NOTE 11 — Commitments and Contingencies

Lease Commitments

On October 10, 2012, the Company entered into Amendment No. 7 to its property lease agreement, extending the lease on its Petaluma, California facility to September 30, 2017. Pursuant to the amendment, in exchange for certain improvements on the building, the Company agreed to increase the lease payment from $10,380 to $11,072 per month.

On October 31, 2011, the Company leased approximately 1,800 square feet of office and manufacturing space in Sacramento, California. On August 30, 2012, the Company entered into an amendment to its lease dated October 31, 2011 for the property located at 3045 65th Street, Suite 13, Sacramento, California 95820, to amend the lease to include a 3,000 square foot industrial unit located at 3021 65th Street, Sacramento, California, and to extend the lease on both properties to October 31, 2013. The total rent for both properties is $2,610 per month.

Minimum lease payments for non-cancelable operating leases are as follows (in thousands):

Rental expense amounted to $392,000 and $431,000 for the years ended March 31, 2013 and 2012, respectively and is recorded in the accompanying consolidated statement of comprehensive loss.

Legal Matters

On July 25, 2011, the Company received notice of a lawsuit filed in Mexico by Cesar Mangotich Pacheco and Prodinnv, S.A. de C.V. represented by Cesar Mangotich Pacheco. The lawsuit appears to allege conversion of assets, tortious interference and defamation, among other claims. The Company is currently evaluating the lawsuit, conferring with local counsel and translating the documents it has received. The Company’s preliminary assessment is that the lawsuit is completely without merit and intends to vigorously defend its position. The Company has not accrued a loss reserve for this matter.

The Company, from time to time, is involved in legal matters arising in the ordinary course of its business including matters involving proprietary technology. While management believes that such matters are currently not material, there can be no assurance that matters arising in the ordinary course of business for which the Company is or could become involved in litigation, will not have a material adverse effect on its business, financial condition or results of comprehensive loss.

Employment Agreements

As of March 31, 2013, the Company had employment agreements in place with five of its key executives. The agreements provide, among other things, for the payment of nine to twenty-four months of severance compensation for terminations under certain circumstances. With respect to these agreements, at March 31, 2013, potential severance amounted to $1,918,000 and aggregated annual salaries amounted to $1,360,000.

Related Party Agreements

On January 26, 2009, the Company entered into a commercial agreement with VetCure, Inc., a California corporation, to market and sell the Company’s Microcyn® Technology-based animal healthcare products branded as Vetericyn®. VetCure, Inc. later changed its name to Vetericyn, Inc.. This agreement was amended on February 24, 2009, July 24, 2009, June 1, 2010, and November 1, 2010. Pursuant to the agreement, the Company provides Vetericyn, Inc. with bulk product and Vetericyn, Inc. bottles, packages, and sells Microcyn® Technology-based animal healthcare products branded as Vetericyn®. The Company receives a fixed amount for each bottle of Vetericyn® sold by Vetericyn, Inc. 

On September 15, 2009, the Company entered a commercial agreement with V&M Industries, Inc., a California corporation, to market and sell certain of the Company’s Microcyn® over-the-counter liquid and gel products.  V&M Industries, Inc. subsequently changed its name to Innovacyn, Inc. On June 1, 2010, September 1, 2010, and November 1, 2010, the Company amended this agreement granting Innovacyn, Inc. the exclusive right to sell certain of its over-the-counter products.

Additionally, on July 1, 2011, Vetericyn, Inc. and Innovacyn, Inc. began to share profits with the Company related to the Vetericyn® and Microcyn® over-the-counter sales with Vetericyn, Inc. and Innovacyn, Inc., resulting in about a 30% royalty of net revenue. During the years ended March 31, 2013 and 2012, the Company recorded revenue related to these agreements in the amounts of$3,906,000 and $3,367,000, respectively. The revenue is recorded in product revenues in the accompanying consolidated statements of comprehensive loss. At March 31, 2013 and 2012, the Company had outstanding accounts receivable of $264,000 and $290,000, respectively, related to Innovacyn, Inc.

Commercial Agreements

On May 8, 2007, and June 11, 2007, the Company entered into separate commercial agreements with two unrelated customers granting such customers the exclusive right to sell the Company’s products in specified territories or for specified uses. Both customers are required to maintain certain minimum levels of purchases of the Company’s products in order to maintain the exclusive right to sell the Company’s products. Non-refundable up-front payments amounting to $625,000 were paid under these agreements and were recorded as deferred revenue. On April 16, 2010, the Company terminated the exclusive agreement with one of the customers.  Accordingly, during the year ended March 31, 2012, the Company recorded as revenue the remaining balance of the unamortized upfront fees which amounted to $210,000.  On September 16, 2012, the Company terminated the exclusive agreement with the other customer.  Accordingly, during the year ended March 31, 2013, the Company recorded as revenue the remaining balance of the unamortized upfront fees which amounted to $160,000. These amounts were included in product licensing fees in the accompanying consolidated statements of comprehensive loss. 

