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MRPI > SEC Filings for MRPI > Form 10-K on 23-Jul-2013All Recent SEC Filings

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Form 10-K for MERA PHARMACEUTICALS INC


23-Jul-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

OVERVIEW

Since inception, our primary operating activities have consisted of basic research and development and production process development, recruiting personnel, purchasing operating assets and raising capital. From September 16, 2002, the effective date of our reorganization, through October 31, 2011, we had an accumulated deficit of $8,886,247. Our losses to date have resulted primarily from costs incurred in research and development and from general and administrative expenses associated with operations. We expect to continue to incur operating losses for the 2012 fiscal year. We expect to have quarter-to-quarter and year-to-year fluctuations in revenues, expenses and losses, some of which could be significant.

We have a limited operating history. An assessment of our prospects should include the technology risks, market risks, expenses and other difficulties frequently encountered by early-stage operating companies, and particularly companies attempting to enter competitive industries with significant technology risks and barriers to entry. We have attempted to address these risks by, among other things, hiring and retaining highly qualified persons and expanding our product offering while increasing our efforts to expand sales and improving our production efficiencies and minimizing our overhead. However, our best efforts cannot guarantee that we will overcome these risks in a timely manner, if at all.

CRITICAL ACCOUNTING POLICIES

This discussion and analysis of the Company's financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates. The Company bases its estimates on historical experience and on other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.


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INVENTORIES

Inventories are stated at the lower of cost or market. The Company determines cost on a first-in, first-out basis. On an ongoing basis, the company tests its inventory for obsolescence.

REVENUE RECOGNITION

Product revenue is recognized upon shipment to customers. Contract services revenue is recognized as services are performed on a cost reimbursement basis.

PLANT AND EQUIPMENT

Plant and equipment are stated at cost. Depreciation is provided on the straight-line method over the estimated useful lives of the assets.

IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED

The Financial Accounting Standards Board ("FASB") Accounting for the Impairment or Disposal of Long-Lived Assets ("ASC 360") establishes the accounting model for long-lived assets to be disposed of by sale and applies to all long-lived assets, including discontinued operations. This statement requires those long-lived assets to be measured at the lower of carrying amount or fair value less cost to sell.

STOCK ISSUED FOR SERVICES

In December 2004, the FASB issued ASC No. 718, Compensation - Stock Compensation ("ASC TOPIC 718"). Under ASC TOPIC 718, companies are required to measure the compensation costs of share-based compensation arrangements based on the grant-date fair value and recognize the costs in the financial statements over which the employees are required to provide services. Share- based compensation arrangements include stock options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. As such, compensation cost is measured on the date of grant at their fair value. Such compensation amounts, if any, are amortized over the respective vesting periods of the option grant. The Company applies this statement prospectively. Equity instruments ("instruments") issued to persons other than employees are recorded on the basis of the fair value of the instruments as required by ASC TOPIC
718. ASC TOPIC No. 505, Equity Based Payments to Non-Employees ("ASC TOPIC 505") defines the measurement date and recognition period for such instruments. In general, the measurement date is (a) when a performance commitment, as defined, is reached or (b) when the earlier of (i) the non-employee performance is complete or (ii) the instruments are vested. The measured value related to the instruments is recognized over a period based on the facts and circumstances of each particular grant as defined in the ASC TOPIC 505.

RESEARCH AND DEVELOPMENT

Research and Development costs are expensed as incurred.

Generally accepted accounting principles state that the costs that provide no discernible future benefits or allocating costs on the basis of association with revenues or among several accounting periods that serve no useful purpose, should be charged to expense in the period occurred. ASC TOPIC 350 "Accounting for Research and Development Costs" requires that certain costs be charged to current operations including, but not limited to: salaries and benefits, contract labor, consulting and professional fees, depreciation, repairs and maintenance on operational assets used in the production of prototypes, testing and modifying product and service capabilities and design, and other similar costs.


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INCOME TAXES

The Company uses the asset and liability method of accounting for income taxes as required by ASC TOPIC 740 Accounting for Income Taxes ("ASC TOPIC 740"). ASC requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of certain assets and liabilities. Since its inception, the Company has incurred net operating losses. Accordingly, no provision has been made for income taxes. Statutory taxes not based on income are included in general and administrative expenses.

