we received a “show cause” letter from the EPA, which stated that, in tests conducted by the EPA, Cidalcyn was found to be ineffective in killing three specified pathogens (pseudomonas aeginose, staphylococcus aureus and mycobacterium tuberculosis) when used according to label directions, which prevents us from marketing Cidalcyn as a hospital grade disinfectant. Our subsequent testing has confirmed two of the three EPA results. Based on its results, the EPA strongly recommended that we immediately recall all Cidalcyn distributed on and after September 28, 2005. Accordingly, we have commenced a voluntary recall of Cidalcyn under the current label. In a second letter, the EPA stated it intended to file a civil administrative complaint against us for violation of federal pesticide legislation. The EPA could assess civil penalties related to the sale and distribution of a pesticide product that does not meet the label’s claims. We believe that such civil penalties could be up to $200,000. The EPA could also require us to stop selling our product, or require us to remove Cidalcyn from the market. Unless and until we prove the label claims of Cidalcyn to the EPA, there will not be any further sales of the product in the United States.

 

We do not have the necessary regulatory approvals to market Microcyn as a drug in the United States.

 

We have obtained three 510(k) clearances in the United States that permit us to sell Microcyn as a medical device to clean, moisten and debride wounds. However, we do not have the necessary regulatory approvals to market Microcyn in the United States as a drug, which we will need to obtain in order to execute our business plan. Before we are permitted to sell Microcyn as a drug in the United States, we must, among other things, successfully complete additional well-controlled clinical trials, submit a New Drug Application, or NDA, to the FDA and obtain FDA approval. At a meeting in August 2006, the FDA requested an additional pivotal trial and additional microbiology and dermatology studies. We expect that this second pivotal trial will have the same design, size and endpoints as our prior pivotal trial, which was completed in July 2006. In the event that we proceed with the second pivotal trial and, assuming that the second pivotal trial and these additional studies are successful, we intend to file an NDA for Microcyn as a pre-operative skin preparation in late 2007. We also intend to seek FDA approval for the use of Microcyn to eliminate infection and accelerate healing in wounds. The FDA approval process is expensive and uncertain, requires detailed and comprehensive scientific and other data and generally takes several years. Despite the time and expense exerted, approval is never guaranteed. We do not know whether we will obtain the necessary regulatory approvals to market Microcyn as a drug in the United States. We anticipate that the earliest we could obtain approval to sell Microcyn as a pre-operative skin preparation in the United States is 2008, and any approval for the use of Microcyn to eliminate infection in wounds in the United States will take even longer. Even if we obtain FDA approval to sell Microcyn as a drug, we may not be able to successfully commercialize Microcyn as a drug in the United States and may never recover the substantial costs we have invested in the development of our Microcyn products.

 

Our inability to raise additional capital on acceptable terms in the future may limit our ability to develop and commercialize new products and technologies.

 

We expect capital outlays and operating expenditures to increase over the next several years as we work to commercialize our products and expand our infrastructure and research and development activities. We may need to raise additional capital to, among other things:

 

 

 

 

 

 

 

 

Our present and future funding requirements will depend on many factors, including:

 

 

 

 

 

 

 

 

If we raise additional funds by issuing equity securities, dilution to our stockholders could result. Any equity securities issued also may provide for rights, preferences or privileges senior to those of holders of our common stock. If we raise additional funds by issuing debt securities, these debt securities would have rights, preferences and privileges senior to those of holders of our common stock, and the terms of the debt securities issued could impose significant restrictions on our operations. If we raise additional funds through collaborations and licensing arrangements, we might be required to relinquish significant rights to our technologies or products, or grant licenses on terms that are not favorable to us. If adequate funds are not available, we may have to scale back our operations or limit our research and development activities.

 

Delays or adverse results in clinical trials could result in increased costs to us and delay our ability to generate revenue.

 

Clinical trials can be long and expensive, and the outcome of clinical trials is uncertain and subject to delays. It may take several years to complete clinical trials, if at all, and a product candidate may fail at any stage of the clinical trial process. The length of time required varies substantially according to the type, complexity, novelty and intended use of the product candidate. Interim results of a preclinical study or clinical trial do not necessarily predict final results, and acceptable results in preclinical studies or early clinical trials may not be repeatable in later subsequent clinical trials. The commencement or completion of any of our clinical trials may be delayed or halted for a variety of reasons, including the following:

 

 

We do not know whether our existing or any future clinical trials will demonstrate safety and efficacy sufficiently to result in additional FDA approvals. While a number of physicians have conducted clinical studies assessing the safety and efficacy of Microcyn for various indications, the data from these studies is not sufficient to support approval of Microcyn as a drug in the United States. The FDA has requested an additional pivotal trial and microbiology and dermatology studies before we submit an NDA for Microcyn as a pre-operative skin preparation. We will be required to conduct additional clinical trials prior to seeking approval of Microcyn for additional indications. Our failure to adequately demonstrate the safety and efficacy of our product candidates to the satisfaction of the FDA will prevent our receipt of FDA approval for additional indications and, ultimately, impact commercialization of our products in the United States. If we experience significant delays or adverse results in clinical trials, our financial results and the commercial prospects for products based on Microcyn will be harmed, our costs would increase and our ability to generate revenue would be delayed.

 

If we fail to obtain, or experience significant delays in obtaining, regulatory clearances to market our current or future products, we will be unable to commercialize these products.

 

Developing, testing, manufacturing, marketing and selling of medical technology products are subject to extensive regulation by numerous governmental authorities in the United States and other countries. The process of obtaining regulatory clearance and approval of medical technology products is costly and time consuming. Even though the underlying product formulation may be the same or similar, our products are subject to different regulations and approval processes depending upon their intended use. In the United States, use of Microcyn to cleanse and debride a wound comes within the medical device regulation framework, while use of Microcyn to prepare the skin pre-operatively and to control infection in wounds will require us to seek FDA approval of Microcyn as a drug in the United States.

 

To obtain regulatory approval of our products as drugs in the United States, we must first show that our products are safe and effective for target indications through preclinical studies (animal testing) and clinical trials (human testing). The FDA generally clears marketing of a medical device through the 510(k) pre-market clearance process if it is demonstrated that the new product has the same intended use and is substantially equivalent to another legally marketed device, including a 510(k)-cleared product, and otherwise meets the FDA’s requirements. Product modifications, including labeling the product for a new intended use, may require the submission of a new 510(k) clearance before the modified product can be marketed. Some higher-risk medical devices must receive pre-market approval, or PMA, before they may be commercialized. The PMA process is more costly, lengthy and uncertain than the 510(k) clearance process and requires the development and submission of clinical studies supporting the safety and effectiveness of the device. We cannot assure you that any new products or any product enhancements we develop will be subject to the shorter 510(k) clearance process instead of the more lengthy PMA or drug approval processes.