On February 14, 2011, the Company entered into a Product Option Agreement with an Amneal Enterprises alliance member, AmDerma Pharmaceuticals, LLC (“AmDerma”).  The Company plans to use its proprietary Microcyn® technology to develop a prescription pharmaceutical product for the treatment of acne in connection with AmDerma (the “Future Acne Product”). Pursuant to the Agreement, the Company sold the option to exclusively sell and distribute the Future Acne Product to AmDerma for a one-time non-refundable payment of $500,000. On June 23, 2011, AmDerma exercised its option to license rights to the drug candidate. On June 21, 2012, the Company finalized a collaboration agreement with AmDerma (the “Collaboration Agreement”). Pursuant to the Collaboration Agreement, AmDerma is responsible for the development of a Microcyn-based acne drug candidate in the United States, including all activities required to gain regulatory approvals. AmDerma will also be responsible for all costs. Additionally, within one year of the first commercial sale by AmDerma, AmDerma shall identify at least one secondary indication that AmDerma will develop. If AmDerma declines to pursue such secondary indication, then the right to develop such secondary indication will revert back to the Company. The Company granted AmDerma an exclusive, royalty-bearing perpetual license in the United States and India, with the right to sublicense and subcontract in certain circumstances, and a right of first refusal to expand the territory of the license to include the European Union, Canada, Brazil, and Japan. The Company retained rights to the “rest of world.” Pursuant to the Collaboration Agreement , $250,000 of the upfront payment will be applied against a future milestone in the transaction and is recorded as deferred revenue in the March 31, 2013 accompanying consolidated balance sheet. The remaining $250,000 of the upfront payment was earned and recognized as revenue during the year ended March 31, 2013.

On June 26, 2011, the Company entered into an agreement with Shanghai Sunvic Technology Co. Ltd., a distributor in China, to sell certain of its gel products, which are currently sold under the product name “Microcyn” in the United States, into the People’s Republic of China. The initial term of the contract is for five years and is cancellable if certain conditions are not met. The non-refundable upfront fee was amortized on a straight line basis over the first contract year which began on the date approval was obtained for commercial sale of the product, or April 13, 2012.  During the year ended March 31, 2013, the Company recorded revenue of $338,000 related to the upfront fee which is included in product licensing fees in the accompanying consolidated statement of comprehensive loss.   In order to maintain exclusivity in subsequent years, the distributor will need to meet minimum purchase requirements each contract year. The initial term of the contract is for five years, and the contract is cancellable if certain conditions are not met.

On August 9, 2012, the Company, along with its Mexican subsidiary and manufacturer Oculus Technologies of Mexico S.A. de C.V. (“Manufacturer”), entered into a license, exclusive distribution and supply agreement with More Pharma Corporation, S. de R.L. de C.V. (“More Pharma”) (the “License Agreement”). For a one-time payment of $500,000, the Company granted More Pharma an exclusive license, with the right to sublicense under certain conditions and with the Company’s consent, to all of the Company’s proprietary rights related to certain of its pharmaceutical products for human application that utilize the Company’s Microcyn® Technology within Mexico. For an additional one-time payment of $3,000,000, the Company also agreed to appoint More Pharma as the exclusive distributor of certain of its products in Mexico for the term of the agreement. Additionally, Manufacturer granted More Pharma an exclusive license to certain of Manufacturer’s then-held trademarks in exchange for a payment of $100,000 to Manufacturer. The Company has the ability to terminate the agreement if certain annual purchase minimums are not met. The term of the agreement is twenty-five years from the effective date of August 15, 2012. The term of the License Agreement will automatically renew after the twenty-five year term for successive two year terms as long as More Pharma has materially complied with any and all of the obligations under the License Agreement, including but not limited to, meeting the minimum purchase requirements set forth therein.