RESULTS OF OPERATIONS

The following discussion and analysis provides information that the Company's management believes is relevant to an assessment and understanding of our results of operations and financial condition. This discussion should be read in conjunction with the financial statements and footnotes, which appear elsewhere in this prospectus.

RESULTS OF OPERATIONS FOR THE FISCAL YEAR ENDED OCTOBER 31, 2011 COMPARED TO THE FISCAL YEAR ENDED OCTOBER 31, 2010

REVENUES. During the years ended October 31, 2011 and 2010, product and technical services revenue totaled $302,624 and $288,888, respectively, resulting in a increase of 4.75%. During fiscal 2011, this revenue was generated principally through direct sales. A small portion of sales were attributed to international distribution of our products and some sales of raw materials.

EXPENSES. Overall operating expenses were $487,418 in 2011 compared with $794,548 in fiscal 2010, a decrease of 38.65%. This decrease resulted principally from a $314,440 impairment loss incurred in 2010.

COST OF PRODUCTS SOLD. Cost of products sold include manufacturing and production costs associated with ASTAFACTOR®, SALMON ESSENTIALS™®, KONA SEA SALT™® as well as the cost of sales of raw materials and certain other products. Expenses decreased in the categories of cost of products sold, due principally to better production methods and inventory management. Cost of product sold in 2011 was $16,260 versus $46,066 in 2010, a decrease of 64.7%. It is expected that the cost of products sold will increase again during 2012 as we attempt to expand our sales going forward.

RESEARCH AND DEVELOPMENT COSTS. Research and development costs include salaries, research supplies and materials and other expenses related to product development, exclusive of those costs for which the company is reimbursed. Research and development costs for the year ended October 31, 2011 were $172,986 as compared to $265,310 for fiscal 2010. This represents an 34.8% decrease due to previous efficiencies and capital constraints.

SELLING AND ADMINISTRATIVE EXPENSES. Selling and administrative expenses consist principally of salaries, fees for professional services and promotional and marketing expenses related to our various product lines. Selling and administrative expenses for the fiscal year 2011 were $306,132 versus $186,790 in 2010, an increase of 63.89%.

IMPAIRMENT OF OTHER LONG-LIVED ASSETS.During Fiscal 2011 and 2010, the Company recorded non-cash impairment charges of $0 and $314,440, respectively, to reduce the net carrying value of certain long-lived assets to their estimated fair value.

INTEREST EXPENSE. For the years ended October 31, 2011 and 2010, interest expense was $5,811 and $4,992, respectively. The amount of interest expense incurred in any particular period varies with the amount of debt outstanding and the rate of interest payable on that debt. The total amount of debt increased in 2011 due to more short term borrowing. It is expected that interest expenses will be comparable in 2012 as the Company's cash position becomes more stable.

LIQUIDITY AND CAPITAL RESOURCES

The Company has operating and liquidity concerns, has incurred an accumulated deficit of approximately $8.9 million, a net loss of $187,680, and as of October 31, 2011, has a working capital deficiency of $880,830 and a stockholders' deficiency of $864,620. This raised substantial doubt about its ability to continue as a going concern. The Company will continue to pursue additional capital investment. However, there can be no assurance that the Company will be able to successfully acquire the necessary capital to continue their on-going development efforts and bring products to the commercial market. These factors, among others, create an uncertainty about the Company's ability to continue as a going concern.


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We have financed our operations until now through public and private sales of debt and equity securities and debt instruments, together with revenues from product sales, contract work and royalties. During the years ended October 31, 2011 and 2010, we did not raise any additional funding.

RISK FACTORS

YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW, IN ADDITION TO ALL OTHER INFORMATION INCLUDED IN THIS REPORT, BEFORE YOU DECIDE TO INVEST IN OUR COMMON STOCK. IF ANY OF THE FOLLOWING RISKS OCCURS, OUR BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS COULD BE MATERIALLY ADVERSELY AFFECTED. THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE DUE TO ANY OF THE FOLLOWING RISKS OR OTHERS NOT YET IDENTIFIED BY MANAGEMENT, AND YOU COULD LOSE ALL OR PART OF YOUR INVESTMENT.

RISKS RELATED TO OUR BUSINESS

WE HAVE INCURRED SUBSTANTIAL OPERATING LOSSES AND EXPECT TO INCUR FUTURE LOSSES. OUR FUTURE FINANCIAL RESULTS ARE UNCERTAIN, AND WE MAY NEVER BECOME A PROFITABLE COMPANY.