 

We do not know whether our products based on Microcyn will receive approval from FDA as a drug. The data from clinical studies of Microcyn conducted by physicians to date will not satisfy FDA’s regulatory criteria for approval of an NDA. In connection with our efforts to commercialize Microcyn as a pre-operative skin preparation, the FDA has requested an additional pivotal trial and additional microbiology and dermatology studies. Before we initiate our second pivotal trial, we plan to discuss with the FDA its request for an additional pivotal trial and additional data. Depending on the results of these discussions we may reassess our priorities, clinical timelines and schedules for filing the NDA for pre-operative skin preparation. We will be required to conduct additional clinical trials prior to seeking approval of Microcyn for additional indications. We are therefore conducting, and will need to conduct additional, well-controlled clinical trials in order to generate data that demonstrates to the satisfaction of FDA that Microcyn is safe and effective for the indications we seek in our NDAs. The outcomes of clinical trials are inherently uncertain, and there is no guarantee that the results of our clinical trials will replicate the data obtained from the physician clinical studies and that these clinical trials will support FDA approval of Microcyn as a drug. In addition, we do not know whether the necessary approvals or clearances will be granted for future products or that FDA review or actions will not involve delays caused by the FDA’s request for additional information or clinical testing that could adversely affect the time to market and sale of products as drugs. If we do not obtain the requisite

regulatory clearances and approvals, we will be unable to commercialize our products as drugs and may never recover any of the substantial costs we have invested in the development of Microcyn.

 

Distribution of our products outside the United States is subject to extensive government regulation. These regulations, including the requirements for approvals or clearance to market, the time required for regulatory review and the sanctions imposed for violations, vary from country to country. We do not know whether we will obtain regulatory approvals in such countries or that we will not be required to incur significant costs in obtaining or maintaining these regulatory approvals. In addition, the export by us of certain of our products that have not yet been cleared for domestic commercial distribution may be subject to FDA export restrictions. Failure to obtain necessary regulatory approvals, the restriction, suspension or revocation of existing approvals or any other failure to comply with regulatory requirements would have a material adverse effect on our future business, financial condition, and results of operations.

 

We may incur significant liabilities in connection with our relationship with a former distributor in Mexico, and our results of operations may be negatively affected by the termination of this relationship.

 

On June 16, 2005, we entered into a series of agreements with Quimica Pasteur, or QP, a Mexico-based distributor of pharmaceutical products to hospitals and health care entities owned or operated by the Mexican Ministry of Health, or MOH. These agreements provided, among other things, for QP to act as our exclusive distributor of Microcyn to the MOH for a period of three years. In connection with these agreements, an individual designated by us who is also one of our executive officers, concurrently acquired, in his individual capacity, a small equity interest in QP. We were granted an option to acquire the remaining equity of QP directly from its principals. In addition, two of our employees were appointed as officers of QP, which resulted in the establishment of financial control of QP by our company under applicable accounting literature.

 

As a result of our agreements, we were required to consolidate QP’s operations with our financial results. In connection with our audit of QP’s financial statements in late 2005, we were made aware of a number of facts that suggested that QP or its principals may have engaged in some form of tax avoidance practice prior to the execution of the agreements between our company and QP. We did not discover these facts prior to our execution of these agreements or for several months thereafter. Our prior independent auditors informed us that we did not have effective anti-fraud programs designed to detect the type of activities in which QP’s principals engaged or the personnel to effectively evaluate and determine the appropriate accounting for non-routine or complex accounting transactions. Our audit committee engaged an outside law firm to conduct an investigation whose findings implicated QP’s principals in a systemic tax avoidance practice prior to June 16, 2005. We estimate that taxes, interest and penalties related to these practices could amount to $7 million or more. Based on the results of this investigation, we terminated our agreements with QP effective March 26, 2006.

 

Although we do not believe that we are responsible for any tax avoidance practices of QP’s principals prior to June 16, 2005, the Mexican taxing authority could make a claim against us or our Mexican subsidiary. We have been informed by counsel in Mexico that the statute of limitations, including for actions for fraud, is five years from the date of our last tax return, which was March 31, 2006.

 

QP had a well-established relationship with the MOH. We lost the benefit of this relationship when we terminated our agreements with QP. Although we currently market Microcyn in Mexico through a dedicated contract sales force and continue to market Microcyn to the MOH, we do not know whether our future sales in Mexico will decline as a result of the termination of our relationship with QP.

 

Our former independent registered public accounting firm has notified us of a number of reportable events constituting a material weakness over financial reporting which, if not successfully remedied, may among other things, impact our ability to develop reliable financial statements and comply with our reporting obligations as a public company.

 

In August 2006, our former independent registered public accounting firm, PricewaterhouseCoopers LLP, or PWC, notified us of a number of deficiencies it believes comprise reportable events that may, among other things, impact our ability to develop reliable financial statements. In its letter, PWC stated that it had advised our audit committee of the following:

 

 

 

 

 

 

 

 

We have filed a copy of the letter from PWC as an exhibit to the registration statement of which this prospectus forms a part. For additional information, please see “Change in Independent Registered Public Accounting Firm.”

 

We may agree to change the brand name of our product in Mexico, which may result in the loss of any brand recognition that we have established with users of our products.

 

We have marketed our products in Mexico under the brand name of Microcyn60. In accordance with the proposed settlement of a trademark confusion lawsuit filed against us in Mexico, we may agree to stop using the name Microcyn60 in Mexico. As a result, we may lose the benefit of the brand name recognition we have generated in the region and our product sales in Mexico could decline. In locations where we have distributed our products, we believe that the brand names of those products have developed name recognition among consumers who purchase them. Any change to the brand name of our other products may cause us to lose such name recognition, which may lead to confusion in the marketplace and a decline in sales of our products.

If our competitors develop products similar to Microcyn, we may need to modify or alter our business strategy, which may delay the achievement of our goals.

 

Competitors may develop products with similar characteristics as Microcyn. Such similar products marketed by larger competitors can hinder our efforts to penetrate the market. As a result, we may be forced to modify or alter our business and regulatory strategy and sales and marketing plans, as a response to changes in the market, competition and technology limitations, among others. Such modifications may pose additional delays in achieving our goals.

 

If we are unable to expand our direct domestic sales force, we may not be able to successfully sell our products in the United States.

 

We currently sell Microcyn in the United States through a network of one national and five regional distributors and our medicial and clinical employees. We plan to sell directly into the United States markets and we plan to expand our domestic sales force in connection with our anticipated receipt of FDA approval to market and sell Microcyn as a drug for pre-operative skin preparation. Developing a sales force is expensive and time consuming, and the lack of qualified sales personnel could delay or limit the success of our product launch. Our domestic sales force, if established, will be competing with the sales operations of our competitors, which are better funded and more experienced. We may not be able to develop domestic sales capacity on a timely basis or at all.

 

Our dependence on distributors for sales could limit or prevent us from selling our products and from realizing long-term revenue growth.

 

We currently depend on distributors to sell Microcyn in the United States, Europe and other countries and intend to continue to sell our products primarily through distributors in Europe and the United States for the foreseeable future. In addition, if we are unable to expand our direct sales force, we will continue to rely on distributors to sell Microcyn. Our existing distribution agreements are generally short-term in duration, and we may need to pursue alternate distributors if the other parties to these agreements terminate or elect not to renew their agreements. If we are unable to retain our current distributors for any reason, we must replace them with alternative distributors experienced in supplying the wound care market, which could be time-consuming and divert management’s attention from other operational matters. In addition, we will need to attract additional distributors to expand the geographic areas in which we sell Microcyn. Distributors may not commit the necessary resources to market and sell our products to the level of our expectations, which could harm our ability to generate revenues. In addition, some of our distributors may also sell products that compete with ours. If current or future distributors do not perform adequately, or we are unable to locate distributors in particular geographic areas, we may not realize long-term revenue growth.