Additionally, on August 9, 2012, the Company, along with Manufacturer, entered into an exclusive distribution and supply agreement with More Pharma (the “Distribution Agreement”). For a one-time payment of $1,500,000, the Company granted More Pharma exclusive ability to market and sell certain of its pharmaceutical products for human application that utilize the Company’s Microcyn® Technology. The Company also appointed More Pharma as its exclusive distributor, with the right to execute sub-distribution agreements under certain conditions and with the Company’s consent, within the following countries: Antigua & Barbuda, Argentina, Aruba & Curacao, Bahamas, Barbados, Belize, Bolivia, Bonaire, Brazil, British Guyana, British Islands, Cayman Islands, Chile, Colombia, Cuba, Dominica, Dominican Republic, Ecuador, El Salvador, French Guyana, Grenada, Guadalupe, Guatemala, Haiti, Honduras, Jamaica, Martinique, Nicaragua, Paraguay, Peru, St. Bartolome, St. Vincent & Grenades, Surinam, Trinidad & Tobago, Turks & Caicos Islands, Uruguay, Venezuela and Virgin Islands.

The Company will recognize the $5,100,000 related to the License Agreement and the Distribution Agreement as revenue on a straight line basis consistent with the Company’s historical experience with contracts with similar terms, which is typically over three to five years of the contract. Additionally, the Company capitalized $214,000 of its transaction costs related to the License Agreement and the Distribution Agreement, which will be amortized by the Company as expense on a straight line basis consistent with the related revenue recognition practices. At March 31, 2013, the Company had outstanding accounts receivable of $580,000 due from More Pharma. During year ended March 31, 2013, the Company recognized $932,000 related to the amortization of the upfront fees received in the transaction. Additionally, during the year ended March 31, 2013, the Company recognized $39,000 as expense related to the transaction costs of the transaction. The Company recognizes product sales on a sell-through basis as More Pharma sells products through to its customers.

Other Matters

NASDAQ Listing Matters

On May 21, 2012, the Company received a letter from the Listing Qualifications staff of The NASDAQ Stock Market LLC (“NASDAQ”), notifying the Company that, for the previous 30 consecutive business days, it failed to comply with NASDAQ Listing Rule 5550(b)(2), which requires the Company to maintain a minimum Market Value of Listed Securities of $35 million for continued listing on the NASDAQ Capital Market. The letter also noted that the Company did not meet the alternative requirements under Listing Rules 5550(b)(1) or 5550(b)(3). In accordance with Listing Rule 5810(c)(3)(C), NASDAQ granted the Company a period of 180 calendar days, or until November 19, 2012, to regain compliance with the Rule.

On November 1, 2012, the Company disclosed it achieved a stockholders’ equity of approximately $4,500,000 on a pro forma basis as of September 30, 2012, as a result of its entry into two transactions on October 29, 2012, and October 30, 2012. In the first transaction, on October 29, 2012, the Company agreed to amend a warrant held by two of its investors to remove a provision in the warrant that contained certain cash-settlement features in exchange for extending the expiration date of the warrant by two years. This transaction increased the Company’s stockholders’ equity by approximately $1,500,000. In the second transaction on October 30, 2012, the Company agreed to issue $3,500,000 of common stock to its primary lender, who agreed to reduce the Company’s debt liability in connection with the potential sale of these common shares. Initially, the issuance of these restricted common shares to the Company’s lender increased the Company’s stockholders’ equity by approximately $3,500,000. On November 9, 2012, the Company was notified by NASDAQ that, based upon its Form 8-K disclosures filed November 1, 2012 and November 5, 2012 and its financial forecast as supplied to NASDAQ and dated November 6, 2012, the staff of NASDAQ has determined that the Company complies with NASDAQ Listing Rule 5550(b)(1), which requires the Company to maintain a minimum stockholders’ equity requirement of $2,500,000 for continued listing on The NASDAQ Capital Market.

On June 18, 2012, the Company received a letter from NASDAQ, notifying the Company that, for the previous 30 consecutive business days, it failed to comply with NASDAQ Listing Rule 5550(a)(2), which requires the Company to maintain a minimum bid price of $1.00 per share for its common stock. In accordance with Listing Rule 5810(c)(3)(C), NASDAQ granted the Company a period of 180 calendar days, or until December 17, 2012, to regain compliance with the Rule. On December 18, 2012, the Company received a second letter from NASDAQ notifying that the Company had not regained compliance with Listing Rule 5550(a)(2) within the grace period allowed by NASDAQ.

Although the Company failed to regain compliance with Listing Rule 5550(a)(2) by December 18, 2012, it appealed NASDAQ’s delisting determination to a NASDAQ Hearings Panel on February 21, 2013. On February 27, 2013, the NASDAQ Hearings Panel notified the Company that the Panel granted the Company’s request for continued listing on The NASDAQ Capital Market, subject to the following conditions: 1) on or before April 15, 2013, the Company must evidence a closing bid price of $1.00 or more for its common stock for a minimum of ten prior consecutive trading days; and 2) the Company must demonstrate continued compliance with all requirements for continued listing on The NASDAQ Capital Market.