From September 16, 2002 (the date that we completed our reorganization proceedings and adopted "fresh-start accounting") through October 31, 2011 we had an accumulated deficit of $8,886,247. Our losses to date are primarily due to the costs of research and development, and the general and administrative costs associated with our operations. We expect to continue to incur operating losses through at least fiscal year 2013. We expect to have quarter-to-quarter and year-to-year fluctuations in revenues and expenses. As a result, our losses may increase in the future, even if we achieve our revenue goals, and some of those losses could be significant.

Should we achieve profitability, we may be unable to sustain or increase profitability on a quarterly or annual basis. Many factors could affect our ability to achieve and maintain profitability, including:

•€€ our ability to complete successfully the commercialization and production cost optimization of our products;

•€€ our ability to manage production costs and yield issues associated with increased production of our products;

•€€ the progress of our research and development programs for developing other microalgal products;

•€€ the time and costs associated with obtaining regulatory approvals for our products;

•€€ our ability to protect our proprietary rights, or the expense of doing so;

•€€ the costs of filing, maintaining, protecting and enforcing our patents;

•€€ competing technological and market developments;

•€€ changes in our pricing policies or the pricing policies of our competitors;

•€€ the costs of commercializing and marketing our existing and potential products; and

•€€ the inability to achieve a level of sales of our products necessary to generate sufficient revenues to cover research, development and operating costs.

If our revenues grow more slowly than we anticipate or if our operating expenses exceed our expectations and cannot be reduced, our losses could continue beyond our present expectations, and we may never become a profitable company.


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WE MAY BE UNABLE TO RAISE ADDITIONAL CAPITAL OR GENERATE THE CAPITAL NECESSARY TO SUPPORT OUR PLANNED LEVEL OF RESEARCH AND DEVELOPMENT ACTIVITIES AND TO MANUFACTURE AND MARKET OUR PRODUCTS.

We will require expenditures to support our research and development activities and to manufacture and market our products. Over the next twelve months, we project expenditures of approximately $500,000 in operating capital, not including any capital expenditures that may be necessary or desirable. Many factors will determine our future capital requirements, including:

•€€ market acceptance of our products;

•€€ our ability to manufacture our products cost-effectively in quantities needed to sustain growing sales of our ASTAFACTOR® and KONA SEA SALT™ line of products;

•€€ the extent and progress of our research and development programs;

•€€ the time and costs of obtaining regulatory clearances for some of our products;

•€€ the costs of filing, maintaining, protecting and enforcing patent claims;

•€€ the need to address competing technological and market developments;

•€€ the cost of developing and/or operating production facilities for our existing and potential products; and

•€€ the costs of commercializing our products.

Revenue from product sales and other sources pay some of our operating costs, but to date that revenue has not been sufficient to cover our operating costs fully. We are seeking investment from various sources to help sustain our operations until we can increase revenues to the point that they can sustain our operations indefinitely. However, additional financing may not be available on favorable terms, if at all. If we do not have adequate funds, we may have to curtail operations significantly. In addition, we may have to enter into unfavorable agreements that could force us to relinquish certain technology or product rights, including patent and other intellectual property rights. If we cannot raise enough capital, then we may have to curtail production, limit our product development activities, reduce marketing activities or delay other plans intended to increase revenue and help us achieve profitability.

IF WE CANNOT OVERCOME THE CHALLENGES OF PRODUCING MICROALGAE ON A COMMERCIAL SCALE, WE MAY NOT ACHIEVE ECONOMIC PRODUCTION COSTS.

To be successful, we must produce products at acceptable costs while ensuring that the quantity and quality of our products comply with contractual and regulatory requirements and regulations. Many factors complicate the production of microalgal products, and they could limit production at any time. These include:

•€€ microbial contamination;

•€€ variability in production cycle times due to technical, environmental and biological factors; and

•€€ losses of final product due to inefficient processing.

We currently have sufficient inventory to meet the foreseeable requirements of our existing customers. However, we are engaged in efforts to increase sales in order to achieve profitability, potentially beyond the capacity of our existing facility to produce. We have prepared to meet that increased demand, should it occur, by acquiring additional space at our Kona, Hawaii facility.