 

We depend on a contract sales force to sell our products in Mexico.

 

We currently depend on a contract sales force to sell Microcyn in Mexico. Our existing agreement is short-term in duration and can be terminated by either party upon 30 days written notice. If we are unable to retain our current agreement for any reason, we may need to build our own internal sales force or find an alternate source for contract sales people. We may be unable to find an alternate source, or the alternate source’s sales force may not generate sufficient revenue. If our current or future contract sales force does not perform adequately, we may not realize long-term revenue growth in Mexico.

 

We intend to license or collaborate with third parties in various potential markets, and events involving these strategic partners or any future collaborations could delay or prevent us from developing or commercializing products.

 

Our business strategy and our short- and long-term operating results will depend in part on our ability to execute on existing strategic collaborations and to license or partner with new strategic partners. We believe collaborations allow us to leverage our resources and technologies and to access markets that are compatible with our own core areas of expertise while avoiding the cost of establishing a direct sales force in each market. To penetrate our target markets, we may need to enter into additional collaborative agreements to assist in the

development and commercialization of future products. For example, depending upon our analysis of the time and expense involved in obtaining FDA approval to sell a product to treat open wounds, we may chose to license our technology to a third party as opposed to pursuing commercialization ourselves. Establishing strategic collaborations is difficult and time-consuming. Potential collaborators may reject collaborations based upon their assessment of our financial, regulatory or intellectual property position and our internal capabilities. Our discussions with potential collaborators may not lead to the establishment of new collaborations on favorable terms. We have limited control over the amount and timing of resources that our current collaborators or any future collaborators devote to our collaborations or potential products. These collaborators may breach or terminate their agreements with us or otherwise fail to conduct their collaborative activities successfully and in a timely manner. Further, our collaborators may not develop or commercialize products that arise out of our collaborative arrangements or devote sufficient resources to the development, manufacture, marketing or sale of these products. By entering into a collaboration, we may preclude opportunities to collaborate with other third parties who do not wish to associate with our existing third party strategic partners. Moreover, in the event of termination of a collaboration agreement, termination negotiations may result in less favorable terms.

 

If we fail to comply with ongoing regulatory requirements, or if we experience unanticipated problems with our products, these products could be subject to restrictions or withdrawal from the market.

 

Regulatory approvals or clearances that we currently have and that we may receive in the future are subject to limitations on the indicated uses for which the products may be marketed, and any future approvals could contain requirements for potentially costly post-marketing follow-up studies. If the FDA determines that our promotional materials or activities constitute promotion of an unapproved use or we otherwise fail to comply with FDA regulations, we may be subject to regulatory enforcement actions, including a warning letter, injunction, seizure, civil fine or criminal penalties. In addition, the manufacturing, labeling, packaging, adverse event reporting, storage, advertising, promotion, distribution and record-keeping for approved products are subject to extensive regulation. Our manufacturing facilities, processes and specifications are subject to periodic inspection by FDA, European and other regulatory authorities and from time to time, we may receive notices of deficiencies from these agencies as a result of such inspections. Our failure to continue to meet regulatory standards or to remedy any deficiencies could result in restrictions being imposed on products or manufacturing processes, fines, suspension or loss of regulatory approvals or clearances, product recalls, termination of distribution or product seizures or the need to invest substantial resources to comply with various existing and new requirements. In the more egregious cases, criminal sanctions, civil penalties, disgorgement of profits or closure of our manufacturing facilities are possible. The subsequent discovery of previously unknown problems with Microcyn, including adverse events of unanticipated severity or frequency, may result in restrictions on the marketing of our products, and could include voluntary or mandatory recall or withdrawal of products from the market.

 

New government regulations may be enacted and changes in FDA policies and regulations, their interpretation and enforcement, could prevent or delay regulatory approval of our products. We cannot predict the likelihood, nature or extent of adverse government regulation that may arise from future legislation or administrative action, either in the United States or abroad. Therefore, we do not know whether we will be able to continue to comply with any regulations or that the costs of such compliance will not have a material adverse effect on our future business, financial condition, and results of operations. If we are not able to maintain regulatory compliance, we will not be permitted to market our products and our business would suffer.

 

We may experience difficulties in manufacturing Microcyn, which could prevent us from commercializing one or more of our products.

 

The machines used to manufacture our Microcyn-based products are complex, use complicated software and must be monitored by highly trained engineers. Slight deviations anywhere in our manufacturing process, including quality control, labeling and packaging, could lead to a failure to meet the specifications required by the FDA, EPA, European notified bodies and Mexican regulatory agencies, which may result in lot failures or product recalls. In August 2006, we received a “show cause” letter form the EPA, which stated that, in tests conducted by the EPA, Cidalcyn was found to be ineffective in killing specified pathogens when used

according to label directions. We have begun gathering records for review to determine if there might have been any problems in production of the lot tested by the EPA. We have also quarantined all remaining quantities of the production lot in question. If we are unable to obtain quality internal and external components, mechanical and electrical parts, if our software contains defects or is corrupted, or if we are unable to attract and retain qualified technicians to manufacture our products, our manufacturing output of Microcyn, or any other product candidate based on our platform that we may develop, could fail to meet required standards, our regulatory approvals could be delayed, denied or revoked, and commercialization of one or more of our Microcyn-based products may be delayed or foregone. Manufacturing processes that are used to produce the smaller quantities of Microcyn needed for our clinical test and current commercial sales may not be successfully scaled up to allow production of significant commercial quantities. Any failure to manufacture our products to required standards on a commercial scale could result in reduced revenues, delays in generating revenue and increased costs.

 

Our competitive position depends on our ability to protect our intellectual property and our proprietary technologies.

 

Our ability to compete and to achieve and maintain profitability depends on our ability to protect our intellectual property and proprietary technologies. We currently rely on a combination of patents, patent applications, trademarks, trade secret laws, confidentiality agreements, license agreements and invention assignment agreements to protect our intellectual property rights. We also rely upon unpatented know-how and continuing technological innovation to develop and maintain our competitive position. These measures may not be adequate to safeguard our Microcyn technology. In addition, we granted a security interest in our assets under a loan and security agreement. The security interest extends to our intellectual property in the event we fail to maintain specified cash reserves under the loan. If we do not protect our rights adequately, third parties could use our technology, and our ability to compete in the market would be reduced.

 

Although we have filed U.S. and foreign patent applications related to our Microcyn based products, the manufacturing technology for making the products, and their uses, only one patent has been issued from these applications to date.

 

Our pending patent applications and any patent applications we may file in the future may not result in issued patents, and we do not know whether any of our in-licensed patents or any additional patents that might ultimately be issued by the U.S. Patent and Trademark Office will protect our Microcyn technology. Any claims that issue may not be sufficiently broad to prevent third parties from producing competing substitutes and may be infringed, designed around, or invalidated by third parties. Even issued patents may later be found to be invalid, or may be modified or revoked in proceedings instituted by third parties before various patent offices or in courts.