A Special Meeting of the Company’s Stockholders was held on March 22, 2013. At the Special Meeting, the Company’s stockholders approved a proposal that authorized its Board of Directors, in its discretion, to effect a reverse stock split by a ratio of not less than 1-for-3 and not more than 1-for-7 of the Company’s outstanding common stock. On the same day, at a special board meeting, the Company’s Board of Directors approved the implementation of a reverse stock split and determined the appropriate reverse stock ratio to be a ratio of 1-for-7. On March 22, 2013, pursuant to board and stockholder approval, the Company filed a Certificate of Amendment to its Restated Certificate of Incorporation, as amended with the State of Delaware to effectuate the reverse stock split at a ratio of 1:7 of its outstanding common stock, with a legal effective date of March 29, 2013. The total number of authorized common stock which the Company shall have the authority to issue as set forth in its Restated Certificate of Incorporation, as amended was also proportionally decreased in conjunction with the reverse stock split. The marketplace effective date of the reverse stock split was April 1, 2013. On April 16, 2013, the Panel notified the Company that it had regained compliance with the applicable minimum bid price rule, as required by the Panel’s decision dated February 27, 2013, and the Company was is in compliance with all other applicable requirements set forth in the decision and required for listing on The NASDAQ Capital Market.

Ruthigen, Inc.

On January 18, 2013, the Company’s wholly owned subsidiary, Ruthigen, Inc., was incorporated in the State of Nevada. Ruthigen has established independent offices in Santa Rosa, California.

On June 6, 2013, the Company announced that it entered into two key agreements, which establish the license and supply as well as shared services with its wholly owned subsidiary, Ruthigen, an entity focused on the discovery, development, and commercialization of pharmaceutical-grade hypochlorous acid-based therapeutics. The Company expects to negotiate and enter into a third agreement (the “Separation Agreement”) governing other terms of its business relationship with Ruthigen. The effective date for all three agreements would be the closing date of Ruthigen’s proposed initial public offering, if any should occur.

License and Supply Agreement

Pursuant to the license and supply agreement, the Company agreed to exclusively license certain of its proprietary technology to Ruthigen to enable Ruthigen’s research and development and commercialization of the newly discovered RUT58-60, and any improvements to it, in the United States, Canada, European Union and Japan, referred to as the Territory, for certain invasive procedures in human treatment as defined in the license and supply agreement.

In addition, the license and supply agreement provides Ruthigen with the exclusive option, exercisable within the first five years following the effective date of the agreement, to expand the license to certain other therapeutic indications upon payment of a license expansion fee of $10 million within the first two years following the effective date of the agreement or, after the two–year period, the same fee plus certain out-of-pocket costs the Company may incur in developing products for any of the indications. Additionally, the Company will be prohibited from using the licensed proprietary technology to sell products that compete with Ruthigen’s products within the Territory, and Ruthigen cannot sell any device or product that competes with the Company’s products being sold or developed as of the effective date of the license and supply agreement.

Ruthigen will be required to make a total of $8,000,000 in payments to the Company based upon the completion of certain development and other future milestones, and at the time of drug approval, if any should occur, supplemented with royalty payments, which will vary between three percent and 20 percent, increasing upon achievement of various net annual sales thresholds and dependent upon the country of sale.

Shared Services Agreement

The Company also entered into a shared services agreement with Ruthigen that would take effect upon the completion of Ruthigen’s proposed initial public offering, if any should occur, pursuant to which it will provide Ruthigen with general services, including general accounting, human resources, laboratory personnel and shared R&D resources while Ruthigen plans to establish an independent facility and systems. As a wholly owned subsidiary of the Company, Ruthigen will be financed by the Company until the completion of the proposed initial public offering, if any should occur, and after such event, Ruthigen would become responsible for its own expenses.

Separation Agreement

The Company anticipates entering into the Separation Agreement with Ruthigen in the near future, which will set forth the terms of the separation of its business and its novel biotechnology business into two separate, publicly-traded companies (the “Separation”). In order to effect the Separation, the Company anticipates an initial public offering of Ruthigen’s common stock, after which it will hold certain shares of Ruthigen’s common stock. The Company anticipates the final terms of the Separation Agreement will outline such customary representations as indemnification, handing of employee matters and tax sharing, among other items.