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IF THE DEMAND FOR NATURAL ASTAXANTHIN OR OUR OTHER PRODUCTS EXCEEDS OUR CURRENT PRODUCTION CAPABILITIES, AND IF WE ARE UNABLE TO EXPAND OUR PRODUCTION CAPACITY IN A TIMELY MANNER, WE MAY EXPERIENCE SIGNIFICANT FINANCIAL, TECHNICAL AND COMMERCIAL CHALLENGES.

The capacity of our existing production facility in Hawaii is sufficient to meet current demand for our products. However, demand for our natural astaxanthin and other products may eventually exceed the current capacity of our Hawaiian production facility. To address this capacity question, we have initiated efforts to increase our production efficiency and to prepare for expansion of our Hawaiian facility, if needed. However, our efforts are focused on generating a level of sales that would make it difficult to meet our total demand from our Hawaiian facility, especially if we develop additional products. We believe that our inventory plus our existing production capacity is sufficient to meet demand for the foreseeable future. In the event that sales increase to a level that we cannot meet with our existing capacity, we have planned for the expansion of our Hawaiian facility. If we are unable to expand our current production facility, we may be unable to meet demand for product and could lose the opportunity to increase our revenues. We could also lose customers, both current and potential, who may not do business with us absent an assurance of the ability to deliver product in sufficient quantities.

OUR CUSTOMER BASE IS CONCENTRATED AMONG RELATIVELY FEW CUSTOMERS, AND THE LOSS OF ANY OF THESE CUSTOMERS WOULD MATERIALLY ADVERSELY AFFECT OUR REVENUES.

Our business currently depends on key distribution relationships in Hawaii. These customers currently purchase approximately 30% of the natural products we sell, with the remainder being sold to smaller retail accounts, directly to consumers or internationally. If we lose one or more of these customers, or if they do not continue buying our products at the current and anticipated purchase levels, then our revenues could decrease. In addition, the loss of one or more of these customers may adversely affect our reputation, and we could have difficulty attracting new customers as a result.

IF WE FAIL TO ATTRACT AND RETAIN KEY PERSONNEL WE WILL BE UNABLE TO EXECUTE OUR BUSINESS PLAN, AND OUR BUSINESS WILL SUFFER.

Our success depends on the continued efforts of the principal members of our management team. The Company presently has the key members of that team that it needs to retain to execute its plans fully. Success in doing so cannot be assured.

OUR BUSINESS WILL NOT OPERATE EFFICIENTLY AND OUR RESULTS OF OPERATIONS WILL BE NEGATIVELY AFFECTED IF WE ARE UNABLE TO MANAGE OUR GROWTH EFFECTIVELY.

Until 2002 we focused almost exclusively on product research and technology development. As we moved toward commercial production of microalgal products we had to initiate or expand many activities, including outsourcing, customer relations, engineering, construction, recruiting and training. During this transition, the size of our organization increased rapidly. During the Company's reorganization, the size of our organization decreased again. We decreased our employee base nominally during fiscal year 2011 and expect to stabilize during fiscal year 2012 in both sales staff and production assuming revenues expand with increased demand for our products. If revenues do not increase, we may not have the financial resources needed to sustain operations.

We expect demands on our financial and management control systems to increase this year. If we fail to upgrade our financial and management control systems, or if we encounter difficulties during upgrades of these systems, then we may not be able to manage our human and financial resources effectively. Such ineffectiveness could make it difficult to retain or attract employees and could directly or indirectly create unnecessary expenses or lead to incorrect decisions by management.

AS WE EXPAND OUR PRODUCT LINE AND ATTEMPT TO PENETRATE ADDITIONAL MARKETS, WE MAY FACE SIGNIFICANT CHALLENGES TO SUCCESS.

We are exploring expanding our product lines. The success of our product lines will depend on our ability to implement our marketing strategy and comply with the standards of Good Manufacturing Practice, or GMP, as and when applicable. We believe the prospects for nutraceutical products will depend, in the short term, on product quality and education of consumers regarding its benefits. Our ability to penetrate new markets for our natural astaxanthin products will, we believe, depend strongly on regulatory approval in several major markets within and outside the United States. We expect the success of our products to depend primarily on our ability to develop and market these new products.

We cannot assure successful development of any potential products, nor can we guarantee market acceptance of any of our products, existing or future. We have limited marketing experience in nutraceutical markets. We have nine years of experience in electronic marketing and direct retail sales. We cannot assure you that we or our consultants or contractors will be successful in our marketing efforts, nor can we prevent them from competing with us or assisting our competitors. If we are unable to develop or commercialize any of our product lines successfully, then our revenues will fail to grow.