 

The degree of future protection for our proprietary rights is more uncertain in part because legal means afford only limited protection and may not adequately protect our rights, and we will not be able to ensure that:

 

 

The policies we use to protect our trade secrets may not be effective in preventing misappropriation of our trade secrets by others. In addition, confidentiality and invention assignment agreements executed by our employees, consultants and advisors may not be enforceable or may not provide meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosures. We cannot be

certain that the steps we have taken will prevent the misappropriation and use of our intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. For example, one of our former contract partners, Nofil Corporation, whom we relied upon to manufacture our proprietary machines had access to our proprietary information and we believe undertook the development and manufacture of the machines to be sold to third parties in violation of our agreement with such company. We have brought a claim against Nofil in the Northern District of California. We believe that a former officer of our Mexico subsidiary collaborated in these acts, misappropriated our trade secrets, and is currently selling products in Mexico that are competitive with our products. In addition, we believe that, through the licensor of the patents that we in-license and who has also assigned patents to us, a company in Japan obtained one of our patent applications, translated it into Hangul and filed it under such company’s and the licensor’s name in South Korea. These and any other leak of confidential data into the public domain or to third parties could allow our competitors to learn our trade secrets.

 

We are in a dispute with the licensor of all of our current issued patents, which could result in our losing all rights under such patents and have a material adverse impact on our business opportunities in Japan.

 

In March 2003, we obtained an exclusive license to six issued Japanese patents and five Japanese published pending patent applications owned by Coherent Technologies. The issued Japanese patents and pending Japanese patent applications relate to an early generation of super-oxidized water product and aspects of the method and apparatus for producing such product and will expire between 2011 and 2014. In June 2006, we received written notice from Coherent advising us that the patent license was terminated, citing various reasons with which we disagree. Although we do not believe Coherent has grounds to terminate the license, we may have to take legal action to preserve our rights under the license and to enjoin Coherent from breaching its terms. We do not know whether we would prevail in any such action, which would be costly and time consuming, and we could lose our rights under the license, which could have a material adverse impact on our business opportunities in Japan. In addition, we could have to defend ourselves against infringement claims from Coherent in Japan based on their position on termination of the license.

 

We may face intellectual property infringement claims that could be time-consuming, costly to defend and could result in our loss of significant rights and the assessment of treble damages.

 

From time to time, we may receive notices of claims of infringement, misappropriation or misuse of other parties’ proprietary rights. In September 2005, a complaint was filed against us in Mexico claiming confusion in trademarks with respect to our Microcyn60 mark. In May 2006, a second unrelated complaint was filed against us in Mexico claiming confusion in trademarks with respect to our Microcyn60 mark. We may agree to cease marketing our product in Mexico under the name Microcyn60 as a result of the proposed settlement of the initial lawsuit. We could incur a liability of approximately $100,000 for the use of the name Microcyn60 during the twelve month period following the date of settlement. We cannot be sure that we will not be required to take additional actions, including making additional payments related to this matter, or that changing our product name will not have a negative impact on our product sales in Mexico.

 

In addition, we may have disputes regarding intellectual property rights with the parties that have licensed those rights to us. Some claims received from third parties may lead to litigation. We cannot assure you that we will prevail in these actions, or that other actions alleging misappropriation or misuse by us of third-party trade secrets, infringement by us of third-party patents and trademarks or the validity of our patents, will not be asserted or prosecuted against us. We may also initiate claims to defend our intellectual property. Intellectual property litigation, regardless of outcome, is expensive and time-consuming, could divert management’s attention from our business and have a material negative effect on our business, operating results or financial condition. If there is a successful claim of infringement against us, we may be required to pay substantial damages (including treble damages if we were to be found to have willfully infringed a third party’s patent) to the party claiming infringement, develop non-infringing technology, stop selling our products or using technology that contains the allegedly infringing intellectual property or enter into royalty or license agreements that may not be available on acceptable or commercially practical terms, if at all. Our failure to develop non-infringing technologies or license the proprietary rights on a timely basis could harm our business. In addition, modifying our products to include

the non-infringing technologies could require us to seek re-approval or clearance from various regulatory bodies for our products, which would be costly and time consuming. Also, we may be unaware of pending patent applications that relate to our technology. Parties making infringement claims on future issued patents may be able to obtain an injunction that would prevent us from selling our products or using technology that contains the allegedly infringing intellectual property, which could harm our business.

 

Our ability to generate revenue will be diminished if we are unable to obtain acceptable prices or an adequate level of reimbursement from third-party payors of healthcare costs.

 

The continuing efforts of governmental and other third-party payors, including managed care organizations such as health maintenance organizations, or HMOs, to contain or reduce costs of health care may affect our future revenue and profitability, and the future revenue and profitability of our potential customers, suppliers and collaborative or license partners and the availability of capital. For example, in certain foreign markets, pricing or profitability of prescription pharmaceuticals is subject to government control. In the United States, governmental and private payors have limited the growth of health care costs through price regulation or controls, competitive pricing programs and drug rebate programs. Our ability to commercialize our products successfully will depend in part on the extent to which appropriate coverage and reimbursement levels for the cost of our Microcyn products and related treatment are obtained from governmental authorities, private health insurers and other organizations, such as HMOs.

 

There is significant uncertainty concerning third-party coverage and reimbursement of newly approved medical products and drugs. Third-party payors are increasingly challenging the prices charged for medical products and services. Also, the trend toward managed healthcare in the United States and the concurrent growth of organizations such as HMOs, as well as legislative proposals to reform healthcare or reduce government insurance programs, may result in lower prices for or rejection of our products. The cost containment measures that health care payors and providers are instituting and the effect of any health care reform could materially and adversely affect our ability to generate revenues.

 

In addition, given ongoing federal and state government initiatives directed at lowering the total cost of health care, the United States Congress and state legislatures will likely continue to focus on health care reform, the cost of prescription pharmaceuticals and the reform of the Medicare and Medicaid payment systems. While we cannot predict whether any proposed cost-containment measures will be adopted, the announcement or adoption of these proposals could reduce the price that we receive for our Microcyn products in the future.

 

We could be required to indemnify third parties for alleged infringement, which could cause us to incur significant costs.

 

Some of our distribution agreements contain commitments to indemnify our distributors against liability arising from infringement of third party intellectual property such as patents. We may be required to indemnify our customers for claims made against them or license fees they are required to pay. If we are forced to indemnify for claims or to pay license fees, our business and financial condition could be substantially harmed.

 

A significant part of our business is conducted outside of the United States, exposing us to additional risks that may not exist in the United States, which in turn could cause our business and operating results to suffer.

 

We have international operations in Mexico and Europe. For the fiscal years ended March 31, 2004, 2005 and 2006 and the three months ended June 30, 2006, approximately 10%, 35%, 75% and 81%, respectively, of our total revenue was generated from sales outside of the United States. Our business is highly regulated for the use, marketing and manufacturing of our Microcyn products both domestically and internationally. Our international operations are subject to risks, including:

 

 

 

We plan to continue to expand internationally to respond to customer requirements and market opportunities. We currently have international manufacturing facilities in Mexico and The Netherlands. Establishing operations in any foreign country or region presents risks such as those described above as well as risks specific to the particular country or region. In addition, until a payment history is established over time with customers in a new geography or region, the likelihood of collecting receivables generated by such operations could be less than our expectations. As a result, there is a greater risk that reserves set with respect to the collection of such receivables may be inadequate. If our international expansion efforts in any foreign country are unsuccessful, we could incur significant losses and we may not achieve profitability.

 

In addition, changes in policies or laws of the United States or foreign governments resulting in, among other things, changes in regulations and the approval process, higher taxation, currency conversion limitations, restrictions on fund transfers or the expropriation of private enterprises, could reduce the anticipated benefits of our international expansion. If we fail to realize the anticipated revenue growth of our future international operations, our business and operating results could suffer.

 

Our sales in international markets subject us to foreign currency exchange and other risks and costs which could harm our business.

 

A substantial portion of our revenues are derived from outside the United States, primarily from Mexico. We anticipate that revenues from international customers will continue to represent a substantial portion of our revenues for the foreseeable future. Because we generate revenues in foreign currencies, we are subject to the effects of exchange rate fluctuations. We incurred foreign currency exchange losses of $4,000, $283,000 and $272,000 for the fiscal years ended March 31, 2004 and 2006 and the three months ended June 30, 2006, respectively, and a gain of $134,000 for the fiscal year ended March 31, 2005. The functional currency of our Mexican subsidiary is the Mexican Peso, and the functional currency of our subsidiary in The Netherlands is the Euro. For the preparation of our consolidated financial statements, the financial results of our foreign subsidiaries are translated into U.S. dollars on average exchange rates during the applicable period. If the U.S. dollar appreciates against the Mexican Peso or the Euro, as applicable, the revenues we recognize from sales by our subsidiaries will be adversely impacted. Foreign exchange gains or losses as a result of exchange rate fluctuations in any given period could harm our operating results and negatively impact our revenues. Additionally, if the effective price of our products were to increase as a result of fluctuations in foreign currency exchange rates, demand for our products could decline and adversely affect our results of operations and financial condition.

 

The loss of key members of our senior management team, one of our directors or our inability to retain highly skilled scientists, technicians and salespeople could adversely affect our business.

 

Our success depends largely on the skills, experience and performance of key members of our executive management team, including Hojabr Alimi, our Chief Executive Officer, and Akihisa Akao, a member of our Board of Directors and one of our consultants. The efforts of these people will be critical to us as we continue to develop our products and attempt to commercialize products in the chronic and acute wound care market. If we were to lose one or more of these individuals, we may experience difficulties in competing effectively, developing our technologies and implementing our business strategies.

Our research and development programs depend on our ability to attract and retain highly skilled scientists and technicians. We may not be able to attract or retain qualified scientists and technicians in the future due to the intense competition for qualified personnel among medical technology businesses, particularly in the San Francisco Bay Area. We also face competition from universities and public and private research institutions in recruiting and retaining highly qualified personnel. In addition, our success depends on our ability to attract and retain salespeople with extensive experience in wound care and close relationships with the medical community, including physicians and other medical staff. We may have difficulties locating, recruiting or retaining qualified salespeople, which could cause a delay or decline in the rate of adoption of our products. If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will adversely affect our ability to support our research, development and sales programs.

 

We maintain key-person life insurance only on Mr. Alimi. We may discontinue this insurance in the future, it may not continue to be available on commercially reasonable terms or, if continued, it may prove inadequate to compensate us for the loss of Mr. Alimi’s services.

 

We may be unable to manage our future growth effectively, which would make it difficult to execute our business strategy.

 

We may experience periods of rapid growth as we expand our business, which will likely place a significant strain on our limited personnel and other resources. Any failure by us to manage our growth effectively could have an adverse effect on our ability to achieve our commercialization goals.

 

Furthermore, we conduct business in a number of geographic regions and are seeking to expand to other regions. We have not established a physical presence in many of the international regions in which we conduct or plan to conduct business, but rather we manage our business from our headquarters in Northern California. As a result, we conduct business at all times of the day and night with limited personnel. If we fail to appropriately target and increase our presence in these geographic regions, we may not be able to effectively market and sell our Microcyn products in these locations or we may not meet our customers’ needs in a timely manner, which could negatively affect our operating results.

 

Future growth will also impose significant added responsibilities on management, including the need to identify, recruit, train and integrate additional employees. In addition, rapid and significant growth will place strain on our administrative and operational infrastructure, including sales and marketing and clinical and regulatory personnel. Our ability to manage our operations and growth will require us to continue to improve our operational, financial and management controls, reporting systems and procedures. If we are unable to manage our growth effectively, it may be difficult for us to execute our business strategy.

 

The wound care industry is highly competitive and subject to rapid technological change. If our competitors are better able to develop and market products that are less expensive or more effective than any products that we may develop, our commercial opportunity will be reduced or eliminated.

 

The wound care industry is highly competitive and subject to rapid technological change. Our success depends, in part, upon our ability to stay at the forefront of technological change and maintain a competitive position.

 

We compete with large healthcare, pharmaceutical and biotechnology companies, along with smaller or early-stage companies that have collaborative arrangements with larger pharmaceutical companies, academic institutions, government agencies and other public and private research organizations. Many of our competitors have significantly greater financial resources and expertise in research and development, manufacturing, pre-clinical testing, conducting clinical trials, obtaining regulatory approvals and marketing approved products than we do. Our competitors may:

 

 

 

As a result, we may not be able to successfully commercialize any future products.

 

The success of our research and development efforts may depend on our ability to find suitable collaborators to fully exploit our capabilities. If we are unable to establish collaborations or if these future collaborations are unsuccessful, our research and development efforts may be unsuccessful, which could adversely affect our results of operations and financial condition.

 

An important element of our business strategy will be to enter into collaborative or license arrangements under which we license our Microcyn technology to other parties for development and commercialization. We expect that while we may initially seek to conduct initial clinical trials on our drug candidates, we may need to seek collaborators for a number of our potential products because of the expense, effort and expertise required to continue additional clinical trials and further develop those potential products candidates. Because collaboration arrangements are complex to negotiate, we may not be successful in our attempts to establish these arrangements. Also, we may not have products that are desirable to other parties, or we may be unwilling to license a potential product because the party interested in it is a competitor. The terms of any arrangements that we establish may not be favorable to us. Alternatively, potential collaborators may decide against entering into an agreement with us because of our financial, regulatory or intellectual property position or for scientific, commercial or other reasons. If we are not able to establish collaborative agreements, we may not be able to develop and commercialize new products, which would adversely affect our business and our revenues.

 

In order for any of these collaboration or license arrangements to be successful, we must first identify potential collaborators or licensees whose capabilities complement and integrate well with ours. We may rely on these arrangements for, not only financial resources, but also for expertise or economies of scale that we expect to need in the future relating to clinical trials, manufacturing, sales and marketing, and for licenses to technology rights. However, it is likely that we will not be able to control the amount and timing of resources that our collaborators or licensees devote to our programs or potential products. If our collaborators or licensees prove difficult to work with, are less skilled than we originally expected, or do not devote adequate resources to the program, the relationship will not be successful. If a business combination, involving a collaborator or licensees and a third party were to occur, the effect could be to diminish, terminate or cause delays in development of a potential product.

 

We may acquire other businesses or form joint ventures that could harm our operating results, dilute your ownership of us, increase our debt or cause us to incur significant expense.

 

As part of our business strategy, we may pursue acquisitions of complementary businesses and assets, as well as technology licensing arrangements. We also intend to pursue strategic alliances that leverage our core technology and industry experience to expand our product offerings or distribution. We have no experience with respect to acquiring other companies and limited experience with respect to the formation of collaborations, strategic alliances and joint ventures. If we make any acquisitions, we may not be able to integrate these acquisitions successfully into our existing business, and we could assume unknown or contingent liabilities. Any future acquisitions by us also could result in significant write-offs or the incurrence of debt and contingent liabilities, any of which could harm our operating results. Integration of an acquired company also may require management resources that otherwise would be available for ongoing development of our existing business. We may not identify or complete these transactions in a timely manner, on a cost-effective basis, or at all, and we may not realize the anticipated benefits of any acquisition, technology license, strategic alliance or joint venture.

 

To finance any acquisitions, we may choose to issue shares of our common stock as consideration, which would dilute your ownership interest in us. If the price of our common stock is low or volatile, we may not be able to acquire other companies for stock. Alternatively, it may be necessary for us to raise additional funds for acquisitions through public or private financings. Additional funds may not be available on terms that are favorable to us, or at all.

If we are unable to comply with broad and complex federal and state fraud and abuse laws, we could face substantial penalties and our products could be excluded from government healthcare programs.

 

We are subject to various federal and state laws pertaining to healthcare fraud and abuse, which, among other things, prohibit payments to induce the referral of products and services and the fraudulent billing of federal healthcare programs. If there is a change in law, regulation or administrative or judicial interpretations of these laws, we may have to change our business practices or our existing business practices could be challenged as unlawful, which could have a negative effect on our business, financial condition and results of operations.

 

If our past or present operations are found to be in violation of these laws or other similar governmental regulations to which we or our customers are subject, we may be subject to penalties, which may include:

 

 

 

 

 

 

 

Healthcare fraud and abuse laws are complex and even minor, inadvertent irregularities can potentially give rise to claims that a statute or regulation has been violated.

 

The frequency of suits to enforce these laws have increased significantly in recent years and have increased the risk that a healthcare company will have to defend a false claim action, pay fines or be excluded from the Medicare, Medicaid or other federal and state healthcare programs as a result of an investigation arising out of such action. We cannot assure you that we will not become subject to such litigation. Any violations of these laws, or any action against us for violation of these laws, even if we successfully defend against it, could harm our reputation, be costly to defend and divert management’s attention from other aspects of our business. Similarly, if the physicians or other providers or entities with whom we do business are found to have violated abuse laws, they may be subject to sanctions, which could also have a negative impact on us.

 

Our efforts to discover and develop potential products may not lead to the discovery, development, commercialization or marketing of actual drug products.

 

We are currently engaged in a number of different approaches to discover and develop new product applications and product candidates. At the present time, we have one Microcyn-based drug candidate in clinical trials. We also have a non-Microcyn based compound in the research and development phase. This compound has potential applications in oncology. Discovery and development of potential drug candidates are expensive and time-consuming, and we do not know if our efforts will lead to discovery of any drug candidates that can be successfully developed and marketed. If our efforts do not lead to the discovery of a suitable drug candidate, we may be unable to grow our clinical pipeline or we may be unable to enter into agreements with collaborators who are willing to develop our drug candidates.

 

We must implement additional and expensive finance and accounting systems, procedures and controls as we grow our business and organization and to satisfy new reporting requirements, which will increase our costs and require additional management resources.

 

As a public reporting company, we will be required to comply with the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the Securities and Exchange Commission, including expanded disclosures and accelerated reporting requirements and more complex accounting rules. Compliance with Section 404 of the Sarbanes-Oxley Act and other requirements will increase our costs and require additional management resources. In a letter following their dismissal, our prior independent auditors informed us that we did not have the appropriate financial management and reporting structure in place to meet the demands of a public company and

that our accounting and financial personnel lacked the appropriate level of accounting knowledge, experience and training. We recently have been upgrading our finance and accounting systems, procedures and controls and will need to continue to implement additional finance and accounting systems, procedures and controls as we grow our business and organization, enter into complex business transactions and take actions designed to satisfy new reporting requirements. Specifically, our experience with QP indicated that we need to better plan for complex transactions and the application of complex accounting principles relating to those transactions. If we are unable to complete the required Section 404 assessment as to the adequacy of our internal control over financial reporting, if we fail to maintain or implement adequate controls, or if our independent registered public accounting firm is unable to provide us with an unqualified report as to the effectiveness of our internal control over financial reporting as of the date of our first Annual Report on Form 10-K for which compliance is required and thereafter, our ability to obtain additional financing could be impaired. In addition, investors could lose confidence in the reliability of our internal control over financial reporting and in the accuracy of our periodic reports filed under the Exchange Act. A lack of investor confidence in the reliability and accuracy of our public reporting could cause our stock price to decline.

 

We may not be able to maintain sufficient product liability insurance to cover claims against us.

 

Product liability insurance for the healthcare industry is generally expensive to the extent it is available at all. We may not be able to maintain such insurance on acceptable terms or be able to secure increased coverage if the commercialization of our products progresses, nor can we be sure that existing or future claims against us will be covered by our product liability insurance. Moreover, the existing coverage of our insurance policy or any rights of indemnification and contribution that we may have may not be sufficient to offset existing or future claims. A successful claim against us with respect to uninsured liabilities or in excess of insurance coverage and not subject to any indemnification or contribution could have a material adverse effect on our future business, financial condition, and results of operations.

 

Risks Related to Our Common Stock

 

Purchasers in this offering will experience immediate and substantial dilution in the book value of their investment.

 

The initial public offering price of our common stock is substantially higher than the net tangible book value per share of our common stock immediately after this offering. Therefore, if you purchase our common stock in this offering, you will incur an immediate dilution of $      in net tangible book value per share from the price you paid, based on the assumed initial public offering price of $      per share. The exercise of outstanding options will result in further dilution of your investment. For additional information, please see “Dilution.”

 

Our operating results may fluctuate, which could cause our stock price to decrease.

 

Fluctuations in our operating results may lead to fluctuations, including declines, in our share price. Our operating results and our share price may fluctuate from period to period due to a variety of factors, including:

 

 

 

Variations in the timing of our future revenues and expenses could also cause significant fluctuations in our operating results from period to period and may result in unanticipated earning shortfalls or losses. In addition, the Nasdaq Global Market in general, and the market for life sciences companies in particular, have experienced significant price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies.

 

If an active, liquid trading market for our common stock does not develop, you may not be able to sell your shares quickly or at or above the initial offering price.

 

Prior to this offering, there has not been a public market for our common stock. An active and liquid trading market for our common stock may not develop or be sustained following this offering. You may not be able to sell your shares quickly or at or above the initial offering price if trading in our stock is not active. The initial public offering price may not be indicative of prices that will prevail in the trading market. See “Underwriting” for more information regarding the factors that will be considered in determining the initial public offering price.

 

Future sales of shares by our stockholders could cause the market price of our common stock to drop significantly, even if our business is doing well.

 

After this offering, we will have           outstanding shares of common stock based on the number of shares outstanding at          , 2006. This includes the           shares we are selling in this offering, which (other than shares purchased by our affiliates) may be resold in the public market immediately. The remaining shares will become available for resale in the public market as shown in the chart below.

 

 

We do not expect to pay dividends in the foreseeable future. As a result, you must rely on stock appreciation for any return on your investment.

 

We do not anticipate paying cash dividends on our common stock in the foreseeable future. Any payment of cash dividends will also depend on our financial condition, results of operations, capital requirements and other factors and will be at the discretion of our board of directors. Accordingly, you will have to rely on appreciation in the price of our common stock, if any, to earn a return on your investment in our common stock. Furthermore, we may in the future become subject to contractual restrictions on, or prohibitions against, the payment of dividends.

We may allocate net proceeds from this offering in ways with which you may not agree.

 

Our management will have broad discretion in using the proceeds from this offering and may use the proceeds in ways with which you may disagree. Because we are not required to allocate the net proceeds from this offering to any specific investment or transaction, you cannot determine at this time the value or propriety of our application of the proceeds. Moreover, you will not have the opportunity to evaluate the economic, financial or other information on which we base our decisions on how to use our proceeds. We may use the proceeds for corporate purposes that do not immediately enhance our prospects for the future or increase the value of your investment. As a result, you and other stockholders may not agree with our decisions.

 

Anti-takeover provisions in our charter, by-laws and Delaware law may make it difficult for you to change our management and may also make a takeover difficult.

 

Our corporate documents and Delaware law contain provisions that limit the ability of stockholders to change our management and may also enable our management to resist a takeover. These provisions include:

 

 

 

 

 

These provisions might discourage, delay or prevent a change of control or in our management. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors and cause us to take other corporate actions. In addition, the existence of these provisions, together with Delaware law, might hinder or delay an attempted takeover other than through negotiations with our board of directors.

 

Purchasers in this offering may experience substantial dilution in the value of their investment if we issue additional shares of our capital stock.

 

Our charter documents allow us to issue up to 100,000,000 shares of our common stock and to issue and designate the rights of, without stockholder approval, up to 5,000,000 shares of preferred stock. In the event we issue additional shares of our capital stock, dilution to our stockholders could result. In addition, if we issue and designate a class of preferred stock, these securities may provide for rights, preferences or privileges senior to those of holders of our common stock.

 

This prospectus contains forward-looking statements that involve risks and uncertainties, such as statements about our plans, objectives, expectations, assumptions, and future events. In some cases, you can identify forward-looking statements by terminology such as “anticipate,” “estimate,” “plan,” “project,” “continue,” “ongoing,” “potential,” “expect,” “predict,” “believe,” “intend,” “may,” “will,” “should,” “could,” “would,” and similar expressions. These statements involve estimates, assumptions, known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from any future results, performances, or achievements expressed or implied by the forward-looking statements. Consequently, you should not place undue reliance on these forward-looking statements. We discuss many of these risks in greater detail under the heading “Risk Factors” above.

 

Forward-looking statements include, but are not limited to, statements about:

 

 

The forward-looking statements speak only as of the date on which they are made, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

 

This prospectus contains market data that we obtained from industry sources. These sources do not guarantee the accuracy or completeness of the information. Although we believe that the industry sources are reliable, we have not independently verified the information.

 

We expect to receive net proceeds of approximately $      million from this offering, based on an assumed initial public offering price of $      per share, after deducting the underwriting discount and estimated offering expenses. If the underwriters exercise their over-allotment option in full, our estimated net proceeds will be approximately $      million. A $1.00 increase or decrease in the assumed initial public offering price of $      per share would increase or decrease, as applicable, the net proceeds to us by approximately $     million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discount and our estimated offering expenses.

 

We currently intend to use the proceeds of this offering as follows:

 

 

 

While we have estimated the particular uses for the net proceeds to be received upon the completion of this offering, the actual amounts and timing of any expenditures will depend upon the rate of growth, if any, of our business, the amount of cash generated by our operations, status of our research and development efforts, competitive and technological developments and the amount of proceeds actually raised in this offering. A portion of the net proceeds may also be used to acquire or invest in complementary businesses, technologies, services or products, although we have no agreements with respect to any such transactions as of the date of this prospectus. Accordingly, our management will have significant flexibility in applying the net proceeds from this offering. Pending these uses described above, we intend to invest the net proceeds in short-term, investment grade securities.

 

We believe that the net proceeds from this offering, together with our future revenues, cash and cash equivalent balances and interest we earn on these balances will be sufficient to meet our anticipated cash requirements through at least the next 12 months.

 

We have never declared or paid any cash dividends on our common stock. Upon the completion of this offering, we anticipate that any earnings will be retained for development and expansion of our business, and we do not anticipate paying any cash dividends in the foreseeable future on our common stock. Our board of directors has sole discretion to pay cash dividends based on our financial condition, results of operations, capital requirements, contractual obligations and other relevant factors. In the future, we may also obtain loans or other credit facilities that may restrict our ability to declare or pay dividends.

 

The following table describes our capitalization as of June 30, 2006:

 

 

 

 

 

You should read this table together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes appearing elsewhere in this prospectus.

 

 

 

 

The information set forth in the table excludes as of June 30, 2006:

 

 

 

 

Our net tangible book value as of June 30, 2006 was approximately $4.3 million, or $0.13 per share of common stock. Our net tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the number of shares of common stock outstanding. Dilution of pro forma net tangible book value per share represents the difference between the amount per share paid by purchasers of shares of common stock in this offering and the pro forma as adjusted net tangible book value per share of common stock immediately after completion of this offering. After giving effect to the sale of           shares of common stock at an assumed initial public offering price of $      per share, which is the midpoint of our expected offering range, and after deducting the underwriting discount and estimated offering expenses payable by us and giving effect to the sale of 338,156 shares of Series C convertible preferred stock at $4.50 per share on September 14, 2006, our pro forma as adjusted net tangible book value as of June 30, 2006 would have been $     million, or $      per share of common stock. This represents an immediate increase in net tangible book value of $      per share of common stock to existing common stockholders and an immediate dilution in pro forma as adjusted net tangible book value of $      per share to new investors purchasing shares of common stock in this offering. The following table illustrates this per share dilution:

 

 

A $1.00 increase or decrease in the assumed initial public offering price of $     per share would increase or decrease, as applicable, our pro forma as adjusted net tangible book value by $     million, pro forma as adjusted net tangible book value per share by $     per share and the dilution to investors in this offering by $     per share, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discount and estimated offering expenses payable by us.

 

The following table summarizes, as of September 15, 2006, the number of shares of common stock purchased from us, the total consideration paid and the average price per share paid to us by existing and new investors purchasing shares of common stock in this offering assuming an initial public offering price of $      per share, which is the midpoint of our expected offering range, before deducting the underwriting discount and estimated offering expenses.

 

 

A $1.00 increase or decrease in the assumed initial public offering price of $     per share would increase or decrease, as applicable, total consideration paid by new investors and total consideration paid by all stockholders by $      million, assuming the number of shares offered by us, as set forth on the cover of this prospectus, remains the same.

 

If the underwriters exercise their over-allotment option in full, our existing stockholders would own  % and our new investors would own  % of the total number of shares of our common stock outstanding after this offering.

 

The number of shares of our common stock referred to above that will be outstanding immediately after completion of this offering is based on 33,163,802 shares of our common stock outstanding as of September 15, 2006, reflects the automatic conversion of our preferred stock into 16,272,874 shares of common stock and excludes:

 

 

 

 

If all of our outstanding options and warrants as of September 15, 2006 were exercised, our pro forma as adjusted net tangible book value per share after this offering would be $      per share, representing an increase attributable to new investors of $      per share, and there would be an immediate dilution of $      per share to new investors.

 

In addition, we may choose to raise additional capital due to market conditions or strategic considerations even if we believe we have sufficient funds for our current or future operating plans. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of these securities could result in further dilution to our stockholders.

 

You should read the following selected consolidated financial data together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus. The selected consolidated statements of operations data for the three months ended June 30, 2005 and 2006 and the selected consolidated balance sheet data as of June 30, 2006 are derived from our unaudited consolidated financial statements and related notes included elsewhere in this prospectus. The selected consolidated statements of operations data for each of the years ended March 31, 2004, 2005 and 2006 and the selected consolidated balance sheet data as of March 31, 2005 and 2006 have been derived from our audited consolidated financial statements and related notes included elsewhere in this prospectus. The selected consolidated statements of operations data for the years ended March 31, 2002 and 2003 and the selected consolidated balance sheet data as of March 31, 2002, 2003 and 2004 have been derived from our consolidated financial statements and related notes not included in this prospectus. The selected consolidated statement of operations data for the year ended March 31, 2003 and the selected consolidated balance sheet data as of March 31, 2003 have not been audited. The unaudited financial statements include, in the opinion of management, all adjustments that management considers necessary for the fair presentation of the financial information set forth in those statements. Our historical results are not necessarily indicative of the results that may be expected in the future.

 

 

 

 

 

 

The following discussion of our financial condition and results of operations should be read together with our consolidated financial statements and related notes included elsewhere in this prospectus. This discussion contains forward-looking statements based upon current expectations that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors,” “Information Regarding Forward-looking Statements” and elsewhere in this prospectus.

 

Overview

 

We develop, manufacture and market a family of products intended to prevent and eliminate infection in chronic and acute wounds. Infection is a serious potential complication in both chronic and acute wounds, and controlling infection is a critical step in wound healing. Our platform technology, called Microcyn, is a non-toxic, super-oxidized water-based solution that is designed to eliminate a wide range of pathogens including viruses, fungi, spores and antibiotic resistant strains of bacteria such as Methicillin-resistant Staphylococcus aureus, or MRSA, and Vancomycin-resistant Enterococcus, or VRE, in wounds. In clinical testing, our products eliminated a wide range of pathogens and were found to be safe, easy to use and complementary to most existing treatment methods in wound care. Our experience and clinical data indicate that the use of Microcyn may shorten hospital stays, lower aggregate patient care costs and, in certain cases, reduce the need for systemic antibiotics. Microcyn also has applications in several other large consumer and professional markets, including respiratory, dermatology, mold and atmospheric remediation, hard surface disinfectant and dental markets.

 

We believe that Microcyn is the first topical product that eliminates a broad range of bacteria and other infectious microbes without causing toxic side effects on, or irritation of, healthy tissue. Unlike most antibiotics, we believe Microcyn does not target specific strains of bacteria, a practice which has been shown to promote the development of resistant bacteria. Because our products are shelf stable and require no special preparation, they can be used in hospitals, clinics, burn centers, extended care facilities and in the home.

 

We currently sell Microcyn in the United States through our medical and clinical employees and through one national and five regional distributors. In Europe, we have a seven-person direct sales force and exclusive distribution agreements with four distributors, all of which are experienced suppliers to the wound care market, with an aggregate combined sales force of over 25 full-time equivalent salespeople. In Mexico, we sell through a dedicated 75-person contract sales force, including salespeople, nurses and clinical support staff, and a network of distributors to both the public and private sector. The MOH, which approves product selection and procurement for government hospitals and healthcare institutions, has approved reimbursement for Microcyn. We plan to expand our direct sales force in the United States, Europe and Mexico to support our distribution network.

 

Our products have received CE Mark approval for wound cleaning and reduction of infection, three U.S. FDA 510(k) clearances as a medical device in wound debridement, lubricating, moistening and dressing and have been granted approval for use as an antiseptic, disinfectant and sterilant in Mexico. Physicians in several countries have conducted studies in which Microcyn eliminated infection in a variety of wounds, including hard-to-treat wounds such as diabetic ulcers and burns, and, in some cases, reduced the need for systemic antibiotics. In July 2006, we completed a pivotal clinical trial for pre-operative skin preparation. The FDA has requested an additional pivotal trial and additional microbiology and dermatology studies. Before we initiate our second pivotal trial, we plan to discuss with the FDA its request for an additional pivotal trial and additional data. Depending on the results of these discussions, we may reassess our priorities, clinical timelines and schedules for filing the NDA for pre-operative skin preparation. In the event that we proceed with the second pivotal trial and, assuming that the second pivotal trial and the additional studies are successful, we intend to file an NDA for the use of Microcyn as a pre-operative skin preparation in late 2007.

 

We intend to seek FDA approval for the use of Microcyn to eliminate infection and accelerate healing in wounds. We have established a protocol, based on comments from the FDA, for a Phase IIb clinical trial to be conducted in patients with diabetic foot ulcers and other open wounds comparing clinical cure rates and the

rate of wound healing. This clinical trial is expected to cost approximately $3 million and will be funded through proceeds from this offering. We anticipate this clinical trial to be completed in late 2007.

 

In the event we choose to pursue a partnering arrangement to commercialize products, we would expect a larger portion of our revenues would be derived from licensing as opposed to direct sales.

 

We also have a non-Microcyn based compound in the research and development phase. This compound has potential applications in oncology. We anticipate spending approximately $500,000 on further clinical studies on this compound, funded by proceeds from this offering. We expect these studies to be completed in 2008.

 

We have incurred significant net losses since our inception and had an accumulated deficit of $54.7 million as of June 30, 2006. We expect to incur significant expenses in the foreseeable future as we seek to commercialize our products, and we cannot be sure that we will achieve profitability.

 

Financial Operations Overview

 

Revenues

 

We derive our revenues from product sales and service arrangements. Product revenues are generated from the sale of Microcyn to hospitals, medical centers, doctors, pharmacies, distributors and strategic partners, and are generally recorded upon shipment following receipt of a purchase order or upon obtaining proof of sell-through by a distributor. Product sales are made either through direct sales personnel or distributors. Historically, a significant majority of our product sales have been in Mexico.

 

Service revenues are derived from consulting and testing contracts. Service revenues are generally recorded upon performance under the service contract. Revenues generated from testing contracts are recorded upon completion of the test and when the final report is sent to the customer. We have refocused our business efforts away from consulting and testing services toward the commercialization of Microcyn. As a result, we expect service revenues to continue to significantly decline in future periods.

 

Cost of Revenues

 

Cost of product revenues represents the costs associated with the manufacturing of our products, including operating expenses for our various facilities which are fixed, and related personnel cost and the cost of materials used to produce our products. Cost of service revenues consists primarily of personnel related expenses and supplies.

 

Research and Development Expense

 

Research and development expense consists of costs related to the research and development of Microcyn and our manufacturing process. Research and development expense represents costs incurred to enhance our manufacturing process, to develop products and new delivery systems for our products and to carry out preclinical studies and clinical trials to obtain various regulatory approvals. Research and development expense is charged as incurred.

 

Selling, General and Administrative Expense

 

Selling, general and administrative expense consists of personnel related costs, including salaries and sales commissions, and education and promotional expenses associated with Microcyn and costs related to administrative personnel and senior management. These expenses also include the costs of educating physicians and other healthcare professionals regarding our products and participating in industry conferences and seminars. Selling, general and administrative expense also includes travel costs, outside consulting services, legal and accounting fees and other professional and administrative costs.

Stock-Based Compensation Expense