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OUR PRODUCTS AND PRODUCTION ACTIVITIES ARE SUBJECT TO GOVERNMENT REGULATION AND ACTION, WHICH ARE SUBJECT TO CHANGE.

We are affected by changes in or the imposition of governmental regulations and actions, including: (i) new laws, regulations and judicial decisions related to the production, marketing and sale of nutraceutical products, (ii) changes in the United States Food and Drug Administration and foreign regulatory approval processes that may delay or prevent the approval of new products and result in lost market opportunity, (iii) new laws, regulations and judicial decisions affecting pricing or marketing of our products and (iv) changes in the tax laws relating to Mera Pharmaceuticals' operations.

WE MAY BE UNABLE TO PROTECT OR ENFORCE OUR INTELLECTUAL PROPERTY RIGHTS ADEQUATELY, AND OUR EFFORTS TO DO SO COULD BE TIME CONSUMING AND EXPENSIVE AND COULD DIVERT MANAGEMENT ATTENTION FROM EXECUTING OUR BUSINESS STRATEGY.

We regard the protection of our patents, copyrights, trade secrets and know-how (collectively intellectual property) as critical to our success. We rely on a combination of patent, copyright and trade secret laws and contractual restrictions to protect our intellectual property and maintain our competitive position. Our future prospects depend in part on our ability to protect our intellectual property while operating without infringing the intellectual property rights of third parties.

We may be unable to develop any additional patentable technologies. We cannot be certain that any patents issued to us or available to us through a license arrangement will establish the means to produce or provide us with any competitive advantage for any product or products. Third parties could challenge our patents or could obtain patents that have a material adverse effect on our ability to do business efficiently and effectively.

The patent positions of nutraceutical, pharmaceutical, biopharmaceutical and biotechnology companies, including ours, are generally uncertain and involve complex legal and factual questions. Patent law continues to evolve in the scope of claims in the technology area in which we operate. Therefore, the degree of future protection for our proprietary rights is uncertain. We cannot guarantee that others will not independently develop similar or alternative technologies. Other parties may duplicate our technologies, or, if patents are issued to us, they may design around those patented technologies. Other parties may have filed or could file patent applications that are similar or identical to some of ours. These patent applications could have priority over ours. To determine the priority of inventions, we may have to participate in interference proceedings declared by the United States Patent and Trademark Office, which could be very costly. In addition, the laws of some foreign countries may not protect our patents and other intellectual property rights to the same extent as the laws of the United States.

We could incur substantial costs in litigation if we need to defend ourselves against patent infringement claims brought by third parties, or if we choose to initiate claims against others. We have in the past, and we may in the future, be required to dedicate significant management time and financial resources to prosecute or defend infringement actions. In addition, a finding of non-infringement or declaration of invalidity of our patents could reduce or eliminate the exclusivity of our proprietary technology. Present and potential collaborators may terminate or decide not to enter into relationships with us if our intellectual property position is weakened. In addition, a finding of non-infringement or declaration of invalidity of our patents could reduce our ability to obtain future financing.

There could be significant litigation in our industry regarding patent and other intellectual property rights. For example, third parties may bring infringement or other claims against us for using intellectual property that we internally developed or license from third parties. In addition, although nondisclosure agreements generally control the disclosure and use of our proprietary technology, know-how and trade secrets, we cannot guarantee that all confidentiality agreements will be honored or that our proprietary technology, know-how and trade secrets will not be disseminated, or that any party responsible for doing so will be able to compensate us adequately for such loss.

We may not prevail in the prosecution or defense of any action, nor can we predict whether third parties will license necessary intellectual property rights to us on commercially acceptable terms, if at all. Any of these outcomes could be very costly and could diminish our ability to develop and commercialize future products.

OUR PRODUCTION CAPABILITY IS HIGHLY DEPENDENT ON ENVIRONMENTAL AND CLIMATIC FACTORS BEYOND OUR CONTROL.

All of our current production capacity is located at a single facility in Kona, Hawaii. We currently have an ample inventory to meet our foreseeable demand, but any future event that causes a long-term disruption in production at our facility could significantly impair our ability to meet customer demand. These events could include fires, volcanic eruptions, earthquakes, tidal waves, hurricanes or other natural disasters. In addition, consistent sunlight, high . . .